1QuickLinks-- Click here to rapidly navigate through this documentUNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549FORMForm 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
/x/
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended
JuneSeptember 30,1999 -------------------------------------------------2000or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period
from____________ to___________________________________fromtoCommission File Number: 0-15638
-------------------------------------------------------- MICHAEL FOODS, INC. - -------------------------------------------------------------------------------- (ExactMichael Foods, Inc.
(Exact name of registrant as specified in its charter)Minnesota 41-0498850 - -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) Suite 324, Park National Bank Building 5353 Wayzata Boulevard Minneapolis, MN, 55416 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip code) (612)
Minnesota
(State or other jurisdiction of
incorporation or organization)
41-0498850
(I.R.S. Employer Identification No.)
Suite 324, Park National Bank Building
5353 Wayzata Boulevard
Minneapolis, MN,
(Address of principal executive offices)
55416
(Zip code)(952) 546-1500
- -------------------------------------------------------------------------------- (Registrant's
(Registrant's telephone number, including area code)Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
[ X ]Yes [ ]NoYes /x/ No / /The number of shares outstanding of the registrant's Common Stock, $.01 par value, as of
AugustNovember 6,19992000 was20,249,62418,284,991 shares.12PART
I -I—FINANCIAL INFORMATIONMICHAEL FOODS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31, ASSETS 1999 1998 - ------ ------------ ------------CURRENT ASSETS Cash and equivalents $ 699,000 $ 2,047,000 Accounts receivable, less allowances 101,522,000 97,639,000 Inventories 79,881,000 74,250,000 Prepaid expenses and other 4,883,000 3,884,000 ------------ ------------ Total current assets 186,985,000 177,820,000 PROPERTY, PLANT AND EQUIPMENT-AT COST Land 4,336,000 4,336,000 Buildings and improvements 105,706,000 105,567,000 Machinery and equipment 366,557,000 328,067,000 ------------ ------------ 476,599,000 437,970,000 Less accumulated depreciation 204,572,000 187,759,000 ------------ ------------ 272,027,000 250,211,000 OTHER ASSETS Goodwill, net 118,450,000 120,172,000 Investments in Joint Ventures and other assets 23,840,000 3,313,000 ------------ ------------ 142,290,000 123,485,000 ------------ ------------ $601,302,000 $551,516,000 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY - ------------------------------------ CURRENT LIABILITIES Current maturities of long-term debt $ 8,067,000 $ 10,663,000 Accounts payable 47,591,000 44,376,000 Accrued Liabilities Compensation 8,414,000 11,034,000 Insurance 7,235,000 7,369,000 Customer programs 20,719,000 19,624,000 Other 26,606,000 23,457,000 ------------ ------------ Total current liabilities 118,632,000 116,523,000 LONG-TERM DEBT, less current maturities 204,466,000 155,444,000 DEFERRED INCOME TAXES 34,389,000 35,400,000 COMMITMENTS AND CONTINGENCIES - - SHAREHOLDERS' EQUITY Common stock 202,000 211,000 Additional paid-in capital 102,093,000 119,871,000 Retained earnings 141,520,000 124,067,000 ------------ ------------ 243,815,000 244,149,000 ------------ ------------ $601,302,000 $551,516,000 ============ ============
September 30,
2000December 31,
1999ASSETS CURRENT ASSETS Cash and equivalents $ 7,682,000 $ 4,961,000 Accounts receivable, less allowances 98,895,000 92,493,000 Inventories 82,721,000 71,197,000 Prepaid expenses and other 4,668,000 4,604,000 Total current assets 193,966,000 173,255,000
PROPERTY, PLANT AND EQUIPMENT-AT COST
Land 4,106,000 4,104,000 Buildings and improvements 133,890,000 133,778,000 Machinery and equipment 376,741,000 357,724,000 514,737,000 495,606,000 Less accumulated depreciation 233,992,000 208,807,000 280,745,000 286,799,000
OTHER ASSETS
Goodwill, net 114,146,000 116,729,000 Joint ventures and other assets 18,660,000 21,134,000 132,806,000 137,863,000 $ 607,517,000 $ 597,917,000
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES Current maturities of long-term debt $ 2,881,000 $ 3,130,000 Accounts payable 51,076,000 47,009,000 Accrued liabilities Compensation 13,071,000 13,143,000 Insurance 7,292,000 7,229,000 Customer programs 18,567,000 20,999,000 Income taxes 11,643,000 11,805,000 Other 13,432,000 18,176,000 Total current liabilities 117,962,000 121,491,000
LONG-TERM DEBT, less current maturities
203,370,000
175,404,000
DEFERRED INCOME TAXES 37,507,000 36,423,000 COMMITMENTS AND CONTINGENCIES — —
SHAREHOLDERS' EQUITY
Common stock 182,000 203,000 Additional paid-in capital 58,390,000 102,777,000 Retained earnings 191,696,000 162,577,000 Accumulated comprehensive income (loss) (1,590,000 ) (958,000 ) 248,678,000 264,599,000 $ 607,517,000 $ 597,917,000 See accompanying notes to condensed consolidated financial statements.
