Chiquita Brands International 10-Q 2011
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended June 30, 2011
For the transition period from to
Commission file number 1-1550
CHIQUITA BRANDS INTERNATIONAL, INC.
(Exact Name of Registrant as Specified in Its Charter)
250 East Fifth Street
Cincinnati, Ohio 45202
(Address of principal executive offices and zip code)
Registrants telephone number, including area code: (513) 784-8000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x.
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date. As of July 28, 2011, there were 45,441,793 shares of Common Stock outstanding.
CHIQUITA BRANDS INTERNATIONAL, INC.
TABLE OF CONTENTS
Item 1 - Financial Statements
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(In thousands, except share data)
See Notes to Condensed Consolidated Financial Statements.
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(In thousands, except share data)
See Notes to Condensed Consolidated Financial Statements.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW (Unaudited)
See Notes to Condensed Consolidated Financial Statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Interim results for Chiquita Brands International, Inc. (CBII) and subsidiaries (collectively, with CBII, Chiquita or the company) are subject to significant seasonal variations typical to the industry and are not indicative of the results of operations for a full fiscal year. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary for a fair statement of the results of the interim periods shown have been made.
See Notes to Consolidated Financial Statements included in the companys 2010 Annual Report on Form 10-K for additional information relating to the companys Consolidated Financial Statements. The December 31, 2010 Condensed Consolidated Balance Sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.
Note 1 Earnings Per Share
Basic and diluted earnings per common share (EPS) are calculated as follows:
The assumed conversions to common stock of the companys stock options, other stock awards and 4.25% Convertible Senior Notes due 2016 (Convertible Notes) are excluded from the diluted EPS computations for periods in which these items, on an individual basis, have an anti-dilutive effect on diluted EPS. For the quarter and six months ended June 30, 2011 and 2010, assumed conversion of the Convertible Notes would have been anti-dilutive because the average trading price of the common shares was below the initial conversion price of $22.45 per share.
Note 2 Finance Receivables
Finance receivables were as follows:
Activity in the reserve for the companys finance receivables is as follows:
Seasonal advances may be made to certain qualified growers of other produce, which are normally collected as the other produce is harvested and sold. The company generally requires property liens and pledges of the seasons produce as collateral to support these advances. If sales of the seasons produce do not result in full repayment of the advance, the company may exercise the collateral provisions or renegotiate the terms, including terms of interest, to collect the remaining balance. The company carries payables to growers related to revenue collected from the sale of the other produce that is subsequently remitted to the grower, less outstanding grower advances and a margin retained by the company based upon the terms of the contract. Grower payables of $12 million, $21 million and $18 million at June 30, 2011, December 31, 2010 and June 30, 2010, respectively, are included in Accounts payable in the Condensed Consolidated Balance Sheets.
Of the total grower advances, $39 million (including $32 million classified as long-term), $50 million (including $20 million classified as long-term) and $46 million (including $11 million classified as long-term) relates to a Chilean grower of grapes and other produce as of June 30, 2011, December 31, 2010 and June 30, 2010, respectively. In the second quarter of 2011, the company recorded a reserve of $32 million for advances made to this Chilean grower, representing the expected remaining carrying value after collections from the current seasons already completed harvest. The reserve was based upon additional information received during the quarter on the growers credit quality, lower than expected collections through the end of the 2010-2011 Chilean grape season, and a decision in the second quarter of 2011 to change the companys grape sourcing model. As previously disclosed, advances to this grower in past seasons were not fully repaid and although the arrangement was restructured in 2009 to provide for collection over several growing seasons, the grower did not fully comply with the established repayment schedule in 2010 or 2011. Negotiations for various repayment options are ongoing; the outstanding balance remains payable on demand and the company will continue to aggressively pursue recovery of the outstanding balance (including liquidation of certain collateral). Although the company does not have an equity interest in the Chilean grower, it is a variable interest entity because of the balance owed to the company. However,
it is not consolidated because the company does not control significant activities of the Chilean grower. The remaining grower advances represent advances to smaller growers.
The company provided seller financing in the 2009 sale of the former joint venture that sourced bananas and pineapples from the Philippines for sale in the Middle East and Asia. The financing for the sale of this joint venture is a note receivable in equal installments through 2019. The company also provided seller financing in the 2004 sale of its former Colombian subsidiary in the form of a note receivable in equal installments through 2012. The terms of the seller financing were based on the earnings power of the businesses sold. Payments are current on both seller financing notes receivable.
The company includes finance receivables in the Condensed Consolidated Balance Sheets net of the reserve, with current portions included in Other receivables, net and long-term portions included in Investments and other assets, net. Reserves are established when the company determines it is probable that the counterparty will not repay the finance receivable timely based on the companys knowledge of the counterpartys financial condition and the companys historical loss experience. Reserves are measured for each individual finance receivable using quantitative and qualitative factors, including consideration of the value of any collateral securing the seller financing or grower advance. Interest receivable on an overdue or renegotiated finance receivable is placed into nonaccrual status when collectibility becomes uncertain. Collectibility is assessed at the end of each reporting period and write-offs are recorded only when collection efforts have been abandoned. Recoveries of other receivables previously reserved are credited to income.
Note 3 Inventories
Note 4 Debt
Debt consists of the following:
REFINANCING SUBSEQUENT EVENT
In July 2011, Chiquita Brands L.L.C. (CBL), the companys main operating subsidiary, entered into a new senior secured credit facility (New Credit Facility) using the proceeds to retire CBLs Preceding Credit Facility (defined below) and purchase $133 million of the companys 8 7/8% Senior Notes due in 2015 in a tender offer at 103.333% of their par value in July 2011; the company has called the remaining $44 million of the 8 7/8% Senior Notes for redemption in August 2011 at 102.958% of their par value and will use the remainder of the proceeds from the New Credit Facility together with available cash to redeem them.
The New Credit Facility includes a $330 million senior secured term loan (New Term Loan) and a $150 million senior secured revolving facility (New Revolver) both maturing July 26, 2016. However, the New Credit Facility will mature six months prior to the maturity of the companys 7 1/2% Senior Notes (May 1, 2014), unless the company refinances, or otherwise extends, the maturity of the 7 1/2% Senior Notes by such date. The New Term Loan and the New Revolver can be increased by up to an aggregate of $50 million at the companys request, under certain circumstances.
The New Term Loan bears interest, at the companys election, at a rate of LIBOR plus 3.00% to 3.75% or a Base Rate plus 2.00% to 2.75%, the spread in each case depending on CBIIs leverage ratio. The Base Rate is the higher of the administrative agents prime rate or the federal funds rate plus 0.50%. The initial interest rate as defined in the New Credit Facility is LIBOR plus 3.00% through December 2, 2011 (3.19% based on June 30, 2011 LIBOR). Subject to the early maturity provision described above, the New Term Loan requires quarterly principal repayments of $4 million beginning September 30, 2011 through June 30, 2013 and quarterly principal repayments of $8 million beginning September 30, 2013 through March 31, 2016, with any remaining principal balance due at June 30, 2016. The New Term Loan may be repaid without penalty, but amounts repaid under the New Term Loan may not be reborrowed.
The New Revolver bears interest, at the companys election, at a rate of LIBOR plus 2.75% to 3.50% or a Base Rate plus 1.75% to 2.50%, the spread in each case depending on CBIIs leverage ratio. Although the company did not initially draw upon the New Revolver, the applicable interest rate as defined in the New Credit Facility would be LIBOR plus 2.75% or Base Rate plus 1.75% through December 2, 2011. The company is required to pay a commitment fee on the daily unused portion of the New Revolver of 0.375% to 0.50% based on CBIIs leverage ratio, initially 0.375% based on CBIIs leverage ratio at June 30, 2011. The company had initially used $22 million of the New Revolver for letters of credit, leaving $128 million available. The New Revolver also has a $100 million sublimit for letters of credit.
The New Credit Facility contains two financial maintenance covenants, a CBL (operating company) leverage ratio (debt divided by EBITDA, each as defined in the New Credit Facility) that is no higher than 3.50x and a fixed charge ratio (the sum of CBLs EBITDA plus Net Rent divided by Fixed Charges, each as defined in the New Credit Facility) that is least 1.15x, which are substantially the same as the Preceding Credit Facility. The New Credit Facilitys financial covenants exclude changes in generally accepted accounting principles effective after December 31, 2010. EBITDA, as defined in the New Credit Facility, excludes certain non-cash items including stock compensation and impairments. Fixed Charges, as defined in the New Credit Facility, includes interest payments and distributions by CBL to CBII other than for normal overhead expenses, net rent and net lease expense. Net rent and net lease expense, as defined in the New Credit Facility, exclude the estimated portion of ship charter costs that represents normal vessel operating expenses. Debt for purposes of the leverage covenant includes subsidiary debt plus letters of credit outstanding and $64 million of synthetic leases at June 30, 2011, which are operating leases under generally accepted accounting principles, but are capital leases for tax purposes.
