UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 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 November 3, 1997 was 21,781,098 shares. PART I - FINANCIAL INFORMATION MICHAEL FOODS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) September 30, December 31, ASSETS 1997 1996 - ------ ------------ ------------ CURRENT ASSETS Cash and equivalents $ 3,742,000 $ 2,585,000 Accounts receivable, less allowances 91,314,000 51,394,000 Inventories 64,639,000 58,976,000 Prepaid expenses and other 2,981,000 2,976,000 ------------ ------------ Total current assets 162,676,000 115,931,000 PROPERTY, PLANT AND EQUIPMENT-AT COST Land 4,188,000 4,110,000 Buildings and improvements 103,796,000 97,470,000 Machinery and equipment 262,362,000 225,215,000 ------------ ------------ 370,346,000 326,795,000 Less accumulated depreciation 153,340,000 144,556,000 ------------ ------------ 217,006,000 182,239,000 OTHER ASSETS Goodwill, net 114,933,000 53,602,000 Other 6,662,000 12,887,000 ------------ ------------ 121,595,000 66,489,000 ------------ ------------ $501,277,000 $364,659,000 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY - ------------------------------------ CURRENT LIABILITIES Current maturities of long-term debt $ 8,649,000 $ 8,410,000 Accounts payable 45,041,000 28,412,000 Accrued compensation 8,739,000 4,604,000 Accrued insurance 7,047,000 6,471,000 Other accrued expenses 31,949,000 11,357,000 ------------ ------------ Total current liabilities 101,425,000 59,254,000 LONG-TERM DEBT, less current maturities 144,163,000 104,491,000 DEFERRED INCOME TAXES 35,857,000 26,872,000 CONTINGENCIES -- -- SHAREHOLDERS' EQUITY Common stock, $.01 par value, 40,000,000 shares authorized, shares issued: 21,720,519 at September 30, 1997 and 19,459,731 at December 31, 1996 217,000 195,000 Additional paid-in capital 138,991,000 113,268,000 Retained earnings 80,624,000 60,579,000 ------------ ------------ 219,832,000 174,042,000 ------------ ------------ $501,277,000 $364,659,000 ============ ============ See accompanying notes to condensed consolidated financial statements. MICHAEL FOODS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS Three Months Ended September 30, (Unaudited) 1997 1996 ------------ ------------ Net sales $245,868,000 $159,928,000 Cost of sales 207,514,000 144,828,000 ------------ ------------ Gross profit 38,354,000 15,100,000 Selling, general and administrative expenses 17,184,000 11,155,000 ------------ ------------ Operating profit 21,170,000 3,945,000 Other expense Interest expense, net 2,673,000 1,730,000 ------------ ------------ Earnings before income taxes 18,497,000 2,215,000 Income tax expense 7,669,000 890,000 ------------ ------------ NET EARNINGS $ 10,828,000 $ 1,325,000 ============ ============ NET EARNINGS PER SHARE $ .50 $ .07 ============ ============ DIVIDENDS PER SHARE $ .05 $ .05 ============ ============ Weighted average shares outstanding 21,583,000 19,396,000 ============ ============ See accompanying notes to condensed consolidated financial statements. MICHAEL FOODS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS Nine Months Ended September 30, (Unaudited) 1997 1996 ------------ ------------ Net sales $679,147,000 $455,478,000 Cost of sales 577,603,000 403,267,000 ------------ ------------ Gross profit 101,544,000 52,211,000 Selling, general and administrative expenses 54,029,000 33,597,000 ------------ ------------ Operating profit 47,515,000 18,614,000 Other expense Interest expense, net 7,954,000 5,474,000 ------------ ------------ Earnings before income taxes 39,561,000 13,140,000 Income tax expense 16,419,000 5,260,000 ------------ ------------ NET EARNINGS $ 23,142,000 $ 7,880,000 ============ ============ NET EARNINGS PER SHARE $ 1.10 $ .41 ============ ============ DIVIDENDS PER SHARE $ .15 $ .15 ============ ============ Weighted average shares outstanding 20,977,000 19,379,000 ============ ============ See accompanying notes to condensed consolidated financial statements. MICHAEL FOODS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Nine Months Ended September 30, (Unaudited) 1997 1996 ------------- ------------- Net cash provided by operating activities $ 65,937,000 $ 30,965,000 Cash flows from investing activities: Capital expenditures (24,841,000) (20,594,000) Business acquisitions, net of cash acquired, and other assets (43,139,000) 968,000 ------------- ------------- Net cash used in investing activities (67,980,000) (19,626,000) Cash flows from financing activities: Payments on notes payable and long-term debt (227,973,000) (99,916,000) Proceeds from notes payable and long-term debt 223,656,000 92,814,000 Purchase of shares -- (500,000) Proceeds from issuance of common stock 10,613,000 213,000 Cash dividends (3,096,000) (2,905,000) ------------- ------------- Net cash provided by (used in) financing activities 3,200,000 (10,294,000) ------------- ------------- Net increase in cash and equivalents 1,157,000 1,045,000 Cash and equivalents at beginning of year 2,585,000 1,921,000 ------------- ------------- Cash and equivalents at end of period $ 3,742,000 $ 2,966,000 ============= ============= 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 September 30, 1997 and September 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 nine month periods ended on September 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 September 30, 1997 and the results of operations for the three and nine month periods ended September 30, 1997 and 1996 and cash flows for the nine months ended September 30, 1997 and 1996. The results of operations for the nine months ended September 30, 1997 are not necessarily indicative of the results for