2
3MICHAEL FOODS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
Three Months Ended
JuneSeptember 30, (Unaudited)
1999 1998 ------------ ------------Net sales $258,031,000 $243,685,000 Cost of sales 207,892,000 199,231,000 ------------ ------------ Gross profit 50,139,000 44,454,000 Selling, general and administrative expenses 27,432,000 22,371,000 ------------ ------------ Operating profit 22,707,000 22,083,000 Interest expense, net 2,801,000 2,580,000 ------------ ------------ Earnings before income taxes 19,906,000 19,503,000 Income tax expense 8,160,000 8,190,000 ------------ ------------ NET EARNINGS $ 11,746,000 $ 11,313,000 ============ ============ Net Earnings Per Share Basic $ 0.57 $ 0.52 Diluted $ 0.57 $ 0.51 ============ ============ Weighted average shares outstanding Basic 20,463,000 21,939,000 Diluted 20,702,000 22,337,000 ============ ============
2000 1999 Net sales $ 276,568,000 $ 269,911,000 Cost of sales 228,820,000 223,162,000 Gross profit 47,748,000 46,749,000 Selling, general and administrative expenses 25,506,000 25,355,000 Operating profit 22,242,000 21,394,000 Interest expense, net 3,524,000 3,241,000 Earnings before income taxes 18,718,000 18,153,000 Income tax expense 6,900,000 7,440,000 NET EARNINGS $ 11,818,000 $ 10,713,000 Net Earnings Per Share Basic $ 0.65 $ 0.53 Diluted $ 0.64 $ 0.52 Weighted average shares outstanding Basic 18,278,000 20,251,000 Diluted 18,516,000 20,522,000 See accompanying notes to condensed consolidated financial statements.
3
4MICHAEL FOODS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
SixNine Months Ended
JuneSeptember 30, (Unaudited)
1999 1998 ------------ ------------Net sales $511,409,000 $489,274,000 Cost of sales 419,139,000 404,664,000 ------------ ------------ Gross profit 92,270,000 84,610,000 Selling, general and administrative expenses 52,476,000 45,515,000 ------------ ------------ Operating profit 39,794,000 39,095,000 Interest expense, net 5,621,000 5,344,000 ------------ ------------ Earnings before income taxes 34,173,000 33,751,000 Income tax expense 14,010,000 14,180,000 ------------ ------------ NET EARNINGS $ 20,163,000 $ 19,571,000 ============ ============ Net Earnings Per Share Basic $ 0.97 $ 0.89 Diluted $ 0.96 $ 0.88 ============ ============ Weighted average shares outstanding Basic 20,736,000 21,892,000 Diluted 20,966,000 22,273,000 ============ ============
2000 1999 Net sales $ 795,110,000 $ 781,320,000 Cost of sales 650,872,000 642,301,000 Gross profit 144,238,000 139,019,000 Selling, general and administrative expenses 79,168,000 77,831,000 Operating profit 65,070,000 61,188,000 Interest expense, net 9,778,000 8,862,000 Earnings before income taxes 55,292,000 52,326,000 Income tax expense 21,710,000 21,450,000 NET EARNINGS $ 33,582,000 $ 30,876,000 Net Earnings Per Share Basic $ 1.75 $ 1.50 Diluted $ 1.73 $ 1.48 Weighted average shares outstanding Basic 19,172,000 20,574,000 Diluted 19,394,000 20,818,000 See accompanying notes to condensed consolidated financial statements.
4
5MICHAEL FOODS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
SixNine Months Ended
JuneSeptember 30, (Unaudited)
1999 1998 ------------ ------------Net cash provided by operating activities $ 35,776,000 $ 40,124,000 Cash flows from investing activities: Capital expenditures (41,419,000) (34,560,000) Investments in joint ventures and other assets (21,017,000) 207,000 ------------ ------------ Net cash used in investing activities (62,436,000) (34,353,000) Cash flows from financing activities: Payments on long-term debt (85,374,000) (5,033,000) Proceeds from long-term debt 131,800,000 700,000 Proceeds from issuance of common stock 523,000 1,817,000 Repurchase of common stock (18,927,000) -- Dividends (2,710,000) (2,406,000) ------------ ------------ Net cash provided by (used in) financing activities 25,312,000 (4,922,000) ------------ ------------ Net increase (decrease) in cash and equivalents (1,348,000) 849,000 Cash and equivalents at beginning of year 2,047,000 4,038,000 ------------ ------------ Cash and equivalents at end of period $ 699,000 $ 4,887,000 ============ ============
2000 1999 Net cash provided by operating activities $ 50,179,000 $ 73,327,000 Cash flows from investing activities: Capital expenditures (25,967,000 ) (60,918,000 ) Investments in joint ventures and other assets 835,000 (20,976,000 ) Net cash used in investing activities (25,132,000 ) (81,894,000 )
Cash flows from financing activities:
Payments on long-term debt (130,383,000 ) (138,696,000 ) Proceeds from long-term debt 158,100,000 177,200,000 Proceeds from issuance of common stock 545,000 755,000 Repurchase of common stock (46,125,000 ) (18,927,000 ) Dividends (4,463,000 ) (4,127,000 )
Net cash provided by (used in) financing activities
(22,326,000
)
16,205,000
Net increase in cash and equivalents
2,721,000
7,638,000
Cash and equivalents at beginning of year
4,961,000
2,047,000
Cash and equivalents at end of period
$
7,682,000
$
9,685,000
See accompanying notes to condensed consolidated financial statements.
