POTASH CORP OF SASKATCHEWAN INC 10-Q 2008
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission File Number 1-10351
POTASH CORPORATION OF SASKATCHEWAN INC.
(Exact name of registrant as specified in its charter)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 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 þ NO o
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. (Check one):
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).
YES o NO þ
As at October 31, 2008, Potash Corporation of Saskatchewan Inc. had 301,730,631 Common Shares outstanding.
PART I. FINANCIAL INFORMATION
Potash Corporation of Saskatchewan Inc.
Condensed Consolidated Statements of Financial Position
(in millions of US dollars except share amounts)
(See Notes to the Condensed Consolidated Financial Statements)
Potash Corporation of Saskatchewan Inc.
Condensed Consolidated Statements of Operations and Retained Earnings
(in millions of US dollars except per-share amounts)
Potash Corporation of Saskatchewan Inc.
Condensed Consolidated Statements of Cash Flow
(in millions of US dollars)
(See Notes to the Condensed Consolidated Financial Statements)
Potash Corporation of Saskatchewan Inc.
Condensed Consolidated Statements of Comprehensive (Loss) Income
(in millions of US dollars)
(See Notes to the Condensed Consolidated Financial Statements)
Potash Corporation of Saskatchewan Inc.
Condensed Consolidated Statement of Accumulated Other Comprehensive Income
(in millions of US dollars)
(See Notes to the Condensed Consolidated Financial Statements)
Potash Corporation of Saskatchewan Inc.
Notes to the Condensed Consolidated Financial Statements
For the Three and Nine Months Ended September 30, 2008
(in millions of US dollars except share, per-share, percentage and ratio amounts)
Basis of Presentation
With its subsidiaries, Potash Corporation of Saskatchewan Inc. (PCS) together known as PotashCorp or the company except to the extent the context otherwise requires forms an integrated fertilizer and related industrial and feed products company. The companys accounting policies are in accordance with accounting principles generally accepted in Canada (Canadian GAAP). These policies are consistent with accounting principles generally accepted in the United States (US GAAP) in all material respects except as outlined in Note 17. The accounting policies used in preparing these interim condensed consolidated financial statements are consistent with those used in the preparation of the 2007 annual consolidated financial statements, except as described below.
These interim condensed consolidated financial statements include the accounts of PCS and its subsidiaries; however, they do not include all disclosures normally provided in annual consolidated financial statements and should be read in conjunction with the 2007 annual consolidated financial statements. In managements opinion, the unaudited financial statements include all adjustments (consisting solely of normal recurring adjustments) necessary to present fairly such information. Interim results are not necessarily indicative of the results expected for the fiscal year.
Change in Accounting Policy
In June 2007, the Canadian Institute of Chartered Accountants (CICA) issued Section 3031, Inventories, which replaces Section 3030 and harmonizes the Canadian standard related to inventories with International Financial Reporting Standards (IFRSs). This standard provides more extensive guidance on the determination of cost, including allocation of overhead; narrows the permitted cost formulas; restricts the classification of spare and replacement parts as inventory; requires impairment testing; and expands the disclosure requirements to increase transparency. This standard applies to interim and annual financial statements relating to fiscal years beginning on or after January 1, 2008. This standard has been applied prospectively; accordingly comparative amounts for prior periods have not been restated. The adoption of this standard resulted in a reclassification of certain spare and replacement parts to property, plant and equipment. The effects of the adjustment were to decrease inventory by $21.5 at January 1, 2008, and to increase property, plant and equipment by the same amount. Since there was no difference in the measurement of the assets, no adjustment to opening retained earnings was necessary.
Recent Accounting Pronouncements
Effective January 1, 2008, the company adopted CICA Section 1535, Capital Disclosures. This pronouncement increases harmonization with IFRSs by establishing standards for disclosing information about an entitys capital and capital management. The companys adoption of Section 1535 has resulted in the capital management disclosure set forth in Note 6.
Effective January 1, 2008, the company adopted CICA Section 3863, Financial Instruments Presentation and CICA Section 3862, Financial Instruments Disclosures, which increases harmonization with IFRSs. Section 3863 establishes standards for presentation of financial instruments and non-financial derivatives. It deals
with the classification of financial instruments, from the perspective of the issuer, between liabilities and equity; the classification of related interest, dividends, losses and gains; and the circumstances in which financial assets and financial liabilities are offset. Section 3862 provides expanded disclosure requirements that call for additional detail by financial asset and liability categories. The applicable disclosures required under these standards are included in Note 4.
Goodwill and Intangible Assets
In February 2008, the CICA issued Section 3064, Goodwill and Intangible Assets, which replaces Section 3062, Goodwill and Other Intangible Assets, and Section 3450, Research and Development Costs. The purpose of this section is to provide more specific guidance on the recognition of internally developed intangible assets and requires that research and development expenditures be evaluated against the same criteria as expenditures for intangible assets. The section increases harmonization of Canadian standards with IFRSs and applies to annual and interim financial statements relating to fiscal years beginning on or after October 1, 2008.
Also in February 2008, the CICA amended portions of Section 1000, Financial Statement Concepts, which the CICA concluded permitted deferral of costs that did not meet the definition of an asset. The amendments apply to annual and interim financial statements relating to fiscal years beginning on or after October 1, 2008.
Upon the companys adoption of Section 3064 and the amendments to Section 1000 on January 1, 2009, capitalized amounts that no longer meet the definition of an asset will be expensed retrospectively. The company is currently reviewing the potential impact, if any, on its consolidated statements.
International Financial Reporting Standards
In April 2008, the CICA published the exposure draft Adopting IFRSs in Canada. The exposure draft proposes to incorporate IFRSs into the CICA Accounting Handbook effective for interim and annual financial statements relating to fiscal years beginning on or after January 1, 2011. At this date, publicly accountable enterprises will be required to prepare financial statements in accordance with IFRSs. The company is currently reviewing the standards to determine the potential impact on its consolidated financial statements.
During the three months ended September 30, 2008, inventories of $1,158.6 (2007 $681.9) were expensed and write-downs of inventory amounting to $1.0 (2007 $1.8) were included in cost of goods sold. During the nine months ended September 30, 2008, inventories of $3,057.8 (2007 $2,056.1) were expensed and write-downs of inventory amounting to $2.6 (2007 $4.1) were included in cost of goods sold. No reversals of write-downs were recorded during the three and nine months ended September 30, 2008 or 2007.
In January 2008, the company settled its forward purchase contract, which was denominated in Hong Kong dollars, to acquire an additional 194,290,175 shares of Sinofert Holdings Limited (Sinofert) for cash consideration of $173.7. A tax-exempt gain of $25.3 was recognized during 2008 as a result of the change in fair value of the contract from December 31, 2007 to the settlement date. During the nine months ended September 30, 2008, the company purchased an additional 191,620,000 shares of Sinofert for cash consideration of $145.3. Net of the
ownership interest dilution that resulted from the issuance of shares of Sinofert, the acquisitions increased the companys ownership interest in Sinofert to approximately 22 percent.
The company assesses at each balance sheet date whether there is objective evidence that a financial asset or a group of financial assets is impaired. In the case of investments classified as available-for-sale, the company considers the length of time and extent to which fair value has been below cost as well as the financial condition and near-term prospects of the investee as indicators that the securities are impaired. If any such evidence exists for available-for-sale financial assets, the cumulative loss, measured as the difference between the acquisition cost and the current fair value, less any impairment loss on that financial asset previously recognized in the statement of operations, is removed from accumulated other comprehensive income and recognized in the statement of operations.
Investments include auction rate securities that are classified as available-for-sale. The company has determined that the fair value of the auction rate securities was $34.7 at September 30, 2008 (face value $132.5) as compared to $56.0 at December 31, 2007.
The changes in fair value, status of impaired investments and related accounting since December 31, 2007 were as follows:
Interest income of $1.1 and $3.6 relating to auction rate securities was included in interest expense for the three and nine month periods ending September 30, 2008, respectively. The current financial credit market crisis continues to cause the companys investments in these securities to be illiquid. The company is able to hold these investments until liquidity improves, but does not expect this to occur in the next 12 months.
