1
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
--------------------------------------------------------
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)(952) 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 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.
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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.
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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.
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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.
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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
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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.
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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.
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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
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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
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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
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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.
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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.
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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
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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
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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)
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