5
6MICHAEL FOODS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
====================================================(Unaudited)
NOTE
A -A—BASIS OF PRESENTATIONThe accompanying unaudited condensed consolidated financial statements have been prepared in accordance with Regulation S-X pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted
accounting principlesin the United States of America have been condensed or omitted pursuant to such rules and regulations, although management believes that the disclosures are adequate to make the information presented not misleading.Michael Foods, Inc. (the "Company") utilizes a fiscal year consisting of either 52 or 53 weeks, ending on the Saturday nearest to December 31 each year. The quarters ended
JuneSeptember 30,19992000 and19981999 each included thirteen weeks of operations. For clarity of presentation, the Company has described both periods presented as if the quarters ended onJuneSeptember 30.In the opinion of management, the unaudited condensed consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position as of
JuneSeptember 30,19992000 and the results of operations for the three andsixnine month periods endedJuneSeptember 30,19992000 and19981999 and cash flows for thesixnine months endedJuneSeptember 30,19992000 and1998.1999. The results of operations for thesixnine months endedJuneSeptember 30,19992000 are not necessarily indicative of the results for the full year.The Company's basic net earnings per share is computed by dividing net earnings by the weighted average number of outstanding common shares. The Company's diluted net earnings per share is computed by dividing net earnings by the weighted average number of outstanding common shares and common share equivalents relating to stock options, when dilutive. Options to purchase
852,767657,676 and826,724681,878 shares of Common Stock, withaweighted average exercisepriceprices of$24.78,$24.91 and $24.87, which were outstanding during the three andsixnine month periods endedJuneSeptember 30,1999,2000, were excluded from the computation of common share equivalents forthat periodthose periods because they were anti-dilutive. Options to purchase8,000390,275 and4,000734,824 shares of common stock, with a weighted average exercise price of$29.75,$25.56 and $24.80, were outstanding during the three andsixnine month periods endedJuneSeptember 30,1998,1999, but were excluded from the computation of common share equivalents forthat periodthose periods because they were anti-dilutive.NOTE
B -B—INVENTORIESInventories, other than flocks, are stated at the lower of cost (determined on a first-in, first-out basis) or market. Flock inventory represents the cost of purchasing and raising flocks to laying maturity, at which time their cost is amortized to operations over their expected useful life of generally one to two years, assuming no salvage value.
Inventories consist of the following:
June 30, December 31, 1999 1998 ----------- ------------Raw materials and supplies $19,040,000 $15,389,000 Work in process and finished goods 39,984,000 36,977,000 Flocks 20,857,000 21,884,000 ----------- ----------- $79,881,000 $74,250,000 =========== ===========
September 30,
2000December 31,
1999Raw materials and supplies $ 16,152,000 $ 15,720,000 Work in process and finished goods 42,885,000 35,447,000 Flocks 23,684,000 20,030,000 $ 82,721,000 $ 71,197,000 6
7 MICHAEL FOODS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS ==================================================== (Unaudited)NOTE
C -C—COMMITMENTS AND CONTINGENCIESUse of Estimates
Preparation of the Company's consolidated financial statements requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and related revenues and expenses. Actual results could differ from the estimates used by management.
License Agreement
The Company has an exclusive license agreement for a patented process for the production and sale of extended shelf-life egg products. Under the license agreement, the Company has the right to defend and prosecute infringement of the licensed patents. The U.S. Federal Court of Appeals has upheld the validity of the four patents subject to the license
agreement, but,agreement. However, subsequently a patent examiner at the U.S. Patent and Trademark Office ("PTO") rejected the patents.The Company is appealingIn August 1999, thedecisionexaminer's rejections were largely overturned by the Board of Appeals and Interferences of theexaminer and believes the validityPTO. Reexamination certificates for three of the patentswill ultimately be upheld. Duringhave since been issued by theappealPTO. In August 2000, the Company and the patent holder received a Notice of Allowability, followed by a Notice of Allowance, regarding the reissuance of the fourth patent, which included the allowance of product claims beyond the processthe patents remain valid and in full force and effect.claims previously allowed. These patents are scheduled to expire in 2006. In the second quarter of 2000, the Company and the patent holder completed a new royalty arrangement whereby the Company pays a reduced amount of royalties and, in turn, is responsible for one-half of any litigation expense incurred to defend the patents.Litigation
The Company is engaged in routine litigation incidental to its business. Management believes it will not have a material effect upon its consolidated financial position, liquidity or results of operations.
NOTE
D -D—SHAREHOLDERS' EQUITYDuring the
three months ended June 30,third quarters of 2000 and 1999 the Company repurchased475,300no shares of Common Stock underathe share repurchase programat an average price of $22.62 per share. Such repurchaseswhich began in July1998. Through June 30,1998 and was expanded in February and May 2000. Repurchases for the first nine months of 2000 and 1999the Company had repurchased 1,902,800were 2,109,400 and 920,100 shares of CommonStock at an average priceStock.NOTE E—COMPREHENSIVE INCOME
Comprehensive income consists of
$22.60 per share. NOTE E - RISKS AND UNCERTAINTIES The Year 2000 issue relates to limitations in computer systemsnet earnings andapplications that may prevent proper recognition offoreign currency translation adjustments. Total comprehensive income was $11,644,000 and $10,713,000 for theyear 2000. The potential effect of the Year 2000 issue on the Company and its business partners will not be fully determinable untilthree months ended September 30, 2000 andthereafter. If Year 2000 modifications are not properly completed either by1999. The total comprehensive income was $32,950,000 and $30,876,000 for theCompany, or entities the Company conducts business with, the Company's net sales and financial condition could be adversely effected. NOTE F - INTERNATIONAL INVESTMENTS, DAIRY PRODUCTS ACQUISITION AND SUBSEQUENT EVENT During the sixnine months endedJuneSeptember 30,1999, the Company made two investments in Europe to further its leadership in global egg products processing. The first investment was a 25% interest in Belovo, S. A., a specialty egg products company based in Belgium. The second investment was a 50/50 joint venture with the founding shareholders of Belovo forming The Lipid Company, a company involved in the extraction of phospholipids from egg yolks for use in the field of nutraceuticals. In May 1999, the Company's Kohler Mix Specialties, Inc. subsidiary acquired certain operating assets, a customer list2000 anda long-term lease, of a dairy mix plant from H. P. Hood Inc., with an option to purchase the building and land at the lease's termination. The plant mainly produces ultra-high temperature pasteurized dairy mixes for foodservice customers in the eastern United States. The facility generated 1998 net sales of approximately $37 million.1999.7
8 MICHAEL FOODS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS ==================================================== (Unaudited)NOTE
F - INTERNATIONAL INVESTMENTS, DAIRY PRODUCTS ACQUISITION AND SUBSEQUENT EVENT, CONT. In July 1999, the Company formed a Canadian joint venture, Trilogy Egg Products, Inc., with two partners, Canadian Inovatech, Inc. and The Egg Producers Co-op Ltd. Trilogy Egg Products, Inc. will sell value-added egg products in Canada. NOTE G -F—BUSINESS SEGMENTSThe Company has adopted Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information.The Company operates in four reportable
segments -segments—Egg Products, Refrigerated Distribution, Dairy Products and Potato Products. Certain financial information on the Company's operating segments is as follows (unaudited, in thousands):
Egg Refrigerated Dairy Potato Products Distribution Products Products Corporate Total -------- ------------ -------- -------- --------- --------THREE MONTHS ENDED JUNE 30, 1999: External net sales $150,488 $ 51,427 $42,091 $14,025 N/A $258,031 Intersegment sales 3,794 24 310 591 N/A 4,719 Operating profit (loss) 19,712 2,534 2,057 1,367 (2,963) 22,707 THREE MONTHS ENDED JUNE 30, 1998: External net sales $144,373 $ 49,841 $36,719 $12,752 N/A $243,685 Intersegment sales 4,456 43 480 479 N/A 5,458 Operating profit (loss) 19,463 1,763 2,108 457 (1,708) 22,083 SIX MONTHS ENDED JUNE 30, 1999: External net sales $302,638 $110,549 $70,753 $27,469 N/A $511,409 Intersegment sales 9,488 45 578 1,198 N/A 11,309 Operating profit (loss) 34,694 4,584 2,953 2,559 (4,996) 39,794 SIX MONTHS ENDED JUNE 30, 1998: External net sales $296,180 $102,866 $64,867 $25,361 N/A $489,274 Intersegment sales 10,386 74 935 958 N/A 12,353 Operating profit (loss) 34,793 3,557 3,190 1,082 (3,527) 39,095ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Egg
ProductsRefrigerated
DistributionDairy
ProductsPotato
ProductsCorporate Total Three Months ended September 30, 2000: External net sales $ 162,461 $ 57,636 $ 41,305 $ 15,166 N/A $ 276,568 Intersegment sales 2,849 10 22 632 N/A 3,513 Operating profit (loss) 16,665 3,829 1,329 1,548 (1,129 ) 22,242 Three Months ended September 30, 1999: External net sales $ 157,843 $ 55,833 $ 41,498 $ 14,737 N/A $ 269,911 Intersegment sales 3,235 24 415 577 N/A 4,251 Operating profit (loss) 17,935 2,462 319 2,006 (1,328 ) 21,394 Nine Months ended September 30, 2000: External net sales $ 472,849 $ 169,073 $ 109,237 $ 43,951 N/A $ 795,110 Intersegment sales 8,676 68 507 1,800 N/A 11,051 Operating profit (loss) 50,757 11,962 2,271 4,534 (4,454 ) 65,070 Nine Months ended September 30, 1999: External net sales $ 460,481 $ 166,382 $ 112,251 $ 42,206 N/A $ 781,320 Intersegment sales 12,723 69 993 1,775 N/A 15,560 Operating profit (loss) 52,537 7,046 3,272 4,565 (6,232 ) 61,188 8
Item 2—Management's Discussion and Analysis of Financial Condition and Results of Operations
THREE MONTHS ENDED
JUNESEPTEMBER 30,19992000 VS THREE MONTHS ENDEDJUNE
SEPTEMBER 30,1998 RESULTS OF OPERATIONS1999Results of Operations
Readers are directed to Note
G -F—Business Segments for data on the unaudited financial results of the Company's four business segments for the three months endedJuneSeptember 30,19992000 and1998. 89 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED ======================================================== THREE MONTHS ENDED JUNE 30, 1999 VS THREE MONTHS ENDED JUNE 30, 1998, CONT. RESULTS OF OPERATIONS, CONT.1999.Egg Products Division net sales for the
19992000 period reflected unit sales increases, particularly for value-added products, which more than offset significant deflationary pricing impacts oncertainindustrial products.SalesSignificant unit sales increases wereparticularly strongrecorded forprecookedextended shelf-life liquid eggs, egg substitutes and dried egg products. Unit sales declined in two categories—frozenomelets, pattiesandcurds.short shelf-life eggs—as the Division chose not to pursue sales with little or no profit margin. Egg pricesdecreasedincreased approximately12%1% compared tosecondthird quarter19981999 levels, as reported by Urner BarryPublications -Publications—a widely quoted industry pricing service. Thisdecrease helped reduceincrease raised the cost of purchased eggswhile also reducing sellingduring a period where prices forcertainindustrial egg products were generally lower than normal. Moreover, extreme volatility in egg prices occurred during the quarter, making it difficult to realize typical spreads between raw material costs andshell eggs.finished industrial egg products prices for any significant length of time. However, earnings increases from value-added egg products largely off-set the margin weakness seen from industrial egg product sales.Approximately two-thirds of the Division's annual egg needs are purchased under contracts, or in the spot market. While a portion of these eggs are secured under fixed price contracts, a majority are priced according to the cost of grain inputs or to egg market prices as reported by Urner Barry. Approximately one-third of annual egg needs are sourced from internal flocks, where feed costs typically represent roughly two-thirds of the cost of producing such eggs. Feed costs were
lowerslightly higher in the19992000 period, compared to the19981999 period, due tolowerhigher prices forbothcorn and soybean meal.DecreasedIncreased egg costs, for both internally and externally procured eggs, in the19992000 period, compared to the19981999 period, weremore than offset by pricing weakness,generally not met with comparable price changes in egg products prices, creating margin pressure for certain industrial egg products. Egg Products results in the 1999 period were impacted by two non-recurring items. First, a gain was recorded on the sale of a shell egg production facility. Second, a Belgium animal feed contamination scare resulted in losses at the Company's two European egg products joint ventures. The net effect of these items was a modest addition to earnings.Refrigerated Distribution Division net sales for the
19992000 period reflected strong unit sales increases, with cheese andMexican itemsbutter showing particular strength. Sales growth resulted from a brand repositioning over the past two years and amore recentbroadening consumer advertising campaign in selected markets, along with notable new account activity and new product introductions. The volume growth, along witha decline inmore normal product costs for items related to the national butterfat market, resulted in margin expansion in the19992000 period.The
significantDairy ProductsDivisionDivision's flat net salesincreasefor the19992000 period reflectedstronglower unit salesgainsvolumes for the core dairy mix business, in part due to the loss of a major industrial (tanker) customer in late 1999, which offset increased volumes for cartoned specialty products and creamer products, and slightly higher unit pricing compared to theeffect of two months' of sales from a plant acquired during1999 period. Divisional operating profit increased in thequarter. Sales were weak for certain cartoned specialty dairy products2000 period as a result of theproduct line having not fully recovered from a recallhigher sales of specialty products, and improvements in1999's first quarter. Divisionaloverhead expenses and operatingprofit declined in the 1999 period as a result of incremental operating expenses incurred post-recall and due to above average labor and freight costs. Labor costs were high due, in part, to training costs for newer production personnel and overtime incurred to meet orders in a timely manner during a strong demand period.expenses.Potato Products Division net sales for the
19992000 period reflecteda strongincreased unit sales,increase,particularly for both retail and foodservice mashed potato items. New account activity and same-account sales growthand new product introductions allcontributed to the sales gain. Thestrongoperating profitincreasedecrease in the19992000 period resultedprimarilyfromthe volume growth, as plant operations at the main potato processing facility benefited from thea less favorable sales mix, reflecting a slight sales decrease for retail shredded products, and increasedproduction throughput.marketing spending.9
The
increase ingross profit margin of the Company for the period endedJuneSeptember 30,1999, as compared2000 was comparable tothe resultsthat of the same period in1998, reflected1999, reflecting the factors discussed above, particularly thestrength inmargin pressures within the industrial egg products category and the margin increases within the Refrigerated Distributionand Potato Products segments.Division. It is management's strategy to increase value-added product sales as a percent of total sales over time, while decreasing commodity-sensitive products' contribution to consolidated sales. These efforts historically have been beneficial to gross profit margins in most periods.Selling, general and administrative expenses
increaseddecreased slightly as a percent of sales in the period endedJuneSeptember 30,1999,2000, as compared to the results of the same period in1998. Expenses1999. Favorable impacts from effective expense management more than offset increaseddueexpenses related to amortization of the costs associated with the910 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED ======================================================== THREE MONTHS ENDED JUNE 30, 1999 VS THREE MONTHS ENDED JUNE 30, 1998, CONT. RESULTS OF OPERATIONS, CONT.Company's information systems upgrade projectamortization of a non-compete agreement related to a Dairy Products acquisition,and additionalsales andmarketing efforts.SIXNINE MONTHS ENDED
JUNESEPTEMBER 30,19992000 VSSIXNINE MONTHS ENDEDJUNE
SEPTEMBER 30,1998 RESULTS OF OPERATIONS1999Results of Operations
Readers are directed to Note
G -F—Business Segments for data on the unaudited financial results of the Company's four business segments for thesixnine months endedJuneSeptember 30,19992000 and1998.1999.Egg Products Division net sales for the
19992000 period reflected unit sales increases, particularly for value-added products, which more than offset significant deflationary pricing impacts on certainproducts.products and an approximate 40% decline in shell egg sales. The latter was by plan and reflects, in part, the sale of a small shell egg facility in the summer of 1999. Sales were particularly strong for extended shelf-life liquid eggs, dried egg products and precooked frozen omelets, patties and curds. Egg prices decreased approximately9%3% compared tofirst half 19981999 levels, as reported by Urner Barry Publications. This decreasehelped reducelowered the cost of purchased eggs,while also reducing sellingbut this occurred during a period where prices forcertainindustrial egg products were generally depressed. Moreover, extreme volatility in egg prices occurred during the 2000 period, making it difficult to realize typical spreads between raw material costs andshell eggs.finished industrial egg products prices for any significant length of time. However, earnings increases from value-added egg products largely off-set the margin weakness seen from industrial egg product sales.Approximately two-thirds of the Division's annual egg needs are purchased under contracts, or in the spot market. While a portion of these eggs are secured under fixed price contracts, a majority are priced according to the cost of grain inputs or to egg market prices as reported by Urner Barry. Approximately one-third of annual egg needs are sourced from internal flocks, where feed costs typically represent roughly two-thirds of the cost of producing such eggs. Feed costs
were lowerin the19992000 periodcomparedwere comparable to the1998 period, due to lower prices for both corn and soybean meal.1999 period. Decreased egg costs, forboth internally andexternally procured eggs, in the19992000 period, compared to the19981999 period, and improved value-added egg products earnings, were more than offset by pricing and margin weaknesscreating margin pressure forin certain industrial egg products.Divisional operating profit for the 2000 period also reflected the benefit of reduced royalty expense, a portion of which was a retroactive adjustment to January 1, 1999. Under an agreement reached during the second quarter of 2000 period, royalties related to products produced and sold by the Company under a license with NCSU are limited to a fixed portion of the annual production. In consideration of the reduced royalty arrangement, the Company is responsible for one-half of any future litigation expense incurred to defend the patented egg ultra-pasteurization processing technology. Egg Products results in the 1999 period were impacted by two non-recurring items.
First, a gain was recorded on the sale of a shell egg production facility. Second, a Belgium animal feed contamination scare resulted in losses at the Company's two European egg products joint ventures. The net effect of these items was a modest addition to earnings.
10
Refrigerated Distribution Division net sales for the
19992000 period reflected strong unit sales increases, with cheese andMexican itemsbutter showing particular strength. Sales growth resulted from a brand repositioning over the past two years and amore recentbroadening consumer advertising campaign in selected markets, along with notable new account activity and new product introductions. The volume growth, along witha decline inmore normal product costs for items related to the national butterfat market, resulted in margin expansion in the19992000 period.The Dairy Products Division net sales
increasedecline for the19992000 period reflectedstronglower unit salesgainsvolumes for the core dairy mixand creamer products andbusiness, in part due to theeffectloss oftwo months' of sales fromaplant acquired during the first half of 1999. Sales were weakmajor industrial (tanker) customer in late 1999, which offset increased volumes for cartoned specialtydairyproductsas a result of a recall of certain items in 1999's first quarter.and creamer products. Divisional operating profit declined in the19992000 period as a result ofincremental operatingthe reduced sales volumes, high overhead expensesincurred as a result of the recallanddue toabove averagelabor and freight costs. Labor costs were high due, in part, to training costs for newer production personnel and overtime incurred to meet orders in a timely manner.operating expenses.Potato Products Division net sales for the
19992000 period reflected a strong unit sales increase, particularly forfoodservicemasheditems.items and retail shredded products. New account activity, same-account sales growth and new product introductions all contributed to the sales gain. Thestrongflat operatingprofit increaseprofits in the 2000 period compared to the 1999 periodresulted primarilyreflect benefits from the volume growth, as plant operations at the main potato processing facility benefited from the increased productionthroughput. 1011 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED ======================================================== SIX MONTHS ENDED JUNE 30, 1999 VS SIX MONTHS ENDED JUNE 30, 1998, CONT. RESULTS OF OPERATIONS, CONT.throughput, which were offset by increased marketing spending.The increase in gross profit margin of the Company for the period ended
JuneSeptember 30,1999,2000, as compared to the results of the same period in1998,1999, reflected the factors discussed above, particularly the strength in the Refrigerated Distributionand Potato Products segments.Division. It is management's strategy to increase value-added product sales as a percent of total sales over time, while decreasing commodity-sensitive products' contribution to consolidated sales. These efforts historically have been beneficial to gross profit margins in most periods.Selling, general and administrative expenses
increasedremained approximately constant as a percent of sales in the period endedJuneSeptember 30,1999,2000, as compared to the results of the same period in1998.1999. Expenses increased due to amortization of the costs associated with the Company's information systems upgrade project, amortization of a non-compete agreement related to a May 1999 Dairy Products acquisition, increases in bad debt expense resulting from a foodservice distributor's bankruptcy filing, and additionalsales andmarketing efforts.GENERALHowever, these increased expenses were offset by effective expense controls in other areas and the favorable impact of the reduced egg products royalty arrangement, including a one-time retroactive benefit.General
Certain of the Company's products are sensitive to changes in commodity prices. The Company's Egg Products Division derived less than
5%3% of the Division's net sales for the firstsixnine months of19992000 from shell eggs, which are sensitive to commodity price swings. Value-added extended shelf-life liquid egg products lines and precooked egg products accounted for approximately 50% of the Egg Products Division's net sales. The remainder of Egg Products Division sales is derived from the sale of other egg products, which vary from being commodity-sensitive to value-added. Gross profit from shell eggs is primarily dependent upon the relationship between shell egg prices and the cost of feed, both of which can fluctuate significantly. Shell egg pricing in the19992000 period was approximately9%3% below19981999 levels as measured bya widely quoted pricing service.Urner Barry Publications. Gross profit margins for extended shelf-life liquid eggs, egg substitutes, and precooked egg products are less sensitive to commodity price fluctuations than are other egg products or shell eggs.The Company's Refrigerated Distribution Division derives approximately 70% of its net sales from refrigerated products produced by others, thereby reducing the effects of commodity price swings. The balance of refrigerated distribution sales are from shell eggs, some of which are produced by the Egg
11
Products Division and are sold on a distribution, or non-commodity, basis by the Refrigerated Distribution Division.
