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CQB > SEC Filings for CQB > Form 10-Q on 7-Nov-2011All Recent SEC Filings

Show all filings for CHIQUITA BRANDS INTERNATIONAL INC

Form 10-Q for CHIQUITA BRANDS INTERNATIONAL INC


7-Nov-2011

Quarterly Report


Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

Overall, our results declined for both the quarter and nine months ended September 30, 2011 compared to the same periods in 2010, primarily driven by weaker value-added salads business results that offset improved performance in bananas. Banana business results were improved in both the quarter and nine months ended September 30, 2011 compared to the same periods in 2010. Our banana business continues to perform well, particularly in North America, where both pricing and volume were higher, and a force majeure surcharge in place for most of the first half helped us to recover significantly higher sourcing costs that began in late 2010 and continued throughout the first half. While the banana business as a whole is seasonal, this is most pronounced in Europe where weekly local currency pricing is significantly affected by variations of supply and demand in the market, with prices typically weaker in the third and fourth quarters than in the first half. In the third quarter, local European pricing was lower, but this was offset by higher average exchange rates, resulting in flat pricing on a U.S. dollar basis. For the nine months ended September 30, 2011, pricing was higher in both local currency and on a U.S. dollar basis as the first quarter customer demand improved from unusually weak conditions in the first quarter of 2010.

In the salad business, we expected year-over-year comparisons to be negative as a result of customers converting value-added salad volume to private label in the first nine months of 2010. However, our costs in the value-added salads business have been higher than expected, particularly with respect to industry input cost inflation, process customization associated with Fresh Rinse and product quality-related costs. We expect certain of these costs to be temporary and be lower in the fourth quarter of 2011 and in 2012. In June 2011, we also initiated a program to realign our value-added salads overhead structure and to integrate our global innovation and marketing functions into the business units, which will reduce operating costs and improve speed, execution and scalability of our product development activities. The full benefit of this realignment was not yet reflected in the business results, but we expect to save approximately $15 million of cost annually.

There are also several other key items that affect year-over-year comparisons:

Other Produce results included a $32 million reserve in the second quarter of 2011 for advances to a Chilean grower. As previously disclosed, advances to this grower in current and past growing seasons were not fully repaid and a reserve was determined to be necessary based on additional information received during the second quarter on the grower's credit quality, lower than expected collections through the end of the 2010-2011 Chilean grape season, and a decision in the second quarter of 2011 to change the company's grape sourcing model. In the third quarter of 2011, the Chilean grower was declared bankrupt; the company continues to negotiate recovery with the bankruptcy trustee and other creditors of the grower.

Income taxes included a benefit of $87 million in the second quarter of 2011 from the release of valuation allowances against deferred tax assets. The release resulted from sustained improvements in our North American businesses and the benefits of debt reduction over the last several years that allowed us to consistently generate U.S. taxable income and made it more likely than not that we will be able to use our net operating loss carryforwards and other deferred tax assets. The release of the valuation allowance will result in a higher effective tax rate, but cash paid for taxes will not change significantly until the NOLs are fully utilized.

In July 2011, we completed a refinancing of a portion of our capital structure by entering into an amended and restated senior secured credit facility ("Credit Facility") which includes a $330 million senior secured term loan and a $150 million senior secured revolving facility using the proceeds to retire $155 million outstanding under the previous credit facility and purchase or call the remainder of the 8 7/8% Senior Notes. The Credit Facility matures on either (a) July 26, 2016 or (b) May 1, 2014, which is six months prior to the maturity of the 7 1/2% Senior Notes due 2014 unless we refinance, or otherwise extend the maturity of, the 7 1/2% Senior Notes by such date. In total, these refinancing efforts resulted in an aggregate $11 million of "Other expense" in the third quarter but are expected to result in interest cost savings of approximately $11 million annually. We intend to monitor the capital markets for additional refinancing opportunities (including with respect to our 7 1/2% Senior Notes), with the goal of further reducing interest expense, extending debt maturities and improving liquidity.


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The nine months ended September 30, 2010 included a $32 million gain on the deconsolidation of the European smoothie business.

Our results are subject to significant seasonal variations and interim results are not indicative of the results of operations for the full fiscal year. Our results during the third and fourth quarters are generally weaker than in the first half of the year due to increased availability of competing fruits and resulting lower banana prices, as well as seasonally lower consumption of salads in the fourth quarter. For a further description of our challenges and risks, see the Overview section of "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Part I - Item 1A - Risk Factors" in our 2010 Annual Report on Form 10-K and discussion below.

Operations

NET SALES

Net sales for the third quarter of 2011 were $723 million, down 1% from the third quarter of 2010. The decrease was the result of lower retail value-added salad volume and the discontinuation of non-strategic, low-margin other produce lines in the fourth quarter of 2010, which were partially offset by higher banana pricing in North America and higher banana volume in core markets. Net sales for the nine months ended September 30, 2011 were $2.4 billion, down 1% from the year-ago period. The decrease was also the result of lower North American retail value-added salad volume and the discontinuation of non-strategic, low-margin other produce lines in the fourth quarter of 2010, which were partially offset by higher banana pricing and volume in North America and higher banana pricing in Europe.

OPERATING INCOME

In the third quarter of 2011, we incurred an operating loss of $10 million compared to operating income of $6 million in the third quarter of 2010. Operating income for the nine months ended September 30, 2011 and 2010 was $46 million and $121 million, respectively. The decline in operating income for the three months ended September 30, 2011 reflects weaker Salads and Healthy Snacks results (mainly in retail value-added salads) offset partially by better Banana results. For the nine months ended September 30, 2011, Salads and Healthy Snacks (mainly retail value-added salads) performance was also weaker, while Banana results were significantly improved. In addition, the nine months ended September 30, 2011 includes a $32 million reserve against advances provided to a Chilean grower, whereas, the nine months ended September 30, 2010 includes a $32 million gain on the deconsolidation of the European smoothie business as described in the Overview above and in Notes 2 and 14 to the Condensed Consolidated Financial Statements, respectively.

REPORTABLE SEGMENTS

We report three business segments: Bananas; Salads and Healthy Snacks; and Other Produce. Segment descriptions and results can be found in Note 12 to the Condensed Consolidated Financial Statements. Certain corporate expenses are not allocated to the reportable segments and are included in "Corporate." Inter-segment transactions are eliminated.

BANANA SEGMENT

Net sales for the segment were $453 million and $431 million for the third quarters of 2011 and 2010, respectively, and $1.5 billion for each of the nine month periods ended September 30, 2011 and 2010. In North America, both pricing and volume were higher, including force majeure surcharges in place from late January until the end of the second quarter to recover significantly higher sourcing costs that began in late 2010. In Europe, banana prices are generally set weekly in local currencies and are significantly affected by variations in supply and demand in the market, and prices are typically weaker in the third and fourth quarters than in the first half. In the first half of 2011 customer demand improved compared to the unusually weak conditions in the first quarter of 2010. In the third quarter of 2011, local pricing was lower than in the third quarter of 2010, but as a result of stronger average exchange rates, European pricing was similar on a dollar basis. Even as industry supply increased late in the second quarter, we reduced our shipments to the Mediterranean markets due to unfavorable pricing conditions, which continued into the third quarter. Industry banana supplies are currently ample compared to severe shortages in the fourth quarter of 2010, which should allow us to supply customer contracts at a lower cost than in the fourth quarter of 2010, assuming that there are no weather-related or other events affecting industry supply.


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The significant increases (decreases) in our Banana segment operating income for the quarter ("Q3") and nine months ("YTD") ended September 30, presented in millions, are as follows:

         Q3               YTD
      $       3      $          71      2010 Banana segment operating income
            (16 )               67      Pricing
              8                 11      Volume
              5                 15      Average European exchange rates1
              9                (35 )    Sourcing and logistics costs2
              1                  3      European tariff costs3
              1                 (1 )    Marketing investment4
             (2 )               (6 )    Selling, general and administrative costs
             (2 )               (3 )    Other

      $       7      $         122      2011 Banana segment operating income

1 Average European exchange rates include the effect of hedging, which was an expense of less than $1 million and an expense of $4 million for the third quarters of 2011 and 2010, respectively, and an expense of $3 million and a benefit of $5 million for the nine months ended September 30, 2011 and 2010, respectively. See Note 5 to the Condensed Consolidated Financial Statements for further description of our hedging program.

2 Sourcing costs include increased costs of purchased fruit. Logistics costs are significantly affected by fuel prices, but include the effect of fuel hedges, which was a benefit of $14 million and an expense of $4 million for the third quarter of 2011 and 2010, respectively, and a benefit of $31 million and an expense of $5 million for the nine months ended September 30, 2011 and 2010, respectively. In the third quarter 2011, we implemented a new shipping configuration that will reduce our total bunker fuel consumption and the ports where the fuel will be purchased. As a result of these changes, accounting standards required us to recognize $12 million of unrealized fuel hedging gains in the third quarter for hedge positions originally intended to hedge fuel purchases in future periods. Additionally, bunker fuel forward contracts that were in excess of our expected core fuel demand were sold and gains of $2 million were realized. See Note 5 to the Condensed Consolidated Financial Statements for further description of our hedging program.

3 See EU Banana Import Regulation below for discussion of tariff costs.

4 Increases in European marketing investments are offset by decreases in North American marketing investments.

The percentage changes in our banana prices in 2011 compared to 2010 were as follows:

                                                   Q3           YTD
                North America1                       2.7 %       7.4 %
                Core Europe:2
                U.S. dollar basis3                  (0.5 )%      7.9 %
                Local currency                     (10.0 )%      1.0 %
                Mediterranean4 and Middle East      (9.4 )%      7.5 %

Our banana sales volumes5 (in 40-pound box equivalents) were as follows:

                                      Q3         Q3          %           YTD        YTD          %
(In millions, except percentages)    2011       2010      Change         2011       2010      Change
North America                         16.2       15.1         7.3 %       48.8       46.5         4.9 %
Europe and the Middle East:
Core Europe2                           9.4        9.0         4.4 %       30.4       30.5        (0.3 )%
Mediterranean4 and Middle East         3.8        4.2        (9.5 )%      10.3       14.0       (26.4 )%

1 North America pricing includes fuel-related and other surcharges.

2 Core Europe includes the 27 member states of the European Union, Switzerland, Norway and Iceland. Bananas sales in Core Europe are primarily in euros.

3 Prices on a U.S. dollar basis exclude the effect of hedging.

4 Mediterranean markets are mainly European and Mediterranean countries that do not belong to the European Union.

5 Volume sold includes all banana varieties, such as Chiquita to Go, Chiquita minis, organic bananas and plantains.


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Banana segment inventory at September 30, 2011 was higher than at December 31, 2010 or September 30, 2010 primarily due to timing of shipping schedules that resulted in more inventory in transit and higher cost of bunker fuel in inventory.

We have entered into hedging instruments (derivatives) to reduce the negative cash flow and earnings effect that any significant decline in the value of the euro would have on the conversion of euro-based revenue into U.S. dollars. Put options, which require an upfront premium payment, can reduce this risk without limiting the benefit of a stronger euro. To minimize the volatility that changes in fuel prices could have on the operating results of our core shipping operations, we also enter into hedge contracts to lock in prices of future bunker fuel purchases. Further discussion of hedging risks and instruments can be found under the caption "Market Risk Management-Financial Instruments" below, and Note 5 to the Condensed Consolidated Financial Statements. The average spot and hedged euro exchange rates were as follows:

                                                 Q3         Q3          %          YTD        YTD          %
(Dollars per euro)                              2011       2010      Change        2011       2010       Change
Euro average exchange rate, spot               $ 1.42     $ 1.28        10.9 %    $ 1.40     $ 1.31          6.9 %
Euro average exchange rate, hedged             $ 1.41     $ 1.24        13.7 %    $ 1.39     $ 1.33          4.5 %

EU Banana Import Regulation

From 2006 through the second quarter of 2010, bananas imported into the European Union ("EU") from Latin America, our primary source of fruit, were subject to a tariff of 176 per metric ton, while bananas imported from African, Caribbean, and Pacific sources have been and continue to be allowed to enter the EU tariff-free (since January 2008, in unlimited quantities). Following several successful legal challenges to this arrangement in the World Trade Organization ("WTO"), the EU and 11 Latin American countries initialed the WTO "Geneva Agreement on Trade in Bananas" ("GATB") in December 2009, under which the EU agreed to reduce tariffs on Latin American bananas in stages, starting with a new rate of 148 per metric ton in 2010, reducing to 143 per metric ton in 2011, further reducing to 136 per metric ton in 2012, and, following further cuts, ending with a rate of 114 per metric ton by 2019. The GATB still needs to be formalized in the WTO. The EU also signed a WTO agreement with the United States, under which it agreed not to reinstate WTO-illegal tariff quotas or licenses on banana imports. The initial 28 per metric ton reduction in the tariff lowered our tariff costs by $26 million for the year ended December 31, 2010.

In another regulatory development, in March 2011, the EU initialed free trade area ("FTA") agreements with (i) Colombia and Peru and (ii) the Central American countries. Under both FTA agreements, the EU committed to reduce its banana tariff to 75 per metric ton over ten years for specified volumes of banana exports from each of the countries covered by these FTAs. The agreements are not expected to be approved and ratified before late 2012, at the earliest. Because the approval procedures remain unsettled, it is unclear when, or whether, these FTAs will be implemented. If they are implemented, despite the decrease in tariffs for the bananas covered by the FTAs, it is unclear what, if any, effect they will have on our operations because the banana implementing arrangements remain unsettled, including the possibility of export licenses.

SALADS AND HEALTHY SNACKS SEGMENT

Net sales for the segment were $240 million and $251 million for the third quarters of 2011 and 2010, respectively and $731 million and $798 million for the nine months ended September 30, 2011 and 2010, respectively. The decline in sales was due to lower volume in retail value-added salads from customer conversions to private label during the first nine months of 2010. Adverse weather conditions and a lettuce blight resulted in lower productivity and higher field and manufacturing costs for the entire industry in the first quarter of 2011, while industry input cost inflation, process customization associated with Fresh Rinse and product quality-related costs have also negatively affected 2011. We expect certain of these costs to be temporary and be lower in the fourth quarter of 2011 and in 2012. Fresh Rinse is the company's new produce wash that significantly reduces microorganisms on particular leafy greens compared to a conventional chlorine sanitizer. We converted all of our facilities to support the use of this technology during the first half of 2011.


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The significant increases (decreases) in our Salads and Healthy Snacks segment operating income for the quarter ("Q3") and nine months ("YTD") ended September 30, presented in millions, are as follows:

    Q3                    YTD
                                             2010 Salads and Healthy Snacks segment operating
$       18            $        99            income
         0                     (6 )          Pricing
        (4 )                  (21 )          Volume primarily in retail value-added salads
        (5 )                   (8 )          Industry input costs
        (3 )                   (8 )          Fresh Rinse technology
                                             Quality-related and manufacturing disruption
        (7 )                  (13 )          costs
                                             Deconsolidation in 2010 and results of the
         0                    (32 )          European smoothie business
        (2 )                   (4 )          Other

                                             2011 Salads and Healthy Snacks segment
$       (3 )          $         7            operating (loss) income

Volume and pricing for Fresh Express-branded retail value-added salads was as follows:

                                      Q3         Q3          %           YTD        YTD          %
(In millions, except percentages)    2011       2010      Change         2011       2010      Change
Volume                                11.8       12.9        (8.5 )%      37.9       42.4       (10.6 )%
Pricing1                                                      0.5 %                              (0.7 )%

1 Represents the net reduction in sales of individual product pricing changes, without considering changes in product mix. The weighted average price of all sales increased by 3.5% for the third quarter and by 1.8% for the nine months, including the favorable changes in product mix.

OTHER PRODUCE SEGMENT

Net sales for the segment were $30 million and $47 million for the third quarters of 2011 and 2010, respectively, and $139 million and $202 million for the nine months ended September 30, 2011 and 2010, respectively. Operating income (loss) for the segment was $(2) million and $1 million for the third quarters of 2011 and 2010, respectively and $(38) million and $4 million for the nine months ended September 30, 2011 and 2010, respectively. Sales decreased primarily due to the discontinuation of non-strategic, low-margin product in the fourth quarter of 2010. Operating income decreased primarily as a result of recording a $32 million reserve in the second quarter of 2011 for advances to a Chilean grower of grapes and other produce. The reserve was based upon additional information received on the grower's credit quality, lower than expected collections through the end of the 2010-2011 Chilean grape season, and a decision in the second quarter of 2011 to change our grape sourcing model. In the third quarter of 2011, the Chilean grower was declared bankrupt; we continue to negotiate recovery with the bankruptcy trustee and other creditors of the grower. See further discussion of grower advances in Note 2 to the Condensed Consolidated Financial Statements. Segment results were also affected by higher avocado sourcing and logistics costs.

CORPORATE

Corporate expenses were $13 million and $15 million for the third quarters of 2011 and 2010, respectively, and $45 million and $53 million for the nine months ended September 30, 2011 and 2010, respectively. Corporate expenses were lower primarily due to lower legal fees, lower incentive compensation and pension costs.

INTEREST AND OTHER INCOME (EXPENSE)

Interest expense was $12 million and $14 million for the third quarters of 2011 and 2010, respectively, and $41 million and $43 million for the nine months ended September 30, 2011 and 2010, respectively. Other expense in 2011 and the decrease in interest expense were related to the refinancing activities that are described in Note 4 to the Condensed Consolidated Financial Statements and in Financial Condition - Liquidity and Capital Resources below. During the third quarter of 2010, we recognized $3 million of expense related to contingencies in Europe. See Note 13 for further discussion of contingencies.


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INCOME TAXES

Income taxes were a net benefit of $4 million and $76 million in the quarter and nine months ended September 30, 2011, respectively, compared to a net benefit of $1 million and net expense of $2 million for the quarter and nine months ended September 30, 2010, respectively. The increase in the income tax benefit for the third quarter 2011 relates to operating losses incurred by U.S. business. The increase in net income tax benefit for the nine months ended September 30, 2011 compared to 2010 is primarily the result of the $87 million U.S. valuation allowance release, partially offset by a $6 million charge for a tax settlement in Italy as described in Notes 8 and 13 to the Condensed Consolidated Financial Statements.

As a result of sustained improvements in the performance of our North American businesses and the benefits of debt reduction over the last several years, we have been generating annual U.S. taxable income beginning with tax year 2009, and expect this trend to continue, even if seasonal losses may be incurred in interim periods. As of June 30, 2011, our forecast included second quarter results as well as increased visibility to North American banana pricing and stabilized sourcing costs. As a result of these considerations, we recognized an $87 million income tax benefit for the reversal of valuation allowances against 100% of the U.S. federal deferred tax assets and a portion of the state deferred tax assets, primarily net operating loss carry forwards ("NOLs"), which are more likely than not to be realized in the future. Through the second quarter of 2011, valuation allowances on available U.S. NOLs significantly affected our effective tax rate; if a deferred tax asset with a full valuation allowance, such as an NOL, was realized, the corresponding valuation allowance was also released, resulting in no net effect to income taxes reported in the Condensed Consolidated Statements of Income.

The reversal of the valuation allowance against U.S. federal deferred tax assets, described above, resulted in changing our interim tax reporting from the discrete method to the effective tax rate method. Under the effective tax rate method, we are required to adjust our effective tax rate for each quarter to be consistent with the estimated annual effective tax rate. Jurisdictions with a projected loss where no tax benefit can be recognized are excluded from the calculation of the estimate annual effective tax rate. This could result in a higher or lower effective tax rate in the interim period based upon the mix and timing of actual earnings versus annual projections. Our overall effective tax rate may vary significantly from period to period due to the level and mix of income among domestic and foreign jurisdictions. Many of these foreign jurisdictions have tax rates that are lower than the U.S. statutory rate, and we continue to maintain full valuation allowances on deferred tax assets in some of these jurisdictions. Other items that do not otherwise affect the our earnings can also affect our overall effective tax rate, such as the effect of changing exchange rates on intercompany balances that can change the mix of income among domestic and foreign jurisdictions. We do not expect our cash paid for taxes to change materially from historic levels for several years due to the availability of U.S. NOLs, but we do expect an increase of future reported income tax expense due to the second quarter release of the valuation allowance booked against those NOLs. Our effective tax rate going forward will reflect a combination of the application of normal U.S. statutory rates and historical levels of foreign taxes.

Financial Condition - Liquidity and Capital Resources

At September 30, 2011, we had a cash balance of $133 million. As described more fully in Note 4 to the Condensed Consolidated Financial Statements, in July 2011 we completed a refinancing of a portion of our capital structure by entering into an amended and restated Credit Facility with a senior secured term loan ("Term Loan") of $330 million, and a $150 million senior secured revolving facility ("Revolver"). While keeping similar terms and covenant flexibility of our previous senior secured credit facility ("Preceding Credit Facility"), we used the proceeds to retire both the Preceding Credit Facility and purchase $133 million of our 8 7/8% Senior Notes due 2015 in a tender offer at 103.333% of their par value in July 2011; we called the remaining $44 million of the 8 7/8% . . .

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