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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-Q

[X]/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934

For the quarterly period ended June 30, 1999
                               -------------------------------------------------2000

                                       or

[ ]/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)15(d) OF THE SECURITIES EXCHANGE
      ACT OF 1934

For the transition period from____________ to___________________________________from ______________________ to ______________________

Commission File Number:       0-15638
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                               MICHAEL FOODS, INC.
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             (Exact name of registrant as specified in its charter)

         Minnesota                                      41-0498850
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(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
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(Address of principal executive offices)              (Zip code)

                                 (612)(952) 546-1500
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              (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 August 6, 19994, 2000 was 20,249,62418,280,457 shares.


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                         PART I - FINANCIAL INFORMATION

                      MICHAEL FOODS, INC. AND SUBSIDIARIES
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                                   (Unaudited)

June 30, December 31, ASSETS2000 1999 1998 - ------ ------------ ------------ ASSETS - ------ CURRENT ASSETS Cash and equivalents $ 699,0001,357,000 $ 2,047,0004,961,000 Accounts receivable, less allowances 101,522,000 97,639,00098,531,000 92,493,000 Inventories 79,881,000 74,250,00083,719,000 71,197,000 Prepaid expenses and other 4,883,000 3,884,0003,942,000 4,604,000 ------------ ------------ Total current assets 186,985,000 177,820,000187,549,000 173,255,000 PROPERTY, PLANT AND EQUIPMENT-AT COST Land 4,336,000 4,336,0004,106,000 4,104,000 Buildings and improvements 105,706,000 105,567,000133,545,000 133,778,000 Machinery and equipment 366,557,000 328,067,000366,844,000 357,724,000 ------------ ------------ 476,599,000 437,970,000504,495,000 495,606,000 Less accumulated depreciation 204,572,000 187,759,000223,262,000 208,807,000 ------------ ------------ 272,027,000 250,211,000281,233,000 286,799,000 OTHER ASSETS Goodwill, net 118,450,000 120,172,000 Investments in115,007,000 116,729,000 Joint Venturesventures and other assets 23,840,000 3,313,00019,760,000 21,134,000 ------------ ------------ 142,290,000 123,485,000134,767,000 137,863,000 ------------ ------------ $601,302,000 $551,516,000$603,549,000 $597,917,000 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY - ------------------------------------ CURRENT LIABILITIES Current maturities of long-term debt $ 8,067,0003,119,000 $ 10,663,0003,130,000 Accounts payable 47,591,000 44,376,00052,290,000 47,009,000 Accrued Liabilitiesliabilities Compensation 8,414,000 11,034,0009,248,000 13,143,000 Insurance 7,235,000 7,369,0007,780,000 7,229,000 Customer programs 20,719,000 19,624,00018,530,000 20,999,000 Income taxes 12,719,000 11,805,000 Other 26,606,000 23,457,00016,440,000 18,176,000 ------------ ------------ Total current liabilities 118,632,000 116,523,000120,126,000 121,491,000 LONG-TERM DEBT, less current maturities 204,466,000 155,444,000208,036,000 175,404,000 DEFERRED INCOME TAXES 34,389,000 35,400,00037,163,000 36,423,000 COMMITMENTS AND CONTINGENCIES - - SHAREHOLDERS' EQUITY Common stock 202,000 211,000182,000 203,000 Additional paid-in capital 102,093,000 119,871,00057,937,000 102,777,000 Retained earnings 141,520,000 124,067,000181,341,000 162,577,000 Accumulated comprehensive income (loss) (1,236,000) (958,000) ------------ ------------ 243,815,000 244,149,000238,224,000 264,599,000 ------------ ------------ $601,302,000 $551,516,000$603,549,000 $597,917,000 ============ ============
See accompanying notes to condensed consolidated financial statements. 2 3 MICHAEL FOODS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS Three Months Ended June 30, (Unaudited)
2000 1999 1998 ------------ ------------ Net sales $266,616,000 $258,031,000 $243,685,000 Cost of sales 216,981,000 207,892,000 199,231,000 ------------ ------------ Gross profit 49,635,000 50,139,000 44,454,000 Selling, general and administrative expenses 25,706,000 27,432,000 22,371,000 ------------ ------------ Operating profit 23,929,000 22,707,000 22,083,000 Interest expense, net 3,304,000 2,801,000 2,580,000 ------------ ------------ Earnings before income taxes 20,625,000 19,906,000 19,503,000 Income tax expense 8,350,000 8,160,000 8,190,000 ------------ ------------ NET EARNINGS $ 11,746,00012,275,000 $ 11,313,00011,746,000 ============ ============ Net Earnings Per Share Basic $ 0.570.64 $ 0.520.57 Diluted $ 0.570.64 $ 0.510.57 ============ ============ Weighted average shares outstanding Basic 19,083,000 20,463,000 21,939,000 Diluted 19,299,000 20,702,000 22,337,000 ============ ============
