MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
On November 24, 2003, our parent, UAP Holding
Corp., acquired the United States and Canadian agricultural inputs businesses of ConAgra Foods in a series of transactions referred to in this prospectus as the “Acquisition” and described in this prospectus in this section under the
heading “Prospectus Summary—The Transactions.” In this prospectus, the term “ConAgra Agricultural Products Business” means the entities that were historically operated by ConAgra Foods as an integrated business, which
included a wholesale fertilizer and other international crop distribution businesses that we did not acquire in the Acquisition. The businesses not acquired are reflected as discontinued operations within the ConAgra Agricultural Products Business
financial statements.
The following discussion
and analysis of our financial condition and results of operations covers periods, in some instances, prior to the Acquisition. Accordingly, the discussion and analysis of historical periods prior to November 24, 2003 do not reflect the significant
impact that the Acquisition had on us. In addition, the statements in the discussion and analysis regarding industry outlook, our expectations regarding the performance of our business, our liquidity and capital resources and the other
non-historical statements in the discussion and analysis are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in
“Risk Factors.” Our actual results may differ materially from those contained in or implied by any forward-looking statements. You should read the following discussion together with the sections entitled “Risk Factors,”
“Unaudited Pro Forma Condensed Consolidated Financial Data,” “Selected Historical Financial and Other Data” and the historical consolidated and combined financial statements and the accompanying notes thereto of the Successor and
Predecessor included elsewhere in this prospectus.
BACKGROUND
Founded in 1978, we are the largest private
distributor of agricultural and non-crop inputs in the United States and Canada. We market a comprehensive line of products including crop protection chemicals, seeds and fertilizers to growers and regional dealers. As part of our product offering,
we provide a broad array of value-added services including crop management, biotechnology advisory services, custom blending, inventory management and custom applications of crop inputs. The products and services we offer are critical to growers
because they lower the overall cost of crop production and improve crop quality and yield. As a result of our broad scale and scope, we provide leading agricultural input companies with an efficient means to access a highly fragmented customer base
of farmers and growers.
At the end of fiscal 2002,
our new management team began to implement several strategic initiatives to increase our operational efficiency. As part of that strategy, we enhanced our credit policies and information systems, improved inventory management, rationalized headcount
and closed unprofitable distribution centers.
Our
implementation of new credit policies has reduced average trade accounts receivables and overall selling, general and administrative costs by lowering bad debt expense. Improved inventory management, including central purchasing, product mix
enhancement, SKU rationalization and enhanced sharing of existing stocks have resulted in lower average inventory levels and higher margins. Headcount reductions and location closures have contributed to lower supply chain and selling, general and
administrative costs. Our financial and operational success has been driven by providing customers with high quality products at competitive prices, supported by consistent and reliable service and expertise. We will continue to seek to grow our
business, improve margins and reduce working capital through the following principal strategies:
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Expanding our presence in seeds, branded and non-crop products; and
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Targeting continued margin enhancement and working capital management.
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Our net sales and our income from continuing operations before income taxes for the twelve-month period ended August 29, 2004 were approximately
$2,564.1 million and $75.1 million, respectively, on a pro forma
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basis for the Acquisition. For fiscal years 2004 and 2003, our net sales were approximately $2,451.9 million and $2,526.8 million, respectively, and our
income from continuing operations before income taxes was approximately $68.5 million (on a pro forma basis for the Acquisition) and $48.2 million, respectively. The improvement in income from continuing operations before income taxes since fiscal
2003 is a result of a series of initiatives taken since current management joined in the middle of fiscal 2002. The initiatives taken to improve the overall profitability of the business included rationalized headcount, locations, customers, and
product lines. Accordingly, we believe that our income from continuing operations before income taxes for fiscal 2003 is not indicative of our income from continuing operations before income taxes for subsequent periods as the complete impact of
those management initiatives was not realized by us until fiscal 2004.
SEASONALITY
Our and our
customers’ businesses are seasonal, based upon the planting, growing and harvesting cycles. During fiscal 2003 and 2004, at least 75% of our net sales occurred during the first and second fiscal quarters of each year because of the condensed
nature of the planting season. As a result of the seasonality of sales, we experience significant fluctuations in our revenues, income and net working capital levels. Since 2002, however, we have taken steps to reduce working capital, including
improved inventory payable management, centralized purchasing and SKU reduction programs. In addition, our integrated network of formulation and blending, distribution and warehousing facilities and technical expertise allows us to efficiently
process, distribute and store product close to our end-users and to supply our customers on a timely basis during the compressed planting and growing season.
Due to the seasonal nature of our business, the amount of borrowings outstanding under the revolving credit facility
varies significantly throughout the fiscal year. During the period from the date of the Acquisition through October 24, 2004, outstanding borrowings (net of cash on hand) reached a period end peak of $275.2 million as of October 24, 2004. During the
same period, utilization of the revolving credit facility was at its lowest when we had $172.6 million of cash on hand as of February 22, 2004. Our average period end borrowings (net of cash on hand) on a historical basis for the twelve-month period
ended October 24, 2004, were approximately $76.5 million.
FINANCIAL INFORMATION
Accounting principles generally accepted in the United States of America require our operating results prior to the Acquisition, the periods prior to November 23, 2003, to be reported as the results of the Predecessor in our historical
financial statements. Our operating results subsequent to the Acquisition are presented as the “Successor’s” results in the historical financial statements and include the thirteen week period from November 24, 2003 through
February 22, 2004 and the twenty-seven week period from February 23, 2004 through August 29, 2004.
The information presented below for the fiscal year ended February 22, 2004 (Pro Forma) has been derived by combining the historical statement of
operations data of United Agri Products, Inc. (the “Successor”) for the thirteen weeks ended February 22, 2004 with the historical statement of operations data of the Predecessor for the thirty-nine weeks ended November 23, 2003 and
applying the pro forma adjustments for the Acquisition. The pro forma statement of operations for the 52 weeks ended February 22, 2004 should be read in conjunction with the “Unaudited Pro Forma Condensed Consolidated Financial Data.” The
information for the twenty-seven weeks ended August 29, 2004 represent the results of operations of the Successor. The information for the fiscal year ended February 23, 2003 and February 24, 2002, and for the twenty-six week period ended August 24,
2003, represent the results of operations of the Predecessor.
The results of operations for any twenty-seven or twenty-six week period are not necessarily indicative of the results to be expected for the full fiscal year.
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TWENTY-SEVEN WEEKS ENDED AUGUST 29, 2004 COMPARED TO TWENTY-SIX WEEKS ENDED AUGUST 24, 2003
Net Sales
. Sales
increased to $1,962.5 million in the twenty-seven weeks ended August 29, 2004 compared to $1,850.2 million for the twenty-six weeks ended August 24, 2003. Sales of crop protection chemicals rose to $1,257.7 million in the twenty-seven weeks ended
August 29, 2004 from $1,221.7 million in the twenty-six weeks ended August 24, 2003. This increase was due to higher chemical volumes across the mid-south and southwest, and higher sales of proprietary products, offset by lower insecticide sales in
the midwest. Sales of fertilizer rose to $409.3 million in the twenty-seven weeks ended August 29, 2004 from $370.5 million for the twenty-six weeks ended August 24, 2003, due to higher pricing, specifically in nitrogen-based fertilizers, and
slightly higher volumes. Sales of seed rose to $260.0 million in the twenty-seven weeks ended August 29, 2004 from $208.7 million for the twenty-six weeks ended August 24, 2003, due to volume growth and slightly higher prices due to increased sales
of seed with enhanced traits. Sales of other products decreased to $35.5 in the twenty-seven weeks ended August 29, 2004 from $49.3 million for the twenty-six weeks ended August 24, 2003, due to lower animal feed sales resulting from the divestment
of our Montana feed division.
Cost of Goods
Sold
. Cost of goods sold was $1,719.7 million in the twenty-seven weeks ended August 29, 2004 compared to $1,588.3 million for the twenty-six weeks ended August 24, 2003. Gross profit (net sales less cost of goods sold)
was $242.8 million in the twenty-seven weeks ended August 29, 2004 compared to $261.9 million for the twenty-six weeks ended August 24, 2003. Gross margin (gross profit as a percentage of net sales) decreased to 12.4% in the twenty-seven weeks ended
August 29, 2004 compared to 14.2% for the twenty-six weeks ended August 24, 2003. Gross profits declined for the following reasons: a $17.4 million dollar fair market adjustment to the inventory on hand on the date of the Acquisition that was sold
during the twenty-seven week period ended August 29, 2004, higher delivery costs due to the price of fuel, and lower upfront pricing for our sales of glyphosate herbicides due to a product mix shift to lower-priced products. These items were
slightly offset by an increase in chemical and seed rebates due to a change in our monthly rebate estimation process.
Selling, General and Administrative Expenses
. Direct selling, general and administrative (“SG&A”) expenses
decreased slightly by $0.7 million to $153.1 million in the twenty-seven weeks ended August 29, 2004 from $154.1 million for the twenty-six weeks ended August 24, 2003. SG&A expenses were 7.8% of sales during the twenty-seven weeks ended August
29, 2004, and 8.3% of sales during for the twenty-six weeks ended August 24, 2003. The lower SG&A expenses are due to lower labor and location expenses as a result of our location rationalization efforts and increased recoveries of bad debts.
These were offset by additional expenses associated with our transition services agreement with ConAgra ($3.8 million), and an extra week of expenses in the current period.
Interest Expense
. Interest expense was $10.5 million in the twenty-seven weeks ended
August 29, 2004, which related primarily to the 8¼% Senior Notes. This expense is net of finance charge income of $3.9 million. Third party interest expense was $0.3 million for the twenty-six weeks ended August 24, 2003, which related to a
vendor financing program. Interest expense to ConAgra Foods for the final settlement payment was $1.9 million. Interest included interest and penalty interest on the 8¼% Senior Notes and the revolving credit facility, and amortization of
initial revolving credit facility fees and costs relating to the issuance of the 8¼% Senior Notes of $1.1 million.
Corporate Allocations—Selling, General and Administrative
. Corporate allocations include charges that have been
allocated by ConAgra Foods and recorded as an expense for corporate services, including executive, finance and tax. Expenses incurred by ConAgra Foods and allocated to the ConAgra Agricultural Products Business are determined based on the specific
services being provided or are allocated based on ConAgra Foods’ investment in the ConAgra Agricultural Products Business in proportion to ConAgra Foods’ total investment in its subsidiaries. Such expenses are included in allocated
selling, general and administrative expenses and were $6.1 million in the twenty-six weeks ended August 24, 2003.
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Corporate Allocations—Finance Charges
. Corporate allocations also
include finance charges that have been allocated by ConAgra Foods based on ConAgra Foods’ investment in the ConAgra Agricultural Products Business in proportion to ConAgra Foods’ total investment in its subsidiaries. ConAgra Foods
allocated finance costs of $8.3 million in the twenty-six weeks ended August 24, 2003.
Income Taxes
. The effective income tax rate was 39.0% for the twenty-seven weeks ended August 29, 2004 compared with 38.0%
for the twenty-six weeks ended August 24, 2003.
FIFTY-TWO WEEKS ENDED FEBRUARY 22, 2004 (PRO FORMA) COMPARED TO FIFTY-TWO WEEKS ENDED FEBRUARY 23, 2003
Net Sales.
Sales declined to $2,451.9 million in fiscal 2004 from $2,526.8 million in fiscal 2003. Sales of crop protection
chemicals declined to $1,579.7 million in fiscal 2004 from $1,661.3 million in fiscal 2003. The decline was largely due to the reduced number of locations from our rationalization efforts throughout the year and a more restrictive customer credit
policy. Sales of fertilizer rose to $526.2 million in fiscal 2004 from $510.6 million in fiscal 2003, due to slightly higher pricing throughout the year. Sales of seed declined to $258.9 million in fiscal 2004 from $270.8 million as store
rationalizations offset volume growth. Sales of other products increased to $87.1 from $84.1 million.
Costs of Goods Sold.
Cost of goods sold was $2,108.7 million in fiscal 2004 compared with $2,166.6 million in fiscal 2003.
Gross profit (net sales less cost of goods sold) was $343.2 million in fiscal 2004 compared with $360.2 million in fiscal 2003; while gross margin (gross profit as a percentage of net sales) was 14.0% in fiscal 2004 compared with 14.3% in fiscal
2003. Gross profits declined due to fewer sales due to location closures and a $3.7 million dollar charge to cost of goods sold from the purchase price allocation of the acquisition.
Selling, General and Administrative Expenses.
Selling, general and administrative
(“SG&A”) expenses decreased to $245.0 million in fiscal 2004 from $275.2 million fiscal 2003 period. SG&A expenses were 10.0% of sales during fiscal 2004 and 10.9% of sales during fiscal 2003. The decline in SG&A expenses is
the result of reduced location expenses associated with the closure of unprofitable locations, gains from the sale of two formulation facilities and the Montana feed business, and lower expenses in the formulation plants as a result of consolidation
efforts.
Interest
Expense.
Third party interest expense was $4.6 million during fiscal 2004, on a pro forma basis for the Acquisition. Third party interest expense was $1.9 million in fiscal 2003, which related to a vendor financing
program.
Corporate Allocations—Selling,
general and administrative.
Corporate allocations include charges that have been allocated by ConAgra Foods and recorded as an expense for corporate services, including executive, finance and tax. Expenses incurred by
ConAgra Foods and allocated to the ConAgra Agricultural Products Business are determined based on the specific services being provided or are allocated based on ConAgra Foods’ investment in the ConAgra Agriculture Products Business in
proportion to ConAgra Foods’ total investment in its subsidiaries. Such expenses are included in allocated selling, general and administrative expenses and are $9.0 million and $10.8 million in fiscal 2004 and fiscal 2003, respectively.
Corporate Allocations—Finance
Charges.
Corporate allocations also include finance charges that have been allocated by ConAgra Foods based on ConAgra Foods’ investment in the ConAgra Agricultural Products Business in proportion to ConAgra
Foods’ total investment in its subsidiaries. ConAgra Foods assessed finance costs of $12.2 million and $22.5 million in fiscal 2004 and fiscal 2003, respectively.
Income Taxes.
The effective income tax rate was 37.9% for fiscal 2004 compared with 38.9%
for fiscal 2003. The decrease in the effective rate was due to the impact of permanent tax differences.
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FISCAL 2003 COMPARED TO FISCAL 2002
Net Sales.
Net sales were $2,526.8 million in fiscal 2003 compared with
$2,770.2 million in fiscal 2002. Net sales of crop protection chemicals declined to $1,661.3 million in fiscal 2003 from $1,826.4 million in fiscal 2002 due largely to the impact of our implementation of strategic initiatives to change customer
mix, product mix, and the rationalization of unprofitable locations. Net sales of fertilizer declined to $510.6 million in fiscal 2003 from $581.0 million in fiscal 2002 on lower prices and volumes primarily due to lower fall applications of
fertilizer. Net sales of seed declined to $270.8 million in fiscal 2003 from $282.8 million in fiscal 2002 due largely to the impact of our implementation of the previously described strategic initiatives to change customer mix and location
rationalization, partially offset by continued volume growth in existing locations. Net sales of other products increased 5.1% to $84.1 million.
Cost of Goods Sold.
Cost of goods sold was $2,166.6 million in fiscal 2003, compared with $2,428.2 million in fiscal 2002.
Gross profit was $360.2 million in fiscal 2003, compared with $342.0 million in fiscal 2002; while gross margin was 14.3% in fiscal 2003 compared with 12.3% in fiscal 2002. Gross margin improved principally due to a more profitable product mix
and lower supply chain costs due to the rationalization of unprofitable locations. Gross margin was also favorably impacted by increased rebate income as a percentage of net sales and improved inventory management resulting in lower inventory
write-offs and markdowns in fiscal 2003. These improvements helped offset the gross profit impact from the decline in net sales. Fiscal 2002 gross margin was unfavorably impacted by fertilizer inventory write-offs of approximately $29.6 million.
Selling, General and Administrative
Expenses.
SG&A expenses decreased to $275.2 million in fiscal 2003 from $334.6 million in fiscal 2002. SG&A expenses were 10.9% of net sales during fiscal 2003, compared with 12.1% of net sales during fiscal 2002.
The decline was due largely to lower bad debt expenses from selling to a more profitable customer mix, and reduced administrative and operating expenses associated with cost management initiatives including, the closure of unprofitable locations.
Fiscal 2002 selling, general and administrative expenses were unfavorably impacted by bad debt expense of approximately $29.2 million due to unfavorable industry conditions.
Interest Expense.
Interest expense decreased to $1.9 million in fiscal 2003 from $5.4 million
in fiscal 2002, due to decreased purchasing activity under a vendor finance program.
Corporate Allocations—Selling, General and Administrative.
Corporate allocations include charges that have been allocated by ConAgra Foods and recorded as an expense for corporate
services, including executive, finance, and tax. Expenses incurred by ConAgra Foods and allocated to the ConAgra Agricultural Products Business are determined based on the specific services being provided or are allocated based on ConAgra
Foods’ investment in the ConAgra Agricultural Products Business in proportion to ConAgra Foods’ total investment in its subsidiaries. Such expenses are included in allocated selling, general and administrative expenses and were $10.8
million and $10.5 million in fiscal 2003 and fiscal 2002, respectively.
Corporate Allocations—Finance Charges.
Corporate allocations also include finance charges that have been allocated by ConAgra Foods based on ConAgra Foods’ investment in the
ConAgra Agricultural Products Business in proportion to ConAgra Foods’ total investment in its subsidiaries. ConAgra Foods allocated finance costs of $22.5 million and $39.5 million in fiscal 2003 and fiscal 2002, respectively.
Income Taxes.
The effective income tax rate
was 38.9% for fiscal 2003, compared with 36.0% for fiscal 2002. The increase in the effect rate was due to the impact of permanent tax differences.
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LIQUIDITY AND CAPITAL RESOURCES
Overview
Our principal liquidity requirements are for working capital, consisting primarily of receivables, inventories, pre-paid expenses, reduced by accounts
payable and accrued expenses; capital expenditures; debt service; and dividends to our parent.
We will fund our liquidity needs, including distributions to UAP Holdings, with cash generated from operations and, to the extent necessary, through
borrowings under our revolving credit facility. In addition, as noted below, we expect to fund any growth capital expenditures with cash generated from operations, reductions in working capital and incremental debt. As of August 29, 2004 and
February 22, 2004, we had $180.3 million and $0.0 million, respectively, outstanding under our revolving credit facility. The revolving credit facility is included in our financial statements as part of our short-term debt.
We believe that our cash flows from operating activities and borrowing
capabilities under our revolving credit facility will be sufficient to meet our liquidity requirements in the foreseeable future, including funding of capital expenditures and payment obligations under our debt service.
If our cash flows from operating activities are insufficient to
fund distributions to UAP Holdings in order to enable it to fund its dividend payments at intended levels, we may need to fund such distributions with borrowings (to the extent we are permitted to do so under our debt agreements) or from other
sources. If we use working capital or permanent borrowings to fund such distributions, we will have less cash available to make principal and interest payments with respect to the notes. Additionally, our revolving credit facility will mature in
2008. If we are unable to refinance such indebtedness prior to its stated maturity, we will be required to use cash to repay such indebtedness, and we may not have sufficient cash available to us at that time. Even if we do have sufficient cash,
such repayment would significantly decrease the amount of cash, if any, to make principal and interest payments with respect to the notes.
Historical Cash Flow from Operating Activities
Historically, the ConAgra Agricultural Products Business’ sources of cash were primarily cash flows from operations and advances received from
ConAgra Foods.
The information presented below for
the fiscal year ended February 22, 2004 (Pro Forma) has been derived by combining the cash flow activity of the Successor for the thirteen weeks ended February 22, 2004 with the cash flow activity of the Predecessor for the thirty-nine weeks ended
November 23, 2003 and applying the pro forma adjustments for the Acquisition. The information for the twenty-seven weeks ended August 29, 2004 represent the cash flow activity of the Successor. The information for the fiscal year ended February 23,
2003 and February 24, 2002 represent the cash flow activity of the Predecessor.
Cash flows provided by (used in) operating activities totaled $(313.3) million in the twenty-seven weeks ended August 29, 2004 and $(129.5) million for the twenty-six weeks ended August 24, 2003. The usage in the
twenty-seven weeks ended August 29, 2004 was due to higher accounts receivable due to increased sales, offset by lower inventories and higher payables due to better inventory payable management. The usage in the twenty-six weeks ended August 24,
2003 was primarily due to higher accounts receivable and inventories, offset by higher payables. The increased usage in the current period versus the prior period was due to the purchasing of inventory closer to the seasonal use in the current
period, as opposed to prepaying for inventory as in the prior period.
Cash flows provided by (used in) operating activities totaled $341.8 million, ($266.8) million and $120.7 million in fiscal 2004, 2003 and 2002, respectively. The increase in fiscal 2004 was due to
improvements in working capital, including better inventory payable management due to a lower participation by us in early purchasing programs from our suppliers. The decrease in fiscal 2003 was primarily due to prepayments to various suppliers for
early payment discounts on crop protection chemicals and lower year-end accounts payable to suppliers. This was partially offset by lower inventories and increased earnings.
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Cash flows used in investing activities totaled $62.9 million in the twenty-seven weeks ended August
29, 2004 and $5.7 million for the twenty-six weeks ended August 24, 2003. The post-closing settlement in June 2004 accounted for $58.2 million of the investing activity. The remaining investing activities primarily represent expenditures for
property, plant and equipment.
Cash flows used in
investing activities totaled $653.1 million, $4.0 million and $12.8 million in fiscal 2004, 2003 and 2002, respectively. The increase in cash used in investing activities in fiscal 2004 was due to the Acquisition. Cash flows used in investing
activities include capital expenditures for property, plant and equipment, which totaled $15.3 million, $6.4 million and $13.6 million in fiscal 2004, 2003 and 2002, respectively.
Cash flows provided by financing activities were $216.9 million in the twenty-seven weeks ended August 29, 2004 and
$106.6 million in the twenty-six weeks ended August 24, 2003. Cash flows provided by financing activities in the twenty-seven week period ended August 29, 2004 reflect borrowings under the revolving credit facility used to accommodate the
seasonal working capital needs of our business. Financing activities in the prior period were primarily limited to net investments by ConAgra Foods and bank overdrafts.
Cash flows provided by (used in) financing activities were $455.4 million, $226.7 million and ($181.5) million in fiscal
2004, 2003 and 2002, respectively. Cash flows provided by financing activities in fiscal 2004 included the contribution of equity by Apollo and issuance of long-term debt in connection with the Acquisition. Financing activities have historically
been primarily limited to investments by and (distributions) to ConAgra Foods, which totaled $231.1 million and ($182.1) million in fiscal 2003 and 2002 respectively.
Capital Expenditures
Capital expenditures are expected to be approximately $18.1 million for fiscal 2005, which includes approximately $5.6 million for maintenance capital
expenditures. This also includes approximately $3.7 million of capital expenditures for transition projects to enable our separation from our former parent, ConAgra Foods, and approximately $5.3 million for an investment in information systems. The
remainder, or approximately $3.5 million, represents growth capital expenditures that are intended to support our strategic growth activities or bring about efficiencies in our formulation facilities. This expected figure represents
management’s estimate of spending, but may change due to a variety of conditions, including local business conditions, changes in the farm economy, competitive conditions, changes that impact the economics of a given project, and the
seasonality of our business. We expect we will finance all capital expenditures from cash generated from operations, reductions in working capital, or incremental debt.
Credit Facilities and Other Long Term Debt
In connection with the Acquisition, United Agri Products entered into the existing five-year $500.0 million asset-based
revolving credit facility. The revolving credit facility also provides for a $20.0 million revolving credit sub-facility for United Agri Products Canada Inc. (“UAP Canada”), a $50.0 million letter of credit sub-facility, a $25.0 million
swingline loan sub-facility and a $25.0 million in-season over-advance sub-facility. At August 29, 2004, there were $180.3 million of borrowings outstanding under the revolving credit facility and United Agri Products had additional borrowing
capacity thereunder of $300.1 million (after giving effect to $19.1 million of letters of credit under the sub-facility).
The interest rates with respect to revolving loans under the revolving credit facility are based, at United Agri Products’ option, on either the
agent’s index rate plus an applicable index margin of between 0.50% and 1.00% or upon LIBOR plus an applicable LIBOR margin of between 1.75% and 2.25%. At the consummation of this offering, the applicable index margin will be 0.75% and the
applicable LIBOR margin will be 2.00%. The interest rates with respect to in-season overadvances under the revolving credit facility are based, at United Agri Products’ option, on either the agent’s index rate plus an applicable index
margin of 2.25% or upon LIBOR plus an applicable LIBOR margin of 3.50%. These applicable margins (other than the margin on in-season
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overadvances) are in each case subject to prospective adjustment on a quarterly basis (with respect to any reduction from current levels, beginning with the
third quarter after consummation of this offering) if United Agri Products reduces its ratio of funded debt to EBITDA (on a consolidated basis). Following an event of default, all amounts owing under the revolving credit facility will bear interest
at a rate per annum equal to the rate otherwise applicable thereto plus an additional 2.0%. The obligations under the revolving credit facility are (or, in the case of future subsidiaries, will be) guaranteed by UAP Holdings and each of its existing
and future direct and indirect U.S. subsidiaries. The obligations under the revolving credit facility are secured by a first priority lien on, or security interest in, subject to certain exceptions, substantially all of UAP Holdings’, United
Agri Products’ and UAP Canada’s properties and assets and the properties and assets of each of the guarantors. The revolving credit facility contains customary representations, warranties and covenants and events of default for the type
and nature of the Acquisition and a business such as ours.
On December 16, 2003, United Agri Products issued $225.0 million aggregate principal amount of 8¼% Senior Notes which mature on December 15, 2011. On April 26, 2004, United Agri Products commenced a tender offer and consent
solicitation with respect to all its outstanding $225.0 million aggregate principal amount of 8¼% Senior Notes. The closing of the tender offer and consent solicitation with respect to the 8¼% Senior Notes was conditioned upon, among other
things, the closing of the Proposed IDS Offering, which was abandoned in order for us to pursue the Common Stock Offering. On October 29, 2004, the tender offer and consent solicitation with respect to the 8¼% Senior Notes was terminated in
connection with the abandonment of the Proposed IDS Offering. Accordingly, with the exception of $21.5 million aggregate principal amount of 8¼% Senior Notes that United Agri Products intends to redeem with a portion of the proceeds of the
Common Stock Offering, the 8¼% Senior Notes remain outstanding following the consummation of the Common Stock Offering. See “Description of Other Indebtedness—8¼% Senior Notes” for a more detailed discussion of the terms of
the 8¼% Senior Notes.
UAP HOLDINGS’ DEPENDENCE
ON US TO SERVICE ITS OBLIGATIONS
As a holding
company with no significant assets other than the ownership of 100% of our common stock, UAP Holdings depends on our cash flows to service its debt and to pay dividends (if any) on its common stock. UAP Holdings intends to pay quarterly cash
dividends on its common stock at an annual rate of $0.50 per share. The declaration of such dividends is at the complete discretion of UAP Holdings’ board of directors, and depends upon many factors, including its financial condition, earnings,
legal requirements, restrictions in its debt agreement, and other factors that its board of directors deems relevant. Because our parent, UAP Holdings, is a holding Company, its primary source of funds to fund its dividend payments will be cash
distributions received from us. To the extent we make such distributions to UAP Holdings, the amount of cash available to us to pay principal of, and interest on, our outstanding debt, including the notes, will be reduced, and we would have less
cash available for other purposes, which could negatively impact our financial condition, our results of operations and our ability to maintain or expand our business. A failure to pay principal of, or interest on, our debt, including the notes,
would constitute an event of default under the applicable debt agreements, giving the holders of that debt the right to accelerate its maturity. If any of our debt is accelerated, we may not have sufficient cash available to repay it in full and we
may be unable to refinance it on satisfactory terms or at all.
UAP Holdings is substantially more leveraged than us. As of August 29, 2004, on a pro forma basis after giving effect to the Special Dividends and the Common Stock Offering, UAP Holdings would have had $531.6 million of total indebtedness.
As described above, UAP Holdings will rely on distributions from us in order to pay amounts due in respect of the 10¾% Senior Discount Notes (which will require cash interest payments at the rate of 10
3
/
4
% per annum, commencing on July 15, 2008) and to pay dividends, if any, on its outstanding common stock. However,
our ability to make distributions to UAP Holdings is restricted by the covenants contained in our revolving credit facility and the indenture governing the 8¼% Senior Notes. While the restrictions in the indenture governing the 8¼% Senior
Notes cover a wide variety of arrangements which have traditionally been used to effect highly leveraged transactions, the indenture governing the 8¼% Senior Notes may not afford the holders of the 8¼% Senior Notes protection in all
circumstances from the adverse aspects of a highly leveraged transaction, reorganization, restructuring, merger or similar transaction. While UAP Holdings
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has no current intention to engage in these types of transactions, there can be no assurance that it will not do so in the future if permitted under the
terms of the revolving credit facility and the indenture governing the 8¼% Senior Notes.
OBLIGATIONS AND COMMITMENTS
As part of our ongoing operations, we enter into arrangements that obligate us to make future payments under contracts such as lease agreements, debt agreements and unconditional purchase obligations (i.e.,
obligations to transfer funds in the future for fixed or minimum quantities of goods or services at fixed or minimum prices, such as “take-or-pay” contracts). We enter into unconditional purchase obligation arrangements in the normal
course of business to ensure that adequate levels of sourced product are available to us. The following is a summary of our contractual obligations as of August 29, 2004:
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Long-Term Debt
|
|
$
|
225.0
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
225.0
|
|
Lease Obligations
|
|
|
21.9
|
|
|
7.8
|
|
|
9.3
|
|
|
2.3
|
|
|
2.5
|
|
Unconditional Purchase Obligations
|
|
|
0.3
|
|
|
0.3
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Borrowings Under Revolving Credit Facility
|
|
|
180.3
|
|
|
180.3
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
427.5
|
|
$
|
188.4
|
|
$
|
9.3
|
|
$
|
2.3
|
|
$
|
227.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We
have excluded lease obligations of $52.8 million from the table above as these are cancelable within one year.
The above table does not include the effects of the Common Stock Offering. As of August 29, 2004, on a pro forma basis after giving effect to the Special
Dividends and the Common Stock Offering, our total indebtedness would have been $443.8 million. The revolving credit facility has a five-year term and will mature in 2008.
As of August 29, 2004, we had $19.1 million of outstanding commercial commitment arrangements (e.g., guarantees).
The 8¼% Senior Notes were issued on December 16,
2003 and the proceeds from such offering were used to repay the entire principal amount, plus accrued interest, incurred in connection with a $175.0 million unsecured senior bridge loan facility. United Agri Products entered into the senior bridge
loan facility on November 24, 2003 and used borrowings thereunder to fund, in part, the Acquisition.
TRADING ACTIVITIES
As of August 29, 2004 and August 24, 2003, we had no outstanding derivative contracts. However, subject to limitations set forth in our debt agreements, we may, in the future, enter into derivative contracts to limit our exposure to changes
in interest rates, foreign currency exchange rates and energy prices.
CRITICAL ACCOUNTING POLICIES
The
process of preparing financial statements requires the use of estimates on the part of management. The estimates used by management are based on our historical experiences combined with management’s understanding of current facts and
circumstances. Certain of our accounting policies are considered critical as they are both important to the portrayal of our financial condition and results of operations and require significant or complex judgment on the part of management. The
following is a summary of certain accounting policies considered critical by our management.
Allowance for Doubtful Accounts.
Our allowance for doubtful accounts reflects reserves for customer receivables to reduce
receivables to amounts expected to be collected. Management uses significant judgment in estimating uncollectible amounts. In estimating uncollectible amounts, management considers factors such as
60
current overall economic conditions, industry-specific economic conditions, historical customer performance and anticipated customer performance. While
management believes our processes effectively address our exposure for doubtful accounts, changes in the economy, industry, or specific customer conditions may require adjustment to the allowance for doubtful accounts recorded by us.
Inventory Valuation.
Management
reviews inventory balances to determine if inventories can be sold at amounts equal to or greater than their carrying amounts. The review includes identification of slow moving inventories, obsolete inventories and discontinued products or lines of
products. The identification process includes historical performance of the inventory, current operational plans for the inventory, as well as industry and customer specific trends. If our actual results differ from management expectations with
respect to the selling of our inventories at amounts equal to or greater than their carrying amounts, we would be required to adjust our inventory balances accordingly.
Impairment of Long-Lived Assets (Including Property, Plant and Equipment), Goodwill and Identifiable Intangible
Assets.
We reduce the carrying amounts of long-lived assets, goodwill and identifiable intangible assets to their fair values when the fair value of such assets is determined to be less than their carrying amounts (i.e.,
assets are deemed to be impaired). Fair value is typically estimated using a discounted cash flow analysis, which requires us to estimate the future cash flows anticipated to be generated by the particular asset(s) being tested for impairment as
well as select a discount rate to measure the present value of the anticipated cash flows. When determining future cash flow estimates, we consider historical results adjusted to reflect current and anticipated operating conditions. Estimating
future cash flows requires significant judgment by us in such areas as future economic conditions, industry-specific conditions, product pricing and necessary capital expenditures. The use of different assumptions or estimates for future cash flows
could produce different impairment amounts (or none at all) for long-lived assets, goodwill and identifiable intangible assets.
Rebate Receivables.
Rebates are received from crop protection and seed products, based on programs offered by our vendors.
The programs vary based on the product type and specific vendor practice. Historically, more than 85% of the rebates earned were from our chemical suppliers. The majority of the rebate programs run on a crop year basis, typically from October 1st to
September 30th, although other periods are sometimes used. We also negotiate individually with our vendors for additional rebates after the conclusion of the crop year and often several months after we have purchased and sold the products for which
we are negotiating rebates. Historically, the majority of the rebates have been earned based on our sales of the suppliers’ products in a given crop year. The rebate receivable recorded monthly is based on actual sales and the historical rebate
percentage received. The actual rebates earned for most programs are finalized in our fourth fiscal quarter and adjustments are made to the accrual as necessary. The majority of our rebate receivables are collected during our fourth quarter. Because
of the nature of the programs and the amount of rebates available are determined by our vendors, there can be no assurance that historical rebate trends will continue.
Stock-Based Compensation.
Certain of our officers, employees and non-executive directors
have equity-based compensation arrangements under which they hold options to acquire shares of UAP Holdings’ common stock. For officers and employees, we account for our stock option plan in accordance with the provisions of Accounting
Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. As such, compensation expense is recorded on the date of grant only if the current market price of the underlying
stock exceeds the exercise price. The exercise price for all of the options granted to date was equal to the fair value of our stock at the date of grant. Accordingly, no compensation expense associated with stock option grants has been recognized.
If the exercise price on future stock option grants exceeds the underlying stock price, compensation expense will be recognized and expensed over the vesting period in accordance with APB Opinion No. 25.
OFF BALANCE SHEET ARRANGEMENTS
In January 2003, the FASB issued FIN No. 46, “Consolidation of
Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 (ARB 51),” which clarifies the consolidation accounting guidance in
61
ARB 51, “Consolidated Financial Statements,” as it applies to certain entities in which equity investors who do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the entities to finance their activities without additional subordinated financial support from other parties. Such entities are known as variable interest entities (VIEs).
FIN No. 46 requires that the primary beneficiary of a VIE consolidates the VIE. FIN No. 46 also requires new disclosures for significant relationships with VIEs, whether or not consolidation accounting is used or anticipated. In December 2003, the
FASB revised and re-released FIN No. 46 as “FIN No. 46(R).” The provisions of FIN No. 46(R) are effective for periods ending after March 15, 2004, and upon adoption by the company as of February 22, 2004, did not have a
material impact on our financial position or results of operations.
All future cash payments required under our noncancelable leasing arrangements having remaining noncancelable lease terms of more than one year are reflected in the “contractual obligations” table above
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