The fair value of the auction rate securities was determined using a valuation methodology developed with the assistance of a valuation specialist. Due to the failed auction status and lack of liquidity in the market for such securities, the valuation methodology includes certain assumptions that were not supported by prices from observable current market transactions in the same instruments nor were they based on observable market data. With the assistance of a valuation specialist, the company estimated the fair value of the auction rate securities based on the following: (1) the underlying structure of each security; (2) the present value of future principal and interest payments discounted at rates considered to reflect current market conditions; (3) consideration of the probabilities of default, passing auction, or earning the maximum rate for each period; and (4) estimates of the recovery rates in the event of defaults for each security. These estimated fair values could change significantly based on future market conditions.
The company is exposed in varying degrees to a variety of financial risks from its use of financial instruments: credit risk, liquidity risk and market risk. The source of risk exposure and how each is managed is outlined below.
The company is exposed to credit risk on its cash and cash equivalents, accounts receivable, derivative instrument assets and auction rate securities. The maximum exposure to credit risk, as represented by the carrying amount of the financial assets, was:
The company manages its credit risk on cash and cash equivalents, derivative instrument assets and auction rate securities through policies guiding:
Derivative instrument assets are comprised of natural gas hedging instruments. At September 30, 2008, the company held no cash margin deposits as collateral relating to these natural gas derivative financial instruments. All of the counterparties to the contracts comprising the derivative financial instruments in an asset position are of investment grade quality.
Accounts receivable is comprised of both trade and non-trade accounts. Trade accounts receivable are recognized initially at fair value and subsequently measured at amortized cost less allowance for doubtful accounts. An allowance for doubtful accounts is established when there is a reasonable expectation that the company will not be able to collect all amounts due according to the original terms of the receivables. The carrying amount of the trade accounts receivable is reduced through the use of the allowance account, and the amount of any increase in the allowance is recognized in the statement of operations. When a trade receivable is uncollectible, it is written off against the allowance account for trade receivables. Subsequent recoveries of amounts previously written off are credited to the statement of operations.
The company seeks to manage the credit risk relating to its trade receivables through a credit management program. Credit approval policies and procedures are in place guiding the granting of credit to new customers as well as the continued extension of credit for existing customers. Existing customer accounts are reviewed every 12-18 months. Credit for international customers is extended based upon an evaluation of both customer and country risk. The company utilizes both external credit reporting, where available, as well as an assessment of other relevant information such as current financial statements, credit agency reports and/or credit references before
assigning credit limits to customers. Customers that fail to meet specified benchmark creditworthiness may transact with the company on a prepayment basis.
The company does not hold any collateral as security. If appropriate, the company may request guarantees or standby letters of credit to mitigate credit risk on trade receivables.
The credit period on sales is generally 15 days for fertilizer customers, 30 days for industrial and feed customers and up to 180 days for selected export sales customers. Interest at 1.5 percent per month is charged on balances remaining unpaid at the end of the sale terms. The company has historically experienced minimal customer defaults and as a result the company considers the credit quality of the trade receivables at September 30, 2008 that were not past due to be high. The company had virtually no impaired accounts receivable. The aging of trade receivables that were past due but not impaired was as follows:
A reconciliation of the accounts receivable allowance for doubtful accounts is as follows:
Of total accounts receivable at September 30, 2008, $148.7 related to non-trade accounts and $427.4 represented amounts receivable from Canpotex Limited (Canpotex). The company sells potash from its Saskatchewan mines for use outside North America exclusively to Canpotex. Sales to Canpotex are at prevailing market prices and are settled on normal trade terms. There were no amounts past due or impaired relating to the Canpotex or non-trade accounts receivable.
Liquidity risk arises from the companys general funding needs and in the management of the companys assets, liabilities and optimal capital structure. The company manages its liquidity risk to maintain sufficient liquid financial resources to fund its operations and meet its commitments and obligations in a cost-effective manner. In managing its liquidity risk, the company has access to a range of funding options. The table below outlines the companys available debt instruments:
Although the commercial paper market has had constraints, the company continues to have access to debt financing under existing bank credit facilities. The company has two syndicated credit facilities that provide for unsecured advances. The first is a $750.0 facility that provides for unsecured advances through May 31, 2013. As of September 30, 2008, $100.0 of borrowings were outstanding under this facility. The second is a $1,000.0 364-day facility entered into during May 2008 and amended on July 29, 2008. As of September 30, 2008, $1,000.0 of borrowings were outstanding under the 364-day facility. The amount available to the company under both facilities is the total facilities amount less direct borrowings and amounts committed in respect of commercial paper. The $75.0 line of credit is effective through May 2009. Outstanding letters of credit and direct borrowings reduce the amount available. The company may also issue up to an additional $2,250.0 in unsecured debt securities under the companys US shelf registration statements. The companys investment grade rating as measured by Moodys senior debt ratings remained unchanged from December 31, 2007 at Baa1 with a stable outlook. Its investment grade rating as measured by Standard & Poors senior debt ratings was upgraded in May 2008, from BBB+ with a stable outlook to BBB+ with a positive outlook, and again in August 2008 to A- with a stable outlook.
As at September 30, 2008, interest rates ranged from 3.3 percent to 3.9 percent on outstanding commercial paper denominated in Canadian dollars and 2.5 percent to 4.4 percent on outstanding commercial paper denominated in US dollars. Interest rates on borrowings under the credit facilities ranged from 2.9 percent to 5.5 percent.
The table below presents a maturity analysis of the companys financial liabilities based on the expected cash flows from the date of the balance sheet to the contractual maturity date. The amounts are the contractual undiscounted cash flows.
Market risk is the risk that financial instrument fair values will fluctuate due to changes in market prices. The significant market risks to which the company is exposed are foreign exchange risk, interest rate risk and price risk (related to commodity and equity securities).
Foreign Exchange Risk
The company is exposed to foreign exchange risk primarily relating to Canadian dollar operating and capital expenditures, income and resource taxes, dividends and capital expenditures denominated in currencies other than the US or Canadian dollar. To manage the companys foreign exchange risk arising from future operating and capital expenditures it may enter into foreign currency forward contracts. The companys treasury risk management policies allow such exposures to be hedged within certain prescribed limits for both forecasted operating and approved capital expenditures. The foreign currency forward contracts are not currently designated as hedging instruments for accounting purposes.
As at September 30, 2008, the company had entered into foreign currency forward contracts to sell US dollars and receive Canadian dollars in the notional amount of $310.0 (2007 $175.0) at an average exchange rate of 1.0455 (2007 1.0690) per US dollar. The company had also entered into other small forward contracts. Maturity dates for all forward contracts are within 2008 and 2009.
The company has certain available-for-sale investments listed on foreign exchanges and denominated in currencies other than the US dollar for which the company is exposed to foreign exchange risk. These investments are held for long-term strategic purposes.
The following table shows the companys exposure to exchange risk and the pre-tax effects on income and other comprehensive income (OCI) of reasonably possible changes in the relevant foreign currency. This analysis assumes all other variables remain constant.
Interest Rate Risk
Fluctuations in interest rates impact the future cash flows and fair values of various financial instruments. With respect to the companys debt portfolio, it addresses interest rate risk by using a diversified portfolio of fixed and floating rate instruments. This exposure is also managed by aligning current and long-term assets with demand and fixed-term debt and by monitoring the effects of market changes in interest rates. Interest rate swaps can and have been used by the company to further manage its interest rate exposure.
The company is also exposed to changes in interest rates related to its investments in marketable securities and auction rate securities. With respect to marketable securities, included in cash and cash equivalents, the companys primary objective is to ensure the security of principal amounts invested and provide for a high degree of liquidity, while achieving a satisfactory return. The companys treasury risk management policies specify various investment parameters including eligible types of investment, maximum maturity dates, maximum exposure by counterparty, and minimum credit ratings.
The following table shows the companys exposure to interest rate risk and the pre-tax effects on net income and other comprehensive income of reasonably possible changes in the relevant interest rates. This analysis assumes all other variables remain constant.