See accompanying notes to condensed consolidated financial statements. 3 4 MICHAEL FOODS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS Six Months Ended June 30, (Unaudited)
2000 1999 1998 ------------ ------------ Net sales $518,542,000 $511,409,000 $489,274,000 Cost of sales 422,052,000 419,139,000 404,664,000 ------------ ------------ Gross profit 96,490,000 92,270,000 84,610,000 Selling, general and administrative expenses 53,662,000 52,476,000 45,515,000 ------------ ------------ Operating profit 42,828,000 39,794,000 39,095,000 Interest expense, net 6,254,000 5,621,000 5,344,000 ------------ ------------ Earnings before income taxes 36,574,000 34,173,000 33,751,000 Income tax expense 14,810,000 14,010,000 14,180,000 ------------ ------------ NET EARNINGS $ 20,163,00021,764,000 $ 19,571,00020,163,000 ============ ============ Net Earnings Per Share Basic $ 0.971.11 $ 0.890.97 Diluted $ 0.961.10 $ 0.880.96 ============ ============ Weighted average shares outstanding Basic 19,619,000 20,736,000 21,892,000 Diluted 19,834,000 20,966,000 22,273,000 ============ ============
See accompanying notes to condensed consolidated financial statements. 4 5 MICHAEL FOODS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Six Months Ended June 30, (Unaudited)
2000 1999 1998 ------------ ------------ Net cash provided by operating activities $ 35,776,00027,492,000 $ 40,124,00035,776,000 Cash flows from investing activities: Capital expenditures (15,182,000) (41,419,000) (34,560,000) Investments in joint ventures and other assets 283,000 (21,017,000) 207,000 ------------ ------------ Net cash used in investing activities (14,899,000) (62,436,000) (34,353,000) Cash flows from financing activities: Payments on long-term debt (78,479,000) (85,374,000) (5,033,000) Proceeds from long-term debt 111,100,000 131,800,000 700,000 Proceeds from issuance of common stock 307,000 523,000 1,817,000 Repurchase of common stock (46,125,000) (18,927,000) -- Dividends (3,000,000) (2,710,000) (2,406,000) ------------ ------------ Net cash provided by (used in) financing activities (16,197,000) 25,312,000 (4,922,000) ------------ ------------ Net increase (decrease)decrease in cash and equivalents (3,604,000) (1,348,000) 849,000 Cash and equivalents at beginning of year 4,961,000 2,047,000 4,038,000 ------------ ------------ Cash and equivalents at end of period $ 699,0001,357,000 $ 4,887,000699,000 ============ ============
See accompanying notes to condensed consolidated financial statements. 5 6 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 accounting principles generally accepted accounting principlesin the United States of America have been condensed or omitted pursuant to such rules and regulations, although management believes that the disclosures are adequate to make the information presented not misleading. Michael Foods, Inc. (the "Company") utilizes a fiscal year consisting of either 52 or 53 weeks, ending on the Saturday nearest to December 31 each year. The quarters ended June 30, 19992000 and 19981999 each included thirteen weeks of operations. For clarity of presentation, the Company has described both periods presented as if the quarters ended on June 30. In the opinion of management, the unaudited condensed consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position as of June 30, 19992000 and the results of operations for the three and six month periods ended June 30, 19992000 and 19981999 and cash flows for the six months ended June 30, 19992000 and 1998.1999. The results of operations for the six months ended June 30, 19992000 are not necessarily indicative of the results for the full year. The Company's basic net earnings per share is computed by dividing net earnings by the weighted average number of outstanding common shares. The Company's diluted net earnings per share is computed by dividing net earnings by the weighted average number of outstanding common shares and common share equivalents relating to stock options, when dilutive. Options to purchase 852,767823,182 and 826,724828,626 shares of Common Stock, with a weighted average exercise price of $24.78,$24.70, which were outstanding during the three and six month periods ended June 30, 1999,2000, were excluded from the computation of common share equivalents for that periodthose periods because they were anti-dilutive. Options to purchase 8,000852,767 and 4,000826,724 shares of common stock, with a weighted average exercise price of $29.75,$24.78, were outstanding during the three and six month periods ended June 30, 1998,1999, but were excluded from the computation of common share equivalents for that periodthose periods because they were anti-dilutive. NOTE B - 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. Inventories consist of the following:
June 30, December 31, 2000 1999 1998 ----------- ----------------------- Raw materials and supplies $19,040,000 $15,389,000$15,662,000 $15,720,000 Work in process and finished goods 39,984,000 36,977,00044,427,000 35,447,000 Flocks 20,857,000 21,884,00023,630,000 20,030,000 ----------- ----------- $79,881,000 $74,250,000$83,719,000 $71,197,000 =========== ===========
