CHS INC. This Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to provide a reader of our financial statements with a narrative from the perspective of our management on our financial condition and results of operations, liquidity and certain other factors that may affect our future results. Our MD&A is presented in the following sections:
• Overview • Business Strategy
• Fiscal 2020 First Quarter Highlights
• Fiscal 2020 Trends Update
• Results of Operations
• Liquidity and Capital Resources
• Off-Balance Sheet Financing Arrangements
• Contractual Obligations
• Critical Accounting Policies
• Effect of Inflation and Foreign Currency Transactions
• Recent Accounting Pronouncements
Our MD&A should be read in conjunction with our Annual Report on Form 10-K for
the year ended
Overview
• Energy. Produces and provides primarily for the wholesale distribution and
transportation of petroleum products.
• Ag. Purchases and further processes or resells grains and oilseeds
originated by our country operations business, by our member cooperatives
and by third parties; also serves as a wholesaler and retailer of agronomy
products.
• Nitrogen Production. Consists solely of our equity method investment in CF
Nitrogen and produces and distributes nitrogen fertilizer, a commodity
chemical.
In addition, our financing and hedging businesses, along with our non-consolidated wheat milling and food production and distribution joint ventures, have been aggregated within Corporate and Other.
The condensed consolidated financial statements include the accounts of CHS and all subsidiaries and limited liability companies in which we have a controlling interest. The effects of all significant intercompany transactions have been eliminated.
Corporate administrative expenses and interest are allocated to each reporting segment, along with Corporate and Other, based on direct use of services, such as information technology and legal, and other factors or considerations relevant to the costs incurred.
Management's Focus. When evaluating our operating performance, management focuses on gross profit and income before income taxes ("IBIT"). As a company that operates heavily in global commodities, there is significant unpredictability and volatility in pricing, costs and global trade volumes. Consequently, we focus on managing the margin we can earn and the resulting IBIT. Management also focuses on ensuring balance sheet strength through appropriate management of financial liquidity, leverage, capital allocation and cash flow optimization.
Seasonality. Many of our business activities are highly seasonal and our operating results vary throughout the year. Our revenues and income generally trend lower during the second and fourth fiscal quarters and higher during the first and third fiscal quarters; however, weather or other events may impact this trend, particularly for IBIT. For example, in our Ag segment, our country operations business generally experiences higher volumes and income during the fall harvest and spring planting seasons, which generally correspond to our first and third fiscal quarters, respectively. Additionally, our agronomy
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business generally experiences higher volumes and income during the spring planting season. Our global grain marketing operations are subject to fluctuations in volume and income based on producer harvests, world grain prices, demand and global trade volumes. Our Energy segment generally experiences higher volumes and profitability in certain operating areas, such as refined products, in the spring, summer and early fall when gasoline and diesel fuel use by agricultural producers is highest and is subject to global supply and demand forces. Other energy products, such as propane, generally experience higher volumes and profitability during the winter heating and fall crop-drying seasons. The graphs below depict the seasonality inherent in our businesses, particularly revenue trends that are not impacted as significantly by other events.
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* Income (loss) before income taxes experienced deviations from historical trends during fiscal 2019 and fiscal 2018 as a result of gains on sales of noncore assets, recoveries of previously recorded losses and a combination of other factors, including poor weather conditions that negatively impacted our Ag segment operations.
Pricing and Volumes. Our revenues, assets and cash flows can be significantly affected by global market prices and sales volumes of commodities such as petroleum products, natural gas, grains, oilseed products and agronomy products. Changes in market prices for commodities we purchase without a corresponding change in the selling prices of those products can affect revenues and operating earnings. Similarly, increased or decreased sales volumes without a corresponding change in the purchase and selling prices of those products can affect revenues and operating earnings. Commodity prices and sales volumes are affected by a wide range of factors beyond our control, including weather, crop damage due to plant disease or insects, drought, availability/adequacy of supply of a commodity, availability of reliable rail and river transportation network, government regulations/policies, global trade disputes and general political/economic conditions.
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Table of Contents Business Strategy
Our business strategies focus on an enterprise-wide effort to create an experience that empowers customers to make CHS their first choice, expands market access to add value for our owners, and transforms and evolves our core businesses by capitalizing on changing market dynamics. To execute on these strategies, we are focused on the implementing agile, efficient and sustainable new technology platforms; building robust and efficient supply chains; hiring, developing and retaining high-performing, diverse and passionate teams; achieving operational excellence and continuous improvement; and maintaining a strong balance sheet.
Fiscal 2020 First Quarter Highlights
• Less advantageous market conditions in our refined fuels business resulted
in a significant decrease in IBIT compared to the same period during the
prior year, primarily driven by decreased Western Canadian Select ("WCS")
crude oil differentials experienced on heavy Canadian crude oil, which is
processed by our refineries.
• Strong supply chain performance in our propane business was a significant
positive contributor to our results. We were able to efficiently source
propane for our customers during a period of significant propane demand
for crop drying and home heating.
• Poor weather conditions during fiscal 2019 continued to negatively impact
our Ag segment's operations, including lower crop yields and poor grain
quality following a late harvest, as well as lower crop nutrient sales
that traditionally occur during the fall.
• We continued to experience significant pressure on grain volumes and
margins due to slow movement of grain, which was associated with
uncertainty in the grain markets related to unresolved trade issues
between the United States and its trading partners.
• We continued to devote considerable resources toward implementation of our
new enterprise resource planning ("ERP") software, which will provide an
improved platform to execute upon our business strategies.
• As more fully described in Item 4 of Part I of this Quarterly Report on
Form 10-Q, we continued dedicating significant internal and external
resources, as well as executive and board focus, to improving our control
environment.
Fiscal 2020 Trends Update
Our Ag and Energy businesses operate in cyclical environments. The favorable
market conditions experienced by the Energy business during the first half of
fiscal 2019, most notably heavy Canadian crude oil price differentials, returned
to lower, more normalized levels during the second half of fiscal 2019 and the
first quarter of fiscal 2020. Although unforeseen market conditions could
positively or negatively impact the energy industry, we expect the normalized
market conditions experienced by our Energy segment during the first quarter of
fiscal 2020 to remain throughout fiscal 2020. The agricultural industry
continues to operate in a challenging environment characterized by lower
margins, reduced liquidity and increased leverage that have resulted from
reduced commodity prices. In addition, trade relations between
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