UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

 

Commission File Number: 0-50150

 

CHS Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES þ     NO o

 

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for shorter period that the Registrant was required to submit and post such files).  YES o     NO o

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  YES o     NO þ

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

 

 

INDEX

 

 

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements involve risks and uncertainties that may cause the Company’s actual results to differ materially from the results discussed in the forward-looking statements. These factors include those set forth in Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, under the caption “Cautionary Statement Regarding Forward-Looking Statements” to this Quarterly Report on Form 10-Q for the quarterly period ended February 28, 2010.

 

 

The accompanying notes are an integral part of the consolidated financial statements (unaudited).

 

 

The accompanying notes are an integral part of the consolidated financial statements (unaudited).

 

 

The accompanying notes are an integral part of the consolidated financial statements (unaudited).

 

 

 

Basis of Presentation and Reclassifications

 

The unaudited consolidated balance sheets as of February 28, 2010 and 2009, the statements of operations for the three and six months ended February 28, 2010 and 2009, and the statements of cash flows for the six months ended February 28, 2010 and 2009, reflect in the opinion of our management, all normal recurring adjustments necessary for a fair statement of the financial position and results of operations and cash flows for the interim periods presented. The results of operations and cash flows for interim periods are not necessarily indicative of results for a full fiscal year because of, among other things, the seasonal nature of our businesses. Our Consolidated Balance Sheet data as of August 31, 2009, has been derived from our audited consolidated financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

 

The consolidated financial statements include our accounts and the accounts of all of our wholly-owned and majority-owned subsidiaries and limited liability companies. The effects of all significant intercompany accounts and transactions have been eliminated.

 

These statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended August 31, 2009, included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission.

 

In December 2007, the Financial Accounting Standards Board (FASB) issued Accounting Standards Codification (ASC) 860-10-65-1, “Noncontrolling Interests in Consolidated Financial Statements, an Amendment of Accounting Research Bulletin (ARB) No. 51.” ASC 860-10-65-1 establishes accounting and reporting standards that require: the ownership interest in subsidiaries held by parties other than the parent to be clearly identified and presented in the consolidated balance sheets within equity, but separate from the parent’s equity; the amount of consolidated net earnings attributable to the parent and the noncontrolling interest to be clearly identified and presented on the face of the consolidated statements of operations; and changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary to be accounted for consistently.

 

We adopted ASC 860-10-65-1 at the beginning of fiscal 2010. In accordance with the accounting guidance, in order to conform to the current period presentation, we made reclassifications within our Consolidated Statements of Operations to present the income attributable to noncontrolling interests as a reconciling item between net income and net income attributable to CHS Inc. Also, noncontrolling interests previously reported as minority interests have been reclassified to a separate section in equity on our Consolidated Balance Sheets. In addition, certain other reclassifications to our previously reported financial information have been made to conform to the current period presentation.

 

Derivative Instruments and Hedging Activities

 

Our derivative instruments primarily consist of commodity and freight futures and forward contracts and, to a minor degree, may include foreign currency and interest rate swap contracts. These contracts are economic hedges of price risk, but are not designated or accounted for as hedging instruments for accounting purposes. These contracts are recorded on our Consolidated Balance Sheets at fair values as discussed in Note 11, Fair Value Measurements.

 

We have netting arrangements for our exchange traded futures and options contracts and certain over-the-counter (OTC) contracts which are recorded on a net basis in our Consolidated Balance Sheets. Although accounting standards permit a party to a master netting arrangement to offset fair value amounts

 

recognized for derivative instruments against the right to reclaim cash collateral or the obligation to return cash collateral under the same master netting arrangement, we have not elected to net our margin deposits.

 

As of February 28, 2010 and 2009, we had the following outstanding contracts:

 

 

As of February 28, 2010, August 31, 2009 and February 28, 2009, the gross fair values of our derivative assets and liabilities were as follows:

 

 

For the three-month periods ended February 28, 2010 and 2009, and the six-month period ended February 28, 2010, the gain (loss) recognized in our Consolidated Statements of Operations for derivatives were as follows:

 

 

Goodwill and Other Intangible Assets

 

Goodwill was $17.3 million, $17.3 million and $18.1 million on February 28, 2010, August 31, 2009 and February 28, 2009, respectively, and is included in other assets in our Consolidated Balance Sheets.

