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CF INDUSTRIES : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. (form 10-Q)

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11/02/2017 | 06:36 pm


You should read the following discussion and analysis in conjunction with
our annual consolidated financial statements and related notes, which were
included in our 2016 Annual Report on Form 10-K filed with the Securities and
Exchange Commission
on February 23, 2017, as well as Item 1. Financial
Statements, in this Form 10-Q. All references to "CF Holdings," "we," "us,"
"our" and "the Company" refer to CF Industries Holdings, Inc. and its
subsidiaries, except where the context makes clear that the reference is only to
CF Industries Holdings, Inc. itself and not its subsidiaries. All references to
"CF Industries" refer to CF Industries, Inc., a 100% owned subsidiary of
CF Industries Holdings, Inc. References to tons refer to short-tons. Notes
referenced in this discussion and analysis refer to the notes to our unaudited
interim consolidated financial statements that are found in the preceding
section: Item 1. Financial Statements. The following is an outline of the
discussion and analysis included herein:
• Overview of CF Holdings


• Our Company



• Items Affecting Comparability of Results



• Financial Executive Summary



• Results of Consolidated Operations



• Third Quarter of 2017 Compared to Third Quarter of 2016





• Nine Months Ended September 30, 2017 Compared to Nine Months
Ended September 30, 2016



• Operating Results by Business Segment



• Liquidity and Capital Resources



• Off-Balance Sheet Arrangements



• Critical Accounting Policies and Estimates



• Recent Accounting Pronouncements



• Forward-Looking Statements





Overview of CF Holdings
Our Company
We are one of the largest manufacturers and distributors of nitrogen fertilizer
and other nitrogen products in the world. Our principal customers are
cooperatives, independent fertilizer distributors, farmers and industrial users.
Our principal nitrogen fertilizer products are ammonia, granular urea, urea
ammonium nitrate solution (UAN) and ammonium nitrate (AN). Our other nitrogen
products include diesel exhaust fluid (DEF), urea liquor, nitric acid and aqua
ammonia, which are sold primarily to our industrial customers, and compound
fertilizer products (NPKs), which are solid granular fertilizer products for
which the nutrient content is a combination of nitrogen, phosphorus, and
potassium. Our manufacturing and distribution facilities are concentrated in the
midwestern United States and other major agricultural areas of the United
States
, Canada and the United Kingdom. We also export nitrogen fertilizer
products from our Donaldsonville, Louisiana and Yazoo City, Mississippi
manufacturing facilities, and our United Kingdom manufacturing facilities in
Billingham and Ince.
Our principal assets include:
• four U.S. nitrogen fertilizer manufacturing facilities located in


Donaldsonville, Louisiana (the largest nitrogen fertilizer complex in



the world); Port Neal, Iowa; Yazoo City, Mississippi; and Woodward,



Oklahoma. These facilities are owned by CF Industries Nitrogen, LLC
(CFN), in which we own approximately 89% and CHS Inc. (CHS), owns the
remainder. See Note 13-Noncontrolling Interests to our unaudited



interim consolidated financial statements for additional information on



our strategic venture with CHS.


• an approximately 75.3% interest in Terra Nitrogen Company, L.P.
(TNCLP), a publicly traded limited partnership of which we are the sole



general partner and the majority limited partner and which, through its



subsidiary Terra Nitrogen, Limited Partnership (TNLP), operates a



nitrogen fertilizer manufacturing facility in Verdigris, Oklahoma;


• two Canadian nitrogen fertilizer manufacturing facilities located in



Medicine Hat, Alberta (the largest nitrogen fertilizer complex in
Canada) and Courtright, Ontario;


• two United Kingdom nitrogen manufacturing complexes located in
Billingham and Ince;



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CF INDUSTRIES HOLDINGS, INC.

• an extensive system of terminals and associated transportation
equipment located primarily in the midwestern United States; and


• a 50% interest in Point Lisas Nitrogen Limited (PLNL), an ammonia
production joint venture located in the Republic of Trinidad and Tobago
that we account for under the equity method.


