Notes to the Consolidated Financial Statements
(in millions of US dollars except share and per-share amounts)
(unaudited)
1. Significant Accounting Policies
Basis of Presentation
With its subsidiaries, Potash Corporation of Saskatchewan Inc. ("PCS") -
together known as "PotashCorp" or "the company" except to the extent the context
otherwise requires - forms an integrated fertilizer and related industrial and
feed products company. The company's accounting policies are in accordance with
accounting principles generally accepted in Canada ("Canadian GAAP"). These
policies are consistent with accounting principles generally accepted in the
United States ("US GAAP") except as outlined in Note 15. The accounting policies
used in preparing these interim consolidated financial statements are consistent
with those used in the preparation of the 2003 annual consolidated financial
statements, except as disclosed in Note 2.
In 2003, the company approved plans to restructure certain operations.
Those plans required significant estimates to be made of: (i) the recoverability
of the carrying value of certain assets based on their capacity to generate
future cash flows, and (ii) employee termination, contract termination and other
exit costs. Because restructuring activities are complex processes that can take
several months to complete, they involve periodically reassessing estimates. As
a result, the company may have to change originally reported estimates as actual
payments are made or activities are completed.
Principles of Consolidation
The consolidated financial statements include the accounts of the company
and its principal operating subsidiaries:
- PCS Sales (Canada) Inc.
- PCS Joint Venture, L.P.
- PCS Sales (USA), Inc.
- PCS Phosphate Company, Inc.
- PCS Purified Phosphates
- White Springs Agricultural Chemicals, Inc.
- PCS Nitrogen, Inc.
- PCS Nitrogen Fertilizer, L.P.
- PCS Nitrogen Ohio, L.P.
- PCS Nitrogen Trinidad Limited
- PCS Cassidy Lake Company
- PCS Yumbes S.C.M. ("PCS Yumbes")
- PCS Fosfatos do Brasil Ltda.
2. Changes in Accounting Policy
Sources of GAAP
Effective January 1, 2004, the company prospectively adopted new
accounting requirements of the Canadian Institute of Chartered Accountants
("CICA") as issued in Section 1100, "Generally Accepted Accounting Principles".
This section establishes standards for financial reporting in accordance with
GAAP and provides guidance on sources to consult when selecting accounting
policies and determining appropriate disclosures when a matter is not dealt with
explicitly in the primary sources of GAAP. In light of the new Section 1100
provisions, the company reviewed the application of its accounting policies and
changed the consolidated financial statement presentation of sales revenue,
freight costs and transportation and distribution
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expenses, without any effect on gross margin or net income. All comparative
information has been appropriately reclassified.
In prior years, the company reported sales revenues (net of discounts, and
including amounts recoverable from customers for freight, transportation and
distribution) net of related freight, transportation and distribution expenses.
The company now reports sales revenues (net of discounts, and including amounts
recoverable from customers for freight, transportation and distribution),
freight costs, and transportation and distribution expenses as separate line
items on the Consolidated Statements of Operations and Retained Earnings.
Asset Retirement Obligations
On January 1, 2004, the company adopted CICA Section 3110, "Accounting for
Asset Retirement Obligations", which requires the company to record an asset and
related liability for the costs associated with the retirement of long-lived
tangible assets when a legal liability to retire such assets exists. This
includes obligations incurred as a result of acquisition, construction, or
normal operation of a long-lived asset. The provisions of Section 3110 require
the asset retirement obligation to be recorded at fair value at the time the
liability is incurred. Accretion expense is recognized as an operating expense
using the credit-adjusted risk-free interest rate in effect when the liability
was recognized. The associated asset retirement obligations are capitalized as
part of the carrying amount of the long-lived asset and depreciated over the
estimated remaining useful life of the asset. The company has recorded asset
retirement obligations primarily associated with certain closure, reclamation,
and restoration costs for its potash and phosphate operations.
The adoption of Section 3110 did not have a significant effect on the
results of operations or financial position of the company. Had the provisions
of Section 3110 been applied as of January 1, 2003, the pro forma effects for
the year ended December 31, 2003 on net loss would not have been material. As
required under the standard, the company will make periodic assessments as to
the reasonableness of its asset retirement obligation estimates and revise those
estimates accordingly. The respective asset and liability balances will be
adjusted, which will correspondingly increase or decrease the amounts expensed
in future periods.
Hedging Relationships
Effective January 1, 2004, the company adopted CICA Accounting Guideline
13 "Hedging Relationships". This guideline sets out the criteria that must be
met in order to apply hedge accounting for derivatives and is based on many of
the principles outlined in the US standards relating to derivative instruments
and hedging activities. Specifically, the guideline provides detailed guidance
on the identification, designation, documentation and effectiveness of hedging
relationships, for purposes of applying hedge accounting, and the discontinuance
of hedge accounting. Income and expenses on derivative instruments designated
and qualifying as hedges under this guideline are recognized in earnings in the
same period as the related hedged item. Ineffective hedging relationships and
hedges not designated in a hedging relationship are carried at fair value on the
Consolidated Statement of Financial Position, and subsequent changes in their
fair value are recorded in earnings. The adoption of this accounting guideline
did not have a material impact on the consolidated financial statements for the
quarter.