 

Intangible assets subject to amortization primarily include customer lists, trademarks and agreements not to compete, and are amortized over the number of years that approximate their respective useful lives (ranging from 2 to 30 years). Excluding goodwill, the gross carrying amount of our intangible assets was $78.3 million with total accumulated amortization of $34.3 million as of February 28, 2010. No intangible assets were acquired during the six-month period ended February 28, 2010, compared to intangible assets of $26.9 million

 

($0.1 million non-cash) that were acquired during the six months ended February 28, 2009. Total amortization expense for intangible assets during the six-month periods ended February 28, 2010 and 2009, was $5.7 million and $5.4 million, respectively. The estimated annual amortization expense related to intangible assets subject to amortization for the next five years will approximate $10.0 million annually for the first two years, $7.5 million for the next year and $3.3 million for the following two years.

 

In our Energy segment, major maintenance activities (turnarounds) at our two refineries are accounted for under the deferral method. Turnarounds are the scheduled and required shutdowns of refinery processing units. The costs related to the significant overhaul and refurbishment activities include materials and direct labor costs. The costs of turnarounds are deferred when incurred and amortized on a straight-line basis over the period of time estimated to lapse until the next turnaround occurs, which is generally 2-3 years. The amortization expense related to turnaround costs are included in cost of goods sold in our Consolidated Statements of Operations. The selection of the deferral method, as opposed to expensing the turnaround costs when incurred, results in deferring recognition of the turnaround expenditures. The deferral method also results in the classification of the related cash flows as investing activities in our Consolidated Statements of Cash Flows, whereas expensing these costs as incurred, would result in classifying the cash outflows as operating activities.

 

Recent Accounting Pronouncements

 

In December 2008, the FASB issued ASC 715-20-65-2, “Employers’ Disclosures about Postretirement Benefit Plan Assets,” which expands the annual disclosure requirements about fair value measurements of plan assets for pension plans, postretirement medical plans and other funded postretirement plans. ASC 715-20-65-2 is effective for fiscal years ending after December 15, 2009. As this standard is only disclosure related, it will not have an impact on our consolidated financial statements.

 

In June 2009, the FASB issued ASC 860-10-65-3, “Accounting for Transfers of Financial Assets,” which requires additional disclosures concerning a transferor’s continuing involvement with transferred financial assets. ASC 860-10-65-3 eliminates the concept of a “qualifying special-purpose entity” and changes the requirements for derecognizing financial assets. The guidance is effective for fiscal years beginning after November 15, 2009. We are currently evaluating the impact that the adoption will have on our consolidated financial statements in fiscal 2011.

 

In June 2009, the FASB issued ASC 860-10-65-2, “Amendments to FASB Interpretation No. 46(R),” which requires an enterprise to conduct a qualitative analysis for the purpose of determining whether, based on its variable interests, it also has a controlling interest in a variable interest entity. ASC 860-10-65-2 clarifies that the determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. ASC 860-10-65-2 requires an ongoing reassessment of whether a company is the primary beneficiary of a variable interest entity. It also requires additional disclosures about a company’s involvement in variable interest entities and any significant changes in risk exposure due to that involvement. ASC 860-10-65-2 is effective for fiscal years beginning after November 15, 2009. We are currently evaluating the impact that the adoption will have on our consolidated financial statements in fiscal 2011.

 

In January 2010, the FASB issued Accounting Standards Update (ASU) No. 2010-06, “Improving Disclosures about Fair Value Measurements,” which amends existing disclosure requirements under ASC 820. ASU No. 2010-06 requires new disclosures for significant transfers between Levels 1 and 2 in the fair value hierarchy and separate disclosures for purchases, sales, issuances, and settlements in the reconciliation of activity for Level 3 fair value measurements. This ASU also clarifies the existing fair value disclosures regarding the level of disaggregation and the valuation techniques and inputs used to measure fair value. ASU No. 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures on purchases, sales, issuances, and settlements in the roll forward of activity for Level 3 fair value measurements. Those disclosures are effective for interim and annual periods beginning after

 

December 15, 2010. As ASU No. 2010-06 is only disclosure related, it will not have an impact on our consolidated financial statements.

 

 

 

 

 

The market prices for crop nutrients products fell significantly during our prior fiscal year, and due to a wet fall season, we had a higher quantity of inventory on hand at the end of our first quarter of fiscal 2009 than is typical at that time of year. In order to reflect our crop nutrients inventories at net realizable values at November 30, 2008, we recorded approximately $84 million of lower-of-cost or market adjustments in cost of goods sold of our Ag Business segment related to our crop nutrients and feed and farm supplies inventories, based on committed sales and current market values. As of February 28, 2009, there were $49.5 million of lower-of-cost or market adjustments remaining in inventory. During the six months ended February 28, 2010, we recorded approximately $3.3 million of lower-of-cost or market adjustments.

