1
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, 1996
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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: 0-15568
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MICHAEL FOODS, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 41-1579532
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
Suite 324, Park National Bank Building
5353 Wayzata Boulevard
Minneapolis, MN 55416
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip code)
(612) 546-1500
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [ X ]Yes [ ]No
The number of shares outstanding of the registrant's Common Stock, $.01
par value, as of November 1, 1996 was 19,395,731 shares.
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PART I - FINANCIAL INFORMATION
MICHAEL FOODS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
==============================================================================================================
September 30, December 31,
ASSETS 1996 1995
- ------ ------------ ------------
CURRENT ASSETS
Cash and cash equivalents $ 2,966,000 $ 1,921,000
Accounts receivable, less allowances 50,472,000 40,583,000
Inventories 57,875,000 58,845,000
Prepaid expenses and other 3,059,000 1,622,000
------------ ------------
Total current assets 114,372,000 102,971,000
PROPERTY PLANT AND EQUIPMENT-AT COST
Land 4,140,000 4,117,000
Buildings and improvements 98,198,000 95,109,000
Machinery and equipment 219,884,000 203,557,000
------------ ------------
322,222,000 302,783,000
Less accumulated depreciation 135,639,000 118,642,000
------------ ------------
186,583,000 184,141,000
OTHER ASSETS
Goodwill, net 56,550,000 57,829,000
Net assets held for sale 3,050,000 4,431,000
Other 9,514,000 9,855,000
------------ ------------
69,114,000 72,115,000
------------ ------------
$370,069,000 $359,227,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES
Notes payable $ 38,700,000 $ --
Current maturities of long-term debt 12,709,000 11,731,000
Accounts payable 37,674,000 27,362,000
Accrued compensation 4,389,000 6,543,000
Accrued insurance 6,907,000 6,945,000
Other accrued expenses 11,713,000 8,295,000
------------ ------------
Total current liabilities 112,092,000 60,876,000
LONG-TERM DEBT, less current maturities 42,910,000 89,690,000
DEFERRED INCOME TAXES 29,758,000 28,566,000
CONTINGENCIES -- --
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value, 3,000,000 shares authorized,
none issued -- --
Common stock, $.01 par value, 25,000,000 shares authorized,
shares issued 19,395,731 at September 30, 1996 and 19,332,001 at
December 31, 1995 194,000 193,000
Additional paid-in capital 112,613,000 112,374,000
Retained earnings 72,502,000 67,528,000
------------ ------------
185,309,000 180,095,000
------------ ------------
$370,069,000 $359,227,000
============ ============
==============================================================================================================
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 September 30, (Unaudited)
1996 1995
------------ ------------
Net sales $159,928,000 $136,257,000
Cost of sales 144,828,000 116,243,000
------------ ------------
Gross profit 15,100,000 20,014,000
Selling, general and administrative expenses 11,155,000 11,367,000
------------ ------------
Operating profit 3,945,000 8,647,000
Other (income) expense
Interest expense 1,976,000 1,841,000
Interest capitalized (234,000) (61,000)
------------ ------------
1,742,000 1,780,000
Interest income (12,000) (12,000)
------------ ------------
1,730,000 1,768,000
------------ ------------
Earnings before income taxes 2,215,000 6,879,000
Income tax expense 890,000 2,650,000
------------ ------------
NET EARNINGS $ 1,325,000 $ 4,229,000
============ ============
NET EARNINGS PER SHARE $ .07 $ .22
============ ============
DIVIDENDS PER SHARE $ .05 $ .05
============ ============
Weighted average shares outstanding 19,396,000 19,332,000
============ ============
See accompanying notes to condensed consolidated financial statements.
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MICHAEL FOODS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
Nine Months Ended September 30, (Unaudited)
1996 1995
---- ----
Net sales $455,478,000 $393,821,000
Cost of sales 403,267,000 333,913,000
------------ ------------
Gross profit 52,211,000 59,908,000
Selling, general and administrative expenses 33,597,000 34,292,000
------------ ------------
Operating profit 18,614,000 25,616,000
Other (income) expense
Interest expense 6,010,000 6,076,000
Interest capitalized (496,000) (113,000)
------------ ------------
5,514,000 5,963,000
Interest income (40,000) (91,000)
------------ ------------
5,474,000 5,872,000
------------ ------------
Earnings before income taxes 13,140,000 19,744,000
Income tax expense 5,260,000 7,600,000
------------ ------------
NET EARNINGS $ 7,880,000 $ 12,144,000
============ ============
NET EARNINGS PER SHARE $ .41 $ .63
============ ============
DIVIDENDS PER SHARE $ .15 $ .15
============ ============
Weighted average shares outstanding 19,379,000 19,326,000
============ ============
See accompanying notes to condensed consolidated financial statements.
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MICHAEL FOODS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, (Unaudited)
1996 1995
---- ----
Net cash provided by operating activities $ 30,965,000 $ 40,927,000
Cash flows from investing activities:
Capital expenditures (20,594,000) (17,275,000)
Net assets held for sale 800,000 453,000
Other assets 168,000 (2,321,000)
------------- --------------
Net cash used in investing activities (19,626,000) (19,143,000)
Cash flows from financing activities:
Purchase of shares (500,000) --
Proceeds from issuance of common stock 213,000 --
Payments on notes payable and long-term debt (99,916,000) (69,743,000)
Proceeds from notes payable and long-term debt 92,814,000 51,503,000
Cash dividends (2,905,000) (2,898,000)
------------- --------------
Net cash used in financing activities (10,294,000) (21,138,000)
------------- --------------
Net increase in cash and cash equivalents 1,045,000 646,000
Cash and cash equivalents at beginning of year 1,921,000 1,641,000
------------- --------------
Cash and cash equivalents at end of period $ 2,966,000 $ 2,287,000
============= ==============
See accompanying notes to condensed consolidated financial statements.