CBLs obligations under the New Credit Facility are guaranteed on a senior secured basis by CBII and all of CBLs material domestic subsidiaries. The obligations under the New Credit Facility are secured by substantially all of the assets of CBL and its domestic subsidiaries, including trademarks, 100% of the stock of substantially all of CBLs domestic subsidiaries and no more than 65% of the stock of CBLs direct material foreign subsidiaries. CBIIs obligations under its guarantee are secured by a pledge of the stock of CBL. The New Credit Facility also places substantially the same customary limitations as the Preceding Credit Facility on the ability of CBL and its subsidiaries to incur additional debt, create liens, dispose of assets, carry out mergers and acquisitions and make investments and capital expenditures, as well as limitations on CBLs ability to make loans, distributions or other transfers to CBII. However, payments to CBII are permitted: (i) whether or not any event of default exists or is continuing under the New Credit Facility, for all routine operating expenses in connection with the companys
normal operations and to fund certain liabilities of CBII, including interest payments on the Senior Notes (defined below), Convertible Notes and any notes used to refinance existing Senior Notes and Convertible Notes, and (ii), subject to no continuing event of default and compliance with the financial covenants, for other financial needs, including (A) payment of dividends and distributions to the companys shareholders and (B) repurchases of the companys common stock. Based on the companys June 30, 2011 covenant ratios, distributions to CBII, other than for normal overhead expenses and interest on the companys Senior Notes and Convertible Notes, were limited to approximately $80 million. The New Credit Facility also requires that the net proceeds of significant asset sales be used within 180 days to prepay outstanding amounts, unless those proceeds are reinvested in the companys business.
7 1/2% AND 8 7/8% SENIOR NOTES
As described above, $133 million of the 8 7/8% Senior Notes were purchased in a tender offer in July 2011 as part of the refinancing, and the remainder of the 8 7/8% Senior Notes have been called for redemption, which will be completed in August 2011. For the six months ended June 30, 2010, the company repurchased in the open market at a small discount $13 million principal amount of its Senior Notes, consisting of $11 million of the 7 1/2% Senior Notes and $2 million of the 8 7/8% Senior Notes. These repurchases resulted in a small extinguishment loss, including the write off of deferred financing fees and transaction costs. The 7 1/2% Senior Notes are callable, in whole or from time to time in part at 102.50% of par value, at 101.25% of par value beginning November 1, 2011 and at par value after November 1, 2012.
4.25% CONVERTIBLE SENIOR NOTES
The $200 million of Convertible Notes:
To estimate the fair value of the debt component, the company discounted the principal balance to result in an effective interest rate of 12.50% for each of the quarters ended June 30, 2011 and 2010. The fair value of the equity component was estimated as the difference between the full principal amount and the estimated fair value of the debt component, net of an allocation of issuance costs and income tax effects. These were Level 3 fair value measurements (described in Note 6) and will be reconsidered in the event that any of the Convertible Notes are converted.
The carrying amounts of the debt and equity components of the Convertible Notes are as follows:
The interest expense related to the Convertible Notes was as follows:
PRECEDING CREDIT FACILITY
CBL maintained a senior secured credit facility (Preceding Credit Facility) that matured on March 31, 2014 and consisted of a senior secured term loan (the Preceding Term Loan) and a $150 million senior secured revolving credit facility (the Preceding Revolver). As described above, the Preceding Credit Facility was retired in July 2011 using a portion of the proceeds from the New Credit Facility.
At the companys election, the interest rate for the Preceding Term Loan was based on LIBOR plus a spread based on CBIIs leverage ratio and was 4.00%, 4.06% and 4.125% at June 30, 2011, December 31, 2010 and June 30, 2010, respectively. The Preceding Term Loan required quarterly principal repayments of $2.5 million through March 31, 2010 and required $5 million thereafter for the life of the loan, with any remaining balance to be paid upon maturity at March 31, 2014.
There were no borrowings under the Preceding Revolver at June 30, 2011, December 31, 2010 or June 30, 2010. The company was required to pay a fee of 0.50% per annum on the daily unused portion of the Preceding Revolver. The Preceding Revolver contained a $100 million sub-limit for letters of credit, subject to a $50 million sub-limit for non-U.S. currency letters of credit. At June 30, 2011, there was $128 million of available Preceding Revolver credit after $22 million was used to support issued letters of credit.
The Preceding Credit Facility contained two financial maintenance covenants, which were substantially the same as those in the New Credit Facility and which are described above. At June 30, 2011, the company was in compliance with the financial covenants of the Preceding Credit Facility.
Note 5 Hedging
Derivative instruments are carried at fair value in the Condensed Consolidated Balance Sheets. For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gains or losses is deferred as a component of Accumulated other comprehensive income (loss) and reclassified into net income in
the same period during which the hedged transaction affects net income. Gains and losses on derivatives representing hedge ineffectiveness are recognized in net income currently. See further information regarding fair value measurements of derivatives in Note 6.
The company purchases euro put option contracts to hedge the cash flow and earnings risks that any significant decline in the value of the euro would have on the conversion of euro-based revenue into U.S. dollars. Purchased euro put options require an upfront premium payment and can reduce these risks without limiting the benefit received from a stronger euro. The company may also sell short-term euro call options to reduce its net option premium expense, although call options can limit the benefit received from a stronger euro. Foreign currency hedge premium expense also reduces any favorable effects of exchange rates when converting euro-denominated sales to U.S. dollars. These purchased euro put options and sold euro call options are designated as cash flow hedging instruments. At June 30, 2011, unrealized net losses of $3 million on the companys purchased euro put options were deferred in Accumulated other comprehensive income (loss), which would be reclassified to net income, if realized, in the next twelve months. At June 30, 2011, unrealized net losses of less than $1 million on the companys sold euro call options were deferred in Accumulated other comprehensive income (loss), which would be reclassified to net income, if realized, in the next twelve months.
Most of the companys foreign operations use the U.S. dollar as their functional currency. As a result, balance sheet translation adjustments due to currency fluctuations are recognized currently in Cost of sales in the Condensed Consolidated Statements of Income. To minimize the resulting volatility, the company also enters into 30-day euro forward contracts each month to economically hedge the net monetary assets exposed to euro exchange rates. These 30-day euro forward contracts are not designated as hedging instruments, and gains and losses on these forward contracts are recognized currently in Cost of sales in the Condensed Consolidated Statements of Income. In the second quarter of 2011, the company recognized $3 million of losses on 30-day euro forward contracts, and $4 million of gains from fluctuations in the value of the net monetary assets exposed to euro exchange rates. In the second quarter of 2010, the company recognized $14 million of gains on 30-day euro forward contracts, and $16 million of expense from fluctuations in the value of the net monetary assets exposed to euro exchange rates. For the six months ended June 30, 2011, the company recognized $10 million of losses on 30-day euro forward contracts, and $12 million of gains from fluctuations in the value of the net monetary assets exposed to euro exchange rates. For the six months ended June 30, 2010, the company recognized $20 million of gain on 30-day euro forward contracts, and $27 million of expense from fluctuations in the value of the net monetary assets exposed to euro exchange rates.
The company also enters into bunker fuel forward contracts for its shipping operations, which permit it to lock in fuel purchase prices for up to three years and thereby minimize the volatility that changes in fuel prices could have on its operating results. These bunker fuel forward contracts are designated as cash flow hedging instruments. At June 30, 2011, unrealized net gains of $52 million on the companys bunker fuel forward contracts were deferred in Accumulated other comprehensive income (loss), including net gains of $31 million which would be reclassified to net income, if realized, in the next twelve months.
At June 30, 2011 the companys portfolio of derivatives consisted of the following:
Activity related to the companys derivative assets and liabilities designated as hedging instruments is as follows:
The following table summarizes the fair values of the companys derivative instruments on a gross basis and the location of these instruments on the Condensed Consolidated Balance Sheets. To the extent derivatives in an asset position and derivatives in a liability position are with the same counterparty, they are netted in the Condensed Consolidated Balance Sheets because the company enters into master netting arrangements with each of its hedging partners.
The following table summarizes the effect of the companys derivatives designated as cash flow hedging instruments on OCI and earnings:
Note 6 Fair Value Measurements
Fair value is the price to hypothetically sell an asset or transfer a liability in an orderly manner in the principal market for that asset or liability. Accounting standards prioritize the use of observable inputs in measuring fair value. The level of a fair value measurement is determined entirely by the lowest level input that is significant to the measurement. The three levels are (from highest to lowest):
The company carried the following financial assets and (liabilities) at fair value:
The company values fuel hedging positions by applying an observable discount rate to the current forward prices of identical hedge positions. The company values currency hedging positions by utilizing observable or market-corroborated inputs such as exchange rates, volatility and forward yield curves. The company trades only with counterparties that meet certain liquidity and creditworthiness standards, and does not anticipate non-performance by any of these counterparties. The company does not require collateral from its counterparties, nor is it obligated to provide collateral when contracts are in a liability position. However, consideration of non-performance risk is required when valuing derivative instruments, and the company includes an adjustment for non-performance risk in the recognized measure of derivative instruments to reflect the full credit default spread (CDS) applied to a net exposure by counterparty. When there is a net asset position, the company uses the counterpartys CDS, which is generally an observable input; when there is a net liability position, the company uses its own estimated CDS, which is an unobservable input. CDS is generally not a significant input in measuring fair value. The companys adjustment for non-performance risk was not significant for any of its derivative instruments in any period presented. See further discussion and tabular disclosure of hedging activity in Note 5.
The company did not elect to carry its debt at fair value. The carrying values of the companys debt represent amortized cost and are summarized below with estimated fair values:
The fair value of the parent company debt is based on observable inputs, which include quoted prices for similar assets or liabilities in an active market and market-corroborated inputs (Level 2). The Term Loan may be traded on the secondary loan market, and the fair value of the Term Loan is based on either the last available trading price, if recent, or trading prices of comparable debt (Level 3). Level 3 fair value measurements are used in the impairment reviews of goodwill and intangible assets, which take place annually during the fourth quarter, or as circumstances indicate the possibility of impairment. Fair value measurements of benefit plan assets included in net benefit plan liabilities are based on quoted market prices in active markets (Level 1) or quoted prices in inactive markets (Level 2). The carrying amounts of cash and equivalents, accounts receivable and accounts payable approximate fair value.