 

As of February 28, 2010, we valued approximately 19% of inventories, primarily related to energy, using the lower of cost, determined on the last in first out (LIFO) method, or market (17% and 15% as of August 31, 2009 and February 28, 2009, respectively). If the first in first out (FIFO) method of accounting had been used, inventories would have been higher than the reported amount by $379.9 million, $311.4 million and $111.0 million at February 28, 2010, August 31, 2009 and February 28, 2009, respectively.

 

 

We have a 50% ownership interest in Agriliance LLC (Agriliance), included in our Ag Business segment, and account for our investment using the equity method. Prior to September 1, 2007, Agriliance was a wholesale and retail crop nutrients and crop protection products company. In September 2007, Agriliance distributed the assets of the crop nutrients business to us, and the assets of the crop protection business to Land O’Lakes, Inc., our joint venture partner. Agriliance continues to exist as a 50-50 joint venture and primarily operates and sells agronomy products on a retail basis. As of March 2010, Agriliance has sold most of its retail facilities to various third parties, as well as to us and to Land O’Lakes, with facilities available for repositioning in Florida. During the six months ended February 28, 2010, we received $90.0 million in cash distributions from Agriliance as a return of capital, primarily from the sale of Agriliance’s retail facilities.

 

During the six months ended February 28, 2009, we invested an additional $76.3 million in Multigrain AG (Multigrain) for its increased capital needs that resulted from expansion of its operations. We have approximately a 40% ownership interest in Multigrain, included in our Ag Business segment, and account for our investment using the equity method.

 

On August 31, 2008, we had a minority ownership interest in VeraSun Energy Corporation (VeraSun), included in our Processing segment. On October 31, 2008, VeraSun filed for relief under Chapter 11 of the U.S. Bankruptcy Code. Consequently, we determined an impairment of our investment was necessary based on VeraSun’s market value of $0.28 per share on November 3, 2008, and we recorded an impairment charge and subsequent loss of $70.7 million during the six months ended February 28, 2009. The impairment did not affect our cash flows and did not have a bearing upon our compliance with any covenants under our credit facilities. Our remaining VeraSun investment of $3.6 million was written off during the third quarter of fiscal 2009 due to the outcome of its bankruptcy.

 

During the six months ended February 28, 2009, we sold our available-for-sale investment of common stock in the New York Mercantile Exchange (NYMEX Holdings) for proceeds of $16.1 million and recorded a pretax gain of $15.7 million.

 

We have a 50% interest in Ventura Foods, LLC, (Ventura Foods), a joint venture which produces and distributes primarily vegetable oil-based products, included in our Processing segment. During the six months ended February 28, 2009, we made a $10.0 million capital contribution to Ventura Foods. We account for Ventura Foods as an equity method investment, and as of February 28, 2010, our carrying value of Ventura Foods exceeded our share of their equity by $14.5 million, of which $1.7 million is being amortized with a remaining life of approximately two years. The remaining basis difference represents equity method goodwill. The following provides summarized unaudited financial information for Ventura Foods balance sheets as of February 28, 2010, August 31, 2009 and February 28, 2009 and statements of operations for the three and six months ended February 28, 2010 and 2009:

 

 

 

 

 

As of November 20, 2009, Cofina Funding, LLC, a wholly-owned subsidiary of Cofina Financial, has an additional $25.0 million available credit under note purchase agreements with various purchasers, through the issuance of short term notes payable ($212.0 million on August 31, 2009).

 

We did not renew our revolving 364-day facility with a committed amount of $300 million that expired in February 2010, but instead, intend to refinance it along with our five-year facility during our third quarter of fiscal 2010.

 

 

 

 

Changes in equity for the six-month periods ended February 28, 2010 and 2009 are as follows:

 

 

 

Total comprehensive income was $205.9 million and $242.9 million for the six months ended February 28, 2010 and 2009, respectively, which included amounts attributable to noncontrolling interests of $6.1 million and $41.5 million, respectively. Total comprehensive income primarily consisted of net income attributable to CHS Inc. during the six months ended February 28, 2010 and 2009. On February 28, 2010 and 2009, accumulated other comprehensive loss primarily consisted of pension liability adjustments.

 

 

 

Employee benefits information for the three and six months ended February 28, 2010 and 2009 is as follows:

 

 

Employer Contributions:

 

Total contributions to be made during fiscal 2010, including the National Cooperative Refinery Association (NCRA) plan, will depend primarily on market returns on the pension plan assets and minimum funding level requirements. During the six months ended February 28, 2010, we made no contributions to the pension plans. NCRA expects to contribute approximately $3.0 million to their pension plan during fiscal 2010.