3. Inventories
March 31, December 31,
2004 2003
(unaudited)
Finished product $ 200.8 $ 160.7
Materials and supplies 107.9 108.0
Raw materials 44.0 54.1
Work in process 67.8 72.4
$ 420.5 $ 395.2
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4. Long-Term Debt
In January and February 2004, the company entered into interest rate swap
contracts designated as fair value hedges that effectively converted a notional
amount of $300.0 of fixed rate debt (due 2011) into floating rate debt based on
six-month US dollar LIBOR rates. Net settlements on the swap instruments are
recorded as adjustments to interest expense. The company did not enter into any
interest rate swap contracts in 2003.
5. Provision for Plant Shutdowns
Memphis and Geismar Nitrogen Operations
In June 2003, the company indefinitely shut down its Memphis, Tennessee
plant and suspended production of ammonia and nitrogen solutions at its Geismar,
Louisiana facilities due to high US natural gas costs and low product margins.
The plants have not been re-started since that time.
The company determined that all employee positions pertaining to the
affected operations would be eliminated and recorded $4.8 in connection with
costs of special termination benefits in the third quarter of 2003. The number
of employees terminated as a result of the shutdowns was 187, of which 185 had
left the company as of March 31, 2004. The company has made payments relating to
the terminations totaling $3.5. All remaining workforce reduction costs
pertaining to the 187 employees are expected to be paid by December 31, 2004.
In connection with the shutdowns, management had determined that the
carrying amounts of the long-lived assets at the Memphis and Geismar nitrogen
facilities were not fully recoverable, and an impairment loss of $101.6, equal
to the amount by which the carrying amount of the facilities' asset groups
exceeded their respective fair values, was recognized. Of the total impairment
charge, $100.6 related to property, plant and equipment and $1.0 related to
other assets. As part of its review, management also wrote down certain parts
inventories at these plants in the amount of $12.4.
In addition to the costs described above, management expects to incur
other shutdown-related costs of approximately $11.1 and nominal annual
expenditures for site security and other maintenance costs. These amounts have
not been recorded in the consolidated financial statements as of March 31, 2004.
Such costs will be recognized and recorded in the period in which they are
incurred.
Kinston Phosphate Feed Plant
The phosphate feed plant at Kinston, North Carolina ceased operations in
the first quarter of 2003. In that quarter, the company recorded $0.6 for costs
of special termination benefits for Kinston employees, $0.3 for parts inventory
writedowns, and $1.3 for long-lived asset impairment charges. In lieu of full
plant closure, the company continued to operate the facility as a warehouse. In
the third quarter of 2003, company management determined that the cost of
operating Kinston as a stand-alone warehouse was uneconomical. This decision
triggered a further review by management of the carrying amounts of the plant's
long-lived assets. As a result of this review, management determined that the
carrying amounts of the long-lived assets were not recoverable, and an
additional impairment charge of $2.7, equal to the amount by which the carrying
amount of the plant's long-lived assets exceeded their fair value, was
recognized.
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No additional costs were incurred in connection with the plant shutdowns
in the first quarter of 2004. The following table summarizes, by reportable
segment, the total amount of costs incurred to date and the total costs expected
to be incurred in connection with the plant shutdowns described above:
Cumulative Total Costs
Costs Expected
Incurred to to be
Date Incurred
Nitrogen Segment
Employee termination and related benefits $ 4.8 $ 4.8
Writedown of parts inventory 12.4 12.4
Asset impairment charges 101.6 101.6
Other related exit costs - 11.1
118.8 129.9
Phosphate Segment
Employee termination and related benefits 0.6 0.6
Writedown of parts inventory 0.3 0.3
Asset impairment charges 4.0 4.0
4.9 4.9
$ 123.7 $ 134.8
The following table summarizes, by reportable segment, the costs accrued
as of March 31, 2004 in connection with the plant shutdowns described above:
Accrued Accrued
Balance Balance
December 31, Cash March 31,
2003 Payments 2004
Nitrogen Segment
Employee termination and related benefits $ 2.1 $ (0.8 ) $ 1.3
Phosphate Segment
Employee termination and related benefits 0.5 (0.1 ) 0.4
$ 2.6 $ (0.9 ) $ 1.7
The accrued balance is included in accounts payable and accrued charges in
the Consolidated Statements of Financial Position as at March 31, 2004.