Note 7 Pension and Severance Benefits
Net pension expense from the companys defined benefit and severance plans is primarily comprised of severance plans covering Central American employees and consists of the following:
Note 8 Income Taxes
As a result of sustained improvements in the performance of the companys North American businesses and the benefits of debt reduction over the last several years, the company has been generating U.S. taxable income beginning with tax year 2009, and expects this trend to continue. As of June 30, 2011, the companys forecast included second quarter results as well as increased visibility to North American banana pricing and stabilized sourcing costs. As a result of these considerations, the company recognized an $87 million income tax benefit for the reversal of valuation allowances against 100% of the U.S. federal deferred tax assets and a portion of the state deferred tax assets, primarily net operating loss carry forwards (NOLs), which are more likely than not to be realized in the future. The company regularly reviews all deferred tax assets to estimate whether these assets are
more likely than not to be realized based on all available evidence. Unless deferred tax assets are more likely that not to be realized, a valuation allowance is established to reduce the carrying value of the deferred tax asset until such time that realization becomes more likely than not. Increases and decreases in these valuation allowances are included in Income tax benefit (expense) in the Condensed Consolidated Statements of Income.
The companys foreign operations are generally taxed at rates lower than the U.S. statutory rate, and the companys overall effective tax rate has varied significantly from period to period due to the level and mix of income among various domestic and foreign jurisdictions. No U.S. taxes have been accrued on foreign earnings because such earnings have been or are expected to be permanently invested in foreign operations. Through the second quarter of 2011, the companys valuation allowances on available NOLs significantly affected its effective tax rate; if a deferred tax asset with a full valuation allowance, such as an NOL, was realized, the corresponding valuation allowance was also released, resulting in no net effect to income taxes in the Condensed Consolidated Statements of Income. As a result of the U.S. valuation allowance release in the second quarter of 2011, the company expects an increase in future income tax expense, but not cash paid for taxes until the NOLs are fully utilized.
The company nets deferred tax assets and liabilities by jurisdiction. The company had $26 million, $5 million and $0 of net current deferred tax assets in Other current assets on the Condensed Consolidated Balance Sheets at June 30, 2011, December 31, 2010 and June 30, 2010, respectively. The company had $54 million, $116 million and $105 million of net non-current deferred tax liabilities at June 30, 2011, December 31, 2010 and June 2010, respectively.
In the ordinary course of business, there are many transactions and calculations where the ultimate income tax determination is uncertain. The evaluation of a tax position is a two-step process. The first step is to evaluate the uncertain tax position for recognition by determining if the weight of available evidence indicates that it is more-likely-than-not that a tax position, including resolution of any related appeals or litigation, will be sustained upon examination based on its technical merits. If the recognition criterion is met, the second step is to measure the income tax benefit to be realized. Tax positions or portions of tax positions that do not meet these criteria are de-recognized by recording reserves. The company establishes reserves for income tax-related uncertainties based on estimates of whether, and the extent to which, additional taxes, penalties and interest could be due. Provisions for and changes to these reserves, as well as the related net interest and penalties, are included in Income tax benefit (expense) in the Condensed Consolidated Statements of Income. Significant judgment is required in evaluating tax positions and determining the companys provision for income taxes. At June 30, 2011, the company had unrecognized tax benefits of approximately $10 million, of which $7 million, if recognized, will reduce income tax expense and affect the companys effective tax rate. Interest and penalties included in income taxes was less than $1 million for both of the quarters ended June 30, 2011 and 2010. The cumulative interest and penalties included in the Condensed Consolidated Balance Sheet at June 30, 2011 was $4 million.
In addition to the U.S. valuation allowance release as described above, Income tax benefit (expense) in the Condensed Consolidated Statements of Income includes $6 million in expense in the second quarter of 2011 related to the settlement of an Italian income tax audit compared to $1 million in benefits in the second quarter of 2010 from the resolution of tax contingencies in various jurisdictions. See Note 13 under Italian Customs and Tax Cases for recent tax contingency developments related to the Italian income tax settlement. During the next twelve months, it is reasonably possible that unrecognized tax benefits impacting the effective tax rate could be recognized as a result of the expiration of statutes of limitation in the amount of $3 million plus accrued interest and penalties.
Note 9 Advertising and Promotion Expense
Advertising and certain promotion expenses are included in Selling, general and administrative in the Condensed Consolidated Statements of Income and were $22 million and $21 million for the second quarters of 2011 and 2010, respectively, and $30 million and $32 million for the six months ended June 30, 2011 and 2010, respectively. Advertising and promotion expense included $1 million and $3 million in the quarter and six months ended June 30, 2010, respectively, related to the European smoothie business (which was deconsolidated in May 2010 as further discussed in Note 14).
Television advertising costs related to production are expensed the first time an ad airs in each market and the cost of advertising time is expensed over the advertising period. Other types of advertising and promotion costs are expensed over the advertising or promotion period. The company also offers sales incentives and certain promotions to its customers and consumers primarily in the Salads and Healthy Snacks segment. Consideration given to customers and consumers for sales incentives is recorded as a reduction of Net sales in the Condensed Consolidated Statements of Income.
Note 10 Stock-Based Compensation
Stock compensation expense totaled $3 million and $5 million for the second quarters of 2011 and 2010, respectively, and $7 million and $9 million for the six months ended June 30, 2011 and 2010, respectively. This expense relates primarily to the companys performance-based long-term incentive program (LTIP) and time-vested restricted stock unit awards. LTIP awards cover three-year performance cycles and are measured partly on performance criteria (cumulative earnings per share or cumulative free cash flow generation) and partly on market criteria (total shareholder return relative to a peer group of companies). In September 2010, the LTIP was modified to allow a portion of the awards to be paid in cash in an amount substantially equal to the estimated tax liability triggered by such awards. LTIP awards outstanding at September 2010 were modified, which changed them to liability-classified awards from equity-classified awards. Both liability-classified and equity-classified awards recognize the fair value of the award ratably over the performance period; however, equity-classified awards only measure the fair value at the grant date, whereas liability-classified awards measure the fair value at each reporting date, with changes in the fair value of the award cumulatively adjusted through expense each period. For modified awards, expense is recognized at the greater of the equity-method or the liability-method. Fair value of LTIP awards measured on performance criteria are based on the companys expectations of performance achievement and the closing stock price on the measurement date, a Level 3 fair value measurement. Fair value of LTIP awards based on market criteria are measured using a Monte-Carlo simulation using publicly available data, a Level 2 fair value measurement. For the quarter and six months ended June 30, 2011, $2 million and $1 million, respectively, was reclassified from liabilities to Capital surplus for the change in the liability value of the modified awards, and Capital surplus increased a total of $5 million and $8 million during the quarter and for the six months ended June 30, 2011, respectively, as a result of stock compensation.
Note 11 Comprehensive Income
In June 2011, the FASB issued authoritative guidance requiring entities to report components of other comprehensive income in either a single continuous statement or in two separate, but consecutive, statements of net income and other comprehensive income. Retrospective application will be required beginning in 2012. The company only expects this authoritative guidance to affect the presentation in its consolidated financial statements.
Note 12 Segment Information
The company reports three business segments:
Certain corporate expenses are not allocated to the reportable segments and are included in Corporate. Inter-segment transactions are eliminated. Financial information for each segment follows:
Note 13 Commitments and Contingencies
The company had accruals, including accrued interest, in the Condensed Consolidated Balance Sheets of $7 million, $7 million and $12 million at June 30, 2011, December 31, 2010 and June 30, 2010, respectively, related to the plea agreement with the U.S. Department of Justice described below. The company also had an accrual of $4 million at June 30, 2010 related to the settlement agreement for the Colombia related shareholder derivative lawsuits described below, a portion of which was recovered through insurance; and the company had an accrual of $11 million and $4 million related to contingencies and legal proceedings in Europe at June 30, 2011 and December 31, 2010, respectively. While other contingent liabilities described below may be material, the company has determined that losses in these matters are not probable and has not accrued any other amounts. Regardless of their outcomes, the company has paid, and will likely continue to incur, significant legal and other fees to defend itself in these proceedings, which may significantly affect the companys financial statements.
EUROPEAN COMPETITION LAW INVESTIGATION
In June 2005, the company announced that its management had become aware that certain of its employees had shared pricing and volume information with competitors in Europe over many years in violation of European competition laws and company policies, and may have engaged in other conduct that did not comply with European
competition laws or applicable company policies. The company promptly stopped the conduct and notified the European Commission (EC) and other regulatory authorities of these matters. In October 2008, the EC announced its final decision that, between 2000 and 2002, Chiquita and other competitors violated the EC Treatys ban on cartels and restrictive practices in eight European Union (EU) member states in Northern Europe by sharing certain information related to the setting of price quotes for bananas. Based on the companys voluntary notification and the companys continued cooperation in the investigation, the EC granted the company final immunity from fines related to this matter.
As previously disclosed, following the announcement of that decision, the EC has also continued to investigate certain alleged conduct in southern Europe. The company believes that it has cooperated with that investigation, under the terms of the ECs previous grant of conditional immunity. In connection with that investigation, in December 2009, the company received a Statement of Objections (SO) from the EC in relation to certain past activities alleged to have occurred during the approximately 18-month period from July 2004 to January 2006. An SO is a confidential procedural document whereby the EC communicates its preliminary view in relation to a possible infringement of EU competition laws and other related matters, and allows the companies identified in the document to present arguments in response. The EC has also expressed a preliminary view questioning the granting of immunity or leniency with respect to the matters set forth in the SO. The company filed its response to the SO with the EC, and a hearing was held in June 2010. A final decision from the EC is expected in the fall of 2011. The company continues to believe that it should be entitled to immunity.