 

 

We have aligned our segments based on an assessment of how our businesses operate and the products and services they sell. Our three business segments: Energy, Ag Business and Processing, create vertical integration to link producers with consumers. Our Energy segment produces and provides primarily for the wholesale distribution of petroleum products and transportation of those products. Our Ag Business segment purchases and resells grains and oilseeds originated by our country operations business, by our member cooperatives and by third parties, and also serves as wholesaler and retailer of crop inputs. Our Processing segment converts grains and oilseeds into value-added products. Corporate and Other primarily represents our business solutions operations, which consists of commodities hedging, insurance and financial services related to crop production.

 

Corporate administrative expenses are allocated to all three business segments, and Corporate and Other, based on direct usage for services that can be tracked, such as information technology and legal, and other factors or considerations relevant to the costs incurred.

 

Many of our business activities are highly seasonal and operating results will vary throughout the year. Historically, our income is generally lowest during the second fiscal quarter and highest during the third fiscal

 

quarter. Our business segments are subject to varying seasonal fluctuations. For example, in our Ag Business segment, agronomy and country operations businesses experience higher volumes and income during the spring planting season and in the fall, which corresponds to harvest. Also in our Ag Business segment, our grain marketing operations are subject to fluctuations in volumes and earnings based on producer harvests, world grain prices and demand. Our Energy segment generally experiences higher volumes and profitability in certain operating areas, such as refined products, in the summer and early fall when gasoline and diesel fuel usage is highest and is subject to global supply and demand forces. Other energy products, such as propane, may experience higher volumes and profitability during the winter heating and crop drying seasons.

 

Our revenues, assets and cash flows can be significantly affected by global market prices for commodities such as petroleum products, natural gas, grains, oilseeds, crop nutrients and flour. Changes in market prices for commodities that we purchase without a corresponding change in the selling prices of those products can affect revenues and operating earnings. Commodity prices are affected by a wide range of factors beyond our control, including the weather, crop damage due to disease or insects, drought, the availability and adequacy of supply, government regulations and policies, world events, and general political and economic conditions.

 

While our revenues and operating results are derived from businesses and operations which are wholly-owned and majority-owned, a portion of our business operations are conducted through companies in which we hold ownership interests of 50% or less and do not control the operations. We account for these investments primarily using the equity method of accounting, wherein we record our proportionate share of income or loss reported by the entity as equity income from investments, without consolidating the revenues and expenses of the entity in our Consolidated Statements of Operations. These investments principally include our 50% ownership in each of the following companies: Agriliance LLC (Agriliance), TEMCO, LLC (TEMCO) and United Harvest, LLC (United Harvest), and our approximately 40% ownership in Multigrain S.A., included in our Ag Business segment; and our 50% ownership in Ventura Foods, LLC (Ventura Foods) and our 24% ownership in Horizon Milling, LLC (Horizon Milling) and Horizon Milling G.P., included in our Processing segment.

 

The consolidated financial statements include the accounts of CHS and all of our wholly-owned and majority-owned subsidiaries and limited liability companies, including NCRA in our Energy segment. The effects of all significant intercompany transactions have been eliminated.

 

Reconciling Amounts represent the elimination of revenues between segments. Such transactions are executed at market prices to more accurately evaluate the profitability of the individual business segments.

 

Segment information for the three and six months ended February 28, 2010 and 2009 is as follows:

 

 

 

 

The following table presents assets and liabilities included in our Consolidated Balance Sheet that are recognized at fair value on a recurring basis, and indicates the fair value hierarchy utilized to determine such fair value. As required by accounting standards, assets and liabilities are classified, in their entirety, based on the lowest level of input that is a significant component of the fair value measurement. The lowest level of input is considered Level 3. Our assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the classification of fair value assets and liabilities within the fair value hierarchy levels. Fair value measurements at February 28, 2010 are as follows:

 

 

Readily marketable inventories — Our readily marketable inventories primarily include our grain and oilseed inventories that are stated at fair values. These commodities are readily marketable, have quoted market prices and may be sold without significant additional processing. We estimate the fair market values of these inventories included in Level 2 primarily based on exchange quoted prices, adjusted for differences in local markets. Changes in the fair market values of these inventories are recognized in our Consolidated Statements of Operations as a component of cost of goods sold.

 

Commodity, freight and foreign currency derivatives — Exchange traded futures and options contracts are valued based on unadjusted quoted prices in active markets and are classified within Level 1. Our forward commodity purchase and sales contracts, flat price or basis fixed derivative contracts, ocean freight contracts and other OTC derivatives are determined using inputs that are generally based on exchange traded prices and/or recent market bids and offers, adjusted for location specific inputs, and are classified within Level 2. The location specific inputs are generally broker or dealer quotations, or market transactions in either the listed or OTC markets. Changes in the fair values of these contracts are recognized in our Consolidated Statements of Operations as a component of cost of goods sold.

