UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
-------------------------------------------------March 31, 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 [ ] No
The number of shares outstanding of the registrant's Common Stock, $.01
par value, as of November 2, 1998May 3, 1999 was 21,209,84820,586,924 shares.
1
PART I - FINANCIAL INFORMATION
MICHAEL FOODS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
=======================================================================================================
September 30, December 31,
ASSETS 1998 1997
- ------ ------------- -------------
CURRENT ASSETS
Cash and equivalents $ 3,587,000 $ 4,038,000
Accounts receivable, less allowances 87,054,000 83,495,000
Inventories 81,987,000 68,929,000
Prepaid expenses and other 3,153,000 1,676,000
------------- -------------
Total current assets 175,781,000 158,138,000
PROPERTY, PLANT AND EQUIPMENT-AT COST
Land 4,336,000 4,336,000
Buildings and improvements 102,071,000 99,023,000
Machinery and equipment 318,543,000 274,980,000
------------- -------------
424,950,000 378,339,000
Less accumulated depreciation 182,363,000 160,800,000
------------- -------------
242,587,000 217,539,000
OTHER ASSETS
Goodwill, net 121,033,000 123,711,000
Other 4,171,000 4,267,000
------------- -------------
125,204,000 127,978,000
------------- -------------
$ 543,572,000 $ 503,655,000
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES
Current maturities of long-term debt $ 9,521,000 $ 8,509,000
Accounts payable 49,136,000 46,910,000
Accrued compensation 10,117,000 10,064,000
Accrued insurance 6,704,000 4,782,000
Discounts and allowances 20,756,000 15,217,000
Other accrued expenses 19,818,000 17,868,000
------------- -------------
Total current liabilities 116,052,000 103,350,000
LONG-TERM DEBT, less current maturities 153,942,000 137,519,000
DEFERRED INCOME TAXES 35,873,000 33,540,000
CONTINGENCIES -- --
SHAREHOLDERS' EQUITY
Common stock, $.01 par value, 40,000,000 shares authorized,
shares issued 21,200,655 at September 30, 1998 and 21,816,098
at December 31, 1997 212,000 218,000
Additional paid-in capital 122,295,000 140,188,000
Retained earnings 115,198,000 88,840,000
------------- -------------
237,705,000 229,246,000
------------- -------------
$ 543,572,000 $ 503,655,000
============= =============
=======================================================================================================
================================================================================
March 31, December 31,
ASSETS 1999 1998
- ------ ------------ ------------
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 September 30,March 31, (Unaudited)
================================================================================
1999 1998
1997
------------- ------------------------- ------------
Net sales $ 253,790,000 $ 245,868,000$253,378,000 $245,589,000
Cost of sales 210,357,000 207,514,000
------------- -------------212,067,000 205,433,000
------------ ------------
Gross profit 43,433,000 38,354,00041,311,000 40,156,000
Selling, general and administrative expenses 22,660,000 17,184,000
------------- -------------24,224,000 23,144,000
------------ ------------
Operating profit 20,773,000 21,170,00017,087,000 17,012,000
Interest expense, net 2,637,000 2,673,000
------------- -------------2,820,000 2,764,000
------------ ------------
Earnings before income tax expense 18,136,000 18,497,000taxes 14,267,000 14,248,000
Income tax expense 7,620,000 7,669,000
------------- -------------5,850,000 5,990,000
------------ ------------
NET EARNINGS $ 10,516,0008,417,000 $ 10,828,000
============= =============8,258,000
============ ============
Net Earnings per sharePer Share
Basic $ 0.490.40 $ 0.500.38
Diluted $ 0.480.40 $ 0.49
============= =============0.37
============ ============
Weighted average shares outstanding
Basic 21,627,000 21,583,00021,009,000 21,846,000
Diluted 21,922,000 21,947,000
============= =============21,230,000 22,208,000
============ ============
================================================================================
See accompanying notes to condensed consolidated financial statements.
3
MICHAEL FOODS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
NineCASH FLOWS
Three Months Ended September 30,March 31, (Unaudited)
================================================================================
1998 1997
------------- -------------
Net sales $ 743,064,000 $ 679,147,000
Cost of sales 615,021,000 577,603,000
------------- -------------
Gross profit 128,043,000 101,544,000
Selling, general and administrative expenses 68,175,000 54,029,000
------------- -------------
Operating profit 59,868,000 47,515,000
Interest expense, net 7,981,000 7,954,000
------------- -------------
Earnings before income tax expense 51,887,000 39,561,000
Income tax expense 21,800,000 16,419,000
------------- -------------
NET EARNINGS $ 30,087,000 $ 23,142,000
============= =============
Earnings per share
Basic $ 1.38 $ 1.10
Diluted $ 1.36 $ 1.09
============= =============
Weighted average shares outstanding
Basic 21,804,000 20,977,000
Diluted 22,156,000 21,201,000
============= =============
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 at beginning of year 2,047,000 4,038,000
------------ ------------
Cash and equivalents at end of period $ 4,679,000 $ 4,891,000
============ ============
================================================================================
See accompanying notes to condensed consolidated financial statements.
4
MICHAEL FOODS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, (Unaudited)
====================================================================================================
1998 1997
------------- -------------
Net cash provided by operating activities $ 53,837,000 $ 65,937,000
Cash flows from investing activities:
Capital expenditures (49,579,000) (24,841,000)
Business acquisitions, net of cash acquired, and other assets 96,000 (43,139,000)
------------- -------------
Net cash used in investing activities (49,483,000) (67,980,000)
Cash flows from financing activities:
Payments on notes payable and long-term debt (15,965,000) (227,973,000)
Proceeds from notes payable and long-term debt 33,400,000 223,656,000
Proceeds from issuance of common stock 2,844,000 10,613,000
Purchase of shares (21,355,000) --
Cash dividends (3,729,000) (3,096,000)
------------- -------------
Net cash (used in) provided by financing activities (4,805,000) 3,200,000
------------- -------------
Net increase (decrease) in cash and equivalents (451,000) 1,157,000
Cash and equivalents at beginning of year 4,038,000 2,585,000
------------- -------------
Cash and equivalents at end of period $ 3,587,000 $ 3,742,000
============= =============
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 fair value of 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.
5
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 September
30,March 31, 1999 and 1998 and 1997 each included thirteen weeks of operations and the three
quarters ended September 30, 1998 and 1997 each included 39 weeks of
operations. For clarity of presentation, the Company has described allboth periods
presented as if the quarter ended on September 30.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 September
30, 1998March 31,
1999 and the results of operations for the three months ended March 31, 1999 and
nine month periods
ended September 30, 1998 and 1997 and cash flows for the ninethree months ended September 30, 1998March 31, 1999 and 1997.1998. The
results of operations for the ninethree months ended September 30, 1998March 31, 1999 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
20,000
and 10,678769,165 shares of Common Stock, with a weighted average exercise pricesprice of
$29.31 and $29.43,$24.83, which were outstanding during the three and nine month periodsperiod ended September 30, 1998,March 31,
1999, were excluded from the computation of common share equivalents for those periodsthat
period because they were anti-dilutive. There were no anti-dilutive options
outstanding during the three month period ended September 30, 1997. Options to purchase 323,068 shares of Common Stock, with a
weighted average exercise price $14.08, which were outstanding during the nine
month period ended September 30, 1997, were excluded from the computation of
common share equivalents for that period because they were anti-dilutive.March 31, 1998.
NOTE B - NEW ACCOUNTING PRONOUNCEMENT
The Financial Accounting Standards Board 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 their
business segments as part of their consolidated financial statements. The
Company will include the required business segment disclosures in its 1998
annual report.
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 salvage value.
6
MICHAEL FOODS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
================================================================================
(Unaudited)
NOTE C - INVENTORIES, cont.
Inventories consist of the following:
September 30,March 31, December 31,
1999 1998
1997
----------- ------------------------ ------------
Raw materials and supplies $14,556,000 $16,047,000$19,814,000 $15,389,000
Work in process and finished goods 41,040,000 30,374,00038,004,000 36,977,000
Flocks 26,391,000 22,508,000
----------- -----------
$81,987,000 $68,929,000
===========19,431,000 21,884,000
------------- ------------
$77,249,000 $74,250,000
============ ===========
NOTE D - ACQUISITION OF PAPETTI'S, MERGER WITH NORTH STAR UNIVERSAL 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 shares of newly issued Common
Stock 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 was 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 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 Nine months ended September 30, 1997
- -----------------------------------------------------------------
Net sales $727,742,000
Net earnings 23,695,000
Earnings per share
Basic $ 1.11
Diluted $ 1.10
============
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.
7
MICHAEL FOODS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
================================================================================
(Unaudited)
NOTE EC - COMMITMENTS AND 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. The U.S. Federal Court of Appeals has upheld the validity of
the patents subject to the license 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 FD - SHAREHOLDERS' EQUITY
During the three months ended September 30, 1998March 31, 1999, the Company repurchased 868,700444,800
shares of Common Stock under a Board of Directors authorized share repurchase program. 8Such 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 SEPTEMBER 30, 1998MARCH 31, 1999 VS THREE MONTHS ENDED SEPTEMBER 30, 1997,
CONT.MARCH 31, 1998
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 Ended Sept. 30,
----------------------------
1998 1997
---- ----
Egg Products 60% 65%
Refrigerated Distribution 21 21
Dairy Products 16 12
Potato Products 5 5
Intercompany Sales (2) (3)
---- ----
TOTAL 100% 100%
==== ====
The following table sets forth the percentage of divisional operating earnings
(before corporate, interestthree months
ended March 31, 1999 and income tax expenses) accounted for by each of
the Company's operating divisions for the periods indicated:
Three Months Ended Sept. 30,
----------------------------
1998 1997
---- ----
Egg Products 77% 75%
Refrigerated Distribution 9 10
Dairy Products 10 13
Potato Products 4 2
---- ----
TOTAL 100% 100%
==== ====
The1998.
Egg Products Division had lower dollarnet sales and higher dollar earnings infor the 1999 period ended September 30, 1998, as compared to the results of the same
period in 1997. Unitreflected unit sales
gains in most product lines wereincreases, particularly for value-added products, which more than offset
by
lower per unit selling prices fordeflationary pricing impacts on certain egg products. Earnings reflected, in
part, favorable spot market egg costs and lower feed costs. Sales were particularly strong
for precooked frozen omelets, patties and curds. Egg prices decreased
approximately 5% compared to thirdfirst 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 particularly value-added egg products, is not
necessarily directly affected by changes inand shell egg pricing.eggs. 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 where such egg cost is determined largely by market pricingprices 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 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 higher 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 selected
markets, along with new account activity and new product introductions. The
volume growth, along with a decline in product costs related to the national
butterfat market, resulted in margin expansion in the period ended September 30, 1998, as compared to the results of
the same period in 1997. Unit sales were flat for core refrigerated grocery
items, reflecting the loss of two grocery chain accounts - one to a low priced
competitor, the other due to a customer's restructuring - earlier in the year,
and the impact of historically high cheese and butter retail price points on
consumer demand. A sharp rise in butter fat market prices during the 1998 period
also had an impact on profitability, as product sourcing costs rose more rapidly
than did retail selling prices for products such as cheese and butter.
91999 period.
7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
================================================================================
THREE MONTHS ENDED SEPTEMBER 30, 1998MARCH 31, 1999 VS THREE MONTHS ENDED SEPTEMBER 30, 1997,MARCH 31, 1998, 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 lower dollar earningscreamer products, which
more than offset the effects of a recall of certain cartoned specialty dairy
products early in the period ended September 30, 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. Dollar sales also
were affected by a sharp rise in the dairy ingredients market, which, under the
Division's cost-plus pricing arrangement with most customers, raised per unit
selling prices significantly. Raw material costs rose substantiallyresult of incremental expenses incurred during the 1998recall
period due to increases inwhich were outside of the pricingscope of certain ingredients tied to the
national butter fat market, which caused margins to decline. The Division also
experienced higher than normal operating costs due to strong volume growth.
Theinsurance coverage.
Potato Products Division had higher 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 higher dollar earningsnew product introductions all contributed to the
sales gain. The significant operating profit increase in the 1999 period
ended September 30, 1998,resulted primarily from the volume growth, as compared to the results of the same
period in 1997. The discontinuation of the sale of frozen potato products in
mid-1997 has allowed for an increased focus on the remaining refrigerated potato
products lines. The increased attention focused on plant operations and sales
volumes had a favorable impact on the Division's financial results in the 1998
period. Sales volumes increased in the 1998 period as compared to the 1997
period and operating efficiencies inat the main
plant were much improved
year-over-year, resulting inpotato processing facility benefited from the improved financial results.increased production throughput.
The increasedecrease in gross profit margin of the Company for the period ended September 30, 1998,March
31, 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 higher 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 September 30, 1998,March 31, 1999, as compared to the results of the same period
in 1997.1998. Expenses increased largely due to higher marketing support for foodservice
selling efforts and spending to supportamortization of the costs associated with the
Company's information systems upgrade project. Also, the 1997 period included a non-recurring gain of
approximately $1.3 million pretax resulting from the disposition of french fry
production assets.
NINE MONTHS ENDED SEPTEMBER 30, 1998 VS NINE MONTHS ENDED SEPTEMBER 30, 1997
RESULTS OF OPERATIONS
The following table sets forth the percentage of net sales accounted for by each
of the Company's operating divisions for the periods indicated:
Nine Months Ended Sept. 30,
---------------------------
1998 1997
---- ----
Egg Products 62% 62%
Refrigerated Distribution 21 23
Dairy Products 14 11
Potato Products 5 7
Intercompany Sales (2) (3)
---- ----
TOTAL 100% 100%
==== ====
10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
================================================================================
NINE MONTHS ENDED SEPTEMBER 30, 1998 VS NINE MONTHS ENDED SEPTEMBER 30, 1997,
CONT.
RESULTS OF OPERATIONS, CONT.
The following table sets forth the percentage of divisional operating earnings
(before corporate, interestproject and income tax expenses) accounted for by each of
the Company's operating divisions for the periods indicated:
Nine Months Ended Sept. 30,
---------------------------
1998 1997
---- ----
Egg Products 79% 79%
Refrigerated Distribution 9 11
Dairy Products 8 11
Potato Products 4 (1)
---- ----
TOTAL 100% 100%
==== ====
The Egg Products Division had higher dollardue to additional sales and
higher dollar earnings in
the period ended September 30, 1998, as compared to the results of the same
period in 1997, due to strong unit sales, favorable spot market egg costs, lower
feed costs and contributions from Papetti's. Owning Papetti's for nine months,
versus seven months in the 1997 period, explained a portion of the increases.
Additionally, sales were strong for certain value-added egg products, notably
extended shelf-life liquid eggs and precooked frozen omelets, patties and curds.
Egg prices decreased approximately 7% in the 1998 period as compared to first
nine months of 1997, as reported by Urner Barry Publications, although pricing
for egg products, particularly value-added egg products, is not necessarily
directly affected by changes in shell egg pricing. Approximately two-thirds of
the Division's annual egg needs are purchased under contracts, or in the spot
market, where such egg cost is determined largely by market pricing 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 lower in the 1998 period than in
the 1997 period, due to lower prices for both corn and soybean meal.
The Refrigerated Distribution Division had flat dollar sales and flat dollar
earnings in the period ended September 30, 1998, as compared to the results of
the same period in 1997. Unit sales were fairly flat for core refrigerated
grocery items, reflecting, in part, some lost business and the impact of
historically high cheese and butter retail price points on consumer demand. A
sharp rise in butter fat market prices during the 1998 period also had an impact
on profitability, as product sourcing costs rose more rapidly than did retail
selling prices for products such as cheese and butter.
The Dairy Products Division had higher dollar sales and flat dollar earnings in
the period ended September 30, 1998, as compared to the results of the same
period in 1997. Unit sales increased sharply and were helped by a stronger dairy
products focus by certain customers, particularly in the quick service
restaurant segment, and by a growing coffee creamer business. Dollar sales also
were affected by a sharp rise in the dairy ingredients market, which, under the
Division's cost-plus pricing arrangement with most customers, raised per unit
selling prices significantly. Raw material costs rose substantially during the
1998 period due to increases in the pricing of certain ingredients tied to the
national butter fat market, which caused margins to decline. The Division also
experienced higher than normal operating costs due to strong volume growth.
The Potato Products Division had lower dollar sales and operated at a profit in
the period ended September 30, 1998, as compared to a loss in the same period in
1997. 1997 results included frozen french fry sales. The frozen french fry
business was discontinued in mid-1997. Losses from the
11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
================================================================================
NINE MONTHS ENDED SEPTEMBER 30, 1998 VS NINE MONTHS ENDED SEPTEMBER 30, 1997,
CONT.
RESULTS OF OPERATIONS, CONT.
french fry business in the 1997 period totaled approximately $0.05 per share.
Efforts begun in 1997 in the areas of improving both plant operations and sales
volumes for the remaining refrigerated product lines were beneficial to the
Division's financial results in the 1998 period. Refrigerated products sales
volumes increased in the 1998 period as compared to the 1997 period and
operating efficiencies in the main plant were much improved year-over-year,
resulting in the improved financial results.
The increase in gross profit margin of the Company for the period ended
September 30, 1998, as compared to the results of the same period in 1997,
reflected the factors discussed above, particularly the strength 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 September 30, 1998, as compared to the results of the same
period in 1997, due primarily to increased foodservice marketing activities and
spending to support the Company's information systems upgrade project. The 1997
period included non-recurring severance expenses, and other costs, including a
reorganization of the Company's sales group, of approximately $2.4 million
pretax and a non-recurring gain of approximately $1.3 million pretax resulting
from the disposition of french fry production assets.efforts.
GENERAL
Certain of the Company's products are sensitive to changes in commodity prices.
The Company's Egg Products Division derived approximately 6% of the Division's
first ninethree months of 19981999 net sales from shell eggs, which are sensitive to
commodity price swings. Value-added extended shelf-life liquid egg productproducts
lines and precooked egg products accounted for approximately 36%50% of the Egg
Products Division's 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 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 19981999 period
was approximately 7%5% below 19971998 levels as measured by a widely quoted pricing
service. 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 effecteffects of commodity price swings. The balance of refrigerated distribution
sales are from shell eggs, some of which are 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's earnings are not typically affected greatly by
raw ingredient price fluctuations, except over short time periods.
12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
================================================================================
GENERAL, CONT.
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. 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
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 $49,580,000$15,308,000 in capital expenditures during the ninethree months
ended September 30, 1998.March 31, 1999. The Company plans to spend approximately $80,000,000$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 September 30, 1998, $22,000,000March 31, 1999, $44,400,000 was outstanding under this line of
credit.
OnIn July 30, 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 such purchases.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 has broken its "Year 2000"Company's Year 2000 initiative is separated into several projects. These
projects includeprojects: legacy
systems, personal computer components, wide area network components, local area
network components, and non - computernon-computer components. The approach used for each of these
projects includes the following phases:
13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
================================================================================
YEAR 2000, CONT.
- - an inventory of possible Year 2000 components;
- -components, an assessment
of Year 2000 compliance of each component;
- - anycomponent, and identification and execution of
corrective actionactions for items that fail the assessment phase.
The status for each ofIn 1995, the projects follows:
Michael FoodsCompany undertook the implementation of the SAP Enterprise Resource
Planning system in 1995 as a means to present a single interface with customers and to
have better information available tofor 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. This project includes
processes that begin with Order Entry1999, except for the Refrigerated Distribution
Division. That division's legacy systems are currently being addressed and end with Accounts Receivable and Cash
Application, plus Transportation and Warehouse Management, the Purchasing
Life-Cycle, Financial Management, Product Costing, and Production Planning. The
SAP system has been certifiedare
expected to be Year 2000 compliant by an outside party.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 will completecompleted corrective actions for all personal computer hardware by November 1998in
late 1998. An evaluation and allany needed remediation of personal computer
software is expected to be completed by December 1998.July 1999. The remaining information
technology systems for wide area networking and local area networking and communications are
currently being assessed for Year 2000 compliance, with corrective action to be
completed by June 1999. OverallThe Company's overall business risk is judged to be not significant from these systems.systems
is not significant.
The Company's non-computer systemscomponents are now being assessed for Year 2000
compliance. The assessment of these systems will be completed by Marchspring 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, Year 2000such issues may have a
material adversecould adversely
affect on the operations of the Company. After assessing the information received
from customers and suppliers and evaluating the successful completionstatus 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 JuneSeptember 1999.
14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
================================================================================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 capital projects and the
Year 2000 initiative may not be completed 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 Aboutabout Market Risk
For- -------------------------------------------------------------------
There were no material changes in the Company's market risk during the three
month period ended September 30, 1998 this disclosure is not applicable to the
registrant.March 31, 1999.
PART II - OTHER INFORMATION
Item 5. Other Information
- --------------------------
On May 3, 1999 the Company announced it had completed the acquisition of certain
operating assets, customer list and the long-term lease of a dairy mix plant
from H. P. Hood Inc. The Newington, CT facility is now controlled by the
Company's Kohler Mix Specialties, Inc. subsidiary. The Company has an option to
purchase the 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.
11
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 September
30, 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: November 13, 1998March 14, 1999 By: /s/ Gregg A. Ostrander
---------------------------------------
Gregg A. Ostrander
(President and Chief Executive Officer)
Date: November 13, 1998March 14, 1999 By: /s/ John D. Reedy
---------------------------------------
John D. Reedy
(Vice President - Finance, Treasurer,
Chief Financial Officer and Principal
Accounting Officer)
1512