6. Provision for PCS Yumbes S.C.M.
In November 2003, the company entered into a share purchase agreement with
Sociedad Quimica y Minera de Chile S.A. ("SQM"), whereby SQM is to acquire the
shares of PCS Yumbes for an aggregate purchase price of $35.0, subject to
adjustments. Under the terms of the share purchase agreement, and prior to the
sale closing, PCS Yumbes will continue to operate the facility and expeditiously
liquidate the inventory of nitrates. All other working capital is to be fully
realized or discharged (as applicable) by the company prior to the closing. It
is expected that the closing will occur no later than the end of 2004.
In 2003, management conducted an assessment of the recoverability of the
long-lived assets of the PCS Yumbes operations. As a result of its review,
management determined that the carrying amounts of PCS Yumbes' long-lived assets
were not recoverable and recorded an impairment charge of $77.4, equal to the
amount by which the carrying amount of the asset group exceeded fair value. Of
the total impairment charge, $13.0 related to property, plant and equipment,
$63.9 related to deferred pre-production costs, and $0.5 related to deferred
acquisition costs. As part of the review, management also wrote down certain
non-parts inventory
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by $50.2 due to the need to liquidate all inventories that would not be
transferred to SQM under the agreement.
The company plans to eliminate all employee positions at PCS Yumbes by
December 31, 2004 and has recorded a provision of $1.8 pertaining to contractual
termination benefits to be paid, primarily under Chilean law. As of March 31,
2004, 124 of the employees had left the company. The remaining 100 employees are
expected to leave the company by December 31, 2004, and all remaining workforce
reduction costs are expected to be paid by that date.
The company had incurred early termination penalties in respect of certain
PCS Yumbes contractual arrangements. The company recorded a provision of $11.1
in the third quarter of 2003 for these contract termination costs and $0.5
remained to be paid at March 31, 2004.
No costs were incurred in connection with the above in the first quarter
of 2004. The following table summarizes the total amount of costs incurred to
date and the total costs expected to be incurred in connection with PCS Yumbes:
Cumulative Total Costs
Costs Expected
Incurred to to be
Date Incurred
Potash Segment
Contract termination costs $ 11.1 $ 11.1
Employee termination and related benefits 1.8 1.8
Writedown of non-parts inventory 50.2 50.2
Asset impairment charges 77.4 77.4
$ 140.5 $ 140.5
The following table summarizes the costs accrued as of March 31, 2004 in
connection with PCS Yumbes as described above:
Accrued Accrued
Balance Balance
December 31, Cash March 31,
2003 Payments Adjustments 2004
Potash Segment
Contract termination costs $ 0.6 $ (0.1 ) $ - $ 0.5
Employee termination and related benefits 1.2 (0.1 ) (0.2 ) 0.9
$ 1.8 $ (0.2 ) $ (0.2 ) $ 1.4
The accrued balance is included in accounts payable and accrued charges in
the Consolidated Statements of Financial Position as at March 31, 2004.
7. Income Taxes
The company's consolidated income tax rate for the current period
approximates 33 percent. In the first quarter of 2003, this rate approximated
40 percent. The decrease in rate is due primarily to the impact of Saskatchewan
resource tax incentives and changes to the Canadian federal resource allowance,
plus the scheduled Canadian federal statutory rate reduction.
8. Net Income Per Share
Basic net income per share for the quarter is calculated on the weighted
average shares issued and outstanding for the three months ended March 31, 2004
of 53,343,000 (2003 - 52,089,000). Diluted net income per share is calculated
based on the weighted average shares issued and outstanding during the period,
adjusted by the total of the additional common shares that would have been
issued assuming exercise of all
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stock options with exercise prices at or below the average market price for the
period. For periods in which there was a loss applicable to common shares, stock
options with exercise prices at or below the average market price for the period
were excluded for the calculations of diluted loss per share, as inclusion of
these securities would have been anti-dilutive to the net loss per share.
Weighted average shares outstanding for the diluted net income per share
calculation for the three months ended March 31, 2004 were 54,023,000 (2003 -
52,312,000).
9. Segment Information
The company has three reportable business segments: potash, phosphate and
nitrogen. These business segments are differentiated by the chemical nutrient
contained in the product that each produces. Inter-segment sales are made under
terms which approximate market prices.
Three Months Ended March 31, 2004
Potash Phosphate Nitrogen All Others Consolidated
Sales $ 223.7 $ 217.6 $ 287.1 $ - $ 728.4
Freight 33.5 15.7 8.9 - 58.1
Transportation and distribution 8.7 5.3 9.0 - 23.0
Net sales - third party 181.5 196.6 269.2 -
Cost of goods sold 114.8 197.5 211.0 - 523.3
Gross Margin 66.7 (0.9 ) 58.2 - 124.0
Depreciation and amortization 16.9 20.5 19.9 2.4 59.7
Inter-segment sales 2.9 3.1 21.8 - -
Three Months Ended March 31, 2003
Potash Phosphate Nitrogen All Others Consolidated
Sales $ 201.2 $ 191.1 $ 269.5 $ - $ 661.8
Freight 32.7 17.9 13.8 - 64.4
Transportation and distribution 8.0 4.8 10.2 - 23.0
Net sales - third party 160.5 168.4 245.5 -
Cost of goods sold 111.1 166.5 215.7 - 493.3
Gross Margin 49.4 1.9 29.8 - 81.1
Depreciation and amortization 15.3 18.6 23.2 1.9 59.0
Inter-segment sales 2.4 2.7 11.6 - -
10. Stock-Based Compensation
The company has two stock option plans. Prior to 2003, the company applied
the intrinsic value based method of accounting for the plans.
Effective December 15, 2003, the company adopted the fair value based
method of accounting for stock options prospectively to all employee awards
granted, modified, or settled after January 1, 2003. Prospective application of
the fair value method did not have an impact on the first three fiscal quarters
of 2003 since the company did not grant any options during those periods. Since
the company's stock option awards vest over two years, the compensation cost
included in the determination of net income for the first quarter of 2004 and
2003 is less than that which would have been recognized if the fair value based
method had been applied to all awards since the original effective date of CICA
Section 3870, "Stock-based Compensation and Other Stock-
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based Payments". The following table illustrates the effect on net income
(loss) and net income (loss) per share if the fair value based method had been
applied to all outstanding and unvested awards in each period.
Three Months Ended
March 31
2004 2003
Net income - as reported $ 50.7 $ 3.2
Add: Stock-based employee compensation expense included in
reported net income, net of related tax effects 2.2 -
Less: Total stock-based employee compensation expense determined
under fair value based method for all awards, net of
related tax effects (3.2 ) (3.7 )
Net income (loss) - pro forma(1) $ 49.7 $ (0.5 )
(1) Compensation expense under the fair value method is recognized over the
vesting period of the related stock options. Accordingly, the pro forma
results of applying this method may not be indicative of future results.
Basic net income (loss) per share
As reported $ 0.95 $ 0.06
Pro forma $ 0.93 $ (0.01 )
Diluted net income (loss) per share
As reported $ 0.94 $ 0.06
Pro forma $ 0.92 $ (0.01 )
In calculating the foregoing pro forma amounts, the fair value of each
option grant was estimated as of the date of grant using the Modified
Black-Scholes option-pricing model with the following weighted average
assumptions:
2003 2002 2001
Expected dividend $ 1.00 $ 1.00 $ 1.00
Expected volatility 27% 32% 32%
Risk-free interest rate 4.06% 4.13% 4.54%
Expected life of options 8 years 8 years 8 years
Expected forfeitures 16% 10% 10%
The fair value of options granted in the fourth quarter of 2003 was $15.7
(2002 - $20.1).
11. Post-Retirement/ Post-Employment Expenses
Three Months Ended
March 31
Pension Plans 2004 2003
Service cost $ 3.5 $ 3.0
Interest cost 7.5 7.4
Expected return on plan assets (8.4 ) (7.6 )
Amortization of net loss 1.1 1.3
Net expense $ 3.7 $ 4.1
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Three Months Ended
March 31
Other Post-retirement Plans 2004 2003
Service cost $ 1.4 $ 1.4
Interest cost 3.5 3.2
Amortization of net loss 0.4 0.5
Net expense $ 5.3 $ 5.1
Pension plan contributions to be paid by the company during 2004 are not
expected to differ significantly from the amounts previously disclosed in the
consolidated financial statements for the year ended December 31, 2003.
12. Seasonality
The company's sales of fertilizer are seasonal. Typically, the second
quarter of the year is when fertilizer sales will be highest, due to the North
American spring planting season. However, planting conditions and the timing of
customer purchases will vary each year and sales can be expected to shift from
one quarter to another.
13. Contingencies
PotashCorp is a shareholder in Canpotex which markets potash offshore.
Should any operating losses or other liabilities be incurred by Canpotex, the
shareholders have contractually agreed to reimburse Canpotex for such losses or
liabilities in proportion to their productive capacity. There were no such
operating losses or other liabilities during the first three months of 2004.
In common with other companies in the industry, the company is unable to
acquire insurance for underground assets.
The terms of a shareholders agreement with Jordan Investment Company
("JIC") provide that, from October 17, 2006 to October 16, 2009, JIC may seek to
exercise a put option (the "Put") to require the company to purchase JIC's
remaining common shares in Arab Potash Company ("APC"). If the Put were
exercised, the company's purchase price would be calculated in accordance with a
specified formula based, in part, on future earnings of APC. The amount, if any,
which the company may have to pay for JIC's remaining common shares if there was
to be a valid exercise of the Put is not presently determinable.
In 1998, the company, along with other parties, was notified by EPA of
potential liability under CERCLA with respect to certain soil and groundwater
conditions at a PCS Joint Venture blending facility in Lakeland, Florida and
certain adjoining property. In 1999, PCS Joint Venture signed an Administrative
Order on Consent with EPA pursuant to which PCS Joint Venture agreed to conduct
a Remedial Investigation and Feasibility Study ("RI/ FS") of these conditions.
PCS Joint Venture and another party are sharing the costs of the RI/ FS. PCS
Joint Venture continues to assess and evaluate the nature and extent of the
impacts at the site. No final determination has yet been made of the nature,
timing or cost of remedial action that may be needed nor to what extent costs
incurred may be recoverable from third parties.
Various other claims and lawsuits are pending against the company. While
it is not possible to determine the ultimate outcome of such actions at this
time, it is management's opinion that the ultimate resolution of such actions,
including those pertaining to environmental matters, will not have a material
adverse effect on the company's financial condition or results of operations.
14. Guarantees
The company enters into agreements in the normal course of business that
may contain features which meet the definition of a guarantee. Various debt
obligations (such as overdrafts, lines of credit with counterparties for
derivatives, and back-to-back loan arrangements) related to certain subsidiaries
have been directly guaranteed by the company under agreements with third
parties. The company would be required to
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perform on these guarantees in the event of default by the guaranteed parties.
No material loss is anticipated by reason of such agreements and guarantees. At
March 31, 2004, the maximum potential amount of future (undiscounted) payments
under significant guarantees provided to third parties approximated $73.4,
representing the maximum risk of loss if there were a total default by the
guaranteed parties, without consideration of possible recoveries under recourse
provisions or from collateral held or pledged. At March 31, 2004, no subsidiary
balances subject to guarantees were outstanding in connection with the company's
cash management facilities, and the company had no liabilities recorded for
other obligations other than subsidiary bank borrowings of approximately $5.9,
which are reflected in other long-term debt and cash margin requirements of
approximately $13.0 to maintain derivatives, which are included in accounts
payable and accrued charges.
Refer to Note 29 of our 2003 Annual Report for a description of other
guarantees relating to the company. There have been no significant changes to
these guarantees during the first three months of 2004.
15. Reconciliation of Canadian and United States Generally Accepted Accounting
Principles
Canadian GAAP varies in certain significant respects from US GAAP. As
required by the United States Securities and Exchange Commission ("SEC"), the
effect of these principal differences on the company's interim consolidated
financial statements is described and quantified below. For a complete
discussion of US and Canadian GAAP differences, see Note 34 to the consolidated
financial statements for the year ended December 31, 2003 in our 2003 Annual
Report.
Long-term investments: The company's investment in Israel Chemicals
Limited ("ICL") is stated at cost. US GAAP requires that this investment be
classified as available-for-sale and be stated at market value with the
difference between market value and cost reported as a component of Other
Comprehensive Income ("OCI").
Property, plant and equipment and goodwill: The net book value of
property, plant and equipment and goodwill under Canadian GAAP is higher than
under US GAAP, as past provisions for asset impairment under Canadian GAAP were
measured based on the undiscounted cash flow from use together with the residual
value of the assets. Under US GAAP they were measured based on fair value, which
was lower than the undiscounted cash flow from use together with the residual
value of the assets.
Pre-operating costs: Operating costs incurred during the start-up phase of
new projects are deferred under Canadian GAAP until commercial production levels
are reached, at which time they are amortized over the estimated life of the
project. US GAAP requires that these costs be expensed as incurred.
Post-retirement and post-employment benefits: Under Canadian GAAP, when a
defined benefit plan gives rise to an accrued benefit asset, a company must
recognize a valuation allowance for the excess of the adjusted benefit asset
over the expected future benefit to be realized from the plan asset. Changes in
the pension valuation allowance are recognized in income. US GAAP does not
specifically address pension valuation allowances, and the US regulators have
interpreted this to be a difference between Canadian and US GAAP. In light of
these developments, a difference between Canadian and US GAAP has been recorded
for the effects of recognizing a pension valuation allowance and the changes
therein under Canadian GAAP.
The company's accumulated benefit obligation for its US pension plans
exceeds the fair value of plan assets. US GAAP requires the recognition of an
additional minimum pension liability in the amount of the excess of the unfunded
accumulated benefit obligation over the recorded pension benefits liability. An
offsetting intangible asset is recorded equal to the unrecognized prior service
costs, with any difference recorded as a reduction of accumulated OCI. No
similar requirement exists under Canadian GAAP.
Foreign currency translation adjustment: The company adopted the US dollar
as its functional and reporting currency on January 1, 1995. At that time, the
consolidated financial statements were translated into US dollars at the
December 31, 1994 year-end exchange rate using the translation of convenience
method under Canadian GAAP. This translation method was not permitted under US
GAAP. US GAAP required the comparative Consolidated Statements of Income and
Consolidated Statements of Cash Flow to be translated at applicable
weighted-average exchange rates; whereas, the Consolidated Statements of
Financial Position were permitted to be translated at the December 31, 1994
year-end exchange rate. The use of disparate
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exchange rates under US GAAP gave rise to a foreign currency translation
adjustment. Under US GAAP, this adjustment is reported as a component of
accumulated OCI.
Derivative instruments and hedging activities: Under Canadian GAAP, income
and expenses on derivative instruments designated as and qualifying as effective
fair value hedges or cash flow hedges are recognized in earnings in the same
period as the related hedged item. Gains or losses arising from settled natural
gas hedging transactions are deferred as a component of inventory until the
product containing the hedged item is sold, at which time both the natural gas
purchase cost and the related hedging deferral are recorded as cost of goods
sold. Derivatives associated with ineffective hedging relationships and hedges
not designated in a hedging relationship are carried at fair value on the
Consolidated Statement of Financial Position, and subsequent changes in their
fair value are recorded in earnings. In accordance with SFAS No. 133 "Accounting
for Derivative Instrument and Hedging Activities" and its related
interpretations and amendments under US GAAP, the company records all
derivatives as either assets or liabilities on the Consolidated Statements of
Financial Position and measures those instruments at fair value. For derivatives
that are designated as and qualify as effective cash flow hedges, the portion of
gain or loss on the derivative instrument effective at offsetting changes in the
hedged item is reported as a component of accumulated OCI and reclassified into
earnings as cost of goods sold when the hedged transaction affects earnings. For
derivative instruments that are designated as and qualify as effective fair
value hedges, the gain or loss on the derivative instrument as well as the
offsetting gain or loss on the hedged item attributable to the hedged risk is
recognized in earnings as interest expense in the period the changes in fair
value occur. Ineffective portions of cash flow or fair value hedges are recorded
in earnings in the current period. Derivatives not designated as hedging
instruments are marked to market through earnings in the period the changes in
fair value occur.
Freight, transportation and distribution: The company has changed its
accounting policy regarding consolidated financial statement presentation of
freight costs and transportation and distribution expenses under US GAAP. In
prior years, the company included freight costs in cost of goods sold and
transportation and distribution expenses in operating expenses under US GAAP.
Effective January 1, 2004, the company discloses freight costs and
transportation and distribution expenses under US GAAP as separate line items
within gross margin on the Consolidated Statements of Operations and Retained
Earnings. This presentation is consistent with the new Canadian GAAP
presentation described in Note 2. All comparative information has been
appropriately reclassified.
Depreciation and amortization: Depreciation and amortization under
Canadian GAAP is higher than under US GAAP, as a result of differences in the
carrying amounts of property, plant and equipment and goodwill under Canadian
and US GAAP.
Comprehensive income: Comprehensive income is recognized and measured
under US GAAP pursuant to SFAS No. 130 "Reporting Comprehensive Income". This
standard defines comprehensive income as all changes in equity other than those
resulting from investments by owners and distributions to owners. Comprehensive
income is comprised of two components, net income and OCI. OCI refers to amounts
that are recorded as an element of shareholders' equity but are excluded from
net income because these transactions or events were attributed to changes from
non-owner sources. The concept of comprehensive income does not yet exist under
Canadian GAAP.
Income taxes: The income tax adjustment reflects the impact on income
taxes of the US GAAP adjustments described above. Accounting for income taxes
under Canadian and US GAAP is similar, except that income tax rates of enacted
or substantively enacted tax law must be used to calculate future income tax
assets and liabilities under Canadian GAAP; whereas only income tax rates of
enacted tax law can be used under US GAAP.
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The application of US GAAP, as described above, would have had the
following effects on net income, net income per share, total assets,
shareholders' equity and other comprehensive income:
Three Months Ended
March 31
2004 2003
(unaudited)
Net income as reported - Canadian GAAP $ 50.7 $ 3.2
Items increasing or decreasing reported net income
Pre-operating costs - 1.3
Depreciation and amortization 2.1 2.1
Accretion of asset retirement obligations 3.3 (0.8 )
Future income taxes (2.0 ) (1.0 )
Net income - US GAAP $ 54.1 $ 4.8
Weighted average shares outstanding - US GAAP 53,343,000 52,089,000
Basic net income per share - US GAAP $ 1.01 $ 0.09
Diluted net income per share - US GAAP $ 1.00 $ 0.09
March 31, December 31,
2004 2003
(unaudited)
Total assets as reported - Canadian GAAP $ 4,538.5 $ 4,567.3
Items increasing (decreasing) reported total assets
Inventory (3.6 ) (2.7 )
Available-for-sale securities (unrealized holding
gain) 61.1 35.0
Fair value of derivative instruments 79.0 59.8
Property, plant and equipment (132.8 ) (134.9 )
Post-retirement and post-employment benefits 13.9 13.9
Intangible asset relating to additional minimum
pension liability 2.7 2.7
Goodwill (46.7 ) (46.7 )
Total assets - US GAAP $ 4,512.1 $ 4,494.4
March 31, December 31,
2004 2003
(unaudited)
Total shareholders' equity as reported - Canadian GAAP $ 2,033.6 $ 1,973.8
Items increasing (decreasing) reported shareholders'
equity
Accumulated other comprehensive income, net of
related income taxes 40.8 14.8
Foreign currency translation adjustment 20.9 20.9
Accretion of asset retirement obligations - (3.3 )
Provision for asset impairment (218.0 ) (218.0 )
Depreciation and amortization 38.5 36.4
Post-retirement and post-employment benefits 13.9 13.9
Future income taxes 32.7 34.7
Shareholders' equity - US GAAP $ 1,962.4 $ 1,873.2
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Three Months Ended
March 31
2004 2003
(unaudited)
Net income - US GAAP $ 54.1 $ 4.8
Other comprehensive income
Change in unrealized holding gain on available-for-sale
securities 26.1 1.0
Change in gains and losses on derivatives designated as
cash flow hedges 23.2 43.8
Reclassification to income of gains and losses on cash
flow hedges (10.5 ) (27.0 )
Future income taxes related to other comprehensive
income (12.8 ) (7.1 )
Other comprehensive income, net of related income taxes 26.0 10.7
Comprehensive income - US GAAP $ 80.1 $ 15.5
The balances related to each component of accumulated other comprehensive
income, net of related income taxes, are as follows:
March 31, December 31,
2004 2003
(unaudited)
Unrealized gains and losses on available-for-sale
securities $ 40.0 $ 22.6
Gains and losses on derivatives designated as cash flow
hedges 51.7 43.1
Additional minimum pension liability (30.0 ) (30.0 )
Foreign currency translation adjustment (20.9 ) (20.9 )
Accumulated other comprehensive income - US GAAP $ 40.8 $ 14.8
Supplemental US GAAP Disclosures
Recent Accounting Pronouncements
In December 2003, the FASB revised FIN No. 46 "Consolidation of Variable
Interest Entities", which clarifies the application of Accounting Research
Bulletin No. 51 "Consolidated Financial Statements" to those entities (defined
as Variable Interest Entities ("VIEs")) in which either the equity at risk is
not sufficient to permit that entity to finance its activities without
additional subordinated financial support from other parties, or equity
investors lack voting control, an obligation to absorb expected losses or the
right to receive expected residual returns. FIN No. 46 requires consolidation by
a business of VIEs in which it is the primary beneficiary. The primary
beneficiary is defined as the party that has exposure to the majority of the
expected losses and/or expected residual returns of the VIE. FIN No. 46 was
effective for the company in the first quarter, and there was no material impact
on its financial position, results of operations or cash flows from adoption. In
Canada, Accounting Guideline 15 "Consolidation of Variable Interest Entities"
has harmonized with FIN No. 46 and is effective for the company no later than
December 31, 2004. The company expects no material impact on its financial
position, results of operations or cash flows from adoption.
In December 2003, the SEC issued Staff Accounting Bulletin (SAB) No. 104
"Revenue Recognition," which supersedes SAB No. 101. The primary purpose of
SAB No. 104 is to rescind accounting guidance contained in SAB No. 101 and the
SEC's "Revenue Recognition in Financial Statements Frequently Asked Questions
and Answers" related to multiple element revenue arrangements. The changes noted
in SAB No. 104 did not have a material impact on the company's financial
position, results of operations, or cash flows.
In December 2003, the Medicare Prescription Drug Improvement and
Modernization Act of 2003 (the "Act") was signed into law. The Act introduces a
prescription drug benefit beginning in 2006 under Medicare (Medicare Part D) as
well as a federal subsidy to sponsors of retiree health care benefit plans that
provide a benefit that is at least actuarially equivalent to Medicare Part D. At
this point, the company's analysis regarding the impact of the legislation is
preliminary, as it awaits guidance from various governmental and
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regulatory agencies concerning the requirements that must be met to obtain these
cost reductions, as well as the manner in which such savings should be measured.
Based on this preliminary analysis, the company expects that the legislation
will eventually reduce its costs for some of its programs; however, the benefit
derived is not expected to be material to its consolidated financial position,
results of operations or cash flows. Some of the company's retiree medical plans
may need to be modified in order to qualify for beneficial treatment under the
Act. Because of the various uncertainties related to this legislation and the
appropriate accounting treatment, the company elected to defer financial
recognition until final accounting guidance is issued by FASB. When issued, the
final guidance could require the company to change previously reported
information. This deferral election is permitted under FSP No. 106-1,
"Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003". FASB has issued a proposed FSP
on the accounting treatment that, if approved, would be effective in the
company's third quarter.
Available-For-Sale Security
The company's investment in ICL is classified as available-for-sale. The
fair market value of this investment at March 31, 2004 was $179.5 and the
unrealized holding gain was $86.7.