 

Other assets — Our available-for-sale investments in common stock of other companies and our Rabbi Trust assets are valued based on unadjusted quoted prices on active exchanges and are classified within Level 1. Changes in the fair market values of these other assets are primarily recognized in our Consolidated Statements of Operations as a component of marketing, general and administrative expenses.

 

Interest rate swap derivatives — Fair values of our interest rate swap liabilities are determined utilizing valuation models that are widely accepted in the market to value such OTC derivative contracts. The specific terms of the contracts, as well as market observable inputs such as interest rates and credit risk assumptions, are input into the models. As all significant inputs are market observable, all interest rate swaps are classified within Level 2. Changes in the fair market values of these interest rate swap derivatives are recognized in our Consolidated Statements of Operations as a component of interest, net.

 

The table below represents a reconciliation at February 28, 2010, for assets measured at fair value using significant unobservable inputs (Level 3). This consisted of our short-term investments representing an enhanced cash fund at NCRA that was closed due to credit-market turmoil.

 

 

 

Guarantees

 

We are a guarantor for lines of credit and performance obligations of related companies. As of February 28, 2010, our bank covenants allowed maximum guarantees of $500.0 million, of which $36.4 million was outstanding. We have collateral for a portion of these contingent obligations. We have not recorded a liability related to the contingent obligations as we do not expect to pay out any cash related to them, and the fair values are considered immaterial. All outstanding loans with respective creditors are current as of February 28, 2010.

 

General

 

The following discussions of financial condition and results of operations should be read in conjunction with the unaudited interim financial statements and notes to such statements and the cautionary statement regarding forward-looking statements found at the beginning of Part I, Item 1, of this Quarterly Report on Form 10-Q, as well as our consolidated financial statements and notes thereto for the year ended August 31, 2009, included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission. This discussion contains forward-looking statements based on current expectations, assumptions, estimates and projections of management. Actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, as more fully described in the cautionary statement and elsewhere in this Quarterly Report on Form 10-Q.

 

CHS Inc. (CHS, we or us) is a diversified company, which provides grain, foods and energy resources to businesses and consumers on a global basis. As a cooperative, we are owned by farmers, ranchers and their member cooperatives across the United States. We also have preferred stockholders that own shares of our 8% Cumulative Redeemable Preferred Stock.

 

We provide a full range of production agricultural inputs such as refined fuels, propane, farm supplies, animal nutrition and agronomy products, as well as services, which include hedging, financing and insurance services. We own and operate petroleum refineries and pipelines, and market and distribute refined fuels and other energy products, under the Cenex^® brand through a network of member cooperatives and independents. We purchase grains and oilseeds directly and indirectly from agricultural producers primarily in the midwestern and western United States. These grains and oilseeds are either sold to domestic and international customers, or further processed into a variety of grain-based food products.

 

The consolidated financial statements include the accounts of CHS and all of our wholly-owned and majority-owned subsidiaries and limited liability companies, including National Cooperative Refinery Association (NCRA) in our Energy segment. The effects of all significant intercompany transactions have been eliminated.

 

We operate three segments: Energy, Ag Business and Processing. Together, these segments create vertical integration to link producers with consumers. Our Energy segment produces and provides for the wholesale distribution of petroleum products and transports those products. Our Ag Business segment purchases and resells grains and oilseeds originated by our country operations business, by our member cooperatives and by third parties, and also serves as wholesaler and retailer of crop inputs. Our Processing segment converts grains and oilseeds into value-added products. Corporate and Other primarily represents our business solutions operations, which consists of commodities hedging, insurance and financial services related to crop production.

 

Corporate administrative expenses are allocated to all three business segments, and Corporate and Other, based on direct usage for services that can be tracked, such as information technology and legal, and other factors or considerations relevant to the costs incurred.

 

Many of our business activities are highly seasonal and operating results will vary throughout the year. Overall, our income is generally lowest during the second fiscal quarter and highest during the third fiscal quarter. Our business segments are subject to varying seasonal fluctuations. For example, in our Ag Business segment, our retail agronomy, crop nutrients and country operations businesses generally experience higher volumes and income during the spring planting season and in the fall, which corresponds to harvest. Also in our Ag Business segment, our grain marketing operations are subject to fluctuations in volume and earnings based on producer harvests, world grain prices and demand. Our Energy segment generally experiences higher volumes and profitability in certain operating areas, such as refined products, in the summer and early fall when gasoline and diesel fuel usage is highest and is subject to global supply and demand forces. Other energy products, such as propane, may experience higher volumes and profitability during the winter heating and crop drying seasons.

Our revenues, assets and cash flows can be significantly affected by global market prices for commodities such as petroleum products, natural gas, grains, oilseeds, crop nutrients and flour. Changes in market prices for commodities that we purchase without a corresponding change in the selling prices of those products can affect revenues and operating earnings. Commodity prices are affected by a wide range of factors beyond our control, including the weather, crop damage due to disease or insects, drought, the availability and adequacy of supply, government regulations and policies, world events, and general political and economic conditions.

 

While our revenues and operating results are derived from businesses and operations which are wholly-owned and majority-owned, a portion of our business operations are conducted through companies in which we hold ownership interests of 50% or less and do not control the operations. We account for these investments primarily using the equity method of accounting, wherein we record our proportionate share of income or loss reported by the entity as equity income from investments, without consolidating the revenues and expenses of the entity in our Consolidated Statements of Operations. These investments principally include our 50% ownership in each of the following companies: Agriliance LLC (Agriliance), TEMCO, LLC (TEMCO) and United Harvest, LLC (United Harvest), and our approximately 40% ownership in Multigrain S.A., included in our Ag Business segment; and our 50% ownership in Ventura Foods, LLC (Ventura Foods) and our 24% ownership in Horizon Milling, LLC (Horizon Milling) and Horizon Milling G.P., included in our Processing segment.

 

In December 2007, the Financial Accounting Standards Board (FASB) issued Accounting Standards Codification (ASC) 860-10-65-1, “Noncontrolling Interests in Consolidated Financial Statements, an Amendment of Accounting Research Bulletin (ARB) No. 51.” ASC 860-10-65-1 establishes accounting and reporting standards that require: the ownership interest in subsidiaries held by parties other than the parent to be clearly identified and presented in the consolidated balance sheets within equity, but separate from the parent’s equity; the amount of consolidated net earnings attributable to the parent and the noncontrolling interest to be clearly identified and presented on the face of the consolidated statements of operations; and changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary to be accounted for consistently.

 

We adopted ASC 860-10-65-1 at the beginning of fiscal 2010. In accordance with the accounting guidance, in order to conform to the current period presentation, we made reclassifications within our Consolidated Statements of Operations to net income to present the income attributable to noncontrolling interests as a reconciling item between net income and net income attributable to CHS Inc. Also, noncontrolling interests previously reported as minority interests have been reclassified to a separate section in equity on our Consolidated Balance Sheets. In addition, certain other reclassifications to our previously reported financial information have been made to conform to the current period presentation.

 

Results of Operations

 

Comparison of the three months ended February 28, 2010 and 2009

 

General.  We recorded income before income taxes of $93.1 million during the three months ended February 28, 2010 compared to $115.6 million during the three months ended February 28, 2009, a decrease of $22.5 million (20%). Operating results reflected lower pretax earnings in our Energy and Processing segments, which were partially offset by increased pretax earnings in our Ag Business segment and Corporate and Other.

 

Our Energy segment generated income before income taxes of $16.4 million for the three months ended February 28, 2010 compared to $93.6 million in the three months ended February 28, 2009. This decrease in earnings of $77.2 million is primarily from lower margins on refined fuels at both our Laurel, Montana refinery and our NCRA refinery in McPherson, Kansas. Earnings in our propane, lubricants, renewable fuels marketing and transportation businesses improved, while our equipment business experienced lower earnings during the three months ended February 28, 2010 when compared to the same three-month period of the previous year.

Our Ag Business segment generated income before income taxes of $70.1 million for the three months ended February 28, 2010 compared to $13.9 million in the three months ended February 28, 2009, an increase in earnings of $56.2 million. Earnings from our wholesale crop nutrients business improved $37.8 million for the three months ended February 28, 2010 compared with the same period in fiscal 2009. The market prices for crop nutrients products fell significantly during the first half of our fiscal 2009 as fertilizer prices, an input to grain production, followed some of the declining grain prices. Late fall of calendar 2008 rains impeded the application of fertilizer during that time period, and as a result, we had a higher quantity of inventories on hand at the end of our first and second fiscal quarters of 2009 than is typical at that time of year. Because there are no future contracts or other derivative instruments that can be used to hedge fertilizer inventories and contracts effectively, a long inventory position with falling prices creates losses. From time to time, crop nutrients hedge some positions in over-the-counter (OTC) swaps. Depreciation in fertilizer prices continued throughout the third quarter of our fiscal 2009 which had the affect of dramatically reducing gross margins on this product. To reflect our wholesale crop nutrients inventories at net-realizable values, we recorded lower-of-cost or market adjustments of approximately $56.8 million during the first quarter of fiscal 2009, of which $18.1 million was remaining at the end of the second quarter of fiscal 2009. The price fluctuations for the first half of fiscal 2010 were far less volatile and we recorded lower-of-cost or market adjustments of approximately $2.0 million during the second quarter of fiscal 2010. Improved financial performance by Agriliance, an agronomy joint venture in which we hold a 50% interest, along with a gain on the sale of many of their remaining facilities were partially offset by reduced earnings from a Canadian agronomy equity investment, which net, resulted in a $23.0 million net increase in earnings from these investments, net of allocated internal expenses. Our country operations earnings increased $3.6 million during the three months ended February 28, 2010 compared to the same period in the prior year, primarily as a result of margins from higher grain volumes, in addition to overall increased margins mostly from acquisitions and improved crop nutrient margins. Our grain marketing earnings decreased by $8.2 million during the three months ended February 28, 2010 compared with the same period in fiscal 2009, primarily as a result of reduced margins on wheat, although during these comparable periods grain volumes increased.