The company is exposed to commodity price risk resulting from its natural gas requirements. Its natural gas strategy is based on diversification for its total gas requirements (which represent the forecast consumption of natural gas volumes by its manufacturing and mining facilities). Its objective is to acquire a reliable supply of natural gas feedstock and fuel on a location-adjusted, cost-competitive basis in a manner that minimizes volatility without undue risk. The company employs derivative commodity instruments related to a portion of its natural gas requirements (primarily futures, swaps and options) for the purpose of managing its exposure to commodity price risk in the purchase of natural gas, not for speculative or trading purposes. The company has an Advisory Committee, comprised of members from senior management, responsible for developing policies and establishing procedural requirements relating to its natural gas activities. Such policies include the establishment of limits for the portion of its natural gas requirements that will be hedged as well as the types of instruments that may be utilized for such hedging activities.
The company is also exposed to equity securities price risk because of its exchange-traded available-for-sale securities. These investments, other than the auction rate securities, are held for long-term strategic purposes. The price risk related to auction rate securities results from the current lack of an active market in which the company is able to liquidate such securities and from credit risk as discussed above.
The following table shows the companys exposure to price risk and the pre-tax effects on net income and other comprehensive income of reasonably possible changes in the relevant commodity or securities prices. This analysis assumes all other variables remain constant.
The sensitivity analyses included in the tables above should be used with caution as the changes are hypothetical and are not predictive of future performance. The above sensitivities are calculated with reference to period-end balances and will change due to fluctuations in the balances throughout the year. In addition, for the purpose of the sensitivity analyses, the effect of a variation in a particular assumption on the fair value of the financial instrument was calculated independently of any change in another assumption. Actual changes in one factor may contribute to changes in another factor, which may magnify or counteract the effect on the fair value of the financial instrument.
Financial assets are recognized initially at fair value, normally being the transaction price plus, other than for held-for-trading assets, directly attributable transaction costs. Regular way purchases and sales of financial assets are accounted for on trade date.
On January 23, 2008, the Board of Directors of PCS authorized a share repurchase program of up to 15,820,000 common shares (approximately 5 percent of the companys issued and outstanding common shares) through a normal course issuer bid. As of September 9, 2008, the company had repurchased the maximum allowable number of shares under the program. On September 11, 2008, the Board of Directors of PCS approved an increase in the share repurchase program to authorize the purchase of up to an additional 15,680,000 common shares (approximately 5 percent of the companys issued and outstanding common shares). If considered advisable, shares may be repurchased from time to time on the open market through January 30, 2009 at prevailing market prices. The timing and amount of purchases, if any, under the program will be dependent upon the availability and alternative uses of capital, market conditions and other factors.
During the three months ended September 30, 2008, the company repurchased for cancellation 4,964,500 common shares under the program, at a cost of $870.7 and an average price per share of $175.38. The repurchase resulted in a reduction of share capital of $23.3, and the excess of cost over the average book value of the shares of $847.4 has been recorded as a reduction of retained earnings. During the nine months ended September 30, 2008, a total of 15,820,000 shares were repurchased at a cost of $2,902.9 and an average price per share of $183.50, resulting in a reduction of share capital of $73.8 and a reduction in retained earnings of $2,829.1.
The companys objectives when managing its capital are to maintain financial flexibility while managing its cost of and optimizing access to capital. In order to achieve these objectives, the companys strategy, which was unchanged from 2007, was to maintain its investment grade credit rating.
The company includes net debt and adjusted shareholders equity as components of its capital structure. The calculation of net debt, adjusted shareholders equity and adjusted capital are set out in the following table:
The company monitors capital on the basis of a number of factors, including the ratios of: adjusted earnings before interest expense, income taxes, depreciation and amortization, and provision for auction rate securities (adjusted EBITDA) to adjusted interest expense; net debt to adjusted EBITDA and net debt to adjusted capital. Adjusted EBITDA to adjusted interest expense and net debt to adjusted EBITDA are calculated utilizing twelve-month trailing adjusted EBITDA and adjusted interest expense.
The company monitors its capital structure and, based on changes in economic conditions, may adjust the structure through adjustments to the amount of dividends paid to shareholders, repurchase of shares, issuance of new shares, or issuance of new debt.
The increase in adjusted EBITDA to adjusted interest expense is a result of operating results. The net debt to adjusted EBITDA ratio remained constant as improved operating results were offset by an increase in net debt. The increase in net debt led to the increase in the net debt to adjusted capital ratio.
The calculations of the twelve-month trailing net income, adjusted EBITDA, interest expense and adjusted interest expense are set out in the following tables:
The companys consolidated reported income tax rate for the three months ended September 30, 2008 was 27 percent (2007 38 percent) and for the nine months ended September 30, 2008 was 27 percent (2007 33 percent). For the three and nine months ended September 30, 2008, the consolidated effective income tax rate was 29 percent (2007 33 percent). Items to note include the following:
Basic net income per share for the quarter is calculated on the weighted average shares issued and outstanding for the three months ended September 30, 2008 of 304,017,000 (2007 315,962,000). Basic net income per share for the year to date is calculated based on the weighted average shares issued and outstanding for the nine months ended September 30, 2008 of 310,076,000 (2007 315,444,000).
Diluted net income per share is calculated based on the weighted average number of shares issued and outstanding during the period. The denominator is: (1) increased by the total of the additional common shares that would have been issued assuming exercise of all stock options with exercise prices at or below the average market price for the period; and (2) decreased by the number of shares that the company could have repurchased if it had used the assumed proceeds from the exercise of stock options to repurchase them on the open market at the average share price for the period. The weighted average number of shares outstanding for the diluted net income per share calculation for the three months ended September 30, 2008 was 314,132,000 (2007 324,741,000) and for the nine months ended September 30, 2008 was 320,484,000 (2007 323,580,000).
The company has three reportable business segments: potash, nitrogen and phosphate. These business segments are differentiated by the chemical nutrient contained in the product that each produces. Inter-segment sales are made under terms that approximate market value. The accounting policies of the segments are the same as those described in Note 1.
On May 8, 2008, the companys shareholders approved the 2008 Performance Option Plan under which the company may, after February 20, 2008 and before January 1, 2009, issue options to acquire up to 1,000,000 common shares. Under the plan, the exercise price shall not be less than the quoted market closing price of the companys common shares on the last trading day immediately preceding the date of grant and an options maximum term is 10 years. In general, options will vest, if at all, according to a schedule based on the three-year average excess of the companys consolidated cash flow return on investment over weighted average cost of capital. As of September 30, 2008, options to purchase a total of 486,450 common shares had been granted under the plan. The weighted average fair value of options granted was $74.76 per share, estimated as of the date of grant using the Black-Scholes-Merton option-pricing model with the following weighted average assumptions:
For the three months ended September 30, 2008, the company contributed $7.7 to its defined benefit pension plans, $3.7 to its defined contribution pension plans and $1.5 to its other post-retirement plans. Contributions for the nine months ended September 30, 2008 were $19.6 to its defined benefit pension plans, $16.0 to its defined contribution pension plans and $5.6 to its other post-retirement plans. Total 2008 contributions to these plans are not expected to differ significantly from the amounts previously disclosed in Note 15 to the consolidated financial statements for the year ended December 31, 2007 in the companys 2007 financial review annual report.
Included in the Other category for the three and nine months ended September 30, 2008, is a gain on sale of the assets of the companys Brazilian phosphate feed plant and inland potash and feed warehouse in the amount of $21.4. The property, plant and equipment had a carrying value of $9.1. In conjunction with the sale of the assets, all employees were terminated on the closing date and rehired by the buyer. Brazilian law requires payment of severance to any employees involuntarily terminated and as a result severance payments of $0.9 were also recorded in the Other category.
The companys sales of fertilizer can be seasonal. Typically, the second quarter of the year is when fertilizer sales will be highest, due to the North American spring planting season. However, planting conditions and the timing of customer purchases will vary each year and sales can be expected to shift from one quarter to another.
PotashCorp is a shareholder in Canpotex, which markets potash offshore. Should any operating losses or other liabilities be incurred by Canpotex, the shareholders have contractually agreed to reimburse Canpotex for such losses or liabilities in proportion to their productive capacity. There were no such operating losses or other liabilities during the first nine months of 2008 or 2007.
In common with other companies in the industry, the company is unable to acquire insurance for underground assets.
Investment in Arab Potash Company Ltd. (APC)
The company is party to a shareholders agreement with Jordan Investment Company (JIC) with respect to its investment in APC. The terms of the shareholders agreement provide that, from October 17, 2006 to October 16, 2009, JIC may seek to exercise a put option (the Put) to require the company to purchase JICs remaining common shares in APC. If the Put were exercised, the companys purchase price would be calculated in accordance with a specified formula based, in part, on earnings of APC. The amount, if any, which the company may have to pay for JICs remaining common shares if there were to be a valid exercise of the Put would be determinable at the time JIC provides appropriate notice to the company pursuant to the terms of the agreement.
Legal and Other Matters
In 1994, PCS Joint Venture Ltd. (PCS Joint Venture) responded to information requests from the US Environmental Protection Agency (USEPA) and the Georgia Department of Natural Resources, Environmental Protection Division (GEPD) regarding conditions at its Moultrie, Georgia location. PCS Joint Venture believes that the lead-contaminated soil and groundwater found at the site are attributable to former operations at the site prior to PCS Joint Ventures ownership. In 2005, the GEPD approved a Corrective Action Plan to address environmental conditions at this location. As anticipated, the approved remedy requires some excavation and off-site disposal of impacted soil and installation of a groundwater recovery and treatment system. PCS Joint Venture began the remediation in November 2005 and completed soil excavation activities in March 2006, and it is proceeding consistent with the projected schedule and budget.
In 1998, the company, along with other parties, was notified by the USEPA of potential liability under the US federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA) with
respect to certain soil and groundwater conditions at a PCS Joint Venture blending facility in Lakeland, Florida and certain adjoining property. In 1999, PCS Joint Venture signed an Administrative Order and Consent with the USEPA pursuant to which PCS Joint Venture agreed to conduct a Remedial Investigation and Feasibility Study (RI/FS) of these conditions. PCS Joint Venture and another party are sharing the costs of the RI/FS, which is now complete. A Record of Decision (ROD) based upon the RI/FS was issued on September 27, 2007. The ROD provides for a remedy that requires excavation of impacted soils and interim treatment of groundwater. The total remedy cost is estimated in the ROD to be $8.5. Soil excavation activities are expected to begin in the first quarter of 2009. In February 2008, the USEPA issued letters to PCS Joint Venture and other alleged potentially responsible parties requiring a good faith offer to perform and/or to pay for the remedy. Negotiations are underway regarding the appropriate share of the cost of the remedy that should be borne by each party. Although PCS Joint Venture sold the Lakeland property in July 2006, it has retained the above-described remediation responsibilities and has indemnified the third-party purchaser for the costs of remediation and certain related claims.
The USEPA has identified PCS Nitrogen, Inc. (PCS Nitrogen) as a potentially responsible party with respect to a former fertilizer blending operation in Charleston, South Carolina, known as the Planters Property or Columbia Nitrogen site, formerly owned by a company from which PCS Nitrogen acquired certain other assets. The USEPA has requested reimbursement of $3.0 of previously incurred response costs and the performance or financing of future site investigation and response activities from PCS Nitrogen and other named potentially responsible parties. In September 2005, Ashley II of Charleston, L.L.C., the current owner of the Planters Property, filed a complaint in the United States District Court for the District of South Carolina (the Court) seeking a declaratory judgment that PCS Nitrogen is liable to pay environmental response costs that Ashley II of Charleston, L.L.C. alleges it has incurred and will incur in connection with response activities at the site. The Court entered an order bifurcating the case into two phases. In the third quarter of 2007, the Court issued its decision for the first phase of the case, in which it determined that PCS Nitrogen is the successor to a former owner of the site and may be liable to Ashley II of Charleston, L.L.C. for its environmental response costs at the site. In the first quarter of 2008, PCS Nitrogen filed a motion with the Court for certification of an interlocutory appeal of the Courts order and to stay further proceedings pending a decision on the appeal from the Fourth Circuit Appellate Court. In April 2008, the Court denied PCS Nitrogens motion for certification finding that an interlocutory appeal of its order at this time would not materially advance the ultimate termination of the litigation. PCS Nitrogen will have to wait until the Court issues a final ruling before it can appeal the Courts decision. PCS Nitrogen has filed third-party complaints against owners and operators that it believes should be responsible parties with respect to the site. PCS Nitrogen is currently pursuing the complaints that it has filed against the third-party defendants. The Court will enter a final decision regarding the allocation and amount of liability that PCS Nitrogen and the third party defendants may have relating to the Planters Property in the second phase of the case. PCS Nitrogen denies that it is a potentially responsible party and is vigorously defending its interests in these actions.
PCS Phosphate Company, Inc. (PCS Phosphate), along with several other entities, has received notice from parties to an Administrative Settlement Agreement (Settling Parties) with the USEPA of alleged contribution liability under CERCLA for costs incurred and to be incurred addressing PCB soil contamination at the Ward Superfund Site in Raleigh, North Carolina (Site). PCS Phosphate has agreed to participate, on a non-joint and several basis, with the Settling Parties in the performance of the removal action and the payment of certain other costs associated with the Site, including reimbursement of the USEPAs past costs. The cost of performing the removal at the Site is estimated at $50.0. The removal activities commenced at the Site in August 2007. The company anticipates recovering some portion of its expenditures in this matter from other liable parties. In September 2008, the USEPA issued a final remedy, with an estimated cost of $6.1, for PCB-impacted sediments downstream of the Site (Operable Unit 1). In October 2008, the USEPA issued special notice letters to PCS Phosphate and other alleged potentially responsible parties requiring a good faith offer to perform and/or pay for the cleanup of Operable Unit 1, to perform further investigation at the Site and adjacent properties, and to reimburse USEPA for its past costs. At this time, the company is unable to evaluate the extent of any exposure that it may have for the matters addressed in the special notice letter.
The USEPA announced an initiative to evaluate implementation within the phosphate industry of a particular exemption for mineral processing wastes under the hazardous waste program. In connection with this industry-wide initiative, the USEPA conducted hazardous waste compliance evaluation inspections at numerous phosphate
operations, including the companys plants in Aurora, North Carolina; Geismar, Louisiana; and White Springs, Florida. The USEPA has notified the company of various alleged violations of the US Resource Conservation and Recovery Act (RCRA) at its Aurora and White Springs plants. The company and other industry members have met with representatives of the US Department of Justice, the USEPA and various state environmental agencies regarding potential resolutions of these matters. During these meetings, the company was informed that the USEPA also believes the Geismar plant is in violation of the requirements. As part of the initiative, in September 2008, the company entered into RCRA 3013 Administrative Orders on Consent to perform certain site assessment activities at its White Springs and Aurora plants. The company is uncertain if any resolution will be possible without litigation, or, if litigation occurs, what the outcome would be. At this time, the company is unable to evaluate the extent of any exposure that it may have in these matters.
The USEPA also has announced an initiative to evaluate compliance with the Clean Air Act at sulfuric and nitric acid plants. In connection with this industry-wide initiative, the USEPA has sent requests for information to numerous facilities, including the companys plants in Augusta, Georgia; Aurora, North Carolina; Geismar, Louisiana; Lima, Ohio; and White Springs, Florida. The USEPA has notified the company of various alleged violations of the Clean Air Act at its Geismar and Lima plants. The company has met and will continue to meet with representatives of the USEPA regarding potential resolutions of these matters. At this time, the company is unable to evaluate the extent of any exposure that it may have in these matters.
Significant portions of the companys phosphate reserves in Aurora, North Carolina are located in wetlands. Under the Clean Water Act, the company must obtain a permit from the U.S. Army Corps of Engineers (the Corps) before disturbing the wetlands. The company has a permit from the Corps to mine specified areas. This permit expires in 2017, but the reserves in these areas could be exhausted before then. The company is seeking a new permit from the Corps to mine additional areas. This process includes significant public review and comment that could affect current mitigation and reclamation practices. The company expects to have the necessary approvals for mine continuation during the first quarter of 2009. Failure to secure the required approvals for continuation of the mining operations on acceptable terms would negatively affect the companys reserves and costs.
