UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1997 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from_____________to_____________ Commission File Number: 0-15638 MICHAEL FOODS, INC. (Exact name of registrant as specified in its charter) Minnesota 41-0498850 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) Suite 324, Park National Bank Building 5353 Wayzata Boulevard Minneapolis, MN 55416 (Address of principal executive offices) (Zip code) (612) 546-1500 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X]Yes [ ]No The number of shares outstanding of the registrant's Common Stock, $.01 par value, as of August 1, 1997 was 21,539,039 shares. PART I - FINANCIAL INFORMATION MICHAEL FOODS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) June 30, December 31, ASSETS 1997 1996 - ------ ------------ ------------ CURRENT ASSETS Cash and equivalents $ 7,614,000 $ 2,585,000 Accounts receivable, less allowances 85,918,000 51,394,000 Inventories 67,913,000 58,976,000 Prepaid expenses and other 2,724,000 2,976,000 ------------ ------------ Total current assets 164,169,000 115,931,000 PROPERTY, PLANT AND EQUIPMENT-AT COST Land 4,205,000 4,110,000 Buildings and improvements 104,040,000 97,470,000 Machinery and equipment 262,789,000 225,215,000 ------------ ------------ 371,034,000 326,795,000 Less accumulated depreciation 156,779,000 144,556,000 ------------ ------------ 214,255,000 182,239,000 OTHER ASSETS Goodwill, net 115,733,000 53,602,000 Other 7,204,000 12,887,000 ------------ ------------ 122,937,000 66,489,000 ------------ ------------ $501,361,000 $364,659,000 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Current maturities of long-term debt $ 8,654,000 $ 8,410,000 Accounts payable 43,860,000 28,412,000 Accrued compensation 6,263,000 4,604,000 Accrued insurance 6,989,000 6,471,000 Other accrued expenses 35,732,000 11,357,000 ------------ ------------ Total current liabilities 101,498,000 59,254,000 LONG-TERM DEBT, less current maturities 161,694,000 104,491,000 DEFERRED INCOME TAXES 33,074,000 26,872,000 CONTINGENCIES -- -- SHAREHOLDERS' EQUITY Common stock, $.01 par value, 40,000,000 shares authorized, shares issued 21,416,970 at June 30, 1997 and 19,459,731 at December 31, 1996 214,000 195,000 Additional paid-in capital 134,007,000 113,268,000 Retained earnings 70,874,000 60,579,000 ------------ ------------ 205,095,000 174,042,000 ------------ ------------ $501,361,000 $364,659,000 ============ ============ See accompanying notes to condensed consolidated financial statements. MICHAEL FOODS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS Three Months Ended June 30, (Unaudited) 1997 1996 ------------ ------------ Net sales $237,861,000 $151,678,000 Cost of sales 198,400,000 133,480,000 ------------ ------------ Gross profit 39,461,000 18,198,000 Selling, general and administrative expenses 22,176,000 10,917,000 ------------ ------------ Operating profit 17,285,000 7,281,000 Other expense Interest expense, net 3,003,000 1,824,000 ------------ ------------ Earnings before income taxes 14,282,000 5,457,000 Income tax expense 5,930,000 2,180,000 ------------ ------------ NET EARNINGS $ 8,352,000 $ 3,277,000 ============ ============ NET EARNINGS PER SHARE $ .39 $ .17 ============ ============ DIVIDENDS PER SHARE $ .05 $ .05 ============ ============ Weighted average shares outstanding 21,258,000 19,389,000 ============ ============ See accompanying notes to condensed consolidated financial statements. MICHAEL FOODS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS Six Months Ended June 30, (Unaudited) 1997 1996 ------------ ------------ Net sales $433,279,000 $295,550,000 Cost of sales 370,089,000 258,439,000 ------------ ------------ Gross profit 63,190,000 37,111,000 Selling, general and administrative expenses 36,845,000 22,442,000 ------------ ------------ Operating profit 26,345,000 14,669,000 Other expense Interest expense, net 5,281,000 3,744,000 ------------ ------------ Earnings before income taxes 21,064,000 10,925,000 Income tax expense 8,750,000 4,370,000 ------------ ------------ NET EARNINGS $ 12,314,000 $ 6,555,000 ============ ============ NET EARNINGS PER SHARE $ .60 $ .34 ============ ============ DIVIDENDS PER SHARE $ .10 $ .10 ============ ============ Weighted average shares outstanding 20,674,000 19,371,000 ============ ============ See accompanying notes to condensed consolidated financial statements. MICHAEL FOODS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Six Months Ended June 30, (Unaudited) 1997 1996 ------------- ------------- Net cash provided by operating activities $ 45,363,000 $ 18,814,000 Cash flows from investing activities: Capital expenditures (13,692,000) (12,458,000) Business acquisitions, net of cash acquired, and other assets (43,468,000) 95,000 ------------- ------------- Net cash used in investing activities (57,160,000) (12,363,000) Cash flows from financing activities: Payments on notes payable and long-term debt (191,187,000) (62,699,000) Proceeds from notes payable and long-term debt 204,405,000 57,200,000 Purchase of shares -- (500,000) Proceeds