UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[ X ][X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
-------------------------------------------------1999
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________________ to ---------------- -----------------________________
Commission File Number: 0-15638
--------------------------------------------------------
MICHAEL 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) 546-1500
- --------------------------------------------------------------------------------
(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 [ X ]Yes [ ]No] No
The number of shares outstanding of the registrant's Common Stock, $.01
par value, as of May 4, 19983, 1999 was 21,934,90620,586,924 shares.
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
MICHAEL FOODS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
==============================================================================================================================================================================
March 31, December 31,
ASSETS 1999 1998 1997
- ------ ------------ ------------
CURRENT ASSETS
Cash and equivalents $ 4,679,000 $ 2,047,000
Accounts receivable, less allowances 92,116,000 97,639,000
Inventories 77,249,000 74,250,000
Prepaid expenses and other 3,727,000 3,884,000
------------ ------------
Total current assets 177,771,000 177,820,000
PROPERTY, PLANT AND EQUIPMENT-AT COST
Land 4,336,000 4,336,000
Buildings and improvements 105,246,000 105,567,000
Machinery and equipment 341,958,000 328,067,000
------------ ------------
451,540,000 437,970,000
Less accumulated depreciation 195,939,000 187,759,000
------------ ------------
255,601,000 250,211,000
OTHER ASSETS
Goodwill, net 119,311,000 120,172,000
Investments in Joint Ventures and other assets 12,440,000 3,313,000
------------ ------------
131,751,000 123,485,000
------------ ------------
$565,123,000 $551,516,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES
Current maturities of long-term debt $ 10,667,000 $ 10,663,000
Accounts payable 49,426,000 44,376,000
Accrued Liabilities
Compensation 7,483,000 11,034,000
Insurance 8,016,000 7,369,000
Customer programs 19,641,000 19,624,000
Other 23,688,000 23,457,000
------------ ------------
Total current liabilities 118,921,000 116,523,000
LONG-TERM DEBT, less current maturities 170,914,000 155,444,000
DEFERRED INCOME TAXES 32,669,000 35,400,000
COMMITMENTS AND CONTINGENCIES - -
SHAREHOLDERS' EQUITY
Common stock 206,000 211,000
Additional paid-in capital 111,195,000 119,871,000
Retained earnings 131,218,000 124,067,000
------------ ------------
242,619,000 244,149,000
------------ ------------
$565,123,000 $551,516,000
============ ============
================================================================================
See accompanying notes to condensed consolidated financial statements.
2
MICHAEL FOODS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
Three Months Ended March 31, (Unaudited)
================================================================================
1999 1998
------------ ------------
Net sales $253,378,000 $245,589,000
Cost of sales 212,067,000 205,433,000
------------ ------------
Gross profit 41,311,000 40,156,000
Selling, general and administrative expenses 24,224,000 23,144,000
------------ ------------
Operating profit 17,087,000 17,012,000
Interest expense, net 2,820,000 2,764,000
------------ ------------
Earnings before income taxes 14,267,000 14,248,000
Income tax expense 5,850,000 5,990,000
------------ ------------
NET EARNINGS $ 8,417,000 $ 8,258,000
============ ============
Net Earnings Per Share
Basic $ 0.40 $ 0.38
Diluted $ 0.40 $ 0.37
============ ============
Weighted average shares outstanding
Basic 21,009,000 21,846,000
Diluted 21,230,000 22,208,000
============ ============
================================================================================
See accompanying notes to condensed consolidated financial statements.
