Land O'Lakes Inc. Annual Report 2002

SALES AND EARNINGS

Net sales for Land O'Lakes, Inc. and subsidiaries (the "Company") in 2002 were $5.8 billion, decreasing slightly from 2001. Excluding the full-year effect of the acquisition of Purina Mills, Inc. in October 2001, net sales in 2002 declined $712 million or 13 percent, with decreases in each business segment.

The decline in Dairy Foods segment sales in 2002 was mainly attributed to lower market prices for butter and cheese products and reduced volumes as sales of branded dairy products continued to be impacted by the weak economy. Excluding the full-year effect of the Purina Mills acquisition, Feed segment sales decreased in 2002 due to the effects of exiting and realigning certain operations, a protein glut which depressed markets for livestock producers and unfavorable weather conditions. Swine feed volumes, in particular, declined as a result of depressed market prices for hog producers. Further, declining dairy commodity prices led dairy producers to shift from branded feed products to lower cost commodity feeds. Depressed market prices impacted Swine segment sales as hog market prices per hundredweight in 2002 averaged in the mid $30's, compared to the mid $40's in the prior year. Seed experienced volume growth in seed corn sales in 2002; however, this increase was more than offset by volume declines in soybeans primarily due to a discontinued partnered soybean brand.

Net earnings were $98.9 million in 2002 compared with $71.5 million in 2001, an increase of $27.4 million. Net earnings included a nonrecurring gain on legal settlements, net of income tax, of $129.3 million. Excluding this gain, the Company incurred a net loss of $30.4 million in 2002. Net earnings in 2002 were impacted by lower market prices and volume declines for dairy, feed and swine commodity products, reduced earnings from equity in affiliated companies, start-up expenses associated with a California cheese plant and restructuring and impairment charges in the Feed and Dairy Foods segments.

Earnings in the Dairy Foods segment were affected by lower butter and cheese prices, driven by depressed commodity markets, and declines in dairy value-added volumes as a result of the weak economy. Earnings in the Feed segment were impacted by declines in livestock feed sales and margins, particularly swine, beef and dairy feed, primarily due to weak agricultural markets. Earnings in the Company's Swine segment declined due to lower commodity markets for hogs.

Earnings from equity in affiliated companies, primarily from our investments in Agriliance, Melrose Dairy Proteins and MoArk, were down considerably in 2002. The decline was attributed to the effect of lower crop nutrient earnings at Agriliance, lower whey, alcohol and cheese commodity markets at Melrose Dairy Proteins and lower egg market prices at MoArk. In spring of 2002, the Company completed the construction of a new cheese plant in California. This resulted in significant start-up expenses which partly contributed to losses in Dairy Foods.

Feed restructuring and impairment charges increased in 2002 as the Company took steps towards achieving the synergies identified in the Purina Mills acquisition plan. In addition, Dairy Foods incurred restructuring and impairment charges primarily related to strategic initiatives in its industrial operations. The Company's lower operating earnings, however, were more than offset by nonrecurring gains related to legal settlements, the divestiture of certain businesses and the sale of an intangible.

FINANCIAL CONDITION

The acquisition of Purina Mills in 2001 has temporarily increased the level of debt on Land O'Lakes balance sheet. The acquisition was financed with long-term debt, which significantly increased the Company's debt-to-capital ratio.

Debt is comprised of short-term and long-term debt, including capital securities. In the fourth quarter of 2001, a new financing package was arranged, with JPMorgan leading the syndication. The package consisted of a $250 million revolving credit facility, a five-year term loan for $325 million and a seven-year term loan for $250 million. All of these facilities are senior debt and are secured by most of the assets of Land O'Lakes. In addition, a ten-year senior unsecured note offering for $350 million was completed in November 2001. During 2002, the Company paid down $55.3 million in term debt. As of December 31, 2002, the outstanding balances of the five-year term loan and the seven-year term loan were $288.3 million and $231.4 million, respectively.

Capital securities of $200 million were issued in March 1998 by a subsidiary of Land O'Lakes. The capital securities carry a coupon interest rate of 7.45 percent and are due in 2028. In 2000, Land O'Lakes repurchased $9.3 million of these securities. At December 31, 2002, the outstanding capital securities balance was $190.7 million.

Long-term debt, excluding current portion and including capital securities, was $1,007.3 million at December 31, 2002. This amount is down $140.2 million from the prior year due to payments on long-term debt and a transfer of certain payments into current portion. Land O'Lakes long-term debt-to-capital ratio, including capital securities, at December 31, 2002 was 51.1 percent, down from 56.1 percent at the end of 2001.

Short-term debt increased $88.9 million to $142.4 million in 2002, compared with $53.5 million in 2001, primarily due to an increase in the current portion of long-term debt which reflects payments anticipated in 2003. Total debt decreased $51.3 million to $1,149.7 million in 2002, compared with $1,201.0 million in the prior year.

As of December 31, 2002, the Company's senior secured debt rating was BB (Standard & Poor's) and B1 (Moody's) and senior unsecured debt rating was B+ (Standard & Poor's) and B2 (Moody's). Finally, the Company's capital securities ratings were B- (Standard & Poor's) and B3 (Moody's).

Capital leases Starting on December 31, 2002, a synthetic lease arrangement of CPI, the Company's 95 percent-owned joint venture cheese plant, is recorded as a capital lease on the Company's consolidated balance sheet.

Equities increased $75.0 million in 2002 to $911.5 million at December 31, 2002. The increase resulted from the net earnings increase in 2002 and was partially offset by equity revolvement, age retirements, estate redemptions and patronage refunds payable.

Cash returns to members in 2002 totaled $37.9 million compared with $46.9 million in the prior year. In 2002, members received $14.5 million of equity revolvement, $20.2 million of cash patronage related to prior year's earnings and $3.2 million of age retirement, estate and other payments.

PERFORMANCE MEASURES

Land O'Lakes is committed to improving profitability in each core business through the effective use of invested capital and increased returns to members. The Company uses two primary performance measures-return on invested capital (ROIC) and return on equity (ROE). ROIC indicates the operating return on invested capital before considering the costs of financing and income taxes. ROE combines the results of operating performance with the effects of financial leverage and income taxes to measure the return on members' investment in Land O'Lakes.

Return on invested capital The Company showed a decrease in its return on invested capital, from 9.1 percent in 2001 to 8.6 percent in 2002. Land O'Lakes average ROIC for the five-year period ended in 2002 was 8.3 percent.

Return on equity The 2002 earnings increase resulted in a 2.9 percentage point increase in ROE from 8.9 percent in 2001 to 11.8 percent in 2002. Average ROE for the five-year period ended in 2002 was 9.7 percent.

SEC REPORTING

As a result of the 2001 issue of ten-year senior unsecured notes, Land O'Lakes has registered the notes in 2002 and files annual (10-K), quarterly (10-Q) and current (8-K) reports with the SEC. The Company's filings can be accessed on the internet at www.sec.gov.