Pursuant to the 1996 Corrective Action Consent Order (the Order) executed between PCS Nitrogen Fertilizer, LP, f/k/a Arcadian Fertilizer, LP (PCS Nitrogen Fertilizer) and GEPD in conjunction with PCS Nitrogen Fertilizers purchase of certain real property located in Augusta, Georgia from the entity from which PCS Nitrogen Fertilizer previously leased such property, PCS Nitrogen Fertilizer agreed to perform certain activities including a facility investigation and, if necessary, a corrective action. In accordance with the Order, PCS Nitrogen Fertilizer has performed an investigation of environmental site conditions and has documented its findings in several successive facility investigation reports submitted to GEPD. Based on these findings and on the requirements of the Order, PCS Nitrogen Fertilizer is implementing a pilot study to evaluate the viability of in-situ bioremediation of groundwater at the site. In the event the technology proves successful and full-scale implementation is warranted, upon GEPD approval, a full-scale bioremediation remedy will be implemented. If the pilot study proves unsuccessful or if GEPD does not approve this remedial strategy, other, more costly remediation alternatives may need to be evaluated and implemented.
The company is also engaged in ongoing site assessment and/or remediation activities at a number of other facilities and sites. Based on current information, it does not believe that its future obligations with respect to these facilities and sites are reasonably likely to have a material adverse effect on its consolidated financial position or results of operations.
Between September 11 and October 2, 2008, the company and PCS Sales (USA), Inc., were named as defendants in three very similar antitrust complaints filed in federal courts. Two of the cases were filed in Chicago and one in Minneapolis. Other potash producers are also defendants in these cases. The complaints allege conspiracy to fix potash prices, to divide markets, to restrict supply and fraudulently to conceal the conspiracy, all in violation of Section 1 of the Sherman Act. The complaints were filed by plaintiffs claiming to have purchased potash directly from at least one of the defendants during the period between July 1, 2003, and the present. All three plaintiffs purport to sue on behalf of a class of persons who purchased potash in the United States directly from a defendant. Each of these complaints seeks unspecified treble damages, injunctive relief, attorneys fees, costs and pre-and post-judgment interest.
In addition to the three direct purchaser cases, plaintiffs claiming to be indirect purchasers of potash filed three other complaints against the company and PCS Sales (USA), Inc., in federal court in Chicago on September 15, 2008. Many of the allegations of these complaints are comparable to those in the direct purchaser actions and the named defendants are the same in all six cases. Each of the indirect purchaser complaints were filed on behalf of a proposed class of indirect purchasers of potash in various states and the District of Columbia that, according to the complaints, permit indirect purchasers to pursue state antitrust law claims. These complaints seek damages for unjust enrichment, treble damages where allowed, costs, fees and pre-and post-judgment interest. One indirect purchaser complaint includes both state antitrust law claims and deceptive practices claims under state consumer protection statutes, unjust enrichment claims and common law restraint of trade claims.
The company and PCS Sales (USA), Inc. believe each of these six private antitrust law lawsuits is without merit and intend to defend them vigorously.
Various other claims and lawsuits are pending against the company in the ordinary course of business. While it is not possible to determine the ultimate outcome of such actions at this time, and there exist inherent uncertainties in predicting such outcomes, it is managements belief that the ultimate resolution of such actions is not reasonably likely to have a material adverse effect on the companys consolidated financial position or results of operations.
The breadth of the companys operations and the global complexity of tax regulations require assessments of uncertainties and judgments in estimating the taxes it will ultimately pay. The final taxes paid are dependent upon many factors, including negotiations with taxing authorities in various jurisdictions, outcomes of tax litigation and resolution of disputes arising from federal, provincial, state and local tax audits. The resolution of these uncertainties and the associated final taxes may result in adjustments to the companys tax assets and tax liabilities.
The company owns facilities which have been either permanently or indefinitely shut down. It expects to incur nominal annual expenditures for site security and other maintenance costs at certain of these facilities. Should the facilities be dismantled, certain other shutdown-related costs may be incurred. Such costs would not be expected to have a material adverse effect on the companys consolidated financial position or results of operations and would be recognized and recorded in the period in which they were incurred.
In the normal course of operations, the company provides indemnifications that are often standard contractual terms to counterparties in transactions such as purchase and sale contracts, service agreements, director/officer contracts and leasing transactions. These indemnification agreements may require the company to compensate the counterparties for costs incurred as a result of various events, including environmental liabilities and changes in (or in the interpretation of) laws and regulations, or as a result of litigation claims or statutory sanctions that may be suffered by the counterparty as a consequence of the transaction. The terms of these indemnification agreements will vary based upon the contract, the nature of which prevents the company from making a reasonable estimate of the maximum potential amount that it could be required to pay to counterparties. Historically, the company has not made any significant payments under such indemnifications and no amounts have been accrued in the accompanying condensed consolidated financial statements with respect to these indemnification guarantees (apart from any appropriate accruals relating to the underlying potential liabilities).
The company enters into agreements in the normal course of business that may contain features that meet the definition of a guarantee. Various debt obligations (such as overdrafts, lines of credit with counterparties for derivatives and back-to-back loan arrangements) and other commitments (such as railcar leases) related to certain subsidiaries and investees have been directly guaranteed by the company under such agreements with third parties. The company would be required to perform on these guarantees in the event of default by the guaranteed parties. No material loss is anticipated by reason of such agreements and guarantees. At September 30, 2008, the maximum potential amount of future (undiscounted) payments under significant guarantees provided to third parties approximated $571.8. As many of these guarantees will not be drawn upon and the maximum potential amount of future payments does not consider the possibility of recovery under recourse or collateral provisions, this amount is not indicative of future cash requirements or the companys expected losses from these arrangements. At September 30, 2008, no subsidiary balances subject to guarantees were outstanding in connection with the companys cash management facilities, the company had no liabilities recorded for other obligations other than
subsidiary bank borrowings of approximately $5.9, which are reflected in other long-term debt, and the company held no cash margin deposits to maintain derivatives.
The company has guaranteed the gypsum stack capping, closure and post-closure obligations of White Springs and PCS Nitrogen in Florida and Louisiana, respectively, pursuant to the financial assurance regulatory requirements in those states.
The environmental regulations of the Province of Saskatchewan require each potash mine to have decommissioning and reclamation plans. Financial assurances for these plans must be established within one year following approval of these plans by the responsible provincial minister. The Minister of Environment for Saskatchewan provisionally approved the plans in July 2000. In July 2001, a Cdn$2.0 irrevocable letter of credit was posted. The company submitted a revised plan when it was due in 2006 and is awaiting a response from the Province. The company is unable to predict, at this time, the outcome of the ongoing review of the plans or the timing of implementation and structure of any financial assurance requirements.
The company has met its financial assurance responsibilities as of September 30, 2008. Costs associated with the retirement of long-lived tangible assets have been accrued in the accompanying consolidated condensed financial statements to the extent that a legal liability to retire such assets exists.
During the period, the company entered into various other commercial letters of credit in the normal course of operations.
The company expects that it will be able to satisfy all applicable credit support requirements without disrupting normal business operations.
Canadian GAAP varies in certain significant respects from US GAAP. As required by the US Securities and Exchange Commission (SEC), the effect of these principal differences on the companys interim condensed consolidated financial statements is described and quantified below. For a complete discussion of US and Canadian GAAP differences, see Note 33 to the consolidated financial statements for the year ended December 31, 2007 in the companys 2007 financial review annual report.
(a) Long-term investments: Certain of the companys investments in international entities are accounted for under the equity method. Accounting principles generally accepted in those foreign jurisdictions may vary in certain important respects from Canadian GAAP and in certain other respects from US GAAP. The companys share of earnings of these equity investees under Canadian GAAP has been adjusted for the significant effects of conforming to US GAAP.
(b) Property, plant and equipment and goodwill: The net book value of property, plant and equipment and goodwill under Canadian GAAP is higher than under US GAAP, as past provisions for asset impairment under Canadian GAAP were measured based on the undiscounted cash flow from use together with the residual value of the assets. Under US GAAP, they were measured based on fair value, which was lower than the undiscounted cash flow from use together with the residual value of the assets. Fair value for this purpose was determined based on discounted expected future net cash flows.
(c) Depreciation and amortization: Depreciation and amortization under Canadian GAAP is higher than under US GAAP, as a result of differences in the carrying amounts of property, plant and equipment under Canadian and US GAAP.
(d) Exploration costs: Under Canadian GAAP, capitalized exploration costs are classified under property, plant and equipment. For US GAAP, these costs are generally expensed until such time as a final feasibility study has confirmed the existence of a commercially mineable deposit.