6 7 MICHAEL FOODS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS ==================================================== (Unaudited) NOTE C - COMMITMENTS AND CONTINGENCIES Use of EstimatesUSE OF ESTIMATES Preparation of the Company's consolidated financial statements requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and related revenues and expenses. Actual results could differ from the estimates used by management. License AgreementLICENSE AGREEMENT The Company has an exclusive license agreement for a patented process for the production and sale of extended shelf-life egg products. Under the license agreement, the Company has the right to defend and prosecute infringement of the licensed patents. The U.S. Federal Court of Appeals has upheld the validity of the four patents subject to the license agreement, but,agreement. However, subsequently a patent examiner at the U.S. Patent and Trademark Office ("PTO") rejected the patents. The Company is appealingIn August 1999, the decisionexaminer's rejections were largely overturned by the Board of Appeals and Interferences of the examiner and believesPTO. Counsel advises that reexamination certificates have now been issued confirming the validity of three of the patentsfour patents. It is expected that the fourth patent will ultimately be upheld. Duringreissued in the appeal process, the patents remain valid and in full force and effect.near future. These patents are scheduled to expire in 2006. LitigationIn the second quarter of 2000 the Company and the patent holder completed a new royalty arrangement whereby the Company pays a reduced amount of royalties and, in turn, is responsible for one-half of any litigation expense incurred to defend the patents. LITIGATION The Company is engaged in routine litigation incidental to its business. Management believes it will not have a material effect upon its consolidated financial position, liquidity or results of operations. NOTE D - SHAREHOLDERS' EQUITY During the three months ended June 30,second quarters of 2000 and 1999 the Company repurchased 475,3001,500,000 and 414,800 shares of Common Stock under a share repurchase program at an average price of $22.62 per share. Such repurchaseswhich began in July 1998. Through June 30,1998 and which was expanded in February and May 2000. Such repurchases for the first six months of 2000 and 1999 the Company had repurchased 1,902,800were 2,109,400 and 920,100 shares of Common Stock at an average price of $22.60 per share.Stock. NOTE E - RISKS AND UNCERTAINTIES The Year 2000 issue relates to limitations in computer systemsCOMPREHENSIVE INCOME Comprehensive income consists of net earnings and applications that may prevent proper recognition offoreign currency translation adjustments. Total comprehensive income was $12,243,000 and $11,746,000 for the year 2000. The potential effect of the Year 2000 issue on the Company and its business partners will not be fully determinable untilthree months ended June 30, 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 sales1999. The total comprehensive income was $21,486,000 and financial condition could be adversely effected. NOTE F - INTERNATIONAL INVESTMENTS, DAIRY PRODUCTS ACQUISITION AND SUBSEQUENT EVENT During$20,163,000 for the six months ended June 30, 1999, the Company made two investments in Europe to further its leadership in global egg products processing. The first investment was a 25% interest in Belovo, S. A., a specialty egg products company based in Belgium. The second investment was a 50/50 joint venture with the founding shareholders of Belovo forming The Lipid Company, a company involved in the extraction of phospholipids from egg yolks for use in the field of nutraceuticals. In May 1999, the Company's Kohler Mix Specialties, Inc. subsidiary acquired certain operating assets, a customer list2000 and a long-term lease, of a dairy mix plant from H. P. Hood Inc., with an option to purchase the building and land at the lease's termination. The plant mainly produces ultra-high temperature pasteurized dairy mixes for foodservice customers in the eastern United States. The facility generated 1998 net sales of approximately $37 million.1999. 7 8 MICHAEL FOODS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS ==================================================== (Unaudited) NOTE F - INTERNATIONAL INVESTMENTS, DAIRY PRODUCTS ACQUISITION AND SUBSEQUENT EVENT, CONT. In July 1999, the Company formed a Canadian joint venture, Trilogy Egg Products, Inc., with two partners, Canadian Inovatech, Inc. and The Egg Producers Co-op Ltd. Trilogy Egg Products, Inc. will sell value-added egg products in Canada. NOTE G - 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 -------- ------------ -------- -------- --------- ---------------------------------------------------------------------------------------------- THREE MONTHS ENDED JUNE 30, 2000: External net sales $156,835 $55,189 $39,903 $14,689 N/A $266,616 Intersegment sales 2,942 40 0 613 N/A 3,595 Operating profit (loss) 18,971 3,828 1,128 1,685 (1,683) 23,929 THREE MONTHS ENDED JUNE 30, 1999: External net sales $150,488 $ 51,427$51,427 $42,091 $14,025 N/A $258,031 Intersegment sales 3,794 24 310 591 N/A 4,719 Operating profit (loss) 19,712 2,534 2,057 1,367 (2,963) 22,707 THREESIX MONTHS ENDED JUNE 30, 1998:2000: External net sales $144,373 $ 49,841 $36,719 $12,752$310,388 $111,437 $67,932 $28,785 N/A $243,685$518,542 Intersegment sales 4,456 43 480 4795,827 58 485 1,168 N/A 5,4587,538 Operating profit (loss) 19,463 1,763 2,108 457 (1,708) 22,08334,092 8,133 942 2,986 (3,325) 42,828 SIX MONTHS ENDED JUNE 30, 1999: External net sales $302,638 $110,549 $70,753 $27,469 N/A $511,409 Intersegment sales 9,488 45 578 1,198 N/A 11,309 Operating profit (loss) 34,694 4,584 2,953 2,559 (4,996) 39,794 SIX MONTHS ENDED JUNE 30, 1998: External net sales $296,180 $102,866 $64,867 $25,361 N/A $489,274 Intersegment sales 10,386 74 935 958 N/A 12,353 Operating profit (loss) 34,793 3,557 3,190 1,082 (3,527) 39,095
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THREE MONTHS ENDED JUNE 30, 19992000 VS THREE MONTHS ENDED JUNE 30, 19981999 RESULTS OF OPERATIONS Readers are directed to Note GF - Business Segments for data on the unaudited financial results of the Company's four business segments for the three months ended June 30, 19992000 and 1998. 8 9 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED ======================================================== THREE MONTHS ENDED JUNE 30, 1999 VS THREE MONTHS ENDED JUNE 30, 1998, CONT. RESULTS OF OPERATIONS, CONT.1999. Egg Products Division net sales for the 19992000 period reflected unit sales increases, particularly for value-added products, which more than offset significant deflationary pricing impacts on certainindustrial products. SalesSignificant unit sales increases were particularly strongrecorded for precooked frozen omelets, pattiesextended shelf-life liquid eggs and curds.dried egg products. Egg prices decreasedincreased approximately 12%6% compared to second quarter 19981999 levels, as 8 THREE MONTHS ENDED JUNE 30, 2000 VS THREE MONTHS ENDED JUNE 30, 1999, CONT. RESULTS OF OPERATIONS, CONT. reported by Urner Barry Publications - a widely quoted industry pricing service. This decrease helped reduceincrease raised the cost of purchased eggs while also reducing sellingduring a period where prices for certainindustrial egg products and shell eggs.were generally declining. Approximately two-thirds of the Division's annual egg needs are purchased under contracts, or in the spot market. While a portion of these eggs are secured under fixed price contracts, a majority are priced according to the cost of grain inputs or to egg market prices as reported by Urner Barry. Approximately one-third of annual egg needs are sourced from internal flocks, where feed costs typically represent roughly two-thirds of the cost of producing such eggs. Feed costs were lowerslightly higher in the 19992000 period, compared to the 19981999 period, due to lowerhigher prices for both corn and soybean meal. DecreasedIncreased egg costs, for both internally and externally procured eggs, in the 19992000 period, compared to the 19981999 period, were more than offset by pricing weakness,generally not met with comparable price changes in egg products prices, creating margin pressure for certain industrial egg products. Divisional operating profit in the 2000 period also reflected the benefit of reduced royalty expense, a portion of which was a retroactive adjustment to January 1, 1999. Under an agreement reached during the 2000 period, royalties related to products produced and sold by the Company under a license with North Carolina State University ("NCSU") are limited to a fixed portion of the annual production. In consideration of the reduced royalty arrangement, the Company is responsible for one-half of any future litigation expense incurred to defend the patented egg ultra-pasteurization processing technology. Refrigerated Distribution Division net sales for the 19992000 period reflected strong unit sales increases, with cheese and Mexican itemsbutter showing particular strength. Sales growth resulted from a brand repositioning over the past two years and a more recentbroadening consumer advertising campaign in selected markets, along with notable new account activity and new product introductions. The volume growth, along with a decline inmore normal product costs for items related to the national butterfat market, resulted in margin expansion in the 19992000 period. The significant Dairy Products Division net sales increasedecline for the 19992000 period reflected stronglower unit sales gainsvolumes for the core dairy mix business, in part due to the loss of a major industrial (tanker) customer in late 1999, which offset increased volumes for cartoned specialty products and creamer products and the effect of two months' of sales from a plant acquired during the quarter. Sales were weak for certain cartoned specialty dairy products as a result of the product line having not fully recovered from a recall in 1999's first quarter.products. Divisional operating profit declined in the 19992000 period as a result of incremental operatingthe reduced sales volumes, high overhead expenses incurred post-recall and due to above average labor and freight costs. Labor costs were high due, in part, to training costs for newer production personnel and overtime incurred to meet orders in a timely manner during a strong demand period.operating expenses. Potato Products Division net sales for the 19992000 period reflected a strong unit sales increase, particularly for foodservice mashedretail grocery items. New account activity, same-account sales growth and new product introductions all contributed to the sales gain. The strong operating profit increase in the 19992000 period resulted primarily from the volume growth, asan improved sales mix, and efficient plant operations at the main potato processing facility benefited from the increased production throughput.facility. The increasedecrease in gross profit margin of the Company for the period ended June 30, 1999,2000, as compared to the results of the same period in 1998,1999, reflected the factors discussed above, particularly the strength inDairy Products weakness and margin pressures within the Refrigerated Distribution and Potato Products segments.industrial egg products category. It is management's strategy to increase value-added product sales as a percent of total sales over time, while decreasing commodity-sensitive products' contribution to consolidated sales. These efforts historically have been beneficial to gross profit margins in most periods. Selling, general and administrative expenses increaseddecreased as a percent of sales in the period ended June 30, 1999,2000, as compared to the results of the same period in 1998. Expenses1999. Favorable impacts, including the reduced egg products royalty arrangement and a related one-time retroactive benefit, more than offset 9 THREE MONTHS ENDED JUNE 30, 2000 VS THREE MONTHS ENDED JUNE 30, 1999, CONT. RESULTS OF OPERATIONS, CONT. increased dueexpenses related to amortization of the costs associated with the 9 10 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED ======================================================== THREE MONTHS ENDED JUNE 30, 1999 VS THREE MONTHS ENDED JUNE 30, 1998, CONT. RESULTS OF OPERATIONS, CONT. Company's information systems upgrade project, amortization ofincreases in bad debt expense resulting from a non-compete agreement related to a Dairy Products acquisition,foodservice distributor's bankruptcy filing, and additional sales and marketing efforts. SIX MONTHS ENDED JUNE 30, 19992000 VS SIX MONTHS ENDED JUNE 30, 19981999 RESULTS OF OPERATIONS Readers are directed to Note GF - Business Segments for data on the unaudited financial results of the Company's four business segments for the six months ended June 30, 19992000 and 1998.1999. Egg Products Division net sales for the 19992000 period reflected unit sales increases, particularly for value-added products, which more than offset significant deflationary pricing impacts on certain products. Sales were particularly strong for extended shelf-life liquid eggs, dried egg products and precooked frozen omelets, patties and curds. Egg prices decreased approximately 9%5% compared to first half 19981999 levels, as reported by Urner Barry Publications. This decrease helped reduce the cost of purchased eggs, while also reducing selling prices for certain egg products and shell 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 prices as reported by Urner Barry. Approximately one-third of annual egg needs are sourced from internal flocks, where feed costs typically represent roughly two-thirds of the cost of producing such eggs. Feed costs were lower in the 19992000 period, compared to the 19981999 period, due to lower prices for both corn and soybean meal.the primary feed ingredient - corn. Decreased egg costs, for both internally and externally procured eggs, in the 19992000 period, compared to the 19981999 period, were more than offset by pricing weakness for certain egg products, creating margin pressure for certainindustrial egg products. Divisional operating profit for the 2000 period also reflected the benefit of reduced royalty expense, a portion of which was a retroactive adjustment to January 1, 1999. Under an agreement reached during the 2000 period, royalties related to products produced and sold by the Company under a license with NCSU are limited to a fixed portion of the annual production. In consideration of the reduced royalty arrangement, the Company is responsible for one-half of any future litigation expense incurred to defend the patented egg ultra-pasteurization processing technology. Included in the 1999 period Egg Products results were two non-recurring items. First, a gain was recorded on the sale of a shell egg production facility. Second, a Belgium animal feed contamination scare resulted in losses at the Company's two European egg products joint ventures. The net effect of these items was a modest addition to earnings. Refrigerated Distribution Division net sales for the 19992000 period reflected strong unit sales increases, with cheese and Mexican itemsbutter showing particular strength. Sales growth resulted from a brand repositioning over the past two years and a more recentbroadening consumer advertising campaign in selected markets, along with notable new account activity and new product introductions. The volume growth, along with a decline inmore normal product costs for items related to the national butterfat market, resulted in margin expansion in the 19992000 period. The Dairy Products Division net sales increasedecline for the 19992000 period reflected stronglower unit sales gainsvolumes for the core dairy mix and creamer products andbusiness, in part due to the effectloss of two months' of sales from a plant acquired during the first half of 1999. Sales were weakmajor industrial (tanker) customer in late 1999, which offset increased volumes for cartoned specialty dairy products as a result of a recall of certain items in 1999's first quarter.and creamer products. Divisional operating profit declined in the 19992000 period as a result of incremental operatingthe reduced sales volumes, high overhead expenses incurred as a result of the recall and due to above average labor and freight costs. Labor costs were high due, in part, to training costs for newer production personnel and overtime incurred to meet orders in a timely manner.operating expenses. 10 SIX MONTHS ENDED JUNE 30, 2000 VS SIX MONTHS ENDED JUNE 30, 1999, CONT. RESULTS OF OPERATIONS, CONT. Potato Products Division net sales for the 19992000 period reflected a strong unit sales increase, particularly for foodservice mashed items.items and retail shredded products. New account activity, same-account sales growth and new product introductions all contributed to the sales gain. The strong operating profit increase in the 19992000 period resulted primarily from the volume growth, as plant operations at the main potato processing facility benefited from the increased production throughput. 10 11 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED ======================================================== SIX MONTHS ENDED JUNE 30, 1999 VS SIX MONTHS ENDED JUNE 30, 1998, CONT. RESULTS OF OPERATIONS, CONT. The increase in gross profit margin of the Company for the period ended June 30, 1999,2000, as compared to the results of the same period in 1998,1999, reflected the factors discussed above, particularly the strength in the Refrigerated Distribution and Potato Products segments. 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 June 30, 1999,2000, as compared to the results of the same period in 1998.1999. Expenses increased due to amortization of the costs associated with the Company's information systems upgrade project, amortization of a non-compete agreement related to a May 1999 Dairy Products acquisition, increases in bad debt expense resulting from a foodservice distributor's bankruptcy filing, and additional sales and marketing efforts. However, the increased expenses were partially offset by the favorable impact of the reduced egg products royalty arrangement, including a one-time retroactive benefit. GENERAL Certain of the Company's products are sensitive to changes in commodity prices. The Company's Egg Products Division derived less than 5%3% of the Division's net sales for the first six months of 19992000 from shell eggs, which are sensitive to commodity price swings. Value-added extended shelf-life liquid egg products lines and precooked egg products accounted for approximately 50% of the Egg Products Division's net sales. The remainder of Egg Products Division sales is derived from the sale of other egg products, which vary from being commodity-sensitive to value-added. Gross profit from shell eggs is primarily dependent upon the relationship between shell egg prices and the cost of feed, both of which can fluctuate significantly. Shell egg pricing in the 19992000 period was approximately 9%5% below 19981999 levels as measured by a widely quoted pricing service.Urner Barry Publications. Gross profit margins for extended shelf-life liquid eggs, egg substitutes, and precooked egg products are less sensitive to commodity price fluctuations than are other egg products or shell eggs. The Company's Refrigerated Distribution Division derives approximately 70% of its net sales from refrigerated products produced by others, thereby reducing the effects of commodity price swings. The balance of refrigerated distribution sales are from shell eggs, some of which are produced by the Egg Products Division and are sold on a distribution, or non-commodity, basis by the Refrigerated Distribution Division. The Dairy Products Division sells its products primarily on a cost-plus basis and, therefore, the Division's earnings are not typically affected greatly by raw ingredient price fluctuations, except over short time periods. The Potato Products Division typically purchases 70%-90% of its raw potatoes from contract producers under annual contracts. The remainder is purchased at market prices to satisfy short-term production requirements or to take advantage of market prices when they are lower than contracted 11 CAPITAL RESOURCES AND LIQUIDITY prices. Moderate variations in the purchase price of raw materials or the selling price per pound of finished products can have a significant effect on Potato Products Division operating results. Inflation is not expected to have a significant impact on the Company's business. The Company generally has been able to offset the impact of inflation through a combination of productivity gains and price increases. 11 12 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED ======================================================== 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 first half of 1999, the Company made two investments in Europe. The first investment was a 25% interest in Belovo, S. A., a specialty egg products company based in Belgium. The second investment was a 50/50 joint venture with the founding shareholders of Belovo forming The Lipid Company, a company involved in the extraction of phospholipids from egg yolks for use in the field of nutraceuticals. The cash paid at the time of closing the transactions was approximately $9.3 million, which was funded through the Company's bank line of credit. The investments will expand the Company's leadership position in global egg products processing. Also in the first half of 1999, the Company acquired certain operating assets and the long-term lease of a dairy products plant in Connecticut. The cash paid at time of closing was approximately $5.7 million, which was funded through the Company's bank line of credit. This transaction greatly expanded the Company's Dairy Products business in the eastern United States. The Company invested $41,419,000$15,182,000 in capital expenditures during the six months ended June 30, 1999.2000. The Company plans to spend approximately $75,000,000$55,000,000 in total capital expenditures in 1999,2000, the majority of which is to expand production capacity for value-added products. The Company has antwo unsecured linelines of credit for $80,000,000 and $20,000,000 with its principal banks. As of June 30, 1999, $70,900,0002000, $77,600,000 was outstanding under this linethese lines of credit. In July 1998, the Company's Board of Directors authorized the purchase of up to two million2,000,000 shares of Common Stock on the open market.market or in privately negotiated transactions. In February 2000, the Board authorized an additional purchase of up to 2,000,000 shares of Common Stock on the open market or in privately negotiated transactions, with an additional 500,000 share authorization made in May 2000. Through June 30, 1999,2000, the Company had repurchased 1,902,8004,012,200 shares of Common Stock for $43,005,000.$89,121,000. During the second quarter of 2000 the Company repurchased 1,500,000 shares of Common Stock. SEASONALITY Consolidated quarterly operating results are affected by the seasonality of the Company's net sales and operating profits. Specifically, shell egg prices typically rise seasonally in the first and fourth quarters of the year due to increased demand during holiday periods. Generally, refrigerated distribution operations experience higher net sales and operating profits in the fourth quarter, coinciding with incremental consumer demand during the holiday season. Net sales and operating profits from dairy operations typically are significantly higher in the second and third quarters due to increased consumption of ice milk and ice cream products during the summer months. Operating profits from potato products are less seasonal, but tend to be higher in the second half of the year coinciding with the potato harvest. YEAR 2000 The Company's Year 2000 initiative is separated into several projects: legacy systems, personal computer components, wide area network components, local area network components, and non-computer components. The approach for each of these projects includes an inventory of 2000 12 13 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED ======================================================== YEAR 2000, CONT. components, an assessment of Year 2000 compliance of each component, and identification and execution of corrective actions for items that fail the assessment phase. In 1995, the Company undertook implementation of the SAP Enterprise Resource Planning system as a means to present a single interface with customers and to have better information available for management to make more effective decisions. The SAP system encompasses all significant processes and has been certified Year 2000 compliant by an outside party. The SAP system will be implemented for three of the five operating companies prior to the end of 1999. The legacy systems of the remaining two operating companies are certified as Year 2000 compliant. Beyond the SAP project, several non-critical legacy systems are being addressed throughout 1999. The costs to modify and test any remaining legacy systems, if necessary, would not be material to the consolidated financial position, liquidity or results of operations of the Company. The Company completed corrective actions for all personal computer hardware in late 1998. An evaluation and any needed remediation of personal computer software is expected to be completed by September 1999. The remaining information technology systems for wide area networking and local area networking are currently being assessed for Year 2000 compliance, with corrective action to be completed by September 1999. The Company's overall business risk from these systems is not significant. The Company's non-computer components have been assessed for Year 2000 compliance. The assessment of these systems was completed in May 1999. Any corrective actions are expected to be completed by September 1999. The Year 2000 projects also include an evaluation of critical vendors, suppliers, brokers and customers relative to their Year 2000 readiness. Information is being solicited from these important business partners and will be evaluated as it is received. Electronic data communications with customers have been tested. Based upon the assessment completed at this time, the Company does not anticipate any significant Year 2000 issues. All Year 2000 projects are generally proceeding according to management's expectations. However, if there are significant delays in their completion, or if major suppliers or customers experience Year 2000 issues with their systems, such issues could adversely affect the operations of the Company. After assessing the information received from its business partners and evaluating the status of the Year 2000 projects, the Company will develop an appropriate contingency plan, as required. It is anticipated that this plan will be developed during the fourth quarter of 1999. Achieving Year 2000 compliance for the Company will largely be a by-product of the SAP system installation. The costs of achieving Year 2000 compliance for software not affected by the SAP system, computer components, and non-computer components is estimated to be less than $3,000,000, of which approximately $2,500,000 has already been incurred and expensed through June 30, 1999. FORWARD-LOOKING STATEMENTS Certain items in this Form 10-Q aremay be forward-looking statements, which are made in reliance upon the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking 13 14 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED ======================================================== FORWARD-LOOKING STATEMENTS, CONT. statements are subject to numerous risks and uncertainties, 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 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. Item12 ITEM 3. Quantitative and Qualitative Disclosures about Market RiskQUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There were no material changes in the Company's market risk during the six month period ended June 30, 1999.2000. PART II - OTHER INFORMATION ItemITEM 4. Submission of Matters to a Vote of Security HoldersSUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The 19992000 Annual Meeting of Shareholders of Michael Foods, Inc. was held on April 29, 1999.27, 2000. The items voted upon and the results of the vote follow: 1. The election of eleventen persons to serve as directors until the next annual election and until their successors are duly elected and qualified:
For Withhold Authority ------------- ------------------ Maureen B. Bellantoni 15,390,929 39,909 Richard A. Coonrod 15,393,280 37,55813,516,812 44,903 Daniel P. Dillon 15,393,460 37,37813,519,006 42,709 Jerome J. Jenko 15,392,335 38,50313,518,748 42,967 Arvid C. Knudtson 15,383,486 47,35213,517,587 44,128 Joseph D. Marshburn 15,387,405 43,43313,518,487 43,228 Jeffrey J. Michael 15,390,410 40,42813,517,906 43,809 Margaret D. Moore 15,391,454 39,38413,519,899 41,816 Gregg A. Ostrander 15,392,360 38,47811,488,838 2,072,877 Arthur J. Papetti 15,393,990 36,84813,517,738 43,977 Stephen T. Papetti 15,393,990 36,84813,519,438 42,277
2. Proposal to ratify an amendment to the 1997 Stock Incentive Plan of Michael Foods, Inc. and Affiliated Companies:
For Against Abstain ---------- --------- ------- 14,063,827 1,323,290 43,721
3. Proposal to ratify the appointment of Grant Thornton LLP as independent auditors for 1999:2000:
For Against Abstain ------------- ------- ------- 15,371,790 47,645 11,40313,518,677 36,414 6,624
14 15 ItemITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.78 Shareholder Agreement By and Between Michael Foods, Inc. and the Shareholders of Michael Foods, Inc. as listed, dated as of May 22, 2000 27.1 Financial Data Schedule
(b) Reports on Form 8-K (a) Exhibits 27.1 Financial Data Schedule (a) There were no reports onThe Company filed a Form 8-K filed duringon May 22, 2000 announcing that it had completed stock repurchases of 1.5 million shares, exhausting repurchase authorizations, and that its Board of Directors authorized the quarter ended June 30, 1999. Signaturespurchase of up to an additional 0.5 million shares of the Company's Common Stock in the open market or in privately negotiated transactions. 13 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: August 16, 199914, 2000 By: /s/ Gregg A. Ostrander -------------------------------------------------------------------- Gregg A. Ostrander (President(Chairman, President and Chief Executive Officer) Date: August 16, 199914, 2000 By: /s/ John D. Reedy -------------------------------------------------------------------- John D. Reedy (Vice(Executive Vice President, - Finance, Treasurer, Chief Financial Officer and Principal Accounting Officer) 15 14