Economic Scenario in Brazil: Since Heringer’s operations are concentrated in Brazil, its operational results are impacted by the country’s economic situation. However, the global recession, increasing protectionism in the importing countries and severe weather conditions can also affect these results.
Brazilian Agricultural Industry Conditions: The demand for, and prices of, its fertilizer products are significantly influenced by the financial results and condition of Brazilian agricultural producers, which are in turn influenced by (1) anticipated market prices for agricultural products; (2) foreign exchange rate variations for crops for which prices are established in or influenced by international market prices; and (3) the cost of various agricultural inputs used to produce their crops. Agricultural producers analyze these variables to estimate their anticipated revenues and, accordingly, their level of spending on crop inputs, including Heringer’s fertilizer products, in a given planting season. In general, higher levels of projected revenues by agricultural producers result in increased spending on inputs, including fertilizer products. In Brazil, approximately 80% of overall fertilizer demand derives from five main crops: soybeans; sugar; corn; coffee; and cotton.
Agricultural Commodity Prices: Agricultural commodity prices have a strong influence on fertilizer demand, since the latter is directly linked to farmers’ decisions to plant certain crops to the detriment of others, or even not to plant at all.
Exchange Variation: Heringer imports approximately 75% of its raw materials. In a stable economic scenario, the exchange variation is naturally passed on to fertilizer prices. Therefore, the inventory works as a natural hedge. In addition, the Company has a Hedge Committee elected by the Board of Directors that maintains a hedge policy aimed at mitigating the risk of foreign exchange variation on dollar-denominated liabilities. The Company also maintains specialized financial consulting services to provide support for decisions involving the contracting of hedge transactions. It is also worth noting that the Company does not use any exotic derivatives to hedge its foreign exchange exposure.
Effect of Fluctuations in Prices for its Imported Raw Materials: Fluctuations in the international market prices of imported raw materials, together with related freight costs and port charges, significantly impact its costs of goods sold and therefore its gross margin, as well as the prices that the Company charges for its products.
Seasonality: Seasonality significantly impacts the fertilizer industry, since fertilizer deliveries are concentrated principally during the planting season for grains from September through December. Heringer’s volumes sold represent, on average, between 35% and 40% in the first half and 60% and 65% in the 2H. As a result of this seasonality, the Company usually operates at its maximum production capacity during the months of peak demand.
The main accounting practices adopted in the preparation of the financial statements are shown below:
Cash and cash equivalents: Cash and cash equivalents include cash, bank deposits, highly liquid short-term financial investments with a negligible value-change risk and used overdraft facility limits.
Financial Instruments
Classification and measurement: The Company classifies its financial assets under the following categories: measured at fair value; loans and receivables; and available for sale. This classification depends on the purpose for which the financial assets were acquired, and is determined by Management on their initial recognition.
Financial assets measured at fair value: Financial assets measured at fair value are financial assets that are maintained for active and frequent trading. Derivatives are also categorized as maintained for trading, and are therefore classified under this category. These assets are classified as current assets. Gains or losses from variations in the fair value of financial assets measured at fair value are recognized in the income statement under “financial result” in the period in which they occur in the same line that is impacted by the operation in question.
Loans and receivables: This category comprises loans granted and receivables that are non-derivative financial assets with fixed or determinable payments that are not listed on an active market. They are classified as current assets, except for those maturing in more than 12 months after the date of the balance sheet, which are classified as non-current assets. The Company’s loans and receivables comprise accounts receivable from clients, other accounts receivable and cash and cash equivalents, excluding short-term financial investments. Loans and receivables are booked at their amortized cost using the effective interest rate method.
Financial assets available for sale: Financial assets available for sale are not derivatives. They are classified under this category either because of their specific nature as such or because they are not classified under any other category. They are included in non-current assets, unless management intends to sell them within 12 months of the date of the balance sheet. Financial assets available for sale are booked at their fair value. Interest on securities available for sale, which is calculated through the effective interest rate method, is booked as financial revenue in the income statement.
Fair value: The fair value of publicly-traded investments is based on current acquisition prices. The fair value of financial assets without an active market or which are not publicly-traded is established through appraisal techniques, including the use of recent operations contracted from third parties, the use of other substantially similar instruments as a reference, discounted cash flow analysis or option pricing models that make the greatest possible use of information from the market and the least possible use of information generated by management of the Company.
On the closing date of the balance sheet, the Company assesses whether there is any objective evidence that a given financial asset or group of financial assets is booked at a value higher than its recoverable value (impairment). If there is any such evidence in the case of financial assets available for sale, the accrued loss (the difference between the acquisition cost and the current fair value less any impairment losses previously recognized in the result) – is removed from the balance sheet and booked in the income statement.
Derivative instruments and hedges: The Company undertakes transactions with derivative financial instruments in order to mitigate the impact of exchange rate volatility, especially on the purchase of imported products. These derivatives are not used for speculative purposes and are booked at their fair value on the date on which the derivative contracts are executed, being subsequently remeasured, also at their fair value. The resulting variations in fair value are booked against the result, except in the case of derivatives designated as cash flow hedge instruments.
Trade accounts receivable: Trade accounts receivable are initially evaluated at their present value and deducted from provisions for doubtful accounts, which are constituted whenever there is objective evidence that the Company will not receive the total amount due from its clients. This evaluation is based on the individual analysis of overdue clients, taking into consideration their payment capacity, the guarantees offered and the opinions of lawyers and specialized debt collection companies. The amount of the provisions is the difference between the book value and the recoverable value.
Present value is calculated based on the effective long-term interest rate, said rate being compatible with the nature, maturity and risk of similar transactions under market conditions.
Inventories: Raw material and packaging inventories are evaluated and booked at their average acquisition cost, which is less than their replacement cost or realization value, in line with the weighted moving average method. The cost of finished products and products under manufacture includes raw materials and labor, as well as other direct costs and production-related expenses in general, always considering normal operational capacity. The net realizable value is the estimated sale price in the normal course of business, excluding execution costs and selling expenses. Imports in progress are booked at the accrued cost of each importation.
Deferred income tax and social contribution: Deferred income tax and social contribution are calculated on tax losses, negative social contribution base and the corresponding temporary differences between the calculation bases of taxes on assets and liabilities and the book values in the financial statements. The tax rates established for determining these deferred credits are 25% for income tax and 9% for social contribution.
Deferred taxes are booked in line with the likelihood that future taxable income will be available to offset the temporary differences and/or fiscal losses, based on future result projections adjusted to present value. These projections are based on technical studies prepared and based on internal premises and future economic scenarios which may, therefore, suffer alterations.
Judicial deposits: These deposits are recognized as deductions from the value of a corresponding liability constituted when there is no possibility of said deposits being redeemed except in the case of a favorable judicial outcome for the Company.
Investments: Investments in the wholly-owned subsidiary are recorded and evaluated through the equity accounting method and recognized in the result as operating income or expenses. In order to calculate equity income, gains and transactions to be realized between the Company and its wholly-owned subsidiary are excluded in the proportion of the Company’s interest.
Conversion into foreign currency: Foreign-currency transactions are converted into Reais at the effective exchange rate on the transaction date. Amounts in the balance sheet accounts are converted using the effective exchange rate on the date of the balance sheet. Exchange gains and losses resulting from the settlement of these transactions and the conversion of monetary assets and liabilities denominated in foreign currency are recognized in the income statement.
Fixed Assets: Sites and buildings refer mostly to factories and are booked at their historical acquisition cost, monetarily restated up to December 31, 1995.
Depreciation is calculated by the straight-line method. Sites are not depreciated.
Gains and losses from sales are determined by comparing the sales value and the book value and are included in the result.
Impairment: Fixed assets and other non-current assets and intangible assets are revised annually in order to identify evidence of non-recoverable losses, or whenever events or changes in conditions indicate that the book value of said assets may not be recoverable, in which case the recoverable amount is calculated to verify any losses. Whenever such losses do occur, they are recognized at the difference between the asset’s book value and its recoverable value (defined as its net sale price or its value in use, whichever is higher). For evaluation purposes, assets are grouped into the smallest asset group for which there are separately identifiable cash flows.
Provisions: Provisions are recognized when the Company has a present, legal or not formalized obligation due to past events and a capital outflow is likely to be necessary in order to settle the obligation and make a reliable estimate.
The Company recognizes a provision for onerous contracts when the benefits expected from a contract are lower than the costs inevitably incurred to settle the obligations assumed in a contract.
Employees’ profit sharing: The Company distributes to its employees 10% of adjusted net income through its profit sharing program, in accordance with its agreement with the union.
Loans: Loans are initially booked at their fair value upon the reception of funds, net of transaction costs. Subsequently, loans are booked based on their amortized cost, i.e., accrued of charges and interest proportional to the incurred period (“pro rata temporis“).
Result assessment and revenue recognition: The result is assessed by the accrual basis of accounting. Product sales revenue is recognized in the result when all risks and benefits inherent to the product are transferred to the buyer, i.e., for FOB sales, revenue is recognized when the buyer collects the product from one of the Company’s units; for CIF sales, revenue is recognized only after the delivery of the product in the location established by the client.
Payments can be made on demand or in installments, as well as through a “Vendor” program, financed with banks, which assume the responsibility for receivables for up to one year.
Bonuses from raw materials purchases, granted by suppliers, are recognized in the fiscal year’s results as cost reducers, under the Cost of goods sold line, as the Company’s is entitled to receive them after complying with purchase volumes and other pre-established parameters.
Freight expenses from auxiliary and raw material purchases are appropriated to cost of goods sold when said goods are sold. Freight expenses related to product delivery, as well as expenses from sales commission, are recorded as commercial expenses, when incurred.
Tax Incentives: ICMS reduction: Tax benefits result from the granting given to the Company in September 2003 due to its participation in the Sergipe Industrial Development Program (PSDI) – Sergipe State Government, which provides a 92% reduction in the State Value-Added Tax (ICMS), calculated in the industrial unit in Rosário do Catete (SE). As of 2008, with the publication of CVM Instruction 555/08, the benefit began to be directly booked in the fiscal year’s result and, afterwards, transferred from the Retained earnings account to the Fiscal incentives profit reserve.
Payable income tax reduction: As of 2007, the Company began enjoying the 75% reduction in payable income tax deriving from the Northeast Development Agency (ADENE). The benefit is determined based on the exploitation profit. It was granted in March 2006 for a ten-year period and comprises the unit in Rosário do Catete (SE). As of 2008, the benefit began to be directly booked in the fiscal year’s results and, afterwards, transferred from the Retained earnings account to the Fiscal incentives profit reserve.