Stock-Based Compensation
Prior to 2003, the company applied the intrinsic value based method of
accounting for its stock option plans under US GAAP. Effective December 15,
2003, the company adopted the fair value based method of accounting for stock
options prospectively to all employee awards granted, modified or settled after
January 1, 2003 pursuant to the transitional provisions of SFAS No. 148
"Accounting for Stock-Based Compensation - Transition and Disclosure".
Prospective application of the fair value method did not have an impact on the
first three fiscal quarters of 2003 since the company did not grant any options
during those periods. Since the company's stock option awards vest over two
years, the compensation cost included in the determination of net income for
2004 and 2003 is less than that which would have been recognized if the fair
value based method had been applied to all awards since the original effective
date of SFAS No. 123 "Accounting for Stock-Based Compensation". The following
table illustrates the effect on net income and net income per share under
US GAAP if the fair value based method had been applied to all outstanding and
unvested awards in each period.
Three Months Ended
March 31
2004 2003
(unaudited)
Net income - as reported under US GAAP $ 54.1 $ 4.8
Add: Stock-based employee compensation expense included in
reported net income, net of related tax effects 2.2 -
Less: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effects (3.2 ) (3.7 )
Net income - pro forma under US GAAP(1) $ 53.1
(1) Compensation expense under the fair value method is recognized over the
vesting period of the related stock options. Accordingly, the pro forma
results of applying this method may not be indicative of future results.
Basic net income per share under US GAAP
As reported $ 1.01 $ 0.09
Pro forma $ 1.00 $ 0.02
Diluted net income per share under US GAAP
As reported $ 1.00 $ 0.09
Pro forma $ 0.98 $ 0.02
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Derivative Instruments and Hedging Activities
The company formally documents all relationships between hedging
instruments and hedged items, as well as its risk-management objective and
strategy for undertaking various hedge transactions. This process includes
attributing derivatives that are designated as cash flow hedges to floating rate
assets or liabilities or forecasted transactions and attributing derivatives
that are designated as fair value hedges to fixed rate assets or liabilities.
The company also formally assesses, both at the inception of the hedge and on an
ongoing basis, whether each derivative is highly effective in offsetting changes
in cash flows or fair value of the hedged item. Fluctuations in the value of the
derivative instruments are generally offset by changes in the hedged item;
however, if it is determined that a derivative is not highly effective as a
hedge or if a derivative is sold, expires or ceases to be a highly effective
hedge, the company will discontinue hedge accounting prospectively for the
affected derivative.
Cash Flow Hedges
The company has designated its natural gas derivative instruments as cash
flow hedges. The company's natural gas purchase strategy is based on
diversification of price for its total gas requirements. The objective is to
acquire a reliable supply of natural gas feedstock and fuel on a
location-adjusted, cost-competitive basis in a manner that minimizes volatility
without undue risk. The company employs derivative instruments including
futures, swaps and option agreements in order to manage the cost on a portion of
its natural gas requirements. These instruments are intended to hedge the future
cost of the committed and anticipated natural gas purchases primarily for its US
nitrogen plants. The maximum period for these hedges cannot exceed five years.
The company uses these instruments to reduce price risk, not for speculative
purposes.
The portion of gain or loss on derivative instruments designated as cash
flow hedges that are effective at offsetting changes in the hedged item is
reported as a component of accumulated OCI and then is reclassified into cost of
goods sold when the product containing the hedged item is sold. Any hedge
ineffectiveness is recorded in cost of goods sold in the current period. During
the quarter, a gain of $10.5 was recognized in cost of goods sold. Of the
deferred gains at quarter-end, approximately $42.3 will be reclassified to cost
of goods sold within the next 12 months. The fair value of the company's gas
hedging contracts at March 31, 2004 was $73.5. The ineffectiveness of hedges on
existing derivative instruments for the quarter ended March 31, 2004 was not
material.
Fair Value Hedges
The company primarily uses interest rate swaps to manage the interest rate
mix of the total debt portfolio and related overall cost of borrowing. At
March 31, 2004, the company had entered into interest rate swap agreements with
total notional amounts of $300.0, whereby the company, over the remaining terms
of the underlying notes, will receive a fixed rate payment equivalent to the
fixed interest rate of the underlying note and pay a floating rate of interest
that is based on six-month US dollar LIBOR. The fair value of the swaps
outstanding at March 31, 2004 was an asset of $5.5. All interest rate swaps
qualify for the shortcut method of hedge accounting, thus there is no
ineffectiveness related to these hedges. Changes in the fair value of
derivatives that hedge interest rate risk are recorded in interest expense each
period. The offsetting changes in the fair values of the related debt are also
recorded in interest expense. The company does not maintain any other fair value
hedges.
16. Comparative Figures
Certain of the prior period's figures have been reclassified to conform
with the current period's presentation.
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