 

Our Processing segment generated income before income taxes of $6.2 million for the three months ended February 28, 2010 compared to $9.2 million in the three months ended February 28, 2009, a decrease in earnings of $3.0 million. Our share of earnings from Ventura Foods, our packaged foods joint venture, net of allocated internal expenses, decreased by $6.9 million during the three months ended February 28, 2010, compared to the same period in the prior year, primarily as a result of increased commodity prices for inputs, reducing margins on the products sold. Our share of earnings from our wheat milling joint ventures, net of allocated internal expenses, increased by $1.9 million for the three months ended February 28, 2010 compared to the same period in the prior year, primarily as a result of improved margins on the products sold. Oilseed processing earnings increased $1.5 million during the three months ended February 28, 2010 compared to the same period in the prior year, primarily due to improved crushing margins, partially offset by lower refining margins. During the three-month period ended February 28, 2009, we reflected a $0.5 million loss related to allocated internal expenses on our investment in VeraSun, an ethanol manufacturer who declared bankruptcy in October, 2008.

 

Corporate and Other generated income before income taxes of $0.5 million for the three months ended February 28, 2010 compared to a loss of $1.1 million in the three months ended February 28, 2009, an increase in earnings of $1.6 million. The three months ended February 28, 2009 included a change in the allocation of corporate variable pay of $1.7 million.

 

Net Income attributable to CHS Inc.  Consolidated net income attributable to CHS Inc. for the three months ended February 28, 2010 was $82.7 million compared to $82.3 million for the three months ended February 28, 2009, which represents a $0.4 million increase.

 

Revenues.  Consolidated revenues were $5.9 billion for the three months ended February 28, 2010 compared to $5.2 billion for the three months ended February 28, 2009, which represents a $0.7 billion (14%) increase.

Total revenues include other revenues generated primarily within our Ag Business segment and Corporate and Other. Our Ag Business segment’s country operations elevators and agri-service centers derive other revenues from activities related to production agriculture, which include grain storage, grain cleaning, fertilizer spreading, crop protection spraying and other services of this nature, and our grain marketing operations receive other revenues at our export terminals from activities related to loading vessels. Corporate and Other derives revenues primarily from our financing, hedging and insurance operations.

 

Our Energy segment revenues, after elimination of intersegment revenues, of $2.0 billion increased by $480.8 million (32%) during the three months ended February 28, 2010 compared to the three months ended February 28, 2009. During the three months ended February 28, 2010 and 2009, our Energy segment recorded revenues from our Ag Business segment of $68.2 million and $57.6 million, respectively. The net increase in revenues of $480.8 million is comprised of a net increase of $262.1 million related to higher prices on refined fuels and renewable fuels marketing products, in addition to $218.7 million related to a net increase in sales volume. Refined fuels revenues increased $207.7 million (24%), of which $345.5 million was related to a net average selling price increase, partially offset by $137.8 million, which was attributable to decreased volumes, compared to the same period in the previous year. The sales price of refined fuels increased $0.66 per gallon (47%), while volumes decreased 16%, mainly from the impact on the global economy with less transport diesel usage, when comparing the three months ended February 28, 2010 with the same period a year ago. Propane revenues decreased $1.2 million, of which $33.4 million was due to a decrease in the net average selling price, partially offset by $32.2 million related to an increase in volumes, when compared to the same period in the previous year. The average selling price of propane decreased $0.12 per gallon (9%), while sales volume increased 10% in comparison to the same period of the prior year. The increase in propane volumes primarily reflects increased demand for home heating. Renewable fuels marketing revenues increased $186.2 million (169%), mostly from a 134% increase in volumes, coupled with an increase in the average selling price of $0.26 per gallon (15%), when compared with the same three-month period in the previous year.