from issuance of common stock 5,628,000 213,000 Cash dividends (2,020,000) (1,936,000) ------------- ------------- Net cash provided by financing activities 16,826,000 (7,722,000) ------------- ------------- Net increase (decrease) in cash and equivalents 5,029,000 (1,271,000) Cash and equivalents at beginning of year 2,585,000 1,921,000 ------------- ------------- Cash and equivalents at end of period $ 7,614,000 $ 650,000 ============= ============= NON-CASH INVESTING AND FINANCING TRANSACTIONS Acquisition: Cash paid, net of cash acquired $ 42,720,000 Stock issued 38,859,000 Fair value of assets acquired (86,334,000) Liabilities assumed 68,223,000 ------------- Purchase price in excess of net assets acquired $ 63,468,000 ============= In connection with the merger with North Star Universal, Inc., Michael Foods, Inc. (the "Company") assumed $21,250,000 of net indebtedness and effectively repurchased 1,782,961 shares of its common stock (see note D). See accompanying notes to condensed consolidated financial statements. MICHAEL FOODS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) NOTE A - BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with Regulation S-X pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although management believes that the disclosures are adequate to make the information presented not misleading. The 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, 1997 and June 30, 1996 each include thirteen weeks of operations. For clarity of presentation, the Company has described all periods presented as if the three month and six month periods 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, 1997 and the results of operations for the three and six month periods ended June 30, 1997 and 1996 and cash flows for the six months ended June 30, 1997 and 1996. The results of operations for the six months ended June 30, 1997 are not necessarily indicative of the results for the full year. NOTE B - NEW ACCOUNTING PRONOUNCEMENT The Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 128, Earnings Per Share, which is effective for periods ending after December 15, 1997. Early adoption of the new standard is not permitted. The new standard eliminates primary and fully diluted earnings per share disclosure and requires presentation of basic and diluted earnings per share, together with disclosure of how the per share amounts were computed. Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted-average common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. The pro forma effect of adopting the new standard would not have an impact on the reported net earnings per share for the three and six month periods ended June 30, 1997 and 1996 for both basic and diluted earnings per share. NOTE C - INVENTORIES Inventories other than flocks, raw potatoes, and potato products 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. Raw potatoes and potato products are stated at the lower of average cost for the year in which produced or at market. Inventories consist of the following: June 30, December 31, 1997 1996 ------------ ----------- Raw materials and supplies $16,487,000 $11,065,000 Work in process and finished goods 29,918,000 21,235,000 Flocks 21,508,000 26,676,000 ------------ ----------- $67,913,000 $58,976,000 ============ =========== MICHAEL FOODS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (Unaudited) NOTE D - ACQUISITION OF PAPETTI'S AND MERGER WITH NORTH STAR UNIVERSAL On February 26, 1997, the Company completed the acquisition of Papetti's Hygrade Egg Products, Inc. and affiliated entities (collectively "Papetti's"). The acquisition has been accounted for as a purchase. Total consideration of $83,174,000, together with the assumption of $22,825,000 of notes payable and long-term debt, was delivered through the issuance of 3,195,455 shares of newly issued common stock valued at $38,859,000, and $44,315,000 in cash and closing costs. The total consideration delivered exceeded the fair value of the net assets acquired by $63,468,000, which has been recorded as goodwill and will be amortized on a straight line basis over 40 years. The Papetti's results of operations have been included in the Company's operating results since the date of acquisition. On February 28, 1997, Michael Foods, Inc., a Delaware corporation, merged into North Star Universal, Inc. ("NSU") with NSU immediately distributing NSU's subsidiary, ENStar Inc., in a tax-free distribution to the former shareholders of NSU. At the time of the merger, NSU changed its name to Michael Foods, Inc. and the management and operations of the continuing entity are those of the Company. The merger has been accounted for as a reverse acquisition utilizing the purchase method of accounting. The effect of the merger is that the Company assumed $21,250,000 of net subordinated indebtedness and effectively retired 1,782,961 shares of the Company's common stock of approximately equal value. The following unaudited pro forma statement of earnings information has been prepared assuming the Papetti's acquisition, the merger with NSU and the refinancing of the Company's debt described in Note E had occurred on January 1, 1997 and 1996: For the six months ended June 30, 1997 1996 - -------------------------------------------------------------------------------- Net sales $481,874,000 $465,706,000 Net earnings $ 12,867,000 $ 7,032,000 Net earnings per share $ .61 $ .34 ============ ============ Weighted average shares outstanding 21,099,000 20,783,000 ============ ============ This unaudited pro forma information is not necessarily indicative of the combined results of operations that would have occurred had the acquisition, merger and refinancing occurred on the respective dates, nor are they indicative of the results which may occur in the future. NOTE E - LONG-TERM DEBT In February, 1997, the Company issued senior notes in the principal amount of $125,000,000 to finance the cash portion of the acquisition of Papetti's, to retire certain Company debt, and to refinance all or a portion of the debt assumed in the Papetti's acquisition and the NSU merger. The senior notes bear interest at 7.58% and are due in five equal annual payments beginning in 2005. In addition, the Company also obtained a new $80,000,000 unsecured revolving line of credit with its principal banks. The revolving line of credit will mature in February, 2002 and bears interest at the banks' reference rate, or at Eurodollar rates as defined, at the Company's option. Proceeds from the revolving line of credit were used to retire the outstanding balance of the preexisting line of credit and to assist with completing the acquisition of Papetti's and the merger with NSU. At June 30, 1997, the Company had $60,000,000 available under this revolving line of credit. MICHAEL FOODS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (Unaudited) NOTE F - CONTINGENCIES Use of Estimates In preparation of the Company's consolidated financial statements, management is required 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. Patent Litigation The Company has an exclusive license agreement for the production and sale of extended shelf-life liquid egg products. Under the terms of this license agreement the Company has the right to defend and prosecute infringement of the patents which are the basis of the exclusive license agreement. The Company can offset up to 50% of the required royalty payments under the agreement with costs associated with the legal defense of the licensed patents. To the extent defense costs exceed the required royalty payments, the agreement permits the Company to defer the excess costs and apply them to future royalty payments. At June 30, 1997 and December 31, 1996, the Company had prepaid royalty payments of approximately $1,580,000 and $7,923,000 included in other assets related to the defense of its licensed patent rights against several infringing parties. In connection with the February 26, 1997 acquisition of Papetti's, which was a defendant in one of these patent infringement cases, a settlement of $6,000,000 was received by the Company. Under the terms of its license agreement, the Company was required to apply this settlement as a reduction of its prepaid royalty payments. During 1996, the Company was informed by the U.S. Patent and Trademark Office that a patent examiner rejected the claims under the four process patents which are the subject of the license agreement. The Company and the holder of the patents are appealing the decision of the examiner and the Company believes the validity of the patents will ultimately be upheld. During the appeal process, the patents remain valid and in full force and effect. There can be no assurance that the Company will be able to fully recover its prepaid royalty payments. If the patents are ultimately denied, the Company would continue to produce and market the products currently subject to the license agreement without incurring royalty cost. Product Litigation In the fall of 1994, a customer of the Company recalled product which was potentially contaminated and the customer has settled claims with consumers who became ill after eating the product. The customer had filed a suit, whereby the Company was a co-defendant with other companies alleged to have supplied contaminated product to the customer's plant. The customer sought damages for losses incurred, as well as alleged loss of past and future profits. In May, 1997 the suit was settled within the Company's insurance coverage. Other Litigation The Company is also engaged in routine litigation incidental to its business, which management believes will not have a material effect upon its consolidated financial position, liquidity or results of operations. NOTE G - RECLASSIFICATIONS Certain 1996 amounts have been reclassified to conform with the 1997 presentation. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THREE MONTHS ENDED JUNE 30, 1997 VS THREE MONTHS ENDED JUNE 30, 1996 RESULTS OF OPERATIONS The Company completed the acquisition of Papetti's on February 26, 1997. Papetti's results of operations since the date of acquisition are included in the Company's Egg Products Division operating results. The following table sets forth the percentage of net sales accounted for by each of the Company's operating divisions for the periods indicated: Three Months Ended June 30, --------------------------- 1997 1996 ---- ---- Egg Products 65% 43% Refrigerated Distribution 20 32 Dairy Products 11 16 Potato Products 6 14 Intercompany Sales (2) (5) ---- ---- TOTAL 100% 100% ==== ==== The following table sets forth the percentage of divisional operating earnings (before corporate, interest and income tax expenses) accounted for by each of the Company's operating divisions for the periods indicated: Three Months Ended June 30, --------------------------- 1997 1996 ---- ---- Egg Products 82% 54% Refrigerated Distribution 8 19 Dairy Products 9 22 Potato Products 1 5 ---- ---- TOTAL 100% 100% ==== ==== The Egg Products Division had higher dollar sales and higher dollar earnings in the period ended June 30, 1997, as compared to the results of the same period in 1996, due, in part, to the acquisition of Papetti's. Strong unit sales, favorable spot market egg prices and earnings contributions from Papetti's operations benefited divisional earnings. Sales were particularly strong for certain value-added egg products, notably Easy Eggs(R) and Table Ready(R) (extended shelf-life liquid whole eggs) and MicroFresh (frozen omelets, patties and curds). Egg prices decreased approximately 10% compared to second quarter 1996 levels, as reported by Urner Barry Publications - a widely quoted industry pricing service, although pricing for egg products is not necessarily directly effected by changes in shell egg pricing. With the acquisition of Papetti's, a substantially greater portion of the Company's egg needs are now purchased in the open market relative to prices reported by Urner Barry. The relationship of open market egg prices to egg products prices was generally favorable during the second quarter of 1997. Feed costs, which typically represent roughly two-thirds of the cost of producing an egg, were lower in the 1997 period than in the 1996 period, due principally to lower corn prices, which benefited margins. The Refrigerated Distribution Division had higher dollar sales and higher dollar earnings in the period ended June 30, 1997, as compared to the results of the same period in 1996. Unit sales were higher for core refrigerated grocery items, reflecting, in part, new customers and new product introductions. This significant volume improvement allowed for divisional earnings growth. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED THREE MONTHS ENDED JUNE 30, 1997 VS THREE MONTHS ENDED JUNE 30, 1996 RESULTS OF OPERATIONS, CONT. The Dairy Products Division had higher dollar sales and higher dollar earnings in the period ended June 30, 1997, as compared to the results of the same period in 1996. Unit sales increased and were helped by improved sales volumes with certain large fast-food customers and by a growing coffee creamer business. Raw material costs declined during the quarter due to decreases in the pricing of certain ingredients tied to the national butter fat market. The Potato Products Division had lower dollar sales, largely due to a planned exiting of the frozen french fry business, and lower dollar earnings in the period ended June 30, 1997, as compared to the same period in 1996, although earnings in both periods were modest. Frozen french fry operations continued to generate losses in the second quarter of 1997, totaling approximately $0.015 per share. These losses were somewhat less than the losses experienced in the second quarter of 1996. The Company announced earlier in 1997 that it would exit the frozen french fry business in mid-1997 and it completed that process in the second quarter. Value-added refrigerated potato product sales generated earnings in the second quarter of 1997, but at levels below those experienced in the second quarter of 1996. Unit sales declined for such products, resulting in a lower utilization of refrigerated products production lines, which pressured margins. The increase in gross profit margin of the Company for the period ended June 30, 1997, as compared to the results of the same period in 1996, reflected the factors discussed above, particularly the strength of Egg Products Division earnings. 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, 1997, as compared to the results of the same period in 1996, due primarily to increased sales training, staffing additions related, in part, to the Papetti's acquisition, and increased foodservice marketing activities. Additionally, non-recurring severance expenses, and other costs, of approximately $2.4 million (pretax) were recorded in the second quarter of 1997 related to the exiting of the frozen french fry business, including a reorganization of the Company's sales group. SIX MONTHS ENDED JUNE 30, 1997 VS SIX MONTHS ENDED JUNE 30, 1996 RESULTS OF OPERATIONS The following table sets forth the percentage of net sales accounted for by each of the Company's operating divisions for the periods indicated: Six Months Ended June 30, ------------------------- 1997 1996 ---- ---- Egg Products 60% 43% Refrigerated Distribution 24 34 Dairy Products 11 14 Potato Products 8 15 Intercompany Sales (3) (6) ---- ---- TOTAL 100% 100% ==== ==== MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED SIX MONTHS ENDED JUNE 30, 1997 VS SIX MONTHS ENDED JUNE 30, 1996 RESULTS OF OPERATIONS, CONT. The following table sets forth the percentage of divisional operating earnings (before corporate, interest and income tax expenses) accounted for by each of the Company's operating divisions for the periods indicated: Six Months Ended June 30, ------------------------- 1997 1996 ---- ---- Egg Products 82% 59% Refrigerated Distribution 12 21 Dairy Products 9 16 Potato Products (3) 4 ---- ---- TOTAL 100% 100% ==== ==== The Egg Products Division had higher dollar sales and higher dollar earnings in the period ended June 30, 1997, as compared to the results of the same period in 1996, due, in part, to the acquisition of Papetti's. Strong unit sales, favorable spot market egg prices and earnings contributions from the recently acquired Papetti's operations benefited divisional earnings. Sales were particularly strong for certain value-added egg products, notably Easy Eggs(R) and Table Ready(R) and MicroFresh. Egg prices decreased approximately 7% compared to first half 1996 levels, as reported by Urner Barry, although pricing for egg products is not necessarily directly effected by changes in shell egg pricing. With the acquisition of Papetti's, a substantially greater portion of the Company's egg needs are now purchased in the open market relative to prices reported by Urner Barry. The relationship of open market egg prices to egg products prices was generally favorable during the second quarter of 1997. Feed costs, which typically represent roughly two-thirds of the cost of producing an egg, were modestly lower in the 1997 period than in the 1996 period, due principally to lower corn prices, which benefited margins. The Refrigerated Distribution Division had higher dollar sales and higher dollar earnings in the period ended June 30, 1997, as compared to the results of the same period in 1996. Unit sales were higher for core refrigerated grocery items, reflecting, in part, new customers and new product introductions. This significant volume improvement allowed for divisional earnings growth. The Dairy Products Division had higher dollar sales and higher dollar earnings in the period ended June 30, 1997, as compared to the results of the same period in 1996. Unit sales increased and were helped by promotional activity with certain customers, improved sales volumes with certain large fast-food customers and by a growing coffee creamer business. The Potato Products Division had lower dollar sales, largely due to a planned exiting of the frozen french fry business, and operated at a loss in the period ended June 30, 1997, as compared to the profitable results of the same period in 1996. Frozen french fry operations generated losses totaling approximately $0.05 per share in the first half of 1997, compared to a loss of approximately $0.07 per share recorded in the first half of 1996. Value-added refrigerated potato product sales generated earnings in the first half of 1997, but at levels below those experienced in the first half of 1996. Unit sales declined for such products, resulting in a lower utilization of refrigerated products production lines, which pressured margins. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED SIX MONTHS ENDED JUNE 30, 1997 VS SIX MONTHS ENDED JUNE 30, 1996 RESULTS OF OPERATIONS, CONT. The increase in gross profit margin of the Company for the period ended June 30, 1997, as compared to the results of the same period in 1996, reflected the factors discussed above, particularly the strength of Egg Products Division earnings. 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, 1997, as compared to the results of the same period in 1996, due primarily to increased sales training, staffing additions related, in part, to the Papetti's acquisition, and increased foodservice marketing activities. Additionally, non-recurring severance expenses, and other costs, of approximately $2.4 million (pretax) were recorded in the second quarter of 1997 related to the exiting of the frozen french fry business, including a reorganization of the Company's sales group. GENERAL Certain of the Company's products are sensitive to changes in commodity prices. The Company's egg products operations derived approximately 7% of that division's first half 1997 net sales from shell eggs, which are sensitive to commodity price swings. The value-added Easy Eggs(R) and Table Ready(R) extended shelf-life liquid egg product lines accounted for approximately 40% of the Egg Products Division's first half 1997 net sales. The remainder of Egg Products Division sales are derived from the sale of other egg products, which vary from being commodity-sensitive to being value-added. Gross profit from shell eggs is primarily dependent upon the relationship between shell egg prices and the cost of feed, both of which can fluctuate significantly. Shell egg pricing in the first half of 1997 was approximately 7% below first half 1996 levels as measured by a widely quoted pricing service. Gross profit margins for extended shelf-life liquid whole eggs and specialty prepared egg products are less sensitive to commodity price fluctuations than are other egg products or shell eggs. The Company's refrigerated distribution operations derive approximately 70% of that division's net sales from refrigerated products produced by others, thereby reducing the effect 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 Potato Products Division derived approximately 70% of its first half 1997 net sales from the refrigerated potato products line. The Potato Products Division typically purchases 70%-90% of its raw potatoes from contract producers under annual contracts. The remainder is purchased at market prices to satisfy short-term production requirements or to take advantage of market prices when they are lower than contracted prices. Small variations in the purchase price of raw materials or the selling price per pound of end products can have a significant effect on Potato Products Division operating results. The impact of raw material costs within the Potato Products Division has been reduced in recent years due to significant increases in higher value-added refrigerated potato products sales. Beginning in the third quarter of 1997, essentially all of the Potato Products Division's sales will be of value-added refrigerated potato products. 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. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED GENERAL, CONT. Inflation is not expected to have a significant impact on the Company's business. The Company generally has been able to offset the impact of inflation through a combination of productivity gains and price increases. CAPITAL RESOURCES AND LIQUIDITY Acquisitions and capital expenditures have been, and will likely continue to be, a significant capital requirement. The Company plans to continue to invest in state-of-the-art production facilities to enhance its competitive position, although the annual rate of spending has declined in recent years. 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. The Company invested approximately $13,700,000 in capital expenditures during the six months ended June 30, 1997. The Company plans to spend approximately $50,000,000 in total capital expenditures in 1997. The Company has an unsecured line of credit for $80,000,000 with its principal banks. As of June 30, 1997, approximately $20,000,000 was borrowed under this line of credit. 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. 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. 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. PART II - OTHER INFORMATION Item 1. Legal Proceedings On February 26, 1997, the Company settled patent litigation with and Papetti's as part of the acquisition of Papetti's. The Company received $6,000,000 under the settlement (see Note F - CONTINGENCIES - Patent Litigation). On May 13, 1997, the Company's Kohler Mix Specialties, Inc. subsidiary ("Kohler Mix"), along with two other defendants, settled a lawsuit filed in May, 1995 by Schwan's Sales Enterprises, Inc. (see Note F- CONTINGENCIES Product Litigation). As a result of the settlement, the suit was dismissed. The terms of the settlement are confidential, although the Kohler Mix portion of the settlement was within the Company's insurance coverage. There was no determination of liability and no admission of guilt by any of the defendants. Item 4. Submission of Matters to a Vote of Security Holders The 1997 Annual Meeting of Shareholders of Michael Foods, Inc. was held on June 5, 1997. The items voted upon and the results of the vote follow: 1. The election of nine 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 17,872,963 48,785 Richard A. Coonrod 17,875,048 46,700 Miles E. Efron 17,872,548 49,200 Arvid C. Knudtson 17,872,548 49,200 Joseph D. Marshburn 17,872,348 49,400 Jeffrey J. Michael 17,873,957 47,791 Gregg A. Ostrander 17,846,746 75,002 Arthur J. Papetti 17,875,133 46,615 Stephen T. Papetti 17,874,831 46,917 2. Proposal to ratify the 1997 Stock Incentive Plan of Michael Foods, Inc. and affiliated companies: For Against Abstain Broker Non-Vote --- ------- ------- --------------- 16,743,769 971,440 30,872 175,667 3. Proposal to approve the appointment of Grant Thornton as independent auditors for 1997: For Against Abstain --- ------- ------- 17,867,830 36,570 17,348 Item 6. Exhibits and Reports on Form 8-K (a) Exhibit 27.1 Financial Data Schedule (b) There were no reports on Form 8-K filed during the quarter ended June 30, 1997. 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 11, 1997 By: /s/ Gregg A. Ostrander --------------------------------------- Gregg A. Ostrander (President and Chief Executive Officer) Date: August 11, 1997 By: /s/ John D. Reedy --------------------------------------- John D. Reedy (Vice President - Finance, Treasurer, Chief Financial Officer and Principal Accounting Officer)