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MICHAEL FOODS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1996 and 1995
(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, 1996 and September 30, 1995 each include thirteen weeks of operations. For
clarity of presentation, the Company has described all periods presented as if
the quarter 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, 1996, the results of operations for the three and nine month periods ended
September 30, 1996 and 1995, and cash flows for the nine month periods ended
September 30, 1996 and 1995. The results of operations for the nine months
ended September 30, 1996 are not necessarily indicative of the results for the
full year.
NOTE B - INVENTORIES
Inventories other than raw potatoes and potato products are stated at the lower
of cost (determined on a first-in, first-out basis) or market. Raw potatoes
and potato products are stated at the lower of average cost for the year in
which produced or market. The cost of purchasing and raising flocks to laying
maturity is capitalized to inventory, then amortized, assuming no salvage
value, over the estimated productive life of each flock. Inventories consist
of the following:
September 30, December 31,
1996 1995
------------- ------------
Work in process and finished goods $21,873,000 $19,848,000
Raw materials and supplies 13,690,000 16,597,000
Flocks 22,312,000 22,400,000
----------- -----------
$57,875,000 $58,845,000
=========== ===========
NOTE C - LONG-TERM DEBT
The Company has an unsecured revolving line of credit with its principal banks
with interest payable at the banks' reference rates, or alternative variable
rates, at the Company's option. The revolving line of credit was increased
from $55,000,000 to $65,000,000 subsequent to the end of the third quarter. At
September 30, 1996, the Company had $2,700,000 outstanding at the reference
rate of 8.25% and $36,000,000 outstanding at an average variable rate of 5.9%.
This revolving line of credit, which matures on March 31, 1997, contains
certain restrictive covenants similar to the covenants contained in the
Company's senior promissory notes. At September 30, 1996, $16,300,000 of the
then available $55,000,000 revolving line of credit was unused.
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MICHAEL FOODS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1996 and 1995
(Unaudited)
NOTE D - 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 had prepaid royalty payments of approximately $8,000,000 at
September 30, 1996 and $8,300,000 as of December 31, 1995 included in other
assets related to an exclusive license agreement for the production and sale of
extended shelf-life liquid egg products. These amounts have arisen as a result
of the Company making payments to prosecute and defend the patents related to
the exclusive license agreement. The Company has the right to offset up to 50%
of otherwise payable royalties for the legal costs which it has incurred to
defend patents underlying the exclusive license agreement. The Company has
been informed by the U.S. Patent and Trademark Office that a patent examiner
has rejected the claims under the four process patents, which are the subject
of the license agreement. Management and the licensor intend to appeal the
decision of the examiner and believe the validity of the patents will
ultimately be upheld. Counsel to the Company and the licensor estimates a full
appeal process could take two years. During the appeal process, the patents
remain valid and in full force and effect. Based upon current and expected
product volume levels, the Company expects to fully recover the remaining
prepaid royalties over the useful life of the exclusive license agreement.
However, there can be no assurance that the Company will be able to fully
recover its prepaid royalty payments. If the patents are ultimately denied
after all appeals have been concluded, 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 is settling claims with consumers who became ill
after eating the product before the recall. The customer has filed a suit,
whereby the Company is a co-defendant with other companies alleged to have
supplied contaminated product to the customer's plant. The customer is seeking
damages for losses incurred, as well as alleged loss of past and future
profits. Management and its counsel believe the Company has substantial
defenses to the allegations and believe it is unlikely the Company will incur a
loss from this claim materially in excess of its 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 results of
operations, liquidity or consolidated financial position.
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MICHAEL FOODS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1996 and 1995
(Unaudited)
NOTE E - SIGNIFICANT ACQUISITION
In June, 1996, the Company entered into an agreement to purchase Papetti's
Hygrade Egg Products, Inc. and its affiliates ("Papetti's") in a cash and stock
transaction, along with other consideration, valued in total at approximately
$91 million. Additionally, the Company is to assume approximately $28 million
in debt issued by Papetti's. Papetti's is a producer of further processed egg
products with annual sales in excess of $275 million and total assets of
approximately $100 million. The cash portion of the purchase price is
approximately $48 million and the Common Stock portion is payable with 3.4
million shares. This acquisition transaction will also resolve the patent
litigation presently pending between the parties (see Note D). Pending
satisfactory completion of the due diligence review process and securing of
financing to fund the proposed transaction, it is expected that the acquisition
will close late in the fourth quarter of 1996 or the first quarter of 1997.
NOTE F - REORGANIZATION AGREEMENT
In December, 1995, the Company entered into a Reorganization Agreement with
North Star Universal, Inc. ("North Star") and NSU Merger Co. The
Reorganization Agreement was amended in September, 1996. North Star holds
approximately 38% of the Company's Common Stock. The effect of the
transactions set forth in the Reorganization Agreement is to distribute these
shares to North Star's shareholders after a certain portion of the holdings are
effectively retired to the Company's treