CHS Inc. — Fiscal 2019 Second-Quarter Form 10-Q
Reporting period: Three and six months ended February 28, 2019. Financial statements are unaudited; comparative 2018 results were restated. Dollar amounts below are in millions unless otherwise noted.
Financial performance and liquidity
| Metric | Three months 2019 | Three months 2018, restated | Six months 2019 | Six months 2018, restated |
|---|---|---|---|---|
| Revenue | $6,483.5 | $6,980.2 | $14,967.8 | $15,012.0 |
| Gross profit | $427.4 | $135.0 | $898.1 | $455.5 |
| Gross margin | 6.6% | 1.9% | 6.0% | 3.0% |
| Operating earnings (loss) | $249.6 | $(41.2) | $564.1 | $142.7 |
| Net income attributable to CHS | $248.8 | $166.0 | $596.3 | $353.7 |
| Interest expense | $41.3 | $40.2 | $80.2 | $80.9 |
- Second-quarter revenue fell 7.1% year over year, while gross profit improved substantially. Six-month revenue was nearly flat, with gross profit nearly doubling.
- Energy segment pretax income rose to $306.6 million from $24.5 million in the quarter; Ag reported a $62.4 million pretax loss versus a $53.5 million loss. Better Energy results and higher equity income from investments supported consolidated earnings.
- Six-month operating cash flow remained negative at $125.3 million, improving from negative $642.4 million a year earlier. Investing cash use was $98.3 million; financing provided $139.0 million. Capital expenditures were $178.0 million. Cash, cash equivalents and restricted cash totaled $457.4 million at period-end; balance-sheet cash and cash equivalents alone were $367.3 million.
- At February 28, working capital was $1.1 billion and the current ratio was 1.2. Notes payable were $2.64 billion and long-term debt, including its current portion, was $1.91 billion. Debt covenants were met. Total equities were $8.40 billion.
Material changes and unusual items
- Energy earnings benefited from favorable heavy Canadian crude oil pricing, hedging gains and lower renewable-fuel credit costs. CHS also recognized an $80.8 million gain, recorded as a reduction of cost of goods sold, after resolving a contingency involving federal excise tax credits tied to manufacturing changes. Management said similar gains may not recur.
- Ag faced weaker grain movement and margin pressure amid price, weather, logistics and trade uncertainty. Lower selling prices reduced reported revenue even where volumes increased.
- Comparative 2018 statements were restated following discovery of intentional manipulation by a former employee of rail-freight contract valuations and quantities, and contracts that did not qualify for derivative accounting. Other intercompany and historical misstatements were also corrected. Investors should use the restated comparatives, not previously filed figures.
- CHS reported disclosure controls and procedures were ineffective at February 28, 2019 because of previously identified material weaknesses in internal control over financial reporting. Remediation was underway, including revised accounting policies, additional training, outside consultants and plans to strengthen staffing and controls.
Outlook, risks and contingencies
- Management expected Energy market conditions to remain generally favorable in the second half of fiscal 2019, but less favorable than in the first half. Ag margins, revenues and cash flows were expected to remain under pressure; management cited trade disputes, low commodity prices, ethanol oversupply, reduced sector liquidity and leverage, and Upper Midwest snow and flooding that disrupted some fertilizer plants and port facilities.
- No specific earnings forecast was provided. CHS expected fiscal 2019 capital expenditures of approximately $628.3 million, including about $200 million for planned McPherson refinery maintenance. Expected preferred-stock dividends were approximately $168.7 million, and expected equity redemptions were approximately $79 million.
- The $3.0 billion unsecured revolving facility had $604 million outstanding. The receivables securitization facility was scheduled to terminate June 17, 2019, subject to possible extension; the related $150 million repurchase facility was fully drawn. CHS said available cash, operating cash flow and borrowing capacity should support operations and expected continued covenant compliance.
- Guarantees for related non-consolidated entities totaled $197.1 million against a permitted maximum of $1.0 billion; CHS had not recorded a liability and did not expect payment. Management expected environmental matters and ordinary-course litigation not to have a material effect, while noting outcomes could affect earnings in an individual period.
- On March 1, 2019, CHS completed its acquisition of West Central Distribution, LLC, in which it had previously held a 25% equity-method interest.
Investor facts to verify
- Review the restatement disclosures and the nature and status of remediation for the material weaknesses; confirm whether controls have since been tested and found effective.
- Assess how much of the earnings increase depended on the $80.8 million excise-tax-credit gain and favorable Energy market conditions, and whether Ag pressure persisted.
- Track operating cash flow, seasonal working-capital requirements, short-term borrowings, and the extension or replacement of the securitization facility before its June 2019 termination date.
- Check actual capital spending, refinery turnaround costs, and progress integrating West Central Distribution against management’s expectations.