If the EC were ultimately to determine to proceed with a decision in this case and to take the position in any such decision that the company is not entitled to immunity, then the EC can seek to impose fines on the company, which, if imposed, could be substantial. Under its existing fining guidelines, the EC has significant discretion in determining the amount of any fine, subject to a maximum amount equal to 10% of a companys worldwide revenue attributable to all of its products for the fiscal year prior to the year in which the fine is imposed. As such, if the EC were to impose a fine, it is possible the fine could have a material adverse impact on the companys consolidated financial results in the particular reporting period in which imposed and, depending on the size of the fine and the companys success in challenging it, a material adverse effect on the companys consolidated financial position. A decision regarding the matters referenced in the SO will not be taken by the EC until the close of the administrative procedure. Other than the potential imposition of fines, as described above, the company does not believe that the reporting of these matters or the cessation of the conduct has had or should in the future have any material adverse effect on the regulatory or competitive environment in which it operates.
DOJ Settlement. As previously disclosed, in March 2007, the company entered into a plea agreement with the U.S. Department of Justice (DOJ) relating to payments made by the companys former Colombian subsidiary to a Colombian paramilitary group designated under U.S. law as a foreign terrorist organization. The company had previously voluntarily disclosed these payments to the DOJ as having been made by its Colombian subsidiary to protect its employees from risks to their safety if the payments were not made. Under the terms of the plea agreement, the company pled guilty to one count of Engaging in Transactions with a Specially-Designated Global Terrorist Group without having first obtained a license from the U.S. Department of Treasurys Office of Foreign Assets Control. The company agreed to pay a fine of $25 million, payable in five equal annual installments with interest. In September 2007, the U.S. District Court for the District of Columbia approved the plea agreement. The DOJ had earlier announced that it would not pursue charges against any current or former company executives. Pursuant to customary provisions in the plea agreement, the Court placed the company on corporate probation for five years, during which time the company and its subsidiaries must not violate the law and must implement and/or maintain certain business processes and compliance programs; violation of these requirements could result in setting aside the principal terms of the plea agreement, including the amount of the fine imposed. The company recorded a charge of $25 million in 2006 and paid the first four $5 million annual installments in September 2007, 2008, 2009 and 2010, respectively. At June 30, 2011 the remaining $5 million installment payment, plus accrued interest of approximately $2 million, is included in Accrued liabilities on the Consolidated Balance Sheet. Accrued interest is payable with the final installment payment due in September 2011.
Tort Lawsuits. Between June 2007 and March 2011, nine lawsuits were filed against the company by Colombian nationals in U.S. federal courts. These lawsuits assert civil tort claims under various laws, including the Alien Tort Statute (ATS), 28 U.S.C. § 1350, the Torture Victim Protection Act (TVPA), 28 U.S.C. § 1350 note, and state laws (hereinafter ATS lawsuits). The plaintiffs either individually or as members of a putative class, claim to be
persons injured, or family members or legal heirs of individuals allegedly killed or injured, by armed groups that received payments from the companys former Colombian subsidiary. The plaintiffs claim that, as a result of such payments, the company should be held legally responsible for the alleged injuries. All of these ATS lawsuits have been centralized in the U.S. District Court for the Southern District of Florida for consolidated or coordinated pretrial proceedings (MDL Proceeding).
At present, claims are asserted on behalf of over 4,000 alleged victims in these nine ATS lawsuits. Plaintiffs counsel have indicated that they may add claims for additional alleged victims to the litigation. The company also has received formal requests to participate in mediation in Colombia concerning similar claims, which could be followed by litigation in Colombia. Eight of the ATS lawsuits seek unspecified compensatory and punitive damages, as well as attorneys fees and costs, and one of them also seeks treble damages and disgorgement of profits, although it does not explain the basis for those demands. The other ATS lawsuit contains a specific demand of $10 million in compensatory damages and $10 million in punitive damages for each of the several hundred alleged victims in that suit. The company believes the plaintiffs claims are without merit and is defending itself vigorously.
In addition to the ATS lawsuits, between March 2008 and March 2011, four tort lawsuits were filed against the company by American citizens who allege that they were kidnapped and held hostage by an armed group in Colombia, or that they are the survivors or the estate of a survivor of American nationals kidnapped and/or killed by the same group in Colombia. The plaintiffs in these cases assert civil claims under the Antiterrorism Act (ATA), 18 U.S.C. § 2331, et seq., and state tort laws (hereinafter ATA lawsuits). These ATA lawsuits have also been centralized in the MDL Proceeding before the U.S. District Court for the Southern District of Florida. Similar to the ATS lawsuits described above, the ATA plaintiffs contend that the company should be held liable because its former Colombian subsidiary allegedly provided material support to the armed group. These ATA lawsuits seek unspecified compensatory damages, treble damages, attorneys fees and costs and punitive damages. The company believes the plaintiffs claims are without merit and is defending itself vigorously.
The company has filed motions to dismiss the nine ATS lawsuits pending in the MDL Proceeding. In June 2011, the companys motion to dismiss the first seven ATS lawsuits was granted in part and denied in part. While the court allowed plaintiffs to move forward with their TVPA claims and some ATS claims, it dismissed various claims asserted under the ATS, state law, and Colombian law. The company believes it has strong defenses to the remaining claims in these cases. Motions to dismiss the remaining two ATS cases not subject to the courts June 2011 order are currently pending.
The company has also filed motions to dismiss the ATA actions pending in the MDL Proceeding. In February 2010, the companys motion to dismiss one of the ATA lawsuits was granted in part and denied in part. The company believes it has strong defenses to the remaining claims in that case. There has been no decision on the companys pending motions to dismiss the other ATA lawsuits.
Insurance Recovery. The company maintains general liability insurance policies that should provide coverage for the types of costs involved in defending the tort lawsuits described above. However, the companys primary general liability insurers whose policies are relevant to the underlying tort lawsuits have disputed their obligations to provide coverage.
In September 2008, the company filed suit in the Common Pleas Court of Hamilton County, Ohio against three of its primary general liability insurers seeking (i) a declaratory judgment with respect to the insurers obligation to reimburse the company for defense costs that it has incurred (and will incur) in connection with the defense of the tort claims described above; and (ii) an award of damages for the insurers breach of their contractual obligation to reimburse the company for defense costs to defend itself in these matters. A fourth primary insurer, National Union Fire Insurance Company of Pittsburgh, PA (National Union), was later added to this case. In August 2009, the company reached a settlement agreement with one of the primary insurers under which this insurer has paid and will continue to pay a portion of defense costs.
In September 2009, the Court ruled that Chiquitas primary insurers that did not settle have a duty to defend the tort lawsuits that include allegations that bodily injury or property damage occurred during the period of their policies as a result of negligence. The Court also ruled that the dispute about the number of occurrences that are involved in the underlying tort cases should be resolved by a trial.
In February 2010, Chiquita reached a settlement agreement with two of the remaining three primary insurers involved in the coverage suit, under which they have paid and will continue to pay a portion of defense costs. National Union, the one remaining primary insurer involved in the coverage suit which has not settled with Chiquita, has also paid a portion of defense costs, but has reserved the right to attempt to obtain reimbursement of these payments from Chiquita. A fifth primary insurer that is not a party to the coverage suits is insolvent.
In October 2010, after a trial, the Court ruled that the defense costs incurred by Chiquita in connection with the underlying tort lawsuits and that were the subject of trialwith certain limited exceptions related to media-related activitywere reasonable and that National Union was obligated to reimburse Chiquita for all defense costs not already paid by other insurers. Pursuant to the Courts order, National Union reimbursed Chiquita for almost all of the defense costs not already paid by other insurers, but continues to reserve its rights to seek reimbursement from Chiquita in the form of loss-sensitive premium, the amount of which is based in part on the number of occurrences. National Union also has sought contribution from other primary insurers with whom Chiquita entered partial settlements. The number of occurrences was the subject of the second phase of the trial involving National Union, which was held in November 2010. In April 2011, the Court ruled that the underlying tort lawsuits arise out of a single occurrence, and that National Union has no legal right to contribution from the insurers who entered partial settlements with Chiquita.
In May 2011, before the trial court entered final judgment, National Union filed a notice of appeal with the Ohio intermediate court of appeals. National Union indicated that it intended to appeal nearly every substantive ruling made by the trial court. In June 2011, the court of appeals granted Chiquitas motion to dismiss National Unions appeal because the appeal was not taken from a final appealable order. National Union is likely to file another appeal after the trial court enters a final judgment.
In addition, in June 2011, Chiquita filed a motion for reconsideration in the trial court, seeking a ruling from the trial court that, even though the judge presiding over the underlying tort lawsuits dismissed the negligence allegations from certain of the underlying complaints, National Union still owes Chiquita coverage for defense costs because Chiquita will be defending against the remaining allegations in the underlying cases by asserting, among other things, a claim of rightnamely, that it acted for the purpose of saving lives rather than causing harm. In July 2011, National Union filed its opposition to Chiquitas motion for reconsideration and a motion seeking affirmative relief. A hearing on the pending motions is set for September 2011. National Union has indicated that it will oppose Chiquitas motion for reconsideration and seek affirmative relief in the trial court. It is unclear when the trial court will rule on Chiquitas motion for reconsideration or National Unions anticipated request for affirmative relief. Through June 30, 2011, the company has received $8 million as expense reimbursement from National Union, which is being deferred in Other liabilities in the Condensed Consolidated Balance Sheets until the appeal process is complete.