The Dairy Products Division sells its products primarily on a cost-plus basis and, therefore, the Division's earnings are not typically affected greatly by raw ingredient price fluctuations, except over short time periods.
The Potato Products Division typically purchases 70%-90% of its raw potatoes from contract producers under annual contracts. The remainder is purchased at market prices to satisfy short-term production requirements or to take advantage of market prices when they are lower than contracted prices. Moderate variations in the purchase price of raw materials or the selling price per pound of finished products can have a significant effect on Potato Products Division operating results.
Inflation is not expected to have a significant impact on the Company's business. The Company generally has been able to offset the impact of inflation through a combination of productivity gains and price increases.
1112 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED ======================================================== CAPITAL RESOURCES AND LIQUIDITYCapital Resources and Liquidity
Acquisitions and capital expenditures have been, and will likely continue to be, a significant capital requirement. The Company plans to continue to invest in state-of-the-art production facilities to enhance its competitive position. Historically, the Company has financed its growth principally from internally generated funds, bank borrowings, issuance of senior debt and the sale of Common Stock. The Company believes that these financing alternatives will continue to meet its anticipated needs.
During the first half of 1999, the Company made two investments in Europe. The first investment was a 25% interest in Belovo, S. A., a specialty egg products company based in Belgium. The second investment was a 50/50 joint venture with the founding shareholders of Belovo forming The Lipid Company, a company involved in the extraction of phospholipids from egg yolks for use in the field of nutraceuticals. The cash paid at the time of closing the transactions was approximately $9.3 million, which was funded through the Company's bank line of credit. The investments will expand the Company's leadership position in global egg products processing. Also in the first half of 1999, the Company acquired certain operating assets and the long-term lease of a dairy products plant in Connecticut. The cash paid at time of closing was approximately $5.7 million, which was funded through the Company's bank line of credit. This transaction greatly expanded the Company's Dairy Products business in the eastern United States.The Company invested
$41,419,000$25,967,000 in capital expenditures during thesixnine months endedJuneSeptember 30,1999.2000. The Company plans to spend approximately$75,000,000$45,000,000 in total capital expenditures in1999,2000, the majority of which is to expand production capacity for value-added products.The Company has
antwo unsecuredlinelines of credit for $80,000,000 and $20,000,000 with its principal banks. As ofJuneSeptember 30,1999, $70,900,0002000, $73,000,000 was outstanding underthis linethese lines of credit.In July 1998, the Company's Board of Directors authorized the purchase of up to
two million2,000,000 shares of Common Stock on the openmarket.market or in privately negotiated transactions. In February 2000, the Board authorized an additional purchase of up to 2,000,000 shares of Common Stock on the open market or in privately negotiated transactions, with an additional 500,000 share authorization made in May 2000. ThroughJuneSeptember 30,1999,2000, the Company had repurchased1,902,8004,012,200 shares of Common Stock for$43,005,000. SEASONALITY$89,121,000. During the third quarter of 2000 the Company did not repurchase any shares of Common Stock.Seasonality
Consolidated quarterly operating results are affected by the seasonality of the Company's net sales and operating profits. Specifically, shell egg prices typically rise seasonally in the first and fourth quarters of the year due to increased demand during holiday periods. Generally, refrigerated distribution operations experience higher net sales and operating profits in the fourth quarter, coinciding with incremental consumer demand during the holiday season. Net sales and operating profits from dairy operations typically are significantly higher in the second and third quarters due to increased consumption of ice milk and ice cream products during the summer months. Operating profits from potato products are less seasonal, but tend to be higher in the second half of the year coinciding with the potato harvest.
YEAR 2000 The Company's Year 2000 initiative is separated into several projects: legacy systems, personal computer components, wide area network components, local area network components, and non-computer components. The approach for each of these projects includes an inventory of 200012
13 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED ======================================================== YEAR 2000, CONT. components, an assessment of Year 2000 compliance of each component, and identification and execution of corrective actions for items that fail the assessment phase. In 1995, the Company undertook implementation of the SAP Enterprise Resource Planning system as a means to present a single interface with customers and to have better information available for management to make more effective decisions. The SAP system encompasses all significant processes and has been certified Year 2000 compliant by an outside party. The SAP system will be implemented for three of the five operating companies prior to the end of 1999. The legacy systems of the remaining two operating companies are certified as Year 2000 compliant. Beyond the SAP project, several non-critical legacy systems are being addressed throughout 1999. The costs to modify and test any remaining legacy systems, if necessary, would not be material to the consolidated financial position, liquidity or results of operations of the Company. The Company completed corrective actions for all personal computer hardware in late 1998. An evaluation and any needed remediation of personal computer software is expected to be completed by September 1999. The remaining information technology systems for wide area networking and local area networking are currently being assessed for Year 2000 compliance, with corrective action to be completed by September 1999. The Company's overall business risk from these systems is not significant. The Company's non-computer components have been assessed for Year 2000 compliance. The assessment of these systems was completed in May 1999. Any corrective actions are expected to be completed by September 1999. The Year 2000 projects also include an evaluation of critical vendors, suppliers, brokers and customers relative to their Year 2000 readiness. Information is being solicited from these important business partners and will be evaluated as it is received. Electronic data communications with customers have been tested. Based upon the assessment completed at this time, the Company does not anticipate any significant Year 2000 issues. All Year 2000 projects are generally proceeding according to management's expectations. However, if there are significant delays in their completion, or if major suppliers or customers experience Year 2000 issues with their systems, such issues could adversely affect the operations of the Company. After assessing the information received from its business partners and evaluating the status of the Year 2000 projects, the Company will develop an appropriate contingency plan, as required. It is anticipated that this plan will be developed during the fourth quarter of 1999. Achieving Year 2000 compliance for the Company will largely be a by-product of the SAP system installation. The costs of achieving Year 2000 compliance for software not affected by the SAP system, computer components, and non-computer components is estimated to be less than $3,000,000, of which approximately $2,500,000 has already been incurred and expensed through June 30, 1999. FORWARD-LOOKING STATEMENTSForward-Looking Statements
Certain items in this Form 10-Q
aremay be forward-looking statements, which are made in reliance upon the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking1314 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED ======================================================== FORWARD-LOOKING STATEMENTS, CONT.statements are subject to numerous risks and uncertainties, includingthe possibility that capital projects and the Year 2000 initiative may not be completed as rapidly as management expects. Additional risks and uncertainties includevariances in the demand for the Company's products due to consumer developments and industry developments, as well as variances in the costs to produce such products, including normal volatility in egg and feed costs. The Company's actual financial results could differ materially from the results estimated by, forecasted by, or implied by the Company in such forward-looking statements.Item 3. Quantitative and Qualitative Disclosures about Market Risk
There were no material changes in the Company's market risk during the
sixnine month period endedJuneSeptember 30,1999.2000.13
PART
II -II—OTHER INFORMATIONItem
4. Submission5—Other InformationOn November 3, 2000, the Company's Crystal Farms Refrigerated Distribution Company ("Crystal Farms") subsidiary initiated a voluntary recall of
Matters totwo cheese items after learning of their possible contamination with Listeria monocytogenes. It is estimated that less than 80,000 pounds of Crystal Farms cheese are affected by the recall. The cheese was produced by aVoteWisconsin-based dairy cooperative and packaged for Crystal Farms by a contract packaging company. Management believes the ultimate outcome ofSecurity Holders The 1999 Annual Meeting of Shareholders of Michael Foods, Inc. was heldthis recall will not have a material effect onApril 29, 1999. The items voted upon andthe Company's consolidated financial position, liquidity or results ofthe vote follow: 1. The election of eleven persons to serve as directors until the next annual election and until their successors are duly elected and qualified:
For Withhold Authority ---------- ------------------Maureen B. Bellantoni 15,390,929 39,909 Richard A. Coonrod 15,393,280 37,558 Daniel P. Dillon 15,393,460 37,378 Jerome J. Jenko 15,392,335 38,503 Arvid C. Knudtson 15,383,486 47,352 Joseph D. Marshburn 15,387,405 43,433 Jeffrey J. Michael 15,390,410 40,428 Margaret D. Moore 15,391,454 39,384 Gregg A. Ostrander 15,392,360 38,478 Arthur J. Papetti 15,393,990 36,848 Stephen T. Papetti 15,393,990 36,8482. Proposal to ratify an amendment to the 1997 Stock Incentive Plan of Michael Foods, Inc. and Affiliated Companies:
For Against Abstain ---------- --------- -------14,063,827 1,323,290 43,7213. Proposal to ratify the appointment of Grant Thornton LLP as independent auditors for 1999:
For Against Abstain ---------- ------- -------15,371,790 47,645 11,4031415operations.Item
6.6—Exhibits and Reports on Form 8-K(a) Exhibits 27.1 Financial Data Schedule
(a) Exhibits
10.77
Consolidated, restated and amended License Agreement by and between North Carolina State University and Michael Foods, Inc.
10.78
Settlement Agreement and Mutual Release entered into by and between Nulaid Foods, Inc., Valley Fresh Foods, Inc., and Nulaid Nest-Best, and North Carolina State University and Michael Foods, Inc.
27.1
Financial Data Schedule
(b)
Reports on Form 8-KThere were no reports on Form 8-K
filed duringin thequarterthree month period endedJuneSeptember 30,1999. Signatures2000.14
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
MICHAEL FOODS, INC. ---------------------------------------------- (Registrant) Date: August 16, 1999 By: /s/ Gregg A. Ostrander -------------------------------------- Gregg A. Ostrander (President and Chief Executive Officer) Date: August 16, 1999 By: /s/ John D. Reedy -------------------------------------- John D. Reedy (Vice President - Finance, Treasurer, Chief Financial Officer and Principal Accounting Officer) 15
| MICHAEL FOODS, INC. (Registrant) | ||||
Date: November 13, 2000 | By: | /s/ GREGG A. OSTRANDER Gregg A. Ostrander (Chairman, President and Chief Executive Officer) | ||
Date: November 13, 2000 | By: | /s/ JOHN D. REEDY John D. Reedy (Executive Vice President, Treasurer, Chief Financial Officer and Principal Accounting Officer) | ||