(e) Pre-operating costs: Operating costs incurred during the start-up phase of new projects are deferred under Canadian GAAP until commercial production levels are reached, at which time they are amortized over the estimated life of the project. US GAAP requires that these costs be expensed as incurred. As at September 30, 2008 and 2007, the start-up costs deferred for Canadian GAAP were not material.
(f) Pension and other post-retirement benefits: Under Canadian GAAP, when a defined benefit plan gives rise to an accrued benefit asset, a company must recognize a valuation allowance for the excess of the adjusted benefit asset over the expected future benefit to be realized from the plan asset. Changes in the pension valuation allowance are recognized in income. US GAAP does not specifically address pension valuation allowances, and the US regulators have interpreted this to be a difference between Canadian and US GAAP. In light of this, a difference between Canadian and US GAAP has been recorded for the effects of recognizing a pension valuation allowance and the changes therein under Canadian GAAP.
In addition, under US GAAP the company is required to recognize the difference between the benefit obligation and the fair value of plan assets in the Consolidated Statements of Financial Position with the offset to OCI. No similar requirement currently exists under Canadian GAAP.
(g) Foreign currency translation adjustment: The company adopted the US dollar as its functional and reporting currency on January 1, 1995. At that time, the consolidated financial statements were translated into US dollars at the December 31, 1994 year-end exchange rate using the translation of convenience method under Canadian GAAP. This translation method was not permitted under US GAAP. US GAAP required the comparative Consolidated Statements of Operations and Consolidated Statements of Cash Flow to be translated at applicable weighted-average exchange rates; whereas, the Consolidated Statements of Financial Position were permitted to be translated at the December 31, 1994 year-end exchange rate. The use of disparate exchange rates under US GAAP gave rise to a foreign currency translation adjustment. Under US GAAP, this adjustment is reported as a component of accumulated OCI.
(h) Offsetting of certain amounts: Effective January 1, 2008, US GAAP requires an entity to adopt a policy of either offsetting or not offsetting fair value amounts recognized for derivative instruments and for the right to reclaim cash collateral or the obligation to return cash collateral against fair value amounts recognized for derivative instruments executed with the same counterparty under the same master netting arrangement. The company adopted a policy to offset such amounts effective January 1, 2008. Under Canadian GAAP offsetting of the margin deposits is not permitted.
(i) Stock-based compensation: Under Canadian GAAP, the companys stock-based compensation plan awards classified as liabilities are measured at intrinsic value at each reporting period. US GAAP requires that these liability awards be measured at fair value at each reporting period. The company uses a Monte Carlo simulation model to estimate the fair value of its performance unit incentive plan liability for US GAAP purposes. As at September 30, 2008, the difference between Canadian and US GAAP was not significant.
Under Canadian GAAP, stock options are recognized over the service period, which for PotashCorp is established by the option performance period. Effective January 1, 2006, under US GAAP, stock options are recognized over the requisite service period which does not commence until the option plan is approved by the companys shareholders and options are granted thereunder. For options granted under the PotashCorp 2006 Performance Option Plan, the service period commenced January 1, 2006 under Canadian GAAP and May 4, 2006 under US GAAP. For options granted under the PotashCorp 2007 Performance Option Plan, the service period commenced January 1, 2007 under Canadian GAAP and May 3, 2007 under US GAAP. For options granted under the PotashCorp 2008 Performance Option Plan, the service period commenced January 1, 2008 under Canadian GAAP and May 8, 2008 under US GAAP. This difference impacts the stock-based compensation cost recorded and may impact diluted earnings per share.
(j) Stripping costs: Under Canadian GAAP, the company capitalizes and amortizes costs associated with the activity of removing overburden and other mine waste minerals in the production phase. US GAAP requires such stripping costs to be attributed to ore produced in that period as a component of inventory and recognized in cost of sales in the same period as related revenue.
(k) Income taxes related to the above adjustments: The income tax adjustment reflects the impact on income taxes of the US GAAP adjustments described above. Accounting for income taxes under Canadian and US GAAP is similar, except that income tax rates of enacted or substantively enacted tax law must be used to calculate future income tax assets and liabilities under Canadian GAAP, whereas only income tax rates of enacted tax law can be used under US GAAP.
(l) Income tax consequences of stock-based employee compensation: Under Canadian GAAP, the income tax benefit attributable to stock-based compensation that is deductible in computing taxable income but is not recorded in the consolidated financial statements as an expense of any period (the excess benefit) is considered to be a permanent difference. Accordingly, such amount is treated as an item that reconciles the statutory income tax rate to the companys effective income tax rate. Under US GAAP, the excess benefit is recognized as additional paid-in capital.
(m) Income taxes related to uncertain income tax positions: US GAAP prescribes a comprehensive model for how a company should recognize, measure, present and disclose in its consolidated financial statements uncertain income tax positions that it has taken or expects to take on a tax return (including a decision whether to file or not to file a return in a particular jurisdiction). Canadian GAAP has no similar requirements related to uncertain income tax positions.
(n) Cash flow statements: US GAAP requires the disclosure of income taxes paid. Canadian GAAP requires the disclosure of income tax cash flows, which would include any income taxes recovered during the year. For the three months ended September 30, 2008, income taxes paid under US GAAP were $213.7 (2007 $59.1) and for the nine months ended September 30, 2008, income taxes paid under US GAAP were $600.6 (2007 $128.2).
The application of US GAAP, as described above, would have had the following effects on net income, net income per share, total assets, shareholders equity and comprehensive income.
Supplemental US GAAP Disclosures
Uncertainty in Income Taxes
The reconciliation of the beginning and ending amount of unrecognized tax benefits, excluding interest, for the nine months ended September 30, 2008 is as follows:
Recent Accounting Pronouncements
Framework for Fair Value Measurement
The company adopted the provisions of SFAS No. 157, Fair Value Measurements, effective January 1, 2008 and all related FASB Staff Positions published to the date of this report. The standard establishes a framework for measuring fair value and expands the disclosures about fair value measurements. The implementation of this standard did not have a material impact on the consolidated financial statements as the companys current policy on accounting for fair value measurements is consistent with this guidance. The company has, however, provided additional prescribed disclosures not required under Canadian GAAP.
SFAS No. 157 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The three levels of the fair value hierarchy are described below:
As required by SFAS No. 157, when the inputs used to measure fair value fall within more than one level of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measure in its entirety.
The following table presents the companys fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis as of September 30, 2008.
Certain natural gas derivative instrument assets are non-exchange based derivatives that trade in less liquid markets with limited pricing information. These derivatives are valued using price quotations that may not be considered observable, market-based inputs. Such instruments are therefore currently categorized in Level 3.
Fair Value Option for Financial Assets and Financial Liabilities
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. This standard permits entities to choose to measure many financial instruments and certain other items at fair value, providing the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without the need to apply hedge accounting provisions. The implementation of SFAS No. 159, effective January 1, 2008, did not have a material impact on the companys consolidated financial statements.
Offsetting of Certain Amounts
In April 2007, the FASB issued FASB Staff Position No. FIN 39-1, Amendment of FASB Interpretation No. 39 (FSP FIN 39-1). FSP FIN 39-1 amends certain paragraphs of FASB Interpretation Number 39, Offsetting of Amounts Related to Certain Contracts, to permit a reporting entity to either (i) offset derivative balances as well as fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral against fair value amounts recognized for derivative instruments executed with the same
counterparty under the same master netting arrangement, or (ii) offset no amounts of derivatives or cash collateral for derivative instruments executed with the same counterparty.
The company adopted the provisions of FSP FIN 39-1 effective January 1, 2008. As a result of the implementation of FSP FIN 39-1 the company changed its accounting policy, on a prospective basis, to offset fair value amounts recognized for derivative instruments under master netting arrangements. This has resulted in a decrease of derivative instrument liabilities of $2.9 due to the netting of margin deposits.
In December 2007, the FASB issued SFAS No. 141(R), Business Combinations. The standard requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; establishes the acquisition date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination. The company is currently reviewing the guidance, which is effective for fiscal years beginning after December 15, 2008, to determine the potential impact, if any, on its consolidated financial statements.
Noncontrolling Interests in Consolidated Financial Statements
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements. The standard requires all entities to report noncontrolling (minority) interests as equity in consolidated financial statements. SFAS No. 160 eliminates the diversity that currently exists in accounting for transactions between an entity and noncontrolling interests by requiring they be treated as equity transactions. The company is currently reviewing the guidance, which is effective for fiscal years beginning after December 15, 2008, to determine the potential impact, if any, on its consolidated financial statements.
Disclosures about Derivative Instruments and Hedging Activities
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities. The standard requires enhanced disclosures about an entitys derivative and hedging activities. Entities are required to provide enhanced disclosures about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedged items are accounted for, and (iii) how derivative instruments and related hedged items affect an entitys financial position, financial performance, and cash flows. The standard increases convergence with IFRSs, as it relates to disclosures of derivative instruments. The company is currently reviewing the guidance, which is effective for fiscal years beginning after November 15, 2008, to determine the potential impact, if any, on its consolidated financial statements.
The Hierarchy of Generally Accepted Accounting Principles
In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles. This standard identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States (the GAAP hierarchy). The FASB does not expect that this standard will result in a change in current practice. SFAS No. 162 will become effective 60 days following the SECs approval of the Public Company Accounting Oversight Board (PCAOB) amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. The company is currently reviewing the guidance to determine the potential impact, if any, on its consolidated financial statements.
Certain of the prior periods figures have been reclassified to conform with the current periods presentation.
The following discussion and analysis is the responsibility of management and is as of November 5, 2008. The Board of Directors carries out its responsibility for review of this disclosure principally through its audit committee, comprised exclusively of independent directors. The audit committee reviews and prior to its publication, approves, pursuant to the authority delegated to it by the Board of Directors, this disclosure. The term PCS refers to Potash Corporation of Saskatchewan Inc. and the terms we, us, our, PotashCorp and the company refer to PCS and, as applicable, PCS and its direct and indirect subsidiaries as a group. Additional information relating to the company, including our Annual Report on Form 10-K, can be found on SEDAR at www.sedar.com and on EDGAR at www.sec.gov/edgar.shtml.
POTASHCORP AND OUR BUSINESS ENVIRONMENT
PotashCorp has built a global business on the natural nutrients potash, nitrogen and phosphate. Our products serve three different markets: fertilizer, industrial and animal feed. We sell fertilizer to North American retailers, cooperatives and distributors that provide storage and application services to farmers, the end users. Our offshore customers are government agencies and private importers who buy under contract and on the spot market; spot sales are more prevalent in North America. Fertilizers are sold primarily for spring and fall application in both northern and southern hemispheres.
Transportation is an important part of the final purchase price for fertilizer so producers usually sell to the closest customers. In North America, we sell mainly on a delivered basis via rail, barge, truck and pipeline. Offshore customers purchase product either at the port where it is loaded or delivered with freight included.
Potash, nitrogen and phosphate are also used as inputs for the production of animal feed and industrial products. Most feed and industrial sales are by contract and are more evenly distributed throughout the year than fertilizer sales.
We seek to be the partner of choice, providing superior value to all our stakeholders. We strive to be the highest quality low-cost producer and sustainable gross margin leader in the products we sell and the markets we serve. Through our strategy, we attempt to minimize the natural volatility of our business. We strive for increased earnings and to outperform our peer group and other basic materials companies in total shareholder return, a key measure of any companys value.
We link our financial performance with areas of extended responsibility that include safety, the environment and all those who have a social or economic interest in our business. We focus on increased transparency to improve our relationships with all our stakeholders, believing this gives us a competitive advantage.
To provide our stakeholders with superior value, our strategy focuses on generating long-term growth while striving to minimize fluctuations in our upward-trending earnings line. This value proposition has given our stakeholders superior value for many years. We apply this strategy by concentrating on our highest margin products. This dictates our Potash First strategy, focusing our capital internally and through investments to build on our world-class potash assets and meet the rising global demand for this vital nutrient. By investing in potash capacity while producing to meet market demand, we create the opportunity for significant growth while limiting downside risk. We complement our potash operations with focused nitrogen and phosphate businesses that emphasize the production of high-margin products with stable and sustainable earnings potential.
We strive to grow PotashCorp by enhancing our position as supplier of choice to our customers, delivering the highest quality products at market prices when they are needed. We seek to be the supplier of choice to high-volume, high-margin customers with the lowest credit risk. It is critical that our customers recognize our ability to create value for them based on the price they pay for our products.
As we plan our future, we carefully weigh our choices for our strong cash flow. We base all investment decisions on cash flow return materially exceeding cost of capital, evaluating the best return on any investment that matches our Potash First strategy. Most of our recent capital expenditures have gone to investments in our own potash capacity, and we look to increase our existing offshore potash investments and seek other merger and acquisition opportunities in this nutrient. We also consider share repurchase and increased dividends as ways to maximize shareholder value over the long term.
KEY PERFORMANCE DRIVERS PERFORMANCE COMPARED TO GOALS
Each year we set targets to advance our long-term goals and drive results. We have developed key performance indicators to monitor our progress and measure success. As we drill down into the organization with these metrics, we believe:
Our long-term goals and 2008 targets are set out on pages 25 to 27 of our 2007 financial review annual report. A summary of our progress against selected goals and representative annual targets is set out below.
This discussion and analysis is based on the companys unaudited interim condensed consolidated financial statements reported under generally accepted accounting principles in Canada (Canadian GAAP). These principles differ in certain significant respects from accounting principles generally accepted in the United States. These differences are described and quantified in Note 17 to the unaudited interim condensed consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q. All references to per-share amounts pertain to diluted net income per share.
For an understanding of trends, events, uncertainties and the effect of critical accounting estimates on our results and financial condition, the entire document should be read carefully together with our 2007 financial review annual report.
The companys guidance for the third quarter of 2008 was earnings per share in the range of $3.25 to $3.75 per share, assuming a period end exchange rate of 1.00 Canadian dollars per US dollar and consolidated effective income tax rate between 28-30 percent. The final result was net income of $1,236.1 million, or $3.93 per share, with a period-end exchange rate of 1.0599 Canadian dollars per US dollar, a consolidated reported income tax rate of 27 percent.
Overview of Actual Results
With higher prices for all potash, nitrogen and phosphate products, third-quarter earnings of $3.93 per share ($1,236.1 million) was a five-fold increase over the $0.75 per share ($243.1 million) earned in the same period last year. This exceeded the $3.40 per share ($1,103.6 million) earned in the full-year 2007. Earnings for the first nine months of 2008 reached $8.45 per share ($2,707.2 million) and gross margin grew to $4,034.3 million, ahead 276 percent and 101 percent of the $2.25 per share ($726.8 million) and $1,346.2 million in gross margin in last years first nine months, respectively.
All three nutrients contributed to record-setting quarterly gross margin of $1,741.0 million, up 266 percent from the $475.1 million generated in the third quarter of 2007. Gross margin for the first nine months of 2008 reached $4,034.3 million compared to $1,346.2 million in the first nine months of 2007 and has already exceeded the record full-year total of $1,881.2 million set last year. While grain and oilseed prices remained supportive through the third quarter, they were caught up in a broad decline in commodity prices. The global financial crisis exacerbated these conditions, damaging investor confidence and sparking sales of liquid assets. By the end of the quarter, we believe lower crop prices no longer reflected the strong underlying global grain fundamentals, and fears about access to credit for agricultural buyers had a negative effect on the psychology of the sector as a whole. In potash, producer inventories were at historically low levels entering the quarter. Reduced production due to seasonal maintenance turnarounds for all producers and ongoing strikes at three PotashCorp facilities limited the available supplies. As a result, potash fundamentals remained strong through the entire quarter. The major markets for solid
nitrogen and phosphate fertilizers namely the US, Brazil and India appeared cautious in light of uncertain global economic conditions. In the US, late spring planting pushed back the fall season and gave distributors time to replenish inventories. In Brazil, weather delays held back planting and enabled fertilizer inventories to reach healthy levels ahead of the spring season. With a late start in other key markets, Indias buyers delayed purchases, opting for low inventories in the hope that weakening global trade and a precipitous drop in sulfur prices would lower fertilizer prices. These trends were offset by the continued restriction of Chinese urea and phosphate trade due to the continuation of prohibitive export taxes on these products.
Potash gross margin as a percentage of net sales rose to 83 percent in the third quarter and 78 percent in the first nine months of 2008, compared to 58 percent and 57 percent in the same periods of 2007, respectively, due to price increases being realized. Driven by higher prices for all our nitrogen products, nitrogen gross margin reached $324.1 million in the quarter and $719.5 million in the first nine months of 2008, up from $123.9 million and $399.4 million in the same periods in 2007, respectively. Price increases pushed phosphate gross margin to $507.2 million in the quarter and $1,004.1 million in the first nine months of 2008, up from $129.9 million in the third quarter of 2007 and $290.9 million in the first nine months.
Selling and administrative expenses were $12.2 million lower than in the same quarter last year though $0.6 million higher than the first nine months. A decline in the price of our common shares reduced the value of deferred share units during the third quarter and first nine months of 2008 causing selling and administrative expenses to decline as compared to the same periods in 2007 when a share price increase had the opposite effect. Provincial mining and other taxes increased more than six times quarter over quarter and more than four times year over year as potash profit per tonne increased substantially compared to the same periods last year. The Canadian dollar weakened during the third quarter and first nine months of 2008, contributing to primarily non-cash foreign exchange gains of $37.4 million and $63.2 million in those periods, respectively. This compares to a strengthening in the third quarter and first nine months of 2007 that contributed to losses of $25.9 million and $67.4 million in the same periods last year, respectively. Other income increased $110.9 million quarter over quarter and $143.9 million year over year as our investments in Arab Potash Company Ltd. (APC), Sociedad Quimica y Minera de Chile (SQM), and Israel Chemicals Ltd. (ICL) contributed an additional $115.4 million during the three-months ended September 30, 2008 compared to the prior year and, along with Sinofert Holdings Limited (Sinofert), an additional $151.3 million during the first nine months of the year compared to 2007. A gain of $25.3 million on a forward purchase contract for shares of Sinofert recognized in first-quarter 2008 further increased other income. These increases were partially offset by an additional $71.3 million provision for other-than-temporary impairment of auction rate securities recorded in other income in the first nine months of 2008, of which $27.5 million was recognized in the third quarter.
Our consolidated reported income tax rate for the three months ended September 30, 2008 was 27 percent (2007 38 percent) and for the nine months ended September 30, 2008 was 27 percent (2007 33 percent). The 2008 third quarter consolidated effective income tax rate remained unchanged from the second quarter at 29 percent (2007 33 percent). An income tax recovery of $29.1 million, related to an increase in permanent deductions in the US from prior years, was recorded in the third quarter in addition to the $42.0 million that was recorded in the first quarter of 2008. The $25.3 million first-quarter 2008 gain recognized as a result of the change in fair value of the forward purchase contract for shares in Sinofert was not taxable.
Total assets were $11,227.5 million at September 30, 2008, an increase of $1,510.9 million or 16 percent over December 31, 2007. Total liabilities increased by $2,213.0 million from December 31, 2007 to $5,910.9 million at September 30, 2008, and total shareholders equity decreased by $702.1 million during the same period to $5,316.6 million.
Accounts receivable, inventories and property, plant and equipment were the largest contributors to the increase in assets during the first nine months of 2008. Accounts receivable increased $776.8 million or 130 percent compared to December 31, 2007 as a result of higher product prices that drove sales up 109 percent in the month of September 2008 compared to December 2007. Although the accounts receivable balance increased, our internal collection statistics indicate that customers continue to meet the terms of their purchases. During the first nine
months of 2008, phosphate inventories increased by $237.8 million, nitrogen inventories increased by $78.4 million and potash inventories decreased by $0.4 million which resulted in a $743.9 million inventory balance at September 30 as compared to $428.1 million at December 31, 2007. Inventory values for phosphate have grown due to higher input costs for sulfur and ammonia and inventory volumes grew at September 30, 2008 as customers anticipate a reduction in prices, while nitrogen inventory values increased mainly due to higher natural gas costs. Additions to property, plant and equipment of $770.6 million were incurred ($549.9 million, or 71 percent, of which related to the potash segment). These increases in assets were offset by a $220.0 million decline in cash and cash equivalents that was primarily due to common share repurchases of $2,902.9 million.
Auction rate securities that are classified as available-for-sale are included in Investments. The company has determined that the fair value of the auction rate securities was $34.7 million at September 30, 2008 (face value $132.5 million), as compared to $56.0 million as of December 31, 2007, $43.1 million as at March 31, 2008 and $46.9 million as of June 30, 2008.
Market conditions at the end of 2007 that caused the investments to be illiquid had further deteriorated at the end of the third quarter of 2008. The decline in fair value from year-end reflects such illiquid or non-existent markets as well as continued concerns over defaults in the challenging sub-prime mortgage market and the ongoing corrections in the housing market that increase the probability of default in some of the underlying collateral of these investments. The increase in the proportion of the impairment that is considered other-than-temporary reflects the reduced fair values, and the fact that all six of the investments (including the two at December 31, 2007 and March 31, 2008, and the four at June 30, 2008) held in our account are now considered to fall into this category. This increase is as a result of the length of time and amount of impairment loss for such investments combined with collateral underlying the investments that is at a higher risk for default. The company is able to hold the investments in auction rate securities until liquidity improves, but does not expect this to occur in the next 12 months.
Liabilities increased primarily as a result of higher short-term debt and accounts payable and accrued charges. Short-term debt increased $1,586.3 million compared to December 31, 2007 as borrowings, together with cash on hand, were used to fund our common share repurchases during the first nine months of 2008. The $556.6 million increase in accounts payable and accrued charges was primarily attributable to: (1) taxes payable, which were up $354.9 million as a result of higher earnings despite significant payments made during the first nine months of 2008; (2) $29.2 million higher accrued provincial mining taxes; (3) accrued natural gas, sulfur and power costs that were up $99.6 million due to sulfur prices; and (4) payables associated with increased potash expansion project activity.
Contributed surplus increased at September 30, 2008 compared to December 31, 2007, while share capital, accumulated other comprehensive income (AOCI) and retained earnings decreased. AOCI decreased $479.1 million as a result of a $402.2 million decrease in net unrealized gains on available-for-sale securities (primarily Sinofert which declined $687.2 million, offset in part by an increase of $249.5 million in unrealized gains on ICL) and a $60.2 million decrease in net unrealized gains on our natural gas derivatives that qualify for hedge accounting. During the first nine months of 2008, we repurchased for cancellation 15,820,000 of our common shares at a cost of $2,902.9 million resulting in a reduction of share capital of $73.8 million. The excess of net cost over the average book value of the shares of $2,829.1 million was recorded as a reduction of retained earnings. Net income of $2,707.2 million for the first nine months of 2008 increased retained earnings while dividends declared of $92.5 million and the impact of the share repurchase program reduced the balance, for a net reduction in retained earnings of $214.4 million at September 30, 2008 compared to December 31, 2007.
Business Segment Review
Note 9 to the unaudited interim condensed consolidated financial statements provides information pertaining to our business segments. Management includes net sales in segment disclosures in the consolidated financial statements pursuant to Canadian GAAP, which requires segmentation based upon our internal organization and reporting of revenue and profit measures derived from internal accounting methods. Net sales (and the related per-tonne amounts) are the primary revenue measures we use and review in making decisions about operating matters on a business segment basis. These decisions include assessments about potash, nitrogen and phosphate performance and the resources to be allocated to these segments. We also use net sales (and the related per-tonne amounts) for business planning and monthly forecasting. Net sales are calculated as sales revenues less freight, transportation and distribution expenses.
Our discussion of segment operating performance is set out below and includes nutrient product and/or market performance where applicable to give further insight into these results. Certain of the prior periods figures have been reclassified to conform to the current periods presentation.
Potash gross margin variance attributable to:
Sales and Cost of Goods Sold
The most significant contributors to the $688.4 million increase in total gross margin quarter over quarter were as follows:
Total potash gross margin grew each quarter in 2008 and 2007 as follows:
The $1,654.8 million total gross margin increase year over year was largely attributable to the following changes:
Nitrogen gross margin variance attributable to: