POTASH CORP OF SASKATCHEWAN INC 10-Q 2010
Documents found in this filing:
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 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
YES o 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):
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, 2010, Potash Corporation of Saskatchewan Inc. had 297,686,739 Common Shares outstanding.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Potash Corporation of Saskatchewan Inc.
(in millions of US dollars except share amounts)
(See Notes to the Condensed Consolidated Financial Statements)
Potash Corporation of Saskatchewan Inc.
(in millions of US dollars except per-share amounts)
(See Notes to the Condensed Consolidated Financial Statements)
Potash Corporation of Saskatchewan Inc.
(in millions of US dollars)
(See Notes to the Condensed Consolidated Financial Statements)
Potash Corporation of Saskatchewan Inc.
(in millions of US dollars)
Condensed Consolidated Statements of Accumulated Other Comprehensive Income
(in millions of US dollars)
(See Notes to the Condensed Consolidated Financial Statements)
Potash Corporation of Saskatchewan Inc.
For the Three and Nine Months Ended September 30, 2010
(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 unaudited interim condensed consolidated financial statements are consistent with those used in the preparation of the 2009 annual consolidated financial statements.
These unaudited 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 2009 annual consolidated financial statements. In managements opinion, the unaudited interim condensed consolidated 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.
Recent Accounting Pronouncements
International Financial Reporting Standards (IFRSs) have been incorporated 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 in Canada will be required to prepare financial statements in accordance with IFRSs. Incorporation of IFRSs into the CICA Accounting Handbook makes possible the early adoption of IFRSs by Canadian entities. The company is currently reviewing the standards to determine the potential impact on its consolidated financial statements.
The carrying amount of inventory recorded at net realizable value was $0.6 at September 30, 2010 and $33.5 at December 31, 2009 with the remaining inventory recorded at cost.
During the three months ended September 30, 2010, the company did not receive any proceeds nor make any repayments under its long-term credit facilities. During the nine months ended September 30, 2010, the company received proceeds from its long-term credit facilities of $400.0, and made repayments of $400.0 under these facilities.
During the second quarter of 2010, the company classified the $600.0 aggregate principal amount of 7.750 percent senior notes due May 31, 2011 as current.
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, its strategy, which was unchanged from 2009, 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: earnings before interest expense, income taxes, depreciation and amortization, and gain on disposal of 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 12-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 adjusted EBITDA increasing more than the increase in adjusted interest expense. The net-debt-to-adjusted-EBITDA ratio decreased as net debt decreased and adjusted EBITDA increased. Net-debt-to-adjusted-capital ratio decreased as net debt decreased and adjusted capital increased.
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 company has three reportable business segments: potash, phosphate and nitrogen. These business segments are differentiated by the chemical nutrient contained in the product that each produces. Inter-segment sales are made under terms that approximate market value. The accounting policies of the segments are the same as those described in Note 1.
In January and February 2010, the company purchased additional shares in Israel Chemicals Ltd. (ICL) for cash consideration of $420.1, increasing its ownership percentage to 14 percent. In conjunction with this purchase, the company incurred a loss of $2.2 on a foreign exchange contract.
Shareholder Rights Plan
During the third quarter of 2010, the Board of Directors adopted a Shareholder Rights Plan (the Rights Plan). In connection with the adoption of the Rights Plan, the Board of Directors authorized the issuance of one share purchase right in respect of each common share of PotashCorp outstanding as of the close of business on August 16, 2010 (and each share issued thereafter, subject to the limitations set out in the Rights Plan). Under the terms of the Rights Plan, the rights will become exercisable if a person, together with its affiliates, associates and joint actors, acquires or announces an intention to acquire beneficial ownership of shares which, when aggregated with its current holdings, total 20 percent or more of PotashCorps outstanding common shares, subject to the ability of the Board of Directors to defer the time at which the rights become exercisable and to waive the application of the Rights Plan.
Following the acquisition of more than 20 percent of the outstanding common shares by any person (and its affiliates, associates and joint actors), each right held by a person other than the acquiring person (and its affiliates, associates and joint actors) would, upon exercise, entitle the holder to purchase common shares at a substantial discount to the then prevailing market price. The Rights Plan permits the acquisition of control of PotashCorp through a permitted bid, a competing permitted bid or a negotiated transaction. A permitted bid is one that, among other things, is made to all holders of shares, is open for a minimum of 90 days and is conditioned on more than 50% of the outstanding common shares of the company held by Independent Shareholders (as defined in the Rights Plan) being deposited to the bid and a further 10 business day extension of the bid should this condition be met.
On May 6, 2010, the companys shareholders approved the 2010 Performance Option Plan under which the company may, after February 19, 2010 and before January 1, 2011, 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 the 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, 2010, options to purchase a total of 444,700 common shares had been granted under the plan. The weighted average fair value of options granted was $47.88 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, 2010, the company contributed $46.6 to its defined benefit pension plans, $6.2 to its defined contribution pension plans and $2.9 to its other post-retirement plans. Contributions for the nine months ended September 30, 2010 were $50.8 to its defined benefit pension plans, $18.3 to its defined contribution pension plans and $6.5 to its other post-retirement plans. Total 2010 contributions to these plans are not expected to differ significantly from the amounts previously disclosed in Note 15 to the consolidated financial statements in the companys 2009 financial review annual report.
Included in other are financial advisory, legal and other fees incurred during the quarter ended September 30, 2010 relating to PotashCorps response actions to the commencement by BHP Billiton Development 2 (Canada) Limited, a wholly owned indirect subsidiary of BHP Billiton Plc (BHP), of an unsolicited offer to purchase all of PotashCorps outstanding common shares (the BHP Offer). The company will be required to pay additional fees to its financial advisors in connection with the BHP Offer. A significant portion of the fees payable to each of the companys financial advisors in connection with their respective engagements is payable on consummation of certain transactions with one or more third parties, including upon consummation of the BHP Offer, in the event the
company does not consummate the BHP Offer and/or if certain other transactions with any party occur before a certain date.
For the three months ended September 30, 2010, the companys income tax expense was $120.0. This compared to an expense of $77.9 for the same period last year. For the nine months ended September 30, 2010, the companys income tax expense was $476.7 (2009 $35.8). The actual effective tax rate, including discrete items, for the three and nine months ended September 30, 2010 was 23 percent and 26 percent, respectively, compared to 24 percent and 5 percent for the three and nine months ended September 30, 2009.
The income tax expense for the nine months ended September 30, 2010 included the following discrete items:
The income tax expense for the nine months ended September 30, 2009 included the following discrete items:
Basic net income per share for the quarter is calculated based on the weighted average shares issued and outstanding for the three months ended September 30, 2010 of 296,971,000 (2009 295,721,000). Basic net income per share for the nine months ended September 30, 2010 is calculated based on the weighted average shares issued and outstanding for the period of 296,492,000 (2009 295,467,000).
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 the 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. For performance-based stock option plans, the number of contingently issuable common shares included in the calculation is based on the number of shares that would be issuable based on period-to-date (rather than anticipated) performance, if the effect is dilutive. The weighted average number of shares outstanding for the diluted net income per share calculation for the three months ended September 30, 2010 was 305,231,000 (2009 303,927,000) and for the nine months ended September 30, 2010 was 304,816,000 (2009 303,802,000).
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 described in Note 26 to the consolidated financial statements in the companys 2009 financial review annual report.
The company is exposed to credit risk on its cash and cash equivalents, receivables, and derivative instrument assets. The maximum exposure to credit risk, as represented by the carrying amount of the financial assets, was:
The aging of trade receivables that were past due but not impaired was as follows:
A reconciliation of the receivables allowance for doubtful accounts is as follows:
The company sells potash from its Saskatchewan mines for use outside Canada and the US 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 amounts owing to the company from Canpotex or the non-trade receivables.
Liquidity risk arises from the companys general funding needs and in the management of its assets, liabilities and capital structure. It 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 facilities:
During the second quarter of 2010, the company entered into an uncommitted $30.0 letter of credit facility. No letters of credit were outstanding under this facility as at September 30, 2010.