 

Our Ag Business segment revenues, after elimination of intersegment revenues, of $3.6 billion, increased $0.2 billion (7%) during the three months ended February 28, 2010 compared to the three months ended February 28, 2009. Grain revenues in our Ag Business segment totaled $3.0 billion and $2.8 billion during the three months ended February 28, 2010 and 2009, respectively. Of the grain revenues increase of $209.6 million (8%), $338.3 million is due to a 12% net increase in volumes, partially offset by $128.7 million, which was attributable to decreased average grain selling prices during the three months ended February 28, 2010 compared to the same period last fiscal year. The average sales price of all grain and oilseed commodities sold reflected a decrease of $0.28 per bushel (4%) over the same three-month period in fiscal 2009. The average month-end market price per bushel of soybeans and corn increased approximately $0.26 and $0.04, respectively, while the price per bushel of spring wheat decreased $1.23 when compared to the three months ended February 28, 2009. Wheat, soybean, barley, sunflowers and corn all had increased volumes compared to the six months ended February 28, 2009.

 

Wholesale crop nutrient revenues in our Ag Business segment totaled $339.0 million and $325.8 million during the three months ended February 28, 2010 and 2009, respectively. Of the wholesale crop nutrient revenues increase of $13.2 million (4%), $54.1 million is attributable to increased volumes, partially offset by $40.9 million which was due to decreased average fertilizer selling prices, during the three months ended February 28, 2010 compared to the same period last fiscal year. The average sales price of all fertilizers sold reflected a decrease of $40 per ton (11%) over the same three-month period in fiscal 2009. Our crop nutrient volumes increased 17% during the three months ended February 28, 2010 compared with the same period of a year ago, mainly due to the reduced sales related to higher fertilizer prices during a falling market in the three months ended February 28, 2009 compared to the same period in fiscal 2010.

 

Our Ag Business segment non-grain or non-wholesale crop nutrients product revenues of $249.0 million increased by $1.5 million (1%) during the three months ended February 28, 2010 compared to the three months ended February 28, 2009, primarily the result of increased revenues in our country operations business of retail energy and crop protection products, partially offset by decreases in feed, seed and crop nutrients

products. Other revenues within our Ag Business segment of $42.9 million during the three months ended February 28, 2010 decreased $0.2 million compared to the three months ended February 28, 2009.

 

Our Processing segment revenues, after elimination of intersegment revenues, of $264.1 million decreased $5.7 million (2%) during the three months ended February 28, 2010 compared to the three months ended February 28, 2009. Because our wheat milling and packaged foods operations are operated through non-consolidated joint ventures, revenues reported in our Processing segment are entirely from our oilseed processing operations. Our oilseed processing operation net revenues decreased $5.7 million, primarily from a decrease in the average selling price of oilseed refined products, and from volume decreases in our oilseed refinery operations, partially offset by increases in processed (crushed) oilseed products average selling price, as compared to the three months ended February 28, 2009. Typically, changes in average selling prices of oilseed products are primarily driven by the average market prices of soybeans.

 

Cost of Goods Sold.  Consolidated cost of goods sold were $5.7 billion for the three months ended February 28, 2010 compared to $5.0 billion for the three months ended February 28, 2009, which represents a $0.7 billion (15%) increase.

 

Our Energy segment cost of goods sold, after elimination of intersegment costs, of $1.9 billion increased by $561.1 million (41%) during the three months ended February 28, 2010 compared to the same period of the prior year. The increase in cost of goods sold is primarily due to increased per unit costs for refined fuels products. Specifically, refined fuels cost of goods sold increased $247.7 million (30%) which reflects an increase in the average cost of refined fuels of $0.73 per gallon (54%); while volumes decreased 16% compared to the three months ended February 28, 2009. On average, we process approximately 55,000 barrels of crude oil per day at our Laurel, Montana refinery and 80,000 barrels of crude oil per day at NCRA’s McPherson, Kansas refinery. The average cost increase is primarily related to higher input costs at our two crude oil refineries and higher average prices on the refined products that we purchased for resale compared to the three months ended February 28, 2009. The aggregate average per unit cost of crude oil purchased for the two refineries increased 82% compared to the three months ended February 28, 2009. The cost of propane decreased $5.9 million (2%) mostly from a decrease in the average cost of $0.14 per gallon (11%), partially offset by a 10% increase in volumes, when compared to the three months ended February 28, 2009. The increase in propane volumes primarily reflects increased demand caused by an improved home heating season. Renewable fuels marketing costs increased $184.2 million (170%), mostly from a 134% increase in volumes, in addition to an increase in the average cost of $0.26 per gallon (16%), when compared with the same three-month period in the previous year.