3
MICHAEL FOODS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31, (Unaudited)
================================================================================
1999 1998
------------ ------------
Net cash provided by operating activities $ 22,199,000 $ 20,425,000
Cash flows from investing activities:
Capital expenditures (15,308,000) (19,514,000)
Investments in joint ventures and other assets (9,169,000) 366,000
------------ ------------
Net cash used in investing activities (24,477,000) (19,148,000)
Cash flows from financing activities:
Payments on long-term debt (36,526,000) (795,000)
Proceeds from long-term debt 52,000,000 700,000
Proceeds from issuance of common stock 219,000 766,000
Repurchase of common stock (9,518,000) --
Dividends (1,265,000) (1,095,000)
------------ ------------
Net cash provided by (used in) financing activities 4,910,000 (424,000)
------------ ------------
Net increase in cash and equivalents 2,632,000 853,000
Cash and equivalents $ 4,891,000 $at beginning of year 2,047,000 4,038,000
Accounts receivable, less allowances 80,387,000 83,495,000
Inventories 70,182,000 68,929,000
Prepaid expenses and other 2,208,000 1,676,000
------------ ------------
Total current assets 157,668,000 158,138,000
PROPERTY, PLANT AND EQUIPMENT-AT COST
Land 4,336,000 4,336,000
BuildingsCash and improvements 100,881,000 99,023,000
Machinery and equipment 291,498,000 274,980,000
------------ ------------
396,715,000 378,339,000
Less accumulated depreciation 168,200,000 160,800,000
------------ ------------
228,515,000 217,539,000
OTHER ASSETS
Goodwill, net 122,754,000 123,711,000
Other 3,901,000 4,267,000
------------ ------------
126,655,000 127,978,000
------------ ------------
$512,838,000 $503,655,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Current maturitiesequivalents at end of long-term debtperiod $ 8,517,0004,679,000 $ 8,509,000
Accounts payable 45,203,000 46,910,000
Accrued compensation 7,294,000 10,064,000
Accrued insurance 5,966,000 4,782,000
Discounts and allowances 16,684,000 15,217,000
Other accrued expenses 21,419,000 17,868,000
------------ ------------
Total current liabilities 105,083,000 103,350,000
LONG-TERM DEBT, less current maturities 137,416,000 137,519,000
DEFERRED INCOME TAXES 32,552,000 33,540,000
CONTINGENCIES -- --
SHAREHOLDERS' EQUITY
Common stock, $.01 par value, 40,000,000 shares authorized,
shares issued 21,889,571 at March 31, 1998 and 21,816,098 at
December 31, 1997 219,000 218,000
Additional paid-in capital 141,566,000 140,188,000
Retained earnings 96,002,000 88,840,000
------------ ------------
237,787,000 229,246,000
------------ ------------
$512,838,000 $503,655,0004,891,000
============ ============
================================================================================
See accompanying notes to condensed consolidated financial statements.
4
MICHAEL FOODS, INC. CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
Three Months Ended March 31, (Unaudited)
==========================================================================
1998 1997
------------ ------------
Net sales $245,589,000 $195,418,000
Cost of sales 205,433,000 171,689,000
------------ ------------
Gross profit 40,156,000 23,729,000
Selling, general and administrative expenses 23,144,000 14,669,000
------------ ------------
Operating profit 17,012,000 9,060,000
Interest expense, net 2,764,000 2,278,000
------------ ------------
Earnings before income tax expense 14,248,000 6,782,000
Income tax expense 5,990,000 2,820,000
------------ ------------
NET EARNINGS $ 8,258,000 $ 3,962,000
============ ============
Earnings per share
Basic $ 0.38 $ 0.20
Diluted $ 0.37 $ 0.20
============ ============
Weighted average common shares outstanding
Basic 21,846,000 20,091,000
Diluted 22,208,000 20,233,000
============ ============
==========================================================================
See accompanying notes to condensed consolidated financial statements.
MICHAEL FOODS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31, (Unaudited)
================================================================================================
1998 1997
------------- -------------
Net cash provided by operating activities $ 20,425,000 $ 8,487,000
Cash flows from investing activities:
Capital expenditures (19,514,000) (6,629,000)
Business acquisitions, net of cash acquired, and other assets 366,000 (43,322,000)
------------- -------------
Net cash used in investing activities (19,148,000) (49,951,000)
Cash flows from financing activities:
Payments on notes payable and long-term debt (795,000) (118,434,000)
Proceeds from notes payable and long-term debt 700,000 166,706,000
Proceeds from issuance of common stock 766,000 1,707,000
Dividends (1,095,000) (973,000)
------------- -------------
Net cash provided by (used in) financing activities (424,000) 49,006,000
------------- -------------
Net increase in cash and equivalents 853,000 7,542,000
Cash and equivalents at beginning of year 4,038,000 2,585,000
------------- -------------
Cash and equivalents at end of period $ 4,891,000 $ 10,127,000
============= =============
NON-CASH INVESTING AND FINANCING TRANSACTIONS
Acquisition:
Cash paid, net of cash acquired $ 42,720,000
Stock issued 38,859,000
Fair value of assets acquired (82,405,000)
Liabilities assumed 73,874,000
-------------
Purchase price in excess of net assets acquired $ 73,048,000
=============
In connection with the merger in 1997 with North Star Universal, Inc., Michael
Foods, Inc. (the "Company") assumed $21,250,000 of net indebtedness and
effectively repurchased 1,783,036 shares of its common stock (see Note D)
================================================================================
See accompanying notes to condensed consolidated financial statements.
MICHAEL FOODS, INC.AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
(Unaudited)
NOTE A - BASIS OF PRESENTATION
The 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 generally accepted accounting principles 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.
The CompanyMichael 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 March 31, 19981999 and March 31, 19971998 each included thirteen weeks of
operations. For clarity of presentation, the Company has described allboth periods
presented as if the quarter ended on March 31.
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 March 31,
19981999 and the results of operations for the three months ended March 31, 1999 and
1998 and cash flows for the three month periodsmonths ended March 31, 19981999 and 1997.1998. The
results of operations for the three months ended March 31, 19981999 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
479,657769,165 shares of common stockCommon Stock, with a weighted average exercise price of
$13.37$24.83, which were outstanding during the three month period ended March 31,
1997, but1999, were excluded from the computation of common share equivalents for that
period because they were anti-dilutive. DuringThere were no anti-dilutive options
outstanding during the three month period ended March 31, 1998 there were no anti-dilutive stock options
outstanding.1998.
NOTE B - NEW ACCOUNTING PRONOUNCEMENTS
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 130, "Reporting Comprehensive Income." Comprehensive income
includes certain changes in equity that were excluded from net earnings. The
adoption of this statement did not impact the Company's consolidated financial
statements; historically there have been no differences between net earnings and
comprehensive income.
The Financial Accounting Standards Board ("FASB") has issued SFAS No. 131
"Disclosures about Segments of an Enterprise and Related Information." This
statement requires companies to disclose financial and other information about
its business segments as part of their consolidated financial statements. The
Company will include the required business segment disclosures in its 1998
annual report.
MICHAEL FOODS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
================================================================================
(Unaudited)
NOTE C - INVENTORIES
Inventories, 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 residualsalvage value.
Inventories consist of the following:
March 31, December 31,
1999 1998 1997
------------- ------------
Raw materials and supplies $13,878,000 $16,047,000$19,814,000 $15,389,000
Work in process and finished goods 31,483,000 30,374,00038,004,000 36,977,000
Flocks 24,821,000 22,508,00019,431,000 21,884,000
------------- ------------
$70,182,000 $68,929,000$77,249,000 $74,250,000
============ ===========
NOTE DC - ACQUISITION OF PAPETTI'S, MERGER WITH NORTH STAR UNIVERSALCOMMITMENTS AND ISSUANCE
OF LONG-TERM DEBT
On February 26, 1997, the Company completed the acquisition of Papetti's Hygrade
Egg Products, Inc. and affiliated entities (collectively "Papetti's"). The
acquisition was accounted for as a purchase with the results of Papetti's
operations included with the Company's from the date of acquisition. Total
consideration included the issuance of 3,195,455 of newly issued common shares
valued at $38,859,000, $44,315,000 in cash and closing costs, and the assumption
of $22,825,000 of notes payable and long-term debt.
On February 28, 1997, the Company completed a merger with North Star Universal,
Inc. ("NSU"). The merger has been accounted for as a reverse acquisition
utilizing the purchase method of accounting. As a result of the merger, NSU
delivered approximately $21,250,000 of net subordinated indebtedness together
with 1,783,036 shares of Company common stock of approximately equal value,
which the Company effectively retired in the form of a treasury stock
redemption.
In February 1997, the Company issued $125,000,000 of 7.58% senior indebtedness
to finance the cash portion of the Papetti's acquisition, to retire a portion of
the Company's existing debt and to refinance the debt assumed in the Papetti's
acquisition and NSU merger.
The following unaudited pro forma statement of earnings information has been
prepared assuming the Papetti's acquisition, the merger with NSU and the
issuance of the senior indebtedness had occurred on January 1, 1997:
For the three months ended March 31,1997
- ----------------------------------------------------------------
Net sales $244,013,000
Net earnings $ 4,515,000
Earnings per share
Basic $ 0.22
Diluted $ 0.21
============
This unaudited pro forma information is not necessarily indicative of the
combined results of operations that would have occurred had the acquisition,
merger and issuance of debt occurred on January 1, 1997, nor are they indicative
of the results which may occur in the future.
MICHAEL FOODS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
================================================================================
(Unaudited)
NOTE E - CONTINGENCIES
Use 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.
5
MICHAEL FOODS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
(Unaudited)
NOTE C - COMMITMENTS AND CONTINGENCIES, cont.
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. In 1994, theThe U.S. Federal Court of Appeals has upheld the validity of
the patents subject to the license agreement. Subsequently,agreement, but, subsequently, a patent
examiner at the U.S. Patent and Trademark Office rejected the patents. The
Company is appealing the decision of the examiner and believes the validity of
the patents will ultimately be upheld. During the appeal process, the patents
remain valid and in full force and effect. These patents are scheduled to expire
in 2006.
Litigation
- ----------
The Company is engaged in routine litigation incidental to its business, which
managementbusiness.
Management believes it will not have a material effect upon its consolidated
financial position, liquidity or results of operations.
NOTE D - SHAREHOLDERS' EQUITY
During the three months ended March 31, 1999, the Company repurchased 444,800
shares of Common Stock under a share repurchase program. Such repurchases began
in July 1998. Through March 31, 1999, the Company had repurchased 1,488,000
shares of Common Stock.
NOTE E - RISKS AND UNCERTAINTIES
The Year 2000 issue relates to limitations in computer systems and applications
that may prevent proper recognition of the year 2000. The potential effect of
the Year 2000 issue on the Company and its business partners will not be fully
determinable until 2000 and thereafter. If Year 2000 modifications are not
properly completed either by the Company, or entities the Company conducts
business with, the Company's net sales and financial condition could be
adversely effected.
NOTE F - INTERNATIONAL INVESTMENTS AND SUBSEQUENT EVENT
During the three months ended March 31, 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 completed an
acquisition of certain operating assets, customer list and the long-term lease
of a dairy mix plant from H. P. Hood Inc. The Company has 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.
6
MICHAEL FOODS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
(Unaudited)
NOTE G - BUSINESS SEGMENTS
The 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 - 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
--------------------------------------------------------------------------------
QUARTER ENDED MARCH 31, 1999:
External net sales $152,150 $59,122 $28,662 $13,444 N/A $253,378
Intersegment sales 5,694 21 268 607 N/A 6,590
Operating profit (loss) 14,982 2,050 896 1,192 (2,033) 17,087
QUARTER ENDED MARCH 31, 1998:
External net sales $151,807 $53,025 $28,148 $12,609 N/A $245,589
Intersegment sales 5,930 31 455 479 N/A 6,895
Operating profit (loss) 15,330 1,794 1,082 625 (1,819) 17,012
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
================================================================================- -------------
THREE MONTHS ENDED MARCH 31, 1999 VS THREE MONTHS ENDED MARCH 31, 1998
VS THREE MONTHS ENDED MARCH 31, 1997
RESULTS OF OPERATIONS
The following table sets forthReaders are directed to Note G - Business Segments for data on the percentage of net sales accounted for by eachunaudited
financial results of the Company's operating divisionsfour business segments for the periods indicated:
Three Months Endedthree months
ended March 31, ----------------------------
1998 1997
---- ----
Egg Products 64% 56%
Refrigerated Distribution 22 27
Dairy Products 12 10
Potato Products 5 10
Intercompany Sales (3) (3)
---- ----
TOTAL 100% 100%
==== ====
The following table sets forth the percentage of operating earnings (before
corporate, interest1999 and income tax expenses) accounted for by each of the
Company's operating divisions for the periods indicated:
Three Months Ended March 31,
----------------------------
1998 1997
---- ----
Egg Products 80% 82%
Refrigerated Distribution 10 21
Dairy Products 6 9
Potato Products 4 (12)
---- ----
TOTAL 100% 100%
==== ====
The1998.
Egg Products Division had higher dollarnet sales and higher dollar earnings infor the 1999 period ended March 31, 1998, as compared to the results of the same period
in 1997, due to strongreflected unit sales
favorable spot market egg prices, lower feed
costs and contributions from Papetti's. Owning Papetti'sincreases, particularly for a full quarter,
versus one month in the 1997 period, explained a large portion of the increases.value-added products, which more than offset
deflationary pricing impacts on certain products. Sales were particularly strong
for certain value-added egg products, notably
Easy Eggs(R) and Table Ready(TM) (extended shelf-life liquid whole eggs) and
MicroFresh and Express Eggs(TM) (frozenprecooked frozen omelets, patties and curds).curds. Egg prices decreased
approximately 6%5% compared to first quarter 19971998 levels, as reported by Urner
Barry Publications - a widely quoted industry pricing service, although
pricingservice. This decrease
helped reduce the cost of purchased eggs, while also reducing selling prices for
certain egg products is not necessarily directly effected by changes inand shell egg pricing. With the acquisition of Papetti's, a substantially greater
portioneggs. Approximately two-thirds of the Company'sDivision's
annual egg needs are now purchased under contracts, or in the openspot 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 relative
to prices as reported
by Urner Barry. Additionally,Approximately one-third of annual egg needs are sourced from
internal flocks, where feed costs which typically represent roughly two-thirds of the
cost of producing an egg,such eggs. Feed costs were lower in the 19981999 period, than incompared
to the 19971998 period, due to lower prices for both corn and soybean meal.
Decreased egg costs, for both internally and externally procured eggs, in the
1999 period, compared to the 1998 period, were more than offset by pricing
weakness, creating margin pressure for certain egg products. The most effected
were egg products sold to industrial users such as bakeries and other food
processors.
Refrigerated Distribution Division had flat dollarnet sales for the 1999 period reflected
strong unit sales increases, with cheese, butter, and lower dollar
earningspotato products showing
particular strength. Sales growth resulted from a brand repositioning over the
past two years and a more recent consumer advertising campaign in the period ended March 31, 1998, as compared to the results of the
same period in 1997. Unit sales were higher for core refrigerated grocery items,
reflecting, in part,selected
markets, along with new customersaccount activity and new product introductions. However,The
volume growth, along with a decline in product costs related to the Division's sales were affected by the timing of the important Easter holiday
sales period, which fellnational
butterfat market, resulted in margin expansion in the first quarter of 1997 and the second quarter of
1998. The Division's cheese business, which represents over one-half of the
Division's annual sales, experienced a margin decline due to a rapid increase in
cheese costs during the 19981999 period.
7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
================================================================================
THREE MONTHS ENDED MARCH 31, 19981999 VS THREE MONTHS ENDED MARCH 31, 19971998, CONT.
RESULTS OF OPERATIONS, CONT.
The modest Dairy Products Division had higher dollarnet sales increase for the 1999 period
reflected strong unit sales gains for core dairy mix and higher dollar earningscreamer products, which
more than offset the effects of a recall of certain cartoned specialty dairy
products early in the period ended March 31, 1998, as compared to the resultsperiod. As a result of the same
period in 1997. Unitrecall, sales increased sharply and were helped by a strongervolumes for
cartoned products (approximately 15-20% of annual sales) for the main dairy
products focus by certain customers, particularlyfacility were well below normal levels for the 1999 period. The recall
has effectively been completed and production and sales of cartoned products
from the main plant have resumed. However, to date, such production and sales
have not returned to pre-recall levels. Divisional operating profit declined in
the quick service
restaurant segment, and by1999 period as a growing coffee creamer business. Raw material costs
roseresult of incremental expenses incurred during the quarter due to increases inrecall
period which were outside of the pricingscope of certain ingredients
tied to the national butter fat market, which caused margins to decline.
Theinsurance coverage.
Potato Products Division had lower dollarnet sales for the 1999 period reflected a strong unit
sales increase, particularly for foodservice mashed items. New account activity,
same-account sales growth and operated at anew product introductions all contributed to the
sales gain. The significant operating profit increase in the 1999 period
ended March 31, 1998, as compared to a loss in the same period in
1997. While core sales of refrigerated potato products increased year-over-year,
1997 results included frozen french fry sales. This business was discontinued in
mid-1997. Lossesresulted primarily from the french fry business involume growth, as plant operations at the 1997 period totaled $0.03
per share.main
potato processing facility benefited from the increased production throughput.
The increasedecrease in gross profit margin of the Company for the period ended March
31, 1998,1999, as compared to the results of the same period in 1997,1998, reflected the
factors discussed above, particularly the strengthweakness in the industrial segment of
the Egg Products Division
operations and the return to profitability in the Potato Products 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 increased as a percent of sales in
the period ended March 31, 1998,1999, as compared to the results of the same period
in 1997,1998. Expenses increased due primarily to increased foodservice marketing activities and greater advertisingamortization of the Crystal Farms(R) brand.costs associated with the
Company's information systems upgrade project and due to additional sales and
marketing efforts.
GENERAL
Certain of the Company's products are sensitive to changes in commodity prices.
The Company's Egg Products Division derived approximately 7%6% of thatthe Division's
first quarter 1998three months of 1999 net sales from shell eggs, which are sensitive to
commodity price swings. The Easy Eggs(R)Value-added extended shelf-life liquid egg products
lines and Table Ready(R) product linesprecooked egg products accounted for approximately 35%50% of the Egg
Products Division's first quarter 1998 net sales. The remainder of Egg Products Division sales areis
derived from the sale of other egg products, which vary from being
commodity-sensitive to being 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 the first quarter of 19981999 period
was approximately 6%5% below first quarter 19971998 levels as measured by a widely quoted pricing
service. Gross profit margins for extended shelf-life liquid whole eggs, egg
substitutes, and specialty preparedprecooked 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
that Division'sits net sales from refrigerated products produced by others, thereby reducing
the effecteffects of commodity price swings. The balance of refrigerated distribution
sales are from shell eggs, some of which are partially produced by the Egg Products
Division and are sold on a distribution, or non-commodity, basis by the
Refrigerated Distribution Division.
8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
================================================================================
THREE MONTHS ENDED MARCH 31, 1999 VS THREE MONTHS ENDED MARCH 31, 1998, CONT.
GENERAL, CONT.
The Dairy Products Division sells its products primarily on a cost-plus basis
and, therefore, the division'sDivision's earnings are not typically affected greatly by
raw ingredient price fluctuations.fluctuations, except over short time periods.
The Potato Products Division typically purchases 80%70%-90% of its raw potatoes
from contract producers under annual contracts. The remainder is purchased at
market prices to satisfy short-term
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
================================================================================
GENERAL, CONT.
production requirements or to take advantage
of market prices when they are lower than contracted prices. SmallModerate variations
in the purchase price of raw materials or the selling price per pound of end
products can have a significant effect on Potato Products Division operating
results. The impact of raw material
costs within the Potato Products Division is lower now that the frozen french
fry business has been discontinued, as refrigerated potato products pricing is
generally not subject to the volatility typically seen in frozen french fry
selling prices.
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.
CAPITAL 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 1999 period, 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.
Subsequent to the end of the 1999 period, the Company completed a previously
announced acquisition of certain operating assets and the long-term lease of a
dairy products plant in Connecticut (see Part II - Item 5). 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 will greatly expand the
Company's Dairy Products business in the eastern United States.
The Company invested $19,514,000$15,308,000 in capital expenditures during the three months
ended March 31, 1998.1999. The Company plans to spend approximately $85,000,000$75,000,000 in
total capital expenditures in 1998,1999, the majority of which is to expand
production capacity.capacity for value-added products.
The Company has an unsecured line of credit for $80,000,000 with its principal
banks. As of March 31, 1998, there were no borrowings1999, $44,400,000 was outstanding under this line of
credit.
In July 1998, the Company's Board of Directors authorized the purchase of up to
two million shares of Common Stock on the open market. Through March 31, 1999,
the Company had repurchased 1,488,000 shares of Common Stock. The line of credit
may be used to finance additional repurchases.
9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
================================================================================
THREE MONTHS ENDED MARCH 31, 1999 VS THREE MONTHS ENDED MARCH 31, 1998, CONT.
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.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 possible Year 2000 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. This project addresses and
replaces a majority of the Company's legacy systems and is scheduled for
completion before the end of 1999, except for the Refrigerated Distribution
Division. That division's legacy systems are currently being addressed and are
expected to be Year 2000 compliant by September 1999. 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 July 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 June 1999. The Company's overall business risk from these systems
is not significant.
The Company's non-computer components are now being assessed for Year 2000
compliance. The assessment of these systems will be completed by spring 1999.
Any corrective actions are expected to be completed by September 1999.
The Year 2000 projects also include an evaluation of critical vendors, suppliers
and customers relative to their Year 2000 readiness. Electronic data
communications with customers will be tested. Information is being solicited
from these important business partners and will be evaluated as it is received.
10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
================================================================================
THREE MONTHS ENDED MARCH 31, 1999 VS THREE MONTHS ENDED MARCH 31, 1998, CONT.
YEAR 2000, CONT.
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 customers and suppliers 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 by September 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
$2,300,000 has already been incurred and expensed through March 31, 1999.
FORWARD-LOOKING STATEMENTS
Certain items in this Form 10-Q are forward-looking statements, which are made
in reliance upon the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. Such forward-looking statements are subject to numerous
risks and uncertainties, including the possibility that acquisition synergiescapital projects and the
Year 2000 initiative may not be realizedcompleted as rapidly as management expects.
Additional risks and uncertainties include variances 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 costs 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 three
month period ended March 31, 1999.
PART II - OTHER INFORMATION
Item 3. Quantitative5. Other Information
- --------------------------
On May 3, 1999 the Company announced it had completed the acquisition of certain
operating assets, customer list and Qualitative Disclosures About Market Risk
For the first quarter ended March 31, 1998 this disclosurelong-term lease of a dairy mix plant
from H. P. Hood Inc. The Newington, CT facility is not applicablenow controlled by the
Company's Kohler Mix Specialties, Inc. subsidiary. The Company has an option to
purchase the registrant.building and land at the lease's termination. The cash paid at
closing was approximately $5.7 million. The plant mainly produces ultra-high
temperature pasteurized dairy mixes for foodservice customers in the eastern
United States.
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Item 6. Exhibits and Reports on Form 8-K
- -----------------------------------------
(a) ExhibitExhibits
10.68* Resolution adopted by the Board of Directors on April 29, 1999,
amending the Severance Plan for Eligible Employees of Michael Foods,
Inc. and Subsidiaries and extending its termination date for one
additional year.
10.69* 1997 Stock Incentive Plan of Michael Foods, Inc. and Affiliated
Companies as Amended Effective April 29, 1999.
27.1 Financial Data Schedule
* Management Contract or Compensation Plan Arrangement
(b) There were no reportsReports on Form 8-K
The Company filed during the quarter ended March 31,
1998.
a Form 8-K on February 25, 1999 disclosing a voluntary recall
of certain cartoned dairy products by its Kohler Mix Specialties, Inc.
subsidiary.
Signatures
- ----------
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: MayMarch 14, 19981999 By: /s/ Gregg A. Ostrander
---------------------------------------
Gregg A. Ostrander
(President and Chief Executive Officer)
Date: MayMarch 14, 19981999 By: /s/ John D. Reedy
---------------------------------------
John D. Reedy
(Vice President - Finance, Treasurer,
Chief Financial Officer and Principal
Accounting Officer)
12