Bron Scherer & Dan Sohre, Protein Sources, 2011 Pork Management Conference, June 14-17, in Nashville, Tenn.

1. 2011 Pork Management Conference
June 16, 2011
Nashville, TN
Bron J. Scherer, CPA & Dan Sohre, Protein Sources, LLP, Mapleton, MN

2.  Bron J. Scherer, CPA
◦ Partner, Protein Sources, LLP, Mapleton, MN
◦ (507) 649-1903, brons@charter.net
 Dan D. Sohre
◦ Partner, Protein Sources, LLP, Mapleton, MN
◦ (507) 420-5141, dsohre@proteinsources.com

3.  Background & history-our risk management
“evolution”
 Accounting and Reporting Challenges
 Mechanics of Risk Management Accounting
 Relevance of the “Matching” Principle
 Management Reporting & Interpretation
 Not a “FASB/ASC” Accounting Principles Class!!

4.  2003-Our “turning point” in Risk
Management
 End of “cost matrix” packer marketing
contracts
◦ Little, if any, forward thinking risk management
undertaken
◦ Simply receive physical revenues/pay physical costs
◦ May have been “ledger” balances

5.  Had to become self-reliant
 Commenced relationship with CIH
 Our business philosophy and values in sync
 CIH had substantial livestock experience (rare)
 Commenced Risk Management Strategies
◦ Lean Hogs
◦ Feed inputs (Corn, SBM)

6.  Began gradually
◦ Studied LH futures trading histories
◦ Historical (in percentiles)swine industry margins
◦ Numerous organizational meetings
◦ Weekly conference calls to:
 Review existing positions
 Consider changes in market conditions
 Review affect of USDA reports
 Review changes in business, production, if any
 For “cooperatives”, develop methodology for “sharing” risk
management gains and losses
 Established fee structure for professional services
 Tested strategies on our own pigs first

7.  Lack of understanding of risk management
strategies
◦ How do futures work?
◦ The effect of basis
◦ Use of futures spreads to mitigate basis risk
◦ Understanding options
 Particularly costs
 Opportunities
 Mitigating net option premium
 “Rolling” strategies at different price levels to future
periods

8.  Margin
◦ Initial
◦ Maintenance
Working Capital Required
◦ Margin
◦ Option Premiums
Bank relationship-effect on borrowing
covenants
◦ Interest costs

9.  Broker Account Activity
◦ Meaningfulness of statements
◦ Regulatory reports (not much thought given to
usefulness)
◦ Transaction Reporting (monthly vs. daily)
◦ Position Reporting (lacks logical groupings)
◦ Options and futures net “P&L’s”-not GAAP

10.  Cash in flow/outflow vs. “economic” results
 Margin account deposits and withdrawals
 Psychological burden on owner/managers
 Excess/deficit cash balance in broker accounts
 Investment in Option Premium
 Don’t forget about the fees
 Settlement of margin calls, day or days subsequent
 Developing the relationship/confidence with lenders

11.  Review of Daily (Broker) Statements
◦ Sort transactions by commodity, by date
◦ Summarize fees by commodity for futures
◦ P&L gains and losses
 Close out futures transactions
 Reverse/exercised/expired option positions
 Summarize commodity transactions by type
 Roll-forward each brokerage account, monthly
 Utilize summary info from daily statements
 Essentially treat as a “cash” account
 May have reconciling items (DIT’s, period end issues)

12.  Roll-forward Option Premium outstanding
◦ Option premium expended/credits
◦ Gains and losses on options reversed/liquidated
◦ Use brokerage and option premium roll-forwards
as support for monthly journal entries (first batch)
 Cash flow recorded previously
 Schedules of outstanding option premium
 By strategy, beginning and end of month
 Schedules of gains and losses, by transaction

13.  We’re not done yet!
 Review all realized gain and loss applicability
to current period
 What’s going on with the physical activity
 What was the intent of the strategy now
realized?
 Determine if realized gains/losses need to be
deferred to future periods
 One of the biggest obstacles to risk
management understanding…”Cash” vs.
period of physical activity

14.  Adjust gains/losses for deferred items
◦ New deferred items
◦ Reversal of prior period deferred items,
now recognized

15. The "Matching" Principle
A typical hog "bear" spread
June/July Spread
Date Month Buy/Sell Price
9/15/2011 June S $85.90
July B $84.15
Spread
Differential $1.75
11/2/2011 June B $84.15 $1.75
July S $86.27 $2.12
Spread
Differential ($2.12) $3.87
June Gain/CWT = $1.75
July Gain/CWT = $2.12
Total Gain/CWT = $3.87
Deferred gain = $1,548.00 (per contract)

16. The "Matching" Principle
A typical corn-"3 way" Feed Input strategy
May 2011 Corn Contracts
Date Market Strike Put/Call Buy/Sell Price Dollars
11/1/2010 $5.96 $6.10 C B $0.61 $3,050.00
$4.80 P S ($0.11) ($550.00)
$7.80 C S ($0.20) ($1,000.00)
$0.30 $1,500.00
1/24/2011 $6.66 $4.80 P B $0.02 $100.00 ($450.00)
2/28/2011 $7.31 $6.10 C S ($1.16) ($5,800.00) ($2,750.00)
$6.50 C B $0.84 $4,200.00
3/15/2011 $6.36 $7.80 C B $0.04 $200.00 ($800.00)
4/4/2011 $7.60 $6.50 C S ($1.00) ($5,000.00) ($800.00)
($4,800.00) ($4,800.00)proof
1/24/2011Defer $450 gain to April/May
2/28/2011Defer $2,750 gain to April/May
3/15/2011Defer $800 gain to April/May
4/4/2011$800 gain recognized, transaction complete & recognized

17.  Executive Summary-Monthly
◦ Balance Sheet Items (Financial Position)
◦ P&L Activity-
 Fees
 Futures
 Options
 Other costs
 Schedule of all deferred gains (losses)
 Liquidating value from Brokerage system

18.  Bank Reporting Critical
◦ Need to know that you know
◦ In concert with your Broker’s web site
◦ Margin sensitivity analysis
◦ No SPECULATION

19.  Recording of unrealized gains and
losses at balance sheet date
◦ To inventories (current assets)
◦ To equity section

20. Mark To Market Adjustment
Close Unrealized Mark to
Date Month Buy/Sell Contracts Sale Price Price Gain/(loss) Market
12/31/201
0 June Sell 1 $93.05 $93.05 $0.00 $0.00
1/31/2011 June $93.05 $100.95 ($3,160.00) $3,160.00
2/28/2011 June $93.05 $100.20 ($2,860.00) $2,860.00
3/31/2011 June $93.05 $103.87 ($4,328.00) $4,328.00
4/29/2011 June $93.05 $95.22 ($868.00) $868.00
Unrealized gain or loss will be exactly offset by the mark to market adjustment unless there
has been a change in basis.

21.  Period Recap
 CME Futures Outstanding
 CME Futures Realized gains & losses
 LH Options Outstanding
 LH Options Realized gains & losses
 Deferred Gains & Losses – Feed
 Executive Summary

22. Questions?

23. Thank you!