With the exception of the defense costs that, as described above, three of Chiquitas primary insurers have agreed to pay pursuant to partial settlement agreements, there can be no assurance that any claims under the applicable policies will result in insurance recoveries.
Colombia Investigation. The Colombian Attorney Generals Office is conducting an investigation into payments made by companies in the banana and other industries to paramilitary groups in Colombia. Included within the scope of the investigation are the payments that were the subject of the companys March 2007 plea agreement with the DOJ, described above. The company believes that it has at all times complied with Colombian law.
ITALIAN CUSTOMS AND TAX CASES
1998-2000 Cases. In October 2004, the companys Italian subsidiary, Chiquita Italia, received the first of several notices from various customs authorities in Italy stating that it is potentially liable for additional duties and taxes on the import of bananas by Socoba S.r.l. (Socoba) from 1998 to 2000 for sale to Chiquita Italia. The customs authorities claim that (i) the amounts are due because these bananas were imported with licenses (purportedly issued by Spain) that were subsequently determined to have been forged and (ii) Chiquita Italia should be jointly liable with Socoba because (a) Socoba was controlled by a former general manager of Chiquita Italia and (b) the import transactions benefited Chiquita Italia, which arranged for Socoba to purchase the bananas from another Chiquita subsidiary and, after customs clearance, sell them to Chiquita Italia. Chiquita Italia is contesting these claims, principally on the basis of its good faith belief at the time the import licenses were obtained and used that they were valid.
Of the original notices, civil customs proceedings in an aggregate amount of 14 million ($21 million) plus interest were ultimately brought and are now pending against Chiquita Italia in four Italian jurisdictions, Genoa, Trento, Aosta and Alessandria (for 7 million, 5 million, 2 million, and 0.4 million, respectively, plus interest). The Aosta case is still at the trial level; in the Genoa case, Chiquita Italia won at the trial level, lost on appeal, and appealed to the Court of Cassation, the highest level of appeal in Italy, where the case is pending; in the Trento and Alessandria cases, Chiquita Italia lost at the trial level, but the cases have been stayed pending a final resolution of a case in Rome. This Rome case was brought by Socoba (and Chiquita Italia intervened voluntarily) on the issue of whether the forged Spanish licenses used by Socoba should be regarded as genuine in view of the apparent inability to distinguish between genuine and forged licenses. In an October 2010 decision, the Rome trial court rejected Socobas claim that the licenses should be considered genuine on the basis that Socoba had not sufficiently demonstrated how similar the forged licenses were to genuine Spanish licenses. Socoba has one year to appeal this decision. In an unrelated case addressing similar forged Spanish licenses used in Belgium, the EU Commission has ruled that these types of licenses were such good forgeries that they needed to be treated as genuine, and Chiquita Italia has brought this decision to the attention of the customs authorities in Genoa to seek relief in relation to the pending customs case but they declined to give the benefit of the decision to Chiquita Italia; Chiquita Italia intends to appeal this decision to the tax court. In Italy, each level of appeal involves a review of the facts and law applicable to the case and the appellate court can render a decision that disregards or substantially modifies the lower courts opinion.
Under Italian law, the amounts claimed in the Trento, Alessandria and Genoa cases have become due and payable notwithstanding the pending appeals and stays of proceedings. In March 2009, Chiquita Italia began to pay the amounts due in the Trento and Alessandria cases, 7 million ($10 million), including interest, in 36 monthly installments. In the Genoa case, Chiquita Italia began making monthly installment payments in March 2010 under a similar arrangement for the amount due of 13 million ($19 million), including interest, but this payment obligation has been temporarily suspended. If Chiquita Italia ultimately prevails in its appeals, all amounts paid will be reimbursed with interest.
2004-2005 Cases. In 2008, Chiquita Italia was required to provide documents and information to the Italian fiscal police in connection with a criminal investigation into imports of bananas by Chiquita Italia during 2004 through 2005, and the payment of customs duties on these imports. The focus of the investigation was on an importation process whereby Chiquita sold some of its bananas to holders of import licenses who imported the bananas and resold them to Chiquita Italia, a practice the company believes was legitimate under both Italian and EU law and was widely accepted by authorities across the EU and by the EC (indirect import challenge). The Italian prosecutors are pursuing this matter. If criminal liability is ultimately determined, Chiquita Italia could be civilly liable for damages, including applicable duties, taxes and penalties.
Both tax and customs authorities have issued assessment notices for the years 2004 and 2005 for this matter. The assessed balances for taxes are 6 million ($9 million) for 2004 and 5 million ($7 million) for 2005 plus, in each case, interest and penalties. Chiquita appealed these assessments to the first level Rome tax court and, in June 2011, the court rejected Chiquita Italias appeal for 2004. Chiquita Italia is in the process of appealing this decision. The assessed balances, for customs for 2004 and 2005, total 18 million ($26 million) plus interest. Chiquita Italia also appealed these assessments to the first level Rome tax court, which rejected the appeal in June 2011. Chiquita Italia is in the process of appealing this decision. Under Italian law, each level of appeal involves a review of the facts and law applicable to the case and the appellate court can render a decision that disregards or substantially modifies the lower courts opinion.
The fiscal police investigation also challenged the involvement of a Chiquita entity incorporated in Bermuda in the sale of bananas directly to Chiquita Italia (direct import challenge), as a result of which the tax authorities claimed additional taxes of 13 million ($19 million) for 2004 and 19 million ($28 million) for 2005, plus interest and penalties. In order to avoid a long and costly tax dispute, in April 2011, Chiquita Italia reached an agreement in principle with the Italian tax authorities to settle the dispute. Under the settlement, the tax authorities agreed that the Bermuda corporations involvement in the importation of bananas was appropriate and Chiquita Italia agreed to an adjustment to the intercompany price paid by Chiquita Italia for the imported bananas it purchased from this company, resulting in a higher income tax liability for those years. The settlement amounts for additional income tax for 2004 and 2005, including interest accrued through July 1, 2011 and penalties, are less than 1 million ($1 million) and 2 million ($4 million), respectively, significantly below the amounts originally claimed. The
settlement is subject to approval by the Rome Tax Court. The 2004 settlement was approved in June 2011 and the 2005 settlement is expected to be approved before the end of 2011. As part of the settlement, Chiquita Italia also agreed to a pricing adjustment for its intercompany purchases of bananas for the years 2006 through 2009. As a result, in June 2011 Chiquita Italia paid 1 million, ($2 million) of additional tax and interest to the Italian tax authorities in full settlement of years 2007 through 2009. In July 2011 Chiquita Italia paid a further less than 1 million, ($1 million) in full settlement of 2006. The indirect import challenge described above is not part of the settlement.
Chiquita Italia filed appeals to object to the tax assessments in May 2010 (for 2004) and in April 2011 (for 2005) for both the indirect import challenge and the direct import challenge. Pending appeal, the 2004 assessment became due and payable, and in February 2011 Chiquita Italia began to make required installment payments for half of the amount assessed plus interest. In March 2011, these payments were temporarily suspended.
Chiquita Italia continues to believe that it acted properly and that all the transactions for which it has received assessment notices were legitimate and reported appropriately, and, aside from those issues already settled, continues to vigorously defend the transactions at issue.
CONSUMPTION TAX REFUND
In March 2008, the company received a favorable decision from a court in Rome, Italy for the refund of certain consumption taxes paid between 1980 and 1990. The Italian Finance Administration did not appeal the decision prior to May 2009, when their right to appeal expired. In the second quarter of 2010, payment was received, and the company recognized other income of 3 million ($3 million or $2 million net of income tax). The company has a number of other similar claims pending in different Italian jurisdictions and any gains that may occur will be recognized as the related gain contingencies are resolved. The March 2008 Rome ruling has no binding effect on pending claims in other jurisdictions, which may take years to resolve.
Note 14 Deconsolidation, Divestitures and Discontinued Operations
DANONE CHIQUITA FRUITS JOINT VENTURE
In May 2010, the company sold 51% of its European smoothie business to Danone S.A., for 15 million ($18 million) and deconsolidated it. The deconsolidation and sale resulted in the creation of the Danone Chiquita Fruits SAS (Danone JV), which is a joint venture intended to develop, manufacture, and sell packaged fruit juices and fruit smoothies in Europe and is financed by Chiquita and Danone in amounts proportional to their ownership interests. The gain on the deconsolidation and sale of European smoothie business was $32 million, which includes a gain of $15 million related to the remeasurement of the retained investment in European smoothie business to its fair value of $16 million on the closing date. No income tax expense resulted from the gain on the sale because sufficient foreign NOLs were in place and, when those foreign NOLs were used, the related valuation allowance was released. The fair value of the investment was a Level 3 measurement (see Note 6) based upon the consideration paid by Danone for 51% of the Danone JV, including a control discount. The companys 49% investment in the joint venture is accounted for as an equity method investment and is included in the Salads and Healthy Snacks segment. Future company contributions to the Danone JV are limited to an aggregate 17 million ($25 million) through 2013 without unanimous consent of the owners. The company contributed a total of 4 million ($5 million) during 2010 and less than $1 million during the second quarter of 2011. The companys carrying value of the Danone JV was $16 million as of June 30, 2011.
The Danone JV is a variable interest entity; however, the company was not the primary beneficiary, and does not consolidate it. The Danone JV will obtain sales, local marketing, and product supply chain management services from the companys subsidiaries; however, the power to direct the JVs most significant activities is controlled by Danone S.A.
SALE OF EQUITY INVESTMENT
In April 2010, the company sold its 49% investment in Coast Citrus Distributors, Inc. for $18 million in cash, which approximated its carrying value. Prior to the sale, the company accounted for this investment using the equity method.
In August 2008, the company sold its subsidiary, Atlanta AG, and the 2010 loss from discontinued operations was related to new information about potential indemnification obligations for tax liabilities. In addition, approximately 6 million ($7 million) was received in February 2010 related to consideration from the sale which had been held in escrow to secure any potential obligations of the company under the sale agreement.
Note 15 Severance
In June 2011, the company realigned its value-added salads overhead cost structure and embedded its global innovation and marketing functions into its business units to better focus on speed, execution and scalability, and to deliver future operating cost savings, particularly in the Salads and Healthy Snacks segment. These actions resulted in $2 million of severance costs, which were recorded in the second quarter of 2011 in Cost of sales and Selling, general and administrative in the Condensed Consolidated Statements of Income.
Item 2 - Managements Discussion and Analysis of Financial Condition and Results of Operations
In the first half of 2011, we delivered higher net income, but lower operating income than 2010; both net income and operating income in the second quarter of 2011 were below 2010 levels. These results reflected a mix of trends and significant items:
In July 2011, we completed a refinancing of a portion of our capital structure by entering into a new senior secured credit facility (New Credit Facility) which includes a $330 million senior secured term loan and a $150 million senior secured revolving facility using the proceeds to retire $155 million outstanding under the previous credit facility and purchase $133 million of the 8 7/8% Senior Notes due 2015 pursuant to a tender offer in July 2011; we called the remaining $44 million of the 8 7/8% Senior Notes and will use the remainder of the proceeds together with available cash to retire the entire issue in August 2011. The New Credit Facility matures on either (a) July 26, 2016 or (b) six months prior to the maturity of the 7 1/2% Senior Notes due 2014 (May 1, 2014) unless we refinance, or otherwise extend the maturity of, the 7 1/2% Senior Notes by such date. In total, these refinancing efforts will result in an aggregate $11 million of expense in the third quarter for tender premiums, call premiums and deferred financing fee write-offs, as well as approximately $5 million of cash expenditures for deferred financing fees for the New Credit Facility, both of which will be recorded in the third quarter of 2011. The refinancing is expected to result in interest cost savings of approximately $11 million annually. We intend to monitor the capital markets for additional refinancing opportunities (including with respect to our 7 1/2% Senior Notes), with the goal of further reducing interest expense, extending debt maturities and improving liquidity.
Our results are subject to significant seasonal variations and interim results are not indicative of the results of operations for the full fiscal year. Our results during the third and fourth quarters are generally weaker than in the first half of the year due to increased availability of competing fruits and resulting lower banana prices, as well as seasonally lower consumption of salads in the fourth quarter. For a further description of our challenges and risks,
see the Overview section of Managements Discussion and Analysis of Financial Condition and Results of Operations and Part I Item 1A Risk Factors in our 2010 Annual Report on Form 10-K and discussion below.
Net sales for the second quarter of 2011 were $870 million, down 5% from the second quarter of 2010. Net sales for the six months ended June 30, 2011 were $1.7 billion, down 2% from the year-ago period. The decrease was the result of lower North American retail value-added salad volume and the discontinuation of non-strategic, low-margin other produce lines in late 2010. Banana sales increased slightly due to higher pricing, partially offset by lower volume due to tight industry-wide supply conditions.
Operating income was $14 million and $107 million for the second quarters of 2011 and 2010, respectively, and $56 million and $114 million for the six months ended June 30, 2011 and 2010, respectively. The second quarter of 2011 includes a $32 million reserve against advances provided to a Chilean grower, as described in Note 2 to the Condensed Consolidated Financial Statements. The second quarter of 2010 included a $32 million gain on the deconsolidation of the European smoothie business, and a $6 million reduction in Cost of sales from recognizing a receivable for retroactively reduced tariff rates on the import of bananas into the EU from Latin America. Otherwise, the decline in operating income was primarily the result of less favorable results in Salads and Healthy Snacks, partially offset by stronger banana pricing.
We report three business segments: Bananas; Salads and Healthy Snacks; and Other Produce. Segment descriptions and results can be found in Note 12 to the Condensed Consolidated Financial Statements. Certain corporate expenses are not allocated to the reportable segments and are included in Corporate. Inter-segment transactions are eliminated.
Net sales for the segment were $555 million and $547 million for the second quarters of 2011 and 2010, respectively, and $1.1 billion and $1.0 billion for the six months ended June 30, 2011 and 2010, respectively. The increase in sales was primarily due to higher pricing in all markets, partially offset by lower volume in Core Europe (defined below), the Mediterranean and Middle East from industry-wide constraints on volume availability. To recover significantly higher sourcing costs that began in late 2010, North American pricing included force majeure surcharges in 2011 from late January until the end of the second quarter, when supply increased to more normal seasonal levels. We also maintained our pricing discipline as supply conditions improved by reducing shipments to Mediterranean markets due to unfavorable pricing conditions. In Europe, banana prices are generally set weekly in local currencies, and are significantly affected by variations in supply and demand in the market. For the first half of 2011, we achieved higher average European local pricing than 2010, which reflected a higher-cost environment as well as improved market conditions versus the unusually weak market conditions in the first quarter of 2010. Average European local currency pricing for the second quarter of 2011 was slightly lower as June pricing declined due to the industry supply increase mentioned above; European exchange rates strengthened during the second quarter versus 2011 which more than offset the effect of lower average local currency pricing.
The significant increases (decreases) in our Banana segment operating income for the quarter (Q2) and six months (YTD) ended June 30, presented in millions, are as follows:
The percentage changes in our banana prices in 2011 compared to 2010 were as follows:
Our banana sales volumes5 (in 40-pound box equivalents) were as follows:
The average spot and hedged euro exchange rates were as follows:
We have entered into euro put option contracts to reduce the negative cash flow and earnings effect that any significant decline in the value of the euro would have on the conversion of euro-based revenue into U.S. dollars. Put options, which require an upfront premium payment, can reduce this risk without limiting the benefit of a stronger euro. To minimize the volatility that changes in fuel prices could have on the operating results of our core shipping operations, we also enter into hedge contracts to lock in prices of future bunker fuel purchases. Further discussion of hedging risks can be found under the caption Market Risk Management - Financial Instruments below, and Note 5 to the Condensed Consolidated Financial Statements.
EU Banana Import Regulation
From 2006 through the second quarter of 2010, bananas imported into the European Union (EU) from Latin America, our primary source of fruit, were subject to a tariff of 176 per metric ton, while bananas imported from African, Caribbean, and Pacific sources have been and continue to be allowed to enter the EU tariff-free (since January 2008, in unlimited quantities). Following several successful legal challenges to this EU import arrangement in the World Trade Organization (WTO), the EU and 11 Latin American countries initialed the WTO Geneva Agreement on Trade in Bananas (GATB) in December 2009, under which the EU agreed to reduce tariffs on Latin American bananas in stages, starting with a new rate of 148 per metric ton in 2010, reducing to 143 per metric ton in 2011 and ending with a rate of 114 per metric ton by 2019. At that time, the EU also initialed a WTO agreement with the United States, under which it agreed not to reinstate WTO-illegal tariff quotas or licenses on banana imports. In June 2010, the EU reduced its tariff to 148 per metric ton retroactively to December 15, 2009, and we recognized a 10 million ($12 million) receivable in Other receivables, net and a reduction of tariff expense included in Cost of sales for these refunds; of this amount, 5 million ($6 million) relates to refunds of tariff expense incurred in the first quarter of 2010. In January 2011, the EU further reduced its tariff to 143 per metric ton as required by the GATB. The WTO agreements were ratified by the European Parliament in February 2011. The GATB still needs to be ratified by Ecuador before being further formalized in the WTO. The initial 28 per metric ton reduction in the tariff lowered our tariff costs by $26 million for the year ended December 31, 2010.
In another regulatory development, in March 2011, the EU initialed a free trade area (FTA) agreement with Colombia and Peru and an FTA with the Central American countries and Panama. Under both FTA agreements, the EU committed to reduce its banana tariff to 75 per metric ton over ten years for specified volumes of banana exports from each of the countries covered by these FTAs. The agreements still need to be officially signed and approved by the European Council, and ratified by the European Parliament and Latin American legislatures. The EU and other FTA countries have expressed hope that their new agreements will take effect by mid-2012 or sooner. Because the approval procedures and banana implementing arrangements for the two agreements remain unsettled, it is unclear when, or whether, one or both of these FTAs will be implemented, and what, if any, effect they will have on our operations.
SALADS AND HEALTHY SNACKS SEGMENT
Net sales for the segment were $253 million and $288 million for the second quarters of 2011 and 2010, respectively and $491 million and $547 million for the six months ended June 30, 2011 and 2010, respectively. The decline in sales was due to lower volume in retail value-added salads from customer conversions to private label during the first nine months of 2010. Adverse weather conditions and a lettuce blight resulted in lower productivity and higher field and manufacturing costs for the entire industry in the first quarter of 2011. A new marketing campaign to promote our value-added salads washed with Fresh Rinse began in the second quarter and we expect our marketing investment to increase in the second half of 2011. Fresh Rinse is a new produce wash that significantly reduces microorganisms on particular leafy greens compared to a conventional chlorine sanitizer. We converted all of our facilities to use this technology during the first half of 2011. As part of our commitment to advancing food safety standards, we plan to make the technology available for license to others in the industry and for other produce wash applications.
The significant increases (decreases) in our Salads and Healthy Snacks segment operating income for the quarter (Q2) and six months (YTD) ended June 30, presented in millions, are as follows:
Volume and pricing for Fresh Express-branded retail value-added salads was as follows:
OTHER PRODUCE SEGMENT
Net sales for the segment were $63 million and $82 million in the second quarters of 2011 and 2010, respectively and $109 million and $155 million for the six months ended June 30, 2011 and 2010, respectively. Operating loss for the segment was $33 million and $37 million for the second quarter and six months ended June 30, 2011 compared to operating income of $1 million and $3 million for the second quarter and six months ended June 30, 2010, respectively. Sales decreased primarily due to the discontinuation of non-strategic, low margin product in the fourth quarter of 2010. Operating income decreased primarily as a result of recording a $32 million reserve for advances to a Chilean grower of grapes and other produce, representing the expected remaining carrying value after collections from the current seasons already completed harvest. The reserve was based upon additional information received during the quarter on the growers credit quality, lower than expected collections through the end of the 2010-2011 Chilean grape season, and a decision in the second quarter of 2011 to change the companys grape sourcing model. As previously disclosed, advances to this grower in current and past growing seasons were not fully repaid and although the arrangement was restructured in 2009 to provide for collection over several growing seasons, the grower did not fully comply with the established repayment schedule in 2010 or 2011. Negotiations for various repayment options are ongoing, the outstanding balance remains payable on demand, and we will continue to aggressively pursue recovery of the outstanding balance (including liquidation of certain collateral). See further discussion of grower advances in Note 2 to the Condensed Consolidated Financial Statements. Segment results were also affected by higher avocado sourcing and logistics costs.
Corporate expenses were $15 million and $20 million for the second quarters of 2011 and 2010, respectively, and $32 million and $39 million for the six months ended June 30, 2011 and 2010, respectively. Corporate expenses were lower primarily due to lower legal fees.
Interest expense was $14 million for each of the second quarters of 2011 and 2010, respectively and $28 million and $29 million for the six months ended June 30, 2011 and 2010, respectively. See discussion of refinancing activities in Note 4 to the Condensed Consolidated Financial Statements and in Financial Condition Liquidity and Capital Resources below.
Income taxes were a net benefit of $77 million and $72 million in the quarter and six months ended June 30, 2011, respectively, compared to net expense of $3 million and $3 million for the quarter and six months ended June 30, 2010, respectively. The increase in net income tax benefit in the second quarter of 2011 compared to 2010 is primarily the result of the U.S. valuation allowance release of $87 million partially offset by a $6 million charge for a tax settlement in Italy as described in Notes 8 and 13 to the Condensed Consolidated Financial Statements.
As a result of sustained improvements in the performance of our North American businesses and the benefits of debt reduction over the last several years, we have been generating U.S. taxable income beginning with tax year 2009, and expect this trend to continue. As of June 30, 2011, our forecast included second quarter results as well as increased visibility to North American banana pricing and stabilized sourcing costs. As a result of these considerations, we recognized an $87 million income tax benefit for the reversal of valuation allowances against 100% of the U.S. federal deferred tax assets and a portion of the state deferred tax assets, primarily net operating loss carry forwards (NOLs), which are more likely than not to be realized in the future. We regularly review all deferred tax assets to estimate whether these assets are more likely than not to be realized based on all available evidence. Unless deferred tax assets are more likely than not to be realized, a valuation allowance is established to reduce the carrying value of the deferred tax asset until such time that realization becomes more likely than not. Increases and decreases in these valuation allowances are included in Income tax benefit (expense) in the Condensed Consolidated Statements of Income.
Our foreign operations are generally taxed at rates lower than the U.S. statutory rate, and our overall effective tax rate varies significantly from period to period due to the level and mix of income among various domestic and foreign jurisdictions. No U.S. taxes have been accrued on foreign earnings because such earnings have been or are expected to be permanently invested in foreign operations. Through the second quarter of 2011, our valuation allowances on available NOLs significantly affected our effective tax rate; if a deferred tax asset with a full valuation allowance, such as an NOL, was realized, the corresponding valuation allowance was also released, resulting in no net effect to income taxes in the Condensed Consolidated Statements of Income. As a result of the U.S. valuation allowance release in the second quarter of 2011, we expect an increase in future income tax expense, but cash paid for taxes will not change significantly until the NOLs are fully utilized. We estimate that our global effective tax rate will be approximately 20% beginning in 2012, before the effects of discrete items such as changes in unrecognized income tax benefits, settlements and changes in remaining valuation allowances. The company expects to begin to apply an annualized effective tax rate methodology to estimate taxes beginning in the third quarter.
Financial Condition Liquidity and Capital Resources
At June 30, 2011, we had a cash balance of $196 million. As described more fully in Note 4 to the Condensed Consolidated Financial Statements, in July 2011 we completed a refinancing of a portion of our capital structure by entering into a New Credit Facility with a secured term loan (New Term Loan) of $330 million, and a $150 million senior secured revolving facility (New Revolver). While keeping similar terms and covenant flexibility of our previous senior secured credit facility (Preceding Credit Facility), we used the proceeds to retire both the Preceding Credit Facility and purchase $133 million of our 8 7/8% Senior Notes due 2015 in a tender offer at 103.333% of their par value in July 2011; we called the remaining $44 million of the 8 7/8% Senior Notes for redemption in August 2011 at 102.958% of their par value and expect to use the remainder of the proceeds from the New Credit Facility together with available cash to retire the 8 7/8% Senior Notes called for redemption, representing the entire issue. In total, these refinancing efforts will result in an aggregate $11 million of expense in the third quarter for tender premiums, call premiums and deferred financing fee write-offs, as well as approximately $5 million of cash expenditures for deferred financing fees for the New Credit Facility, both of which will be recorded in the third quarter of 2011. This is expected to reduce our annual interest expense by approximately $11 million, excluding deferred financing fee write-offs. The New Term Loan requires quarterly principal payments of $4 million beginning September 30, 2011 through June 30, 2013 and quarterly principal repayments of $8 million
beginning September 30, 2013 through March 31, 2016, with any remaining principal balance due at June 30, 2016, subject to the following early maturity provision. The New Credit Facility matures on either (a) July 26, 2016 or (b) six months before the maturity of the 7 1/2% Senior Notes due 2014 (May 1, 2014) unless we refinance, or otherwise extend the maturity of the 7 1/2% Senior Notes by such date. Initially we did not draw on the New Revolver and used $22 million to support letters of credit, leaving an available balance of $128 million. We are in compliance with the financial covenants of our New Credit Facility and expect to remain in compliance for more than twelve months from the date of this filing. We intend to monitor the capital markets for additional refinancing opportunities (including with respect to our 7 1/2% Senior Notes), with the goal of further reducing interest expense, extending debt maturities and improving liquidity.
Cash provided by operations was $77 million and $21 million for the six months ended June 30, 2011 and 2010, respectively, and improved in 2011 primarily due to faster seasonal working capital reductions. Seasonal working capital demands typically use cash in the first quarter and provide cash in the second quarter.
Cash flow from investing activities includes capital expenditures of $31 million and $17 million for the six months ended June 30, 2011 and 2010, respectively. The increase in capital expenditures primarily relates to the implementation of Fresh Rinse into all of our value-added salad facilities and other cost saving and rejuvenation projects during the first half of 2011. We expect capital expenditures for the full year to be between $75 and $85 million, a level that is higher than historic levels, primarily due to investments for growth and innovation such as Fresh Rinse, improved packaging and expansion of our fresh cut apples program. The first half of 2010 also included 15 million ($18 million) of proceeds from the sale of 51% of our European smoothie business to Danone and $18 million of proceeds from the sale of an equity method investment in Coast Citrus Distributors, Inc. See Note 14 to the Condensed Consolidated Financial Statements for further discussion of deconsolidation and divestiture transactions.
Cash used in financing activities related to the quarterly principal payment under the term loan of our Preceding Credit Facility and in 2010 also included the open-market repurchase of $13 million of our Senior Notes, consisting of $11 million of the 7 1/2% Senior Notes and $2 million of the 8 7/8% Senior Notes. During the six months ended 2011 and 2010, we did not draw on the Revolver to fund normal seasonal working capital needs. Management evaluates opportunities to reduce debt to the extent it is economically efficient and attractive and has a long-term goal to improve the ratio of debt to EBITDA (earnings before interest, taxes, depreciation and amortization) to 3 to 1. See Note 4 to the Condensed Consolidated Financial Statements for further description of our debt agreements (including covenants and restrictions) and financing activities.
A subsidiary has an approximately 17 million ($25 million) uncommitted credit line for bank guarantees used primarily for payments due under import licenses and duties in European Union countries. At June 30, 2011, we had approximately 12 million ($17 million) of cash equivalents in a compensating balance arrangement related to this uncommitted credit line.
Depending on fuel prices, we can have significant obligations or amounts receivable under our bunker fuel hedging arrangements, although we would expect any liability or asset from these arrangements to be offset by lower or higher fuel purchase costs, respectively. At June 30, 2011 and 2010, our bunker fuel forward contracts were an asset of $54 million and a liability of $10 million, respectively. The amount ultimately due or receivable will depend upon fuel prices at the dates of settlement. See Item 3 Quantitative and Qualitative Disclosures About Market Risk below and Note 5 to the Condensed Consolidated Financial Statements for further information about our hedging activities. We expect operating cash flows will be sufficient to cover our hedging obligations, if any.
We face certain contingent liabilities which are described in Note 13 to the Condensed Consolidated Financial Statements; in accordance with generally accepted accounting principles, reserves have not been established for most of the ongoing matters. It is possible that in future periods we could have to pay fines, penalties or damages with respect to one or more of these matters, the exact amount of which would be at the discretion of the applicable court or regulatory body. We presently expect that we would use existing cash resources to satisfy any such liabilities; however, depending on the size and timing of any such liability, it could have a material adverse effect on our financial position or results of operations and we could need to explore additional sources of financing, the availability and terms of which would be dependent on prevailing market and other conditions. In addition, we are making payments and may be required to make additional payments to preserve our right to appeal assessments of Italian customs cases, as more fully described in Note 13 to the Condensed Consolidated Financial Statements.
Such payments are typically made over a period of time under a payment plan. If we ultimately prevail in these cases, the amounts will be repaid with interest.
We have not made dividend payments since 2006, and any future dividends would require approval by the board of directors. Under the New Credit Facility, CBL may distribute cash to CBII, the parent company, for routine CBII operating expenses, interest payments on CBIIs 7 1/2% and 8 7/8% Senior Notes and its Convertible Notes, any refinancing of these Senior Notes and Convertible Notes and payment of certain other specified CBII liabilities (permitted payments). CBL may distribute cash to CBII for other purposes, including dividends, if we are in compliance with the covenants and not in default under the New Credit Facility. The CBII 7 1/2% Senior Notes also have dividend payment limitations with respect to the ability and extent of declaration of dividends. At June 30, 2011, distributions to CBII, other than for permitted payments, were limited to approximately $80 million annually.
Risks of International Operations
We operate in many foreign countries, including those in Central America, Europe, the Middle East, China and Africa. Our activities are subject to risks inherent in operating in these countries, including government regulation, currency restrictions and other restraints, import and export restrictions, burdensome taxes, risks of expropriation, threats to employees, political instability, terrorist activities, including extortion, and risks of U.S. and foreign governmental action in relation to us. Should such circumstances occur, we might need to curtail, cease or alter our activities in a particular region or country. Trade restrictions apply to certain countries, such as Iran, that require us to obtain licenses from the U.S. government for sales in these countries; these sales are able to be licensed because the products we sell are food staples and the specific parties involved in the sales are cleared by the U.S. government.
See Part II, Item 1 Legal Proceedings in this Quarterly Report on Form 10-Q and Note 13 to the Condensed Consolidated Financial Statements for a further description of legal proceedings and other risks.
Critical Accounting Policies and Estimates
There have been no material changes to our critical accounting policies and estimates described in Managements Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2010.
New Accounting Standards
Reference is made to Note 1 of the Consolidated Financial Statements in Exhibit 13 of our 2010 Annual Report on Form 10-K. See Note 11 to the Condensed Consolidated Financial Statements for information on a relevant new accounting standard related to comprehensive income.
* * * * *
This quarterly report contains certain statements that are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to a number of assumptions, risks and uncertainties, many of which are beyond our control, including: the customary risks experienced by global food companies, such as prices for fuel and other commodity inputs, currency exchange rate fluctuations, industry and competitive conditions (all of which may be more unpredictable in light of continuing uncertainty in the global economic environment), government regulations, food safety issues and product recalls affecting us or the industry, labor relations, taxes, political instability and terrorism; unusual weather events, conditions or crop risks; access to and cost of financing; and the outcome of pending litigation and governmental investigations involving us, as well as the legal fees and other costs incurred in connection with these items.
The forward-looking statements speak as of the date made and are not guarantees of future performance. Actual results or developments may differ materially from the expectations expressed or implied in the forward-looking statements, and we undertake no obligation to update any such statements.
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
Reference is made to the discussion under Managements Discussion and Analysis of Financial Condition and Results of Operations Market Risk Management Financial Instruments in our 2010 Annual Report on Form 10-K. As of June 30, 2011, the only material changes from the information presented in the Form 10-K are contained in the information provided below.
Our products are distributed in nearly 70 countries. International sales are made primarily in U.S. dollars and major European currencies. We reduce currency exchange risk from sales originating in currencies other than the U.S. dollar by exchanging local currencies for dollars promptly upon receipt. We consider our exposure, current market conditions and hedging costs in determining when and whether to enter into new hedging instruments (principally euro put option contracts) to hedge the dollar value of our estimated net euro cash flow exposure up to 18 months into the future. Put option contracts allow us to exchange a certain amount of euros for U.S. dollars at either the exchange rate in the option contract or the spot rate. At July 28, 2011, we had hedge positions that protect approximately 60% of our expected net exposure for the remainder of 2011 from a decline in the exchange rate below $1.42 per euro. We also had hedge positions that limit the benefit of an increase in the exchange rate above $1.48 per euro for approximately 60% of our expected net exposure in the remainder of 2011; these positions could also result in a loss if the actual exchange rate exceeds the strike rate. However, we expect that any loss on these contracts would be more than offset by an increase in the dollar realization of the underlying sales denominated in foreign currencies.
Our shipping operations are exposed to the risk of rising fuel prices. To reduce the risk of rising fuel prices, we enter into bunker fuel forward contracts (swaps) that allow us to lock in fuel prices up to three years in the future. Bunker fuel forward contracts can offset increases in market fuel prices or can result in higher costs from declines in market fuel prices, but in either case reduce the volatility of changing fuel prices in our results. At July 28, 2011, we had hedging coverage for approximately three-fourths of our expected fuel purchases through 2011 at average bunker fuel swap rates of $439 per metric ton, hedging coverage for approximately one-half of our expected fuel purchases in 2012 at average bunker fuel swap rates of $459 per metric ton, hedging coverage for approximately 40% of our expected fuel purchases in 2013 at average bunker fuel swap rates of $488 per metric ton and hedging coverage for approximately one-third of our expected fuel purchases in the first quarter of 2014 at average bunker fuel swap rates of $566 per metric ton.
We carry hedging instruments at fair value on our Condensed Consolidated Balance Sheets, and defer potential gains and losses to the extent that the hedges are effective in Accumulated other comprehensive income (loss) until the hedged transaction occurs (the euro sale or fuel purchase to which the hedging instrument was intended to apply). The fair value of the foreign currency options and bunker fuel forward contracts was a net asset of $54 million, $28 million and $6 million at June 30, 2011, December 31, 2010 and June 30, 2010, respectively. A hypothetical 10% increase in the euro currency rates would have resulted in a decline in fair value of the euro put and call options of approximately $11 million at June 30, 2011. However, we expect that any loss on these put and call options would be more than offset by an increase in the dollar realization of the underlying sales denominated in foreign currencies. A hypothetical 10% decrease in bunker fuel rates would result in a decline in fair value of the bunker fuel forward contracts of approximately $23 million at June 30, 2011. However, we expect that any decline in the fair value of these contracts would be offset by a decrease in the cost of underlying fuel purchases.
See Note 5 to the Condensed Consolidated Financial Statements for additional discussion of our hedging activities. See Note 6 to the Condensed Consolidated Financial Statements for additional discussion of fair value measurements, as it relates to our hedging instruments.
We are exposed to interest rate risk on our variable rate debt, which is primarily the outstanding balance under our Credit Facility. As of July 28, 2011, we had approximately $330 million of variable rate debt (see Note 4 to the Condensed Consolidated Financial Statements). A 1% change in interest rates would result in a change to interest expense of approximately $3 million annually.
Although the Condensed Balance Sheets do not present debt at fair value, we have a significant amount of fixed-rate debt whose fair value could fluctuate as a result of changes in prevailing market interest rates. As of July
28, 2011, we have $44 million of 8 7/8% Senior Notes due 2015 remaining, which have all been called for redemption in August 2011 at 102.958% of their par value. Because the remaining 8 7/8% Senior Notes have been called, changes in interest rates are not expected to significantly affect the fair value of these instruments. As of July 28, 2011, we also have $357 million principal balance of other fixed-rate debt, which includes the 7 1/2% Senior Notes due 2014 and the 4.25% Convertible Senior Notes due 2016. The $200 million principal balance of the Convertible Notes is greater than their $139 million carrying value due to the accounting standards for convertible notes such as ours that are described in Note 4 to the Condensed Consolidated Financial Statements. A hypothetical 0.50% increase in interest rates would have resulted in a decline in the fair value of our other fixed-rate debt of approximately $7 million at June 30, 2011.
Item 4 - Controls and Procedures
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our periodic filings with the SEC is (a) accumulated and communicated to management in a timely manner and (b) recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms. An evaluation was carried out by management, with the participation of the Chief Executive Officer and Chief Financial Officer, of the effectiveness as of June 30, 2011 of our disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that these disclosure controls and procedures were effective as of that date.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
We also maintain a system of internal accounting controls, which includes internal control over financial reporting, that is designed to provide reasonable assurance that our financial records can be relied upon for preparation of our consolidated financial statements in accordance with generally accepted accounting principles in the United States and that our assets are safeguarded against loss from unauthorized use or disposition. Based on an evaluation by management, with the participation of the Chief Executive Officer and Chief Financial Officer, during the quarter ended June 30, 2011, there were no changes in our internal control over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 1 - Legal Proceedings
The information included in Note 13 to the Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q regarding the Tort Lawsuits, Insurance Recovery and the Italian Customs and Tax Cases is incorporated by reference into this Item. Reference is made to the discussion under Part 1, Item 3 Legal Proceedings Personal Injury Cases in our Annual Report on Form 10-K for the year ended December 31, 2010 and under Part II, Item 1 Legal Proceedings in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2011. Regarding the DBCP cases pending in California, the appeal of the Costa Rica residents has been denied by the California Supreme Court, making the dismissal final, although they still have the right to re-file in Costa Rica. In May 2011, seven cases were filed in the Eastern District of Louisiana involving approximately 250 plaintiffs from Panama, Ecuador and Costa Rica. Some of these plaintiffs were also plaintiffs in the California litigation. There is not enough information available to determine if we are a proper defendant as to any of these plaintiffs.
Item 6 Exhibits
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
August 5, 2011