the full year. NOTE B - NEW ACCOUNTING PRONOUNCEMENTS The Financial Accounting Standards Board ("FASB") 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 a material impact on the reported net earnings per share for the three and nine month periods ended September 30, 1997 and 1996 for both basic and diluted earnings per share. In June 1997, the FASB issued Statement No. 130 "Reporting Comprehensive Income" and Statement No. 131 "Disclosures about Segments of an Enterprise and Related Information" which are effective for fiscal years beginning after December 15, 1997. Statement No. 130 will require the Company to display an amount representing total comprehensive income, as defined by the statement, as part of the Company's basic financial statements. Comprehensive income will include items such as unrealized gains or losses on certain investment securities and foreign currency items. Statement No. 131 will require the Company to disclose financial and other information about its business segments, as defined by the statement, their products and services, geographical areas, major customers, revenue, profits, assets and other information. The adoption of these two statements is not expected to have a material effect on the consolidated financial statements of the Company. MICHAEL FOODS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 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: September 30, December 31, 1997 1996 ----------- ----------- Raw materials and supplies $14,476,000 $11,065,000 Work in process and finished goods 29,666,000 21,235,000 Flocks 20,497,000 26,676,000 ----------- ----------- $64,639,000 $58,976,000 =========== =========== 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 nine months ended September 30, 1997 1996 - ---------------------------------------- ------------ ------------ Net sales $727,742,000 $716,874,000 Net earnings $ 23,695,000 $ 7,725,000 Net earnings per share $ 1.11 $ .37 ============ ============ Weighted average shares outstanding 21,260,000 20,791,000 ============ ============ 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. MICHAEL FOODS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (Unaudited) 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 September 30, 1997, the Company had $77,000,000 available under this revolving line of credit. 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 September 30, 1997 and December 31, 1996, the Company had prepaid royalty payments of approximately $1,512,000 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. 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. MICHAEL FOODS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (Unaudited) 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 SEPTEMBER 30, 1997 VS THREE MONTHS ENDED SEPTEMBER 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 September 30, --------------------------- 1997 1996 ----- ----- Egg Products 65% 42% Refrigerated Distribution 21 32 Dairy Products 12 18 Potato Products 5 13 Intercompany Sales (3) (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 September 30, --------------------------- 1997 1996 ----- ----- Egg Products 75% 61% Refrigerated Distribution 10 35 Dairy Products 13 42 Potato Products 2 (38) ----- ----- TOTAL 100% 100% ===== ===== The Egg Products Division had higher dollar sales and higher dollar earnings in the period ended September 30, 1997, as compared to the results of the same period in 1996, due to strong unit sales, favorable spot market egg prices, lower feed costs and contributions from Papetti's. Sales were particularly strong for certain value-added egg products, notably Easy Eggs(R), Table Ready(R) (extended shelf-life liquid whole eggs) and MicroFresh (frozen omelets, patties and curds). Egg prices decreased approximately 8% compared to third 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 third quarter of 1997. Feed costs, which 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 September 30, 1997, as compared to the results of the same period in 1996. Unit sales MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED THREE MONTHS ENDED SEPTEMBER 30, 1997 VS THREE MONTHS ENDED SEPTEMBER 30, 1996 RESULTS OF OPERATIONS, CONT. were higher for core refrigerated grocery items, reflecting, in part, new customers, new product introductions and increased promotional activities. 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 September 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 the discontinuation of frozen french fry sales, and operated profitably in the period ended September 30, 1997, as compared to a loss in the same period in 1996. The Company announced earlier in 1997 that it would exit the frozen french fry business in mid-1997 and it essentially completed that process in the second quarter. The remaining business of the division, production and distribution of value-added refrigerated potato products, generated greater earnings in the third quarter of 1997 than in the third quarter of 1996, although earnings were relatively modest in both periods. While unit sales declined for such products, production costs were notably lower in the 1997 period than the 1996 period. In the 1997 period benefits were seen from investments made in capital expenditures and training over the prior 9-12 months. Profitability in the 1996 period was hampered by significant losses in the former frozen french fry business. The increase in gross profit margin of the Company for the period ended September 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 in the period ended September 30, 1997 were a comparable percent of sales, as compared to the results of the same period in 1996. Increased expenditures for sales training, staffing additions related, in part, to the Papetti's acquisition, and foodservice marketing activities were largely offset by a non-recurring gain. This gain of approximately $1.3 million pretax, or $0.04 per share after taxes, resulted from the disposition of french fry production assets. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED NINE MONTHS ENDED SEPTEMBER 30, 1997 VS NINE MONTHS ENDED SEPTEMBER 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: Nine Months Ended September 30, --------------------------- 1997 1996 ----- ----- Egg Products 62% 43% Refrigerated Distribution 23 33 Dairy Products 11 16 Potato Products 7 14 Intercompany Sales (3) (6) ----- ----- 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: Nine Months Ended September 30, --------------------------- 1997 1996 ----- ----- Egg Products 79% 60% Refrigerated Distribution 11 24 Dairy Products 11 23 Potato Products (1) (7) ----- ----- TOTAL 100% 100% ===== ===== The Egg Products Division had higher dollar sales and higher dollar earnings in the period ended September 30, 1997, as compared to the results of the same period in 1996, due to strong unit sales, favorable spot market egg prices and contributions from the recently acquired Papetti's operations. Sales were particularly strong for certain value-added egg products, notably Easy Eggs(R), Table Ready(R) and MicroFresh. Egg prices decreased approximately 7% compared to levels in the comparable 1996 period, 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 1997 period. 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 September 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, new product introductions and increased promotional activity. This significant volume improvement allowed for divisional earnings growth. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED NINE MONTHS ENDED SEPTEMBER 30, 1997 VS NINE MONTHS ENDED SEPTEMBER 30, 1996 RESULTS OF OPERATIONS, CONT. The Dairy Products Division had higher dollar sales and higher dollar earnings in the period ended September 30, 1997, as compared to the results of the same period in 1996. Unit sales increased and were helped by promotional activities with certain customers, increased 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, in the period ended September 30, 1997, as compared to the results of the same period in 1996 and operated at a loss in both periods. The loss in the 1997 period was smaller than the loss in the 1996 period. Frozen french fry operations generated losses totaling approximately $0.05 per share (after tax) in the 1997 period, compared to a loss of approximately $0.13 per share (after tax) recorded in the 1996 period. Value-added refrigerated potato product sales generated earnings in the first nine months of 1997, but at levels below those experienced in the comparable 1996 period. Unit sales declined for such products, resulting in a reduced utilization of refrigerated products production lines, which pressured margins. The increase in gross profit margin of the Company for the period ended September 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 sales of commodity-sensitive products. Selling, general and administrative expenses increased as a percent of sales in the period ended September 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. Also, a non-recurring gain of approximately $1.3 million (pretax) was recorded in the third quarter of 1997, as a result of the disposition of french fry production assets. GENERAL Certain of the Company's products are sensitive to changes in commodity prices. The Company's Egg Products Division derived approximately 7% of net sales for the first nine months of 1997 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 net sales for the first nine months of 1997. 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 nine months of 1997 was approximately 7% below levels in the comparable 1996 period 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. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED GENERAL, CONT. 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 typically purchases 70%-90% of its raw potatoes from 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. Presently, all of the Potato Products Division's sales are 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. 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 $24,841,000 in capital expenditures during the nine months ended September, 1997. The Company plans to spend approximately $45,000,000 in total capital expenditures in 1997. The Company has an unsecured line of credit for $80,000,000 with its principal banks. As of September 30, 1997, there was $3,000,000 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 Reference is made to the Company's Form 10-Q filed for the quarterly period ended June 30, 1997 for discussion regarding two litigation matters settled earlier in 1997. Item 6. Exhibits and Reports on Form 8-K (a) Exhibit 27.1 Financial Data Schedule 10.51 Resolution adopted by the Board of Directors on September 2, 1997, amending the Severance Plan for Eligible Employees of Michael Foods, Inc. and Subsidiaries and extending its termination date for one additional year. (b) There were no reports on Form 8-K filed during the quarter ended September 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: November 12, 1997 By: /s/ Gregg A. Ostrander Gregg A. Ostrander (President and Chief Executive Officer) Date: November 12, 1997 By: /s/ John D. Reedy John D. Reedy (Vice President - Finance, Treasurer, Chief Financial Officer and Principal Accounting Officer)