Certain of the companys derivative instruments contain provisions that require its debt to maintain specified credit ratings from two of the major credit rating agencies. If the companys debt were to fall below the specified ratings, it would be in violation of these provisions, and the counterparties to the derivative instruments could request immediate payment or demand immediate and ongoing full overnight collateralization on derivative instruments in net liability positions. The aggregate fair value of all derivative instruments with credit risk-related contingent features that were in a liability position on September 30, 2010 was $315.7, for which the company has posted collateral of $224.1 in the normal course of business. If the credit risk-related contingent features underlying these agreements were triggered on September 30, 2010, the company would have been required to post an additional $89.7 of collateral to its counterparties.
The table below presents a maturity analysis of the companys financial liabilities and gross settled derivative contracts 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 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 following table shows the companys significant exposure to exchange risk and the pre-tax effects on income and OCI of reasonably possible changes in the relevant foreign currency. The company has no significant foreign currency exposure related to cash and cash equivalents and receivables. This analysis assumes all other variables remain constant.
At September 30, 2010, the company had entered into foreign currency forward contracts to sell US dollars and receive Canadian dollars in the notional amount of $80.0 (December 31, 2009 $140.0) at an average exchange rate of 1.0625 (December 31, 2009 1.0681) per US dollar. Maturity dates for all forward contracts were within 2010.
At September 30, 2010, the company had foreign currency swaps to sell US dollars and receive Canadian dollars in the notional amount of $20.0 (December 31, 2009 $262.5) at an average exchange rate of 1.0401 (December 31, 2009 1.0551) per US dollar. Maturity dates for all swaps were within 2010.
Interest Rate Risk
The company does not have significant exposure to interest rate risk at September 30, 2010 and December 31, 2009. The only financial assets bearing any variable interest rate exposure are cash and cash equivalents. As for financial liabilities, the company only has an insignificant exposure related to a long-term loan that is subject to variable rates. Short-term debt, related to commercial paper, is excluded from interest rate risk as the interest rates are fixed for the stated period of the debt. The company would only be exposed to variable interest rate risk on the issuance of new commercial paper. The company does not measure any fixed-rate debt at fair value. Therefore, changes in interest rates will not affect income or OCI as there is no change in the carrying value of fixed-rate debt and interest payments are fixed. This analysis assumes all other variables remain constant.
The following table shows the companys exposure to price risk and the pre-tax effects on net income and OCI of reasonably possible changes in the relevant commodity or securities prices. This analysis assumes all other variables remain constant.
At September 30, 2010, the company had natural gas derivatives qualifying for hedge accounting in the form of swaps for which it has price risk exposure; which derivatives represented a notional amount of 104.5 million MMBtu with maturities in 2010 through 2019. At December 31, 2009, the notional amount of swaps was 123.0 million MMBtu with maturities in 2010 through 2019.
Fair value represents point-in-time estimates that may change in subsequent reporting periods due to market conditions or other factors.
Presented below is a comparison of the fair value of each financial instrument to its carrying value.
Due to their short-term nature, the fair value of cash and cash equivalents, receivables, short-term debt, and payables and accrued charges is assumed to approximate carrying value. The fair value of the companys senior notes at September 30, 2010 reflected the yield valuation based on observed market prices. Yields on senior notes ranged from 1.34 percent to 5.71 percent (December 31, 2009 1.73 percent to 5.83 percent).
Interest rates used to discount estimated cash flows related to derivative instruments that were not traded in an active market at September 30, 2010 were between 0.65 percent and 3.89 percent (December 31, 2009 between 0.23 percent and 4.67 percent) depending on the settlement date.
The following table presents the companys fair value hierarchy for those financial assets and financial liabilities carried at fair value at September 30, 2010. During the quarter ended September 30, 2010, there were no transfers between Level 1 and Level 2 and no transfers into or out of Level 3.
Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
For the year ended December 31, 2009, auction rate securities considered to be a Level 3 measurement had a beginning balance of $17.2; a gain of $115.3 was included in earnings for the period reported in other income
related to the disposal of such securities for the full face amount of $132.5, resulting in an end of year balance of $NIL.
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.
PCS 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. Through September 30, 2010, there were no such operating losses or other liabilities.
In common with other companies in the industry, the company is unable to acquire insurance for underground assets.
Legal and Other Matters
Significant environmental site assessment and/or remediation matters of note include the following:
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.
Other significant matters of note include the following:
Statement of Claim, the company has asserted that it has the right under the mining and processing agreement to receive potash from Mosaic until at least 2012, and seeks an order from the Court declaring the amount of potash which the company has the right to receive. Mosaic in its Statement of Defence dated June 16, 2009 asserts that at a delivery rate of 1.24 million tons of product per year, the companys entitlement to receive potash under the mining and processing agreement will terminate by August 30, 2010. Also, on June 16, 2009, Mosaic commenced a counterclaim against the company asserting that the company has breached the mining and processing agreement due to its refusal to take delivery of potash product under the agreement based on an event of force majeure. Based on a contention that the force majeure is not valid, and that any tons not taken during such period are somehow forfeited, Mosaic has indicated that it may begin to temporarily suspend delivery of product as early as November 15, 2010. If that should occur, or occurs subsequently, the Company intends to take all necessary steps to enforce its right under the agreements, pending determination of the matters currently in issue before the Court.
The company will continue to assert its position in these proceedings vigorously and it denies liability to Mosaic in connection with its counterclaim.
In addition, 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 the companys belief that the ultimate resolution of such actions is not reasonably likely to have a material adverse effect on its 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 are not 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 are 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 unaudited interim 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, 2010, the maximum potential amount of future (undiscounted) payments under significant guarantees provided to third parties approximated $557.5. It is unlikely that these guarantees will 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, 2010, no subsidiary balances subject to guarantees were outstanding in connection with the companys cash management facilities, and it had no liabilities recorded for other obligations other than subsidiary bank borrowings of approximately $5.9.
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. In addition, the company has guaranteed the performance of certain remediation obligations of PCS Joint Venture and PCS Nitrogen at the Lakeland, Florida and Augusta, Georgia sites respectively. The USEPA has announced that it plans to adopt rules requiring financial assurance from a variety of mining operations, including phosphate rock mining. It is too early in the rulemaking process to determine what the impact, if any, on the companys facilities will be when these rules are issued.
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 their approval by the responsible provincial minister. The Minister of the Environment for Saskatchewan (MOE) has approved the plans. The company had previously provided a CDN $2.0 irrevocable letter of credit and in the second quarter of 2010 finalized all matters regarding the financial assurances for the 2006 review, including the payment of CDN $2.8 into the agreed upon trust fund. Under the regulations, the decommissioning and reclamation plans and financial assurances are to be reviewed at least once every five years, or sooner as required by the MOE. The next scheduled review for the decommissioning and reclamation plans and financial assurances is in 2011 and discussions regarding these financial assurances have commenced. The MOE has indicated it is seeking an increase of the amount paid into the trust fund by the company. Based on current information, the company does not believe that its financial assurance requirements or future obligations with respect to this matter are reasonably likely to have a material impact on its consolidated financial position or results of operations.
The company has met its financial assurance responsibilities as of September 30, 2010. Costs associated with the retirement of long-lived tangible assets have been accrued in the accompanying unaudited interim condensed consolidated 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. As at September 30, 2010, $35.3 of letters of credit were outstanding.
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 United States Securities and Exchange Commission, the effect of these principal differences on the companys unaudited interim condensed consolidated financial statements is described and quantified below. For a complete discussion of US and Canadian GAAP differences, see Note 31 to the consolidated financial statements in the companys 2009 financial review annual report.
(a) Inventory valuation: Under Canadian GAAP, when the circumstances that previously caused inventories to be written down below cost no longer exist or when there is clear evidence of an increase in net realizable value because of changed economic circumstances, the amount of the write-down is reversed. The reversal is limited to the amount of the original writedown. Under US GAAP, the reversal of a writedown is not permitted unless the reversal relates to a writedown recorded in a prior interim period during the same fiscal year.
(b) 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.
In addition, the companys interest in a foreign joint venture is accounted for using proportionate consolidation under Canadian GAAP. US GAAP requires joint ventures to be accounted for using the equity accounting method. As a result, an adjustment is recorded to reflect the companys interest in the joint venture under the equity method of accounting.
(c) 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 is determined based on discounted expected future net cash flows. In certain cases, US GAAP requires that writedowns be based on discounted cash flows, a prescribed discount rate and the un-weighted average first-day-of-the-month resource prices for the prior twelve months; whereas Canadian GAAP requires undiscounted cash flows using estimated future resource prices based on the best information available to the company.
(d) 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.
(e) 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.
(f) Pension and other post-retirement benefits: 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.
In addition, 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.
(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: 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. 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.
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.
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 period. For the three months ended September 30, 2010, income taxes paid under US GAAP were $74.3 (2009 $3.6) and for the nine months ended September 30, 2010, income taxes paid under US GAAP were $145.1 (2009 $740.4).
The application of US GAAP, as described above, would have had the following effects on net income, net income per share, total assets and shareholders equity.
Supplemental US GAAP Disclosures
Disclosures About Derivative Instruments and Hedging Activities
Fair Values of Derivative Instruments in the Consolidated Statements of Financial Position
The Effect of Derivative Instruments on the Consolidated Statements of Operations for the Three Months Ended September 30
The Effect of Derivative Instruments on the Consolidated Statements of Operations for the Nine Months Ended September 30
Uncertainty in Income Taxes
During the three and nine months ended September 30, 2010, unrecognized tax benefits increased $4.3 and decreased $17.1, respectively. It is reasonably possible that a reduction in a range of $17.0 to $19.0 of unrecognized income tax benefits may occur within 12 months as a result of projected resolutions of worldwide income tax disputes.
Recent Accounting Pronouncements
Variable Interest Entities
In June 2009, the Financial Accounting Standards Board (FASB) issued a revised accounting standard to improve financial reporting by enterprises involved with variable interest entities. The standard replaces the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entitys economic performance and: (i) the obligation to absorb losses of the entity; or (ii) the right to receive benefits from the entity. The implementation of this guidance prospectively effective January 1, 2010 did not have a material impact on the companys consolidated financial statements.
Fair Value Disclosures
In January 2010, the FASB issued a new accounting standard aimed at improving disclosures about fair value measurements. As of January 1, 2010, the company is required to disclose information on significant transfers in and out of Levels 1 and 2 and the reasons for those transfers. The implementation of this guidance did not have a material impact on the companys consolidated financial statements. Additional disclosures related to details of activity in Level 3 will be required effective January 1, 2011. The company is currently reviewing the impact, if any, on its consolidated financial statements.
In April 2010, the FASB issued an accounting standard update to clarify the classification of an employee share-based payment award with an exercise price denominated in the currency of a market in which the underlying equity security trades. The update clarifies that an employee share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entitys equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity. The amendments in this update will be effective for the first fiscal quarter beginning after December 15, 2010, with early adoption permitted. The company is currently reviewing the impact, if any, on its consolidated financial statements.
During the quarter ended March 31, 2010, prior period non-cash errors were identified pertaining to the computation of asset retirement obligations for the phosphate segment, specifically relating to mine reclamation capping costs. The impact of the errors on annual financial statement components, as originally stated and as corrected, is as follows:
n/a = not applicable since the company did not begin to report accumulated other comprehensive income and comprehensive income for Canadian GAAP purposes until 2007
The adjustments are not material to the periods to which they relate. However, as correcting the errors in the first quarter of 2010 would have materially distorted net income for the first quarter, the company has corrected them by revising the impacted balances in the relevant periods, with an adjustment to the opening balance recorded to retained earnings in the first period presented. The impact on the comparative figures presented in the condensed consolidated statements of financial position at December 31, 2009 was as described above.
The impact on the comparative figures presented in the companys unaudited interim condensed consolidated financial statements for the three months ended September 30, 2009 was as follows:
The impact on the comparative figures presented in the companys unaudited interim condensed consolidated financial statements for the nine months ended September 30, 2009 was as follows:
The following discussion and analysis is the responsibility of management and is as of November 5, 2010. 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 is an integrated producer of fertilizer, industrial and animal feed products. We are the worlds largest fertilizer enterprise by capacity, producing the three primary plant nutrients: potash, phosphate and nitrogen. We sell fertilizer to North American retailers, cooperatives and distributors that provide storage and application services to farmers, the end users. Offshore customers supplied by PotashCorp or Canpotex Limited (Canpotex, the offshore marketing company for Saskatchewan potash producers) are government agencies and private importers who buy under contract and on the spot market; spot sales are more prevalent in North America, South America and Southeast Asia. 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, phosphate and nitrogen 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.
On August 20, 2010, BHP Billiton Development 2 (Canada) Limited, a wholly owned indirect subsidiary of BHP Billiton Plc (BHP), commenced an unsolicited offer to purchase all of the companys issued and outstanding common shares for US$130 per common share (the BHP Offer). The BHP Offer, unless extended, is open for acceptance until November 18, 2010.
After carefully considering the BHP Offer, with the benefit of advice from its independent financial and legal advisors, the Board of Directors unanimously determined that the BHP Offer is not in the best interests of the company, its shareholders or other stakeholders. The Board of Directors has unanimously recommended that shareholders reject the BHP Offer and not tender their common shares to the BHP Offer. For more information, see PotashCorps Directors Circular and Solicitation/Recommendation Statement on Schedule 14D-9 filed with the US Securities and Exchange Commission (SEC) and Canadian provincial securities commissions.
As events unfold in connection with the BHP Offer, PotashCorps outlook may vary materially from the narrative in this Managements Discussion and Analysis (MD&A) and it is impossible to predict whether the BHP Offer or any alternative transaction will be consummated. Statements regarding the BHP Offer, PotashCorps response and the pursuit of strategic alternatives are subject to various risks and assumptions. See Forward-Looking Statements.
To provide our stakeholders with long-term value, our strategy focuses on generating growth while striving to minimize fluctuations in an 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. Such analysis 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 phosphate and nitrogen businesses that emphasize the production of higher-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 preferred supplier 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 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 repurchases 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. Our long-term goals and 2010 targets are set out on pages 39 to 43 of our 2009 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 2009 financial review annual report.
Earnings Guidance Third Quarter 2010
Overview of Actual Results
Earnings in the third quarter and first nine months of 2010 were higher than the same periods of 2009 as buyers returned to the market and purchased more of all three nutrients following an unprecedented decline in fertilizer demand in 2009. In 2010, potash represented 65 percent of total third-quarter gross margin (73 percent in 2009) and 69 percent of first nine months gross margin (71 percent in 2009). Sales prices for phosphate fertilizer products and all nitrogen products increased significantly during the third quarter and first nine months of 2010 compared to the same periods in 2009.
The continuing challenge of meeting increases in food demand became more pronounced through the third quarter. Added strain from crop production issues in key producing regions exacerbated by recent under-application of nutrients reduced global grain inventories and drove crop prices higher. The positive impact of this on grower economics has historically been a powerful driver for the fertilizer sector, and that was the case again in this quarter. Improving agricultural fundamentals established a firm foundation for continuing growth in demand for nutrients and ongoing pricing momentum. Further aided by an early harvest and extended fall application window, customers in North America moved quickly to secure potash following the announcement of summer-fill pricing programs in late July. On near record demand, North American producers shipped 2.3 million tonnes to the domestic market, more than triple the shipments in the third quarter of 2009 and 42 percent above the previous five-year average. Shipments for the first nine months of 2010 reached 7.0 million tonnes, reflecting a return to normal demand in this mature agriculture market. North American producer offshore potash shipments totaled 2.3 million tonnes in third-quarter 2010, 85 percent higher than in the same quarter last year. As expected, Latin American buyers bought aggressively in preparation for their key planting season, while all other major offshore markets continued large purchases through the quarter. The acceleration of demand combined with diminished distributor inventory levels and typical maintenance related shutdowns pushed global potash producer inventories lower. Inventories of North American producers declined by 41 percent during the quarter and were 17 percent below the previous five-year average at its end. Tightening supplies caused shipping delays and shortfalls and, by the end of the quarter, some suppliers including Canpotex Limited (Canpotex), the offshore marketing company for Saskatchewan potash producers had largely allocated all available product through the end of the year. In the face of tightening fundamentals, pricing momentum escalated meaningfully by September and resulted in shipments being booked at higher prices in spot markets. Phosphate and nitrogen markets also benefited from improved conditions. Robust North American fall demand for solid phosphate fertilizers left US producers with
limited product for offshore markets, which resulted in significantly higher domestic shipments and relatively flat offshore movement compared to the same period last year. Inventories continued to decline and reached record lows in the third quarter, supporting an improved phosphate pricing environment. In nitrogen, strong agricultural demand pushed third-quarter urea shipments from US producers 41 percent higher on a quarter-over-quarter basis. Stronger prices due to robust demand, tight producer inventories and higher gas prices in key exporting regions coupled with softer US gas prices toward the end of the quarter, improved domestic producer margins.
Other significant factors that affected earnings in the third quarter and first nine months of 2010 compared to the same periods in 2009 were: (1) higher income taxes as a result of increased earnings in 2010 and discrete items which resulted in lower income taxes in 2009 (the effective rate was considerably lower mainly due to an internal restructuring and an increase in permanent deductions that resulted in a recovery; these were partly offset by a functional currency election); (2) higher provincial mining and other taxes as a result of increased sales revenue; (3) increased selling and administrative expenses as a result of our financial performance exceeding budget and an increase in our share price; and (4) increased other income from our share of earnings in Sociedad Quimica y Minera de Chile (SQM) and dividends received from Israel Chemicals Ltd (ICL), while a gain on disposal of auction rate securities in the second quarter of 2009 did not repeat in 2010. Other comprehensive income in 2010 was impacted by the fair value of our investments in ICL and Sinofert Holdings Limited (Sinofert) (which increased more in the third quarter of 2010 compared to 2009 but did not increase as much in the first nine months in 2010 as in the same period in 2009) and the fair value of hedge-accounted natural gas derivatives, which declined due to falling natural gas prices.
Changes in Balances December 31, 2009 to September 30, 2010 (in $ millions)
The increase in property, plant and equipment related primarily (84 percent) to our previously announced potash capacity expansions and other potash projects. Investments rose mainly due to the increase in the fair value of our investments in both ICL and Sinofert. The decrease in receivables was due to the refund of income taxes receivable and provincial mining and other taxes receivable exceeding increased trade receivables (a result of higher
sales) and increased hedge margin deposits (a result of lower natural gas prices). The decrease in inventories was mainly the result of lower potash levels.
The increase in short-term debt and current portion of long-term debt was the result of reclassifying our senior notes due May 31, 2011 as current, which exceeded the reduction in our outstanding commercial paper during the first nine months of 2010. Payables and accrued charges increased mainly as a result of increased income taxes payable (due to higher anticipated earnings coupled with lower required income tax instalments), increased accrued payroll (higher accruals for incentive plans as a result of our financial performance being above budget and a higher share price) and increased accrued provincial mining taxes (due to higher sales revenue). Other liabilities increased mainly as a result of increases to asset retirement obligations while the fair value of our natural gas derivatives declined due to falling natural gas prices.
Significant changes in equity were the result of net income and other comprehensive income earned during the first nine months of 2010, which is described above.
Business Segment Review
Note 6 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. As a component of gross margin, 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, phosphate and nitrogen 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 results where applicable to give further insight into these results.
Potash gross margin variance attributable to:
Canpotex sales to major markets, by percentage of sales volumes, were as follows:
The most significant contributors to the change in total gross margin quarter over quarter were as follows(1):
The change in market mix produced an unfavorable variance of $35.9 million related to sales volumes and a favorable variance of $37.3 million in sales prices due to the proportional increase in North American sales of higher-priced granular product exceeding the proportional increase in offshore sales of lower-priced standard product. North American customers prefer premium priced granular product over standard product more typically consumed offshore.
(1) Direction of arrows refer to impact on gross margin while the symbol signifies a neutral impact.
The most significant contributors to the change in total gross margin year over year were as follows(1):
The change in market mix year over year produced an unfavorable variance of $50.9 million related to sales volumes and a favorable variance of $62.7 million in sales prices due to the proportional increase in North American sales of higher-priced granular product exceeding the proportional increase in offshore sales of lower-priced standard product.
(1) Direction of arrows refer to impact on gross margin while the symbol signifies a neutral impact.