Items Affecting Comparability of Results
Nitrogen Fertilizer Selling Prices
Over the last decade, strong demand, high capacity utilization and increasing
operating margins as a result of higher global nitrogen fertilizer prices
stimulated global investment in nitrogen production facilities, which resulted
in an increase in global nitrogen fertilizer production capacity. As a result,
global nitrogen fertilizer supply increased more quickly than global nitrogen
fertilizer demand, creating the current global oversupply in the market, and
leading to lower nitrogen fertilizer selling prices.
A significant amount of new nitrogen production capacity came on line in 2016
and 2017, including an increase in production capacity located in North America,
which has further increased supply. We expect the lower priced environment to
continue until global supply and demand become more balanced through a
combination of continued demand growth and supply reductions as producers
respond to lower realized margins by taking higher cost production facilities
off line.
The U.S. Gulf is a major global fertilizer pricing point due to the volume of
nitrogen fertilizer that trades there. Through most of 2016, nitrogen pricing at
the U.S. Gulf declined, often trading below parity with other international
pricing points due to continued imports from various exporting regions and
decreased North American buyer interest as a result of greater global nitrogen
supply availability. Seasonal decreases in agricultural demand combined with
delayed customer purchasing activity resulted in multi-year lows in nitrogen
fertilizer selling prices in the second half of 2016. During the first quarter
of 2017, prices began to increase as the supply and demand balance tightened in
anticipation of spring fertilizer demand for the planting and growing season.
However, as the first quarter progressed, increased imports into North America
increased fertilizer supply in the region, which pressured selling prices
downward as the quarter ended. During the second quarter of 2017, anticipated
demand failed to materialize and the increased imports into the United States
that occurred in the first quarter of 2017 continued in the second quarter,
negatively impacting selling prices. During the third quarter of 2017, selling
prices for most nitrogen products increased throughout the quarter, ending
higher than at the beginning of the quarter. The strengthening price environment
was driven by significantly lower Chinese exports; higher energy and production
costs in parts of the world, including higher natural gas costs in Europe and
higher coal costs in China; a weaker U.S. dollar; and strong global demand.
The greater global nitrogen supply availability and resulting low nitrogen
fertilizer selling prices significantly impacted our results for the three and
nine months ended September 30, 2017. The average selling price for our products
for the three months ended September 30, 2017 was $178 per ton compared to $185
per ton for the three months ended September 30, 2016, a decrease of 4%
resulting in a decrease in both net sales and gross margin of approximately $62
million
between the periods. The average selling prices for our products in the
nine months ended September 30, 2017 was $207 per ton compared to $230 per ton
for the nine months ended September 30, 2016, a decrease of 10%, resulting in a
decrease in both net sales and gross margin of approximately $326 million
between the periods. In addition to the direct impact of lower selling prices,
during periods of declining prices, customers tend to delay purchasing
fertilizer in anticipation of prices in the future being lower than current
prices.
In addition to the impact of market conditions on nitrogen fertilizer selling
prices, certain significant items impacted our financial results during the
three and nine months ended September 30, 2017 and 2016. The following table and
related discussion outline these significant items and how they impacted the
comparability of our financial results during these periods. During the three
months ended September 30, 2017 and 2016, we reported a net loss attributable to
common stockholders of $(87) million and $(30) million, respectively. During the
nine months ended September 30, 2017 and 2016, we reported net (loss) earnings
attributable to common stockholders of $(107) million and $43 million,
respectively.

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CF INDUSTRIES HOLDINGS, INC.

Three Months Ended September 30, Nine Months Ended September 30,
2017 2016 2017 2016
Pre-Tax After-Tax Pre-Tax After-Tax Pre-Tax After-Tax Pre-Tax After-Tax
(in millions) (in millions)
Depreciation and
amortization(1) $ 226 $ 142 $ 148 $ 93 $ 648 $ 407 $ 475 $ 298
Unrealized net mark-to-market
(gain) loss on natural gas
derivatives(2) (7 ) (4 ) 21 13 64 40 (169 ) (106 )
Capacity expansion project
expenses(3) - - 24 15 - - 59 37
Start-up costs Donaldsonville
ammonia(2) - - 18 11 - - 18 11
Transaction costs - - - - - - 179 96
Loss on foreign currency
transactions including
intercompany loans(3) 1 1 3 4 2 2 86 85
Equity method investment tax
contingency accrual(4) - - - - 7 7 - -
Financing costs related to
bridge loan commitment fee(5) - - - - - - 28 18
Strategic Venture with CHS:
Noncontrolling interest(6) 17 17 27 27 40 40 67 67
Loss on embedded
derivative(3) 1 - 22 14 4 2 22 14
Total Impact of Significant
Items $ 238 $ 156 $ 263 $ 177 $ 765 $ 498 $ 765 $ 520



______________________________________________________________________________



(1) Included primarily in cost of sales and selling, general and administrative
expenses in our consolidated statements of operations.
(2) Included in cost of sales in our consolidated statements of operations.
(3) Included in other operating-net in our consolidated statements of
operations.
(4) Included in equity in losses of operating affiliates in our consolidated
statements of operations.
(5) Included in interest expense in our consolidated statements of operations.
(6) Included in net earnings attributable to noncontrolling interests in our
consolidated statements of operations.



The following describes the significant items that impacted the comparability of
our financial results for the three and nine months ended September 30, 2017 and
2016. Descriptions of items below that refer to amounts in the table above,
refer to the pre-tax amounts.
Depreciation and amortization
Total depreciation and amortization expense recognized in the three and nine
months ended September 30, 2017 was $226 million and $648 million, respectively,
and for the three and nine months ended September 30, 2016 was $148 million and
$475 million, respectively. This increase in depreciation expense reflects the
completion of our capacity expansion projects and placing in service all five of
the new plants prior to the end of 2016. The capacity expansion projects were
originally announced in 2012 and included the construction of new ammonia, urea,
and UAN plants at our Donaldsonville, Louisiana complex and new ammonia and urea
plants at our Port Neal, Iowa complex. These plants increased our overall
production capacity by approximately 25%, improved our product mix flexibility
at Donaldsonville, and improved our ability to serve upper-Midwest urea
customers from our Port Neal location. The following table indicates the quarter
in which each of the five expansion plants were placed in service.
Quarter placed in service Expansion plant location
Q4 2015 Donaldsonville Urea
Q1 2016 Donaldsonville UAN
Q4 2016 Donaldsonville Ammonia
Q4 2016 Port Neal Ammonia and Urea



Depreciation expense pertaining to each of our capacity expansion plants
commenced once the applicable plant was placed in service.



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CF INDUSTRIES HOLDINGS, INC.

Unrealized net mark-to-market (gain) loss on natural gas derivatives
Natural gas is typically the largest and most volatile single component of the
manufacturing cost for nitrogen-based products. We manage the risk of changes in
natural gas prices through the use of derivative financial instruments. The
derivatives that we use for this purpose are primarily natural gas fixed price
swaps and natural gas options. We use natural gas derivatives as an economic
hedge of natural gas price risk, but without the application of hedge
accounting. This can result in volatility in reported earnings due to the
unrealized mark-to-market adjustments that occur from changes in the value of
the derivatives, which is reflected in cost of sales in our consolidated
statements of operations. In the three months ended September 30, 2017 and 2016,
we recognized unrealized net mark-to-market (gain) loss on natural gas
derivatives of $(7) million and $21 million, respectively. In the nine months
ended September 30, 2017 and 2016, we recognized unrealized net mark-to-market
loss (gain) of $64 million and $(169) million, respectively.
Capacity expansion projects
Our capacity expansion projects were completed as of December 31, 2016. Capacity
expansion project expenses in the three and nine months ended September 30, 2016
were $24 million and $59 million, respectively, generally consisting of
administrative costs and other project costs that did not qualify for
capitalization. Start-up costs of $18 million, which primarily relate to the
cost of commencing production at the Donaldsonville ammonia plant, were incurred
in the three and nine months ended September 30, 2016.
Transaction costs
On August 6, 2015, we entered into a definitive agreement (as amended, the
Combination Agreement) to combine with the European, North American and global
distribution businesses of OCI N.V. (OCI). On May 22, 2016, CF Holdings, OCI and
the other parties to the Combination Agreement entered into a termination
agreement under which the parties agreed to terminate the Combination Agreement
by mutual written consent. In the nine months ended September 30, 2016, we
incurred $179 million of transaction costs associated with the proposed
combination with certain businesses of OCI and our strategic venture with CHS,
including a $150 million termination fee paid to OCI in the second quarter of
2016 and costs for various consulting and legal services.
Loss on foreign currency transactions including intercompany loans
In the three and nine months ended September 30, 2016, we recognized losses of
$3 million and $86 million, respectively, from the impact of changes in foreign
currency exchange rates on primarily British pound and Canadian dollar
denominated intercompany loans that were not permanently invested. Due to a
restructuring of certain intercompany loans, we did not incur the same level of
foreign exchange rate impacts in the three and nine months ended September 30,
2017
.
Equity method investment tax contingency accrual
The Trinidad tax authority (the Board of Inland Revenue) has issued a tax
assessment against our equity method investment in the Republic of Trinidad and
Tobago
, PLNL, related to a dispute over whether tax depreciation must be claimed
during a tax holiday period that was granted to PLNL under the Trinidad Fiscal
Incentives Act. The tax holiday was granted as an incentive to construct PLNL's
ammonia plant. PLNL is appealing the assessment. Based on the facts and
circumstances of this matter, PLNL recorded a tax contingency accrual in the
second quarter of 2017, which reduced our equity in earnings of PLNL for the
nine months ended September 30, 2017 by approximately $7 million reflecting our
50% ownership interest.
Strategic Venture with CHS
We commenced a strategic venture with CHS on February 1, 2016, at which time CHS
purchased a minority equity interest in CFN for $2.8 billion, which represented
approximately 11% of the membership interest of CFN. We own the remaining
membership interest. Under the terms of CFN's limited liability company
agreement, each member's percentage membership interest will reflect, over time,
the impact of the profitability of CFN and any member contributions made to, and
distributions received from, CFN. CHS also began receiving deliveries pursuant
to a supply agreement under which CHS has the right to purchase annually from
CFN up to approximately 1.1 million tons of granular urea and 580,000 tons of
UAN at market prices. As a result of its minority equity interest in CFN, CHS is
entitled to semi-annual cash distributions from CFN. We are also entitled to
semi-annual cash distributions from CFN. The amounts of distributions from CFN
to us and CHS are based generally on the profitability of CFN and determined
based on the volume of granular urea and UAN sold by CFN to us and CHS pursuant
to supply agreements, less a formula driven amount based primarily on the cost
of natural gas used to produce the granular urea and UAN, and adjusted for the
allocation of items such as operational efficiencies and overhead amounts. We
began recognizing the noncontrolling interest pertaining to CHS' ownership
interest in CFN on February 1, 2016. We recognized earnings attributable to the
noncontrolling interest in CFN of $17 million and $40 million for the three and
nine months ended September 30, 2017, respectively, and $27 million and $67
million
for the three and nine months ended

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CF INDUSTRIES HOLDINGS, INC.

September 30, 2016, respectively. See Note 13-Noncontrolling Interests for
additional information on our strategic venture with CHS.
Under the terms of our strategic venture with CHS, if our credit rating as
determined by two of three specified credit rating agencies is below certain
levels, we are required to make a non-refundable yearly payment of $5 million to
CHS. The payment would continue on a yearly basis until the earlier of the date
that our credit rating is upgraded to or above certain levels by two of three
specified credit rating agencies or February 1, 2026. In the fourth quarter of
2016, as a result of a reduction in our credit rating, we made a $5 million
payment to CHS. This term of the strategic venture is recognized on our
consolidated balance sheet as an embedded derivative liability. Included in
other operating-net in our consolidated statement of operations for the nine
months ended September 30, 2017 is an unrealized loss of $4 million to adjust
the liability to fair value.
Financial Executive Summary
We reported a net loss attributable to common stockholders of $87 million for
the three months ended September 30, 2017 compared to a net loss of $30 million
for the three months ended September 30, 2016. Diluted net loss per share
attributable to common stockholders was $0.37 in the third quarter of 2017
compared to $0.13 in the third quarter of 2016.
During the third quarter of 2017, we experienced higher net losses attributable
to common stockholders compared to the third quarter of 2016 due primarily to
lower average selling prices resulting from the excess global supply of nitrogen
fertilizer, higher realized natural gas costs, and higher depreciation as a
result of the completion of our capacity expansion projects. These items were
partially offset by an increase in sales volume as a result of increased
production from the completion of our capacity expansion projects and higher
gross margin as a result of higher unrealized net mark-to-market gains on
natural gas derivatives.
Net interest expense increased to $76 million in the three months ended
September 30, 2017 from $29 million in the three months ended September 30,
2016
, due primarily to higher amounts of capitalized interest in 2016 related to
our capacity expansion projects that reduced interest expense in 2016. The
completion of our capacity expansion projects reduced the amount of capitalized
interest in 2017. Capitalized interest of $1 million was recorded for the three
months ended September 30, 2017 compared to $53 million for the three months
ended September 30, 2016.
Our total gross margin increased by $7 million to $9 million in the third
quarter of 2017 from $2 million in the third quarter of 2016. The change in
gross margin was due primarily to:
•an increase in sales volume of 33%, which increased gross margin by $63
million
, primarily driven by an increase in sales volume for ammonia and
granular urea of 64% and 42%, respectively,
•targeted cost reduction initiatives and production efficiencies due to
increased volume,
•a higher unrealized net mark-to-market gain on natural gas derivatives, which
increased gross margin by $28 million as the third quarter of 2017 included a
$7 million gain and the third quarter of 2016 included a $21 million loss,
•start-up costs of $18 million of the new ammonia plant at our Donaldsonville
facility that occurred in the third quarter of 2016,
•a decrease in average selling prices of 4%, which reduced gross margin by $62
million
. In the third quarter, the average selling prices for ammonia, UAN and
granular urea declined by 18%, 8%, and 4%, respectively, while the average
selling price for AN increased by 17%,
•an increase in depreciation and amortization due primarily to the completion of
our capacity expansion projects, and
•an increase in physical natural gas costs in the third quarter of 2017,
partially offset by the impact of natural gas derivatives that settled in the
period, which decreased gross margin by $46 million as compared to the third
quarter of 2016.

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