Archer Daniels Midland (ADM) - 10-Q quarterly report FY

Archer-Daniels-Midland Company

Notes to Consolidated Financial Statements

(Unaudited)

Note 1.  Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, these statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the quarter and nine months ended March 31, 2008 are not necessarily indicative of the results that may be expected for the year ending June 30, 2008. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended June 30, 2007.

Last-in, First-out (LIFO) Inventories

Interim period LIFO calculations are based on interim period costs and management’s estimates of year-end inventory levels.  Because the availability and cost of agricultural commodity-based LIFO inventories are unpredictable due to factors such as weather, government farm programs and policies, and changes in global demand, quantities of LIFO-based inventories at interim periods may vary significantly from management’s estimates of year-end inventory levels.

Note 2.  New Accounting Standards

During September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements (SFAS 157).  SFAS 157 establishes a framework for measuring fair value within generally accepted accounting principles, clarifies the definition of fair value within that framework, and expands disclosures about the use of fair value measurements. SFAS 157 does not require any new fair value measurements in generally accepted accounting principles.  However, the definition of fair value in SFAS 157 may affect assumptions used by companies in determining fair value.  The Company will be required to adopt SFAS 157 for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually) on July 1, 2008.  The Company has not completed its evaluation of the impact of adopting SFAS 157 on the Company’s financial statements, but currently believes the impact of the adoption of SFAS 157 will not require material modification of the Company’s fair value measurements and will be substantially limited to expanded disclosures in the notes to the Company’s consolidated financial statements.

During February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159). SFAS 159 allows entities to voluntarily choose, at specified election dates, to measure many financial assets and financial liabilities at fair value. The election is made on an instrument-by-instrument basis and is irrevocable. If the fair value option is elected for an instrument, SFAS 159 specifies that all subsequent changes in fair value for that instrument shall be reported in earnings.  The Company will be required to adopt SFAS 159 on July 1, 2008 and does not believe such adoption will have a significant impact on the Company’s financial statements.

Archer-Daniels-Midland Company

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 2.  New Accounting Standards (Continued)

During December 2007, the FASB issued SFAS No. 141(R), Business Combinations (SFAS 141(R)) and SFAS No. 160, Accounting and Reporting of Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (SFAS 160).  SFAS 141(R) replaces SFAS 141, Business Combinations.  SFAS 141(R) and SFAS 160 will change the financial accounting and reporting of business combination transactions and noncontrolling (or minority) interests in consolidated financial statements.  SFAS 141(R) requires recognizing, with certain exceptions, 100 percent of the fair values of assets acquired, liabilities assumed, and noncontrolling interests in acquisitions of less than a 100 percent controlling interest when the acquisition constitutes a change in control of the acquired entity; measuring acquirer shares issued and contingent consideration arrangements in connection with a business combination at fair value on the acquisition date with subsequent changes in fair value reflected in earnings; and expensing as incurred acquisition-related transaction costs. SFAS 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary.  It also amends ARB 51’s consolidation procedures for consistency with the requirements of SFAS 141(R).  The Company will be required to adopt SFAS 141(R) for business combination transactions for which the acquisition date is on or after July 1, 2009. The Company will also be required to adopt SFAS 160 on July 1, 2009.  The Company has not yet assessed the impact of the adoption of these standards on its financial statements.

During March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133 (SFAS 161). SFAS 161 expands and disaggregates the disclosure requirements in SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133).  The disclosure provisions of SFAS 161 apply to all entities with derivative instruments subject to SFAS 133 and also apply to related hedged items, bifurcated derivatives, and nonderivative instruments that are designated and qualify as hedging instruments. SFAS 161 requires an entity with derivatives to disclose how and why it uses derivative instruments; how derivative instruments and related hedged items are accounted for under SFAS 133; and how derivative instruments and related hedged items affect the entity’s financial position, financial performance, and cash flows. Entities must provide tabular disclosures of the location, by line item, of amounts of gains and losses reported in the statement of earnings.  The Company will be required to adopt SFAS 161 on July 1, 2009 and has not yet assessed the impact of the adoption of this standard on the Company’s financial statements.

Note 3.  Debt and Financing Arrangements

The Company has outstanding $1.2 billion principal amount of convertible senior notes (the Notes) due in 2014. As of March 31, 2008, none of the conditions permitting conversion of the Notes had been satisfied.  Therefore, no share amounts related to the conversion of the Notes or exercise of the warrants sold in connection with the issuance of the Notes were included in diluted average shares outstanding.  For further information on the Notes, refer to Note 7 “Debt and Financing Arrangements” in the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended June 30, 2007.

In December 2007, the Company issued $500 million of debentures which are due in 2038 and bear interest at a rate of 6.45%.  In March 2008, the Company issued $700 million of notes which are due in 2018 and bear interest at a rate of 5.45%.

 

Archer-Daniels-Midland Company

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 3.  Debt and Financing Arrangements (Continued)

At March 31, 2008, the Company had lines of credit totaling $7.4 billion, of which $2.5 billion was unused.  The weighted average interest rates on short-term borrowings outstanding at March 31, 2008 and 2007 were 3.64% and 5.62%, respectively.  Of the Company’s total lines of credit, $5.3 billion support a commercial paper borrowing facility, against which there were borrowings of $4.1 billion at March 31, 2008.

Archer-Daniels-Midland Company

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 6.  Income Taxes

The Company files income tax returns in multiple jurisdictions and is subject to examination by taxing authorities throughout the world.  In the U.S., the Company remains subject to Federal examination for tax years 2005 and 2007. The amount of unrecognized tax benefits at March 31, 2008 was immaterial.  There were no significant increases or decreases in unrecognized tax benefits as a result of tax positions taken during a prior period or taken during the current quarter and there were no material settlements during the quarter ended March 31, 2008.  The Company classifies interest and penalties related to uncertain tax positions as interest expense and penalty expense which are included in the accompanying consolidated statements of earnings in other income–net and selling, general and administrative expenses, respectively.  The amount of interest expense and penalty expense was immaterial for the quarter ended March 31, 2008.

Note 7.  Segment Information

The Company is principally engaged in procuring, transporting, storing, processing, and merchandising agricultural commodities and products.  Beginning July 1, 2007, the Company has reclassified certain operations within its reportable segments to reflect how the Company now manages its businesses following a realignment of the organizational structure of the Company and to reflect the activities of the Company as viewed by the Company’s chief operating decision maker.  The Company’s operations are classified into three reportable business segments:  Oilseeds Processing, Corn Processing and Agricultural Services.  Each of these segments is organized based upon the nature of products and services offered.  The Company’s remaining operations are aggregated and classified as Other. The reclassification of certain operations in the Company’s reportable segments principally resulted in the movement of certain food, feed, and industrial operations previously classified in Other to the respective segment which produces the raw material feedstock used in those operations.  The Oilseeds Processing segment now includes the Company’s natural health and nutrition and protein specialties operations, the Corn Processing segment now includes the Company’s industrial bioproducts operations, and the Agricultural Services segment now includes the Company’s formula feed processing and edible bean origination operations.  Prior period segment information has been reclassified to conform to the new presentation.

The Oilseeds Processing segment includes activities related to the crushing and origination of oilseeds such as soybeans, cottonseed, sunflower seeds, canola, peanuts, and flaxseed into vegetable oils and meals principally for the food and feed industries.  In addition, oilseeds and oilseed products may be used internally or resold into the marketplace as raw materials for other processing.  Crude vegetable oil is sold "as is" or is further processed by refining, bleaching, and deodorizing into salad oils.  Salad oils can be further processed by hydrogenating and/or interesterifying into margarine, shortening, and other food products. Partially refined oil is sold for use in chemicals, paints, and other industrial products.  Refined oil can be further processed for use in the production of biodiesel.  Oilseed meals are primary ingredients used in the manufacture of commercial livestock and poultry feeds.  Oilseeds Processing includes activities related to the production of natural health and nutrition products and the production of other specialty food and feed ingredients.  This segment also includes activities related to the Company’s interests in unconsolidated affiliates in Asia, principally Wilmar International Limited.

The Corn Processing segment includes activities related to the production of sweeteners, starches, dextrose, and syrups for the food and beverage industry as well as activities related to the production, by fermentation, of bioproducts such as ethanol, amino acids, and other food, feed and industrial products.

Archer-Daniels-Midland Company

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 7.  Segment Information (Continued)

The Agricultural Services segment utilizes the Company’s extensive grain elevator and transportation network to buy, store, clean, and transport agricultural commodities, such as oilseeds, corn, wheat, milo, oats, barley, and edible beans, and resells or processes these commodities primarily as food and feed ingredients for the agricultural processing industry.  Agricultural Services’ grain sourcing and transportation network provides reliable and efficient services to the Company’s agricultural processing operations. Also included in Agricultural Services are the activities of A.C. Toepfer International, a global merchandiser of agricultural commodities and processed products.

Other includes the Company’s remaining operations, consisting of activities related to processing agricultural commodities into food ingredient products such as wheat into wheat flour, cocoa into chocolate and cocoa products, and barley into malt. Other also includes financial activities related to banking, captive insurance, private equity fund investments, and futures commission merchant activities.

Intersegment sales have been recorded at amounts approximating market.  Operating profit for each segment is based on net sales less identifiable operating expenses, including an interest charge related to working capital usage. Also included in segment operating profit are the related equity in earnings of affiliates based on the equity method of accounting.  General corporate expenses, investment income, unallocated interest expense, marketable securities transactions, FIFO to LIFO inventory adjustments, and minority interest eliminations have been excluded from segment operations and classified as Corporate.

For detailed information regarding the Company’s reportable segments, see Note 14 to the consolidated financial statements included in the Company’s annual report on Form 10-K for the year ended June 30, 2007.

 

Oilseeds Processing operating profits increased 28% to $237 million due principally to continuing strong demand for protein meal and vegetable oil in most global markets.  Crushing and Origination operating profits increased 77% to $179 million due to improved processing margins in North and South America, and a 10% increase in worldwide crush volumes.  The prior year quarter results for Refining, Packaging, Biodiesel and Other include a $14 million gain on a business disposal. Excluding the prior year gain, Refining, Packaging, Biodiesel and Other operating profit decreased $2 million principally due to weaker biodiesel margins in Europe.

Corn Processing operating profits decreased 31% to $172 million due principally to higher net corn costs and increased manufacturing expenses.  Manufacturing expenses increased principally due to higher energy costs.  Sweeteners and Starches operating profit decreased 26% to $98 million reflecting higher net corn costs and increased manufacturing expenses, partially offset by higher average sales prices.    Bioproducts operating profit decreased 38% to $74 million principally due to higher net corn costs and increased manufacturing expenses, partially offset by increased ethanol and lysine sales volumes and, to a lesser extent, higher average lysine selling prices.

Agricultural Services operating profit increased 696% to $366 million. Merchandising and Handling operating profit increased $320 million to $341 million due principally to enhanced merchandising and handling margins caused by volatile global grain and freight markets, and favorable risk management results.  Transportation operating profits were similar to last year’s quarter.

Other operating profits increased 24% to $138 million.  Wheat, Cocoa and Malt operating profit increased 10% to $90 million due principally to favorable risk management results in wheat and malt, partially offset by decreased cocoa processing margins primarily reflecting the competitive pressures experienced in the North American chocolate market.  Last year’s Wheat, Cocoa and Malt results included a $39 million gain on a business disposal.  Financial operating profits increased due principally to higher brokerage services income, decreased insurance loss provisions, marketable securities gains, and improved earnings from private equity fund investments.

Corporate expense increased $121 million to $158 million principally due to a $64 million charge, compared to a $23 million charge in the prior year quarter, related to the effect of increased commodity costs on LIFO inventory valuations, decreased investment income and increased minority interest eliminations.

Income taxes increased due principally to higher pretax earnings.  The Company’s effective tax rate for the quarter is 31.5% this year and 34.8% in the prior year quarter.  The decrease in the Company’s effective tax rate is primarily due to changes in the geographic mix of pretax earnings.

 

Nine Months Ended March 31, 2008 Compared to Nine Months Ended March 31, 2007

Net earnings for the nine months increased principally due to increased segment operating profits.  This increase was partially offset by increased corporate expenses principally related to LIFO inventory valuation charges resulting from increased commodity costs and by increased minority interest eliminations.

As an agricultural-based business, the Company is subject to a variety of market factors which affect the Company’s operating results.  Weather conditions, increasing demand and other factors contributed to significantly higher agricultural commodity costs.  Commodity and freight markets experienced increased volatility which created exceptional profit opportunities for the Company’s merchandising and handling operations.  Demand for protein meal and vegetable oil increased globally.  Biodiesel markets continue to develop and contribute to the increased demand for refined and crude vegetable oils.  Ethanol demand increased reflecting higher gasoline prices, improved gasoline blending economics and demand from newly-opened markets in the southeastern United States.  Manufacturing expenses increased due principally to higher energy and fuel costs.  Other operating results for the nine months ended March 31, 2007 include a gain of $53 million from sales of Company businesses.

Analysis of Statements of Earnings

Net sales and other operating income increased 51% to $48 billion for the nine months.  Approximately 82% of the increase is due principally to increased costs of underlying agricultural commodities and the remainder is due to increased sales volumes.

Net sales and other operating income by segment for the nine months are as follows:

Oilseeds Processing sales increased 59% to $15.6 billion principally due to increased average selling prices resulting primarily from increases in underlying commodity costs and from continuing strong demand for protein meal and vegetable oil.  Sales quantities of vegetable oil, biodiesel and merchandised grains also increased.  Corn Processing sales increased 18% to $5 billion. Good demand for sweeteners and starches drove higher average selling prices.  Bioproducts sales increased primarily as a result of increased ethanol sales volumes partially offset by decreased average ethanol selling prices. Higher ethanol sales volumes reflect higher gasoline prices, improved gasoline blending economics and additional demand, principally from newly-opened markets in the southeastern United States. Agricultural Services sales increased 58% to $23.6 billion primarily due to increased underlying commodity costs and, to a lesser extent, increased sales volumes.  Other sales increased 36% to $3.9 billion primarily due to higher average selling prices and volumes of wheat flour and, to a lesser extent, higher average selling prices and volumes of cocoa products.

Cost of products sold increased 54% to $45 billion primarily due to higher agricultural commodity costs and, to a lesser extent, increased sales volumes.  Manufacturing expenses increased $334 million primarily due to increased energy and fuel costs, increased employee-related costs, higher storage and handling costs and the impact of foreign currency translation.

Selling, general and administrative expenses increased $169 million to $1.1 billion primarily due to higher employee-related and outside service costs including $41 million related to an organizational realignment and a reorganization of the Company’s European headquarters.  Selling, general and administrative expenses also increased due to the impact of foreign currency translation.

Other (income) expense - net decreased $21 million due primarily to last year’s $53 million gain from the sale of Company businesses and increased minority interest eliminations.  These decreases were partially offset by increased equity in earnings of affiliates resulting primarily from increased valuations of the Company’s private equity fund investments.  

Operating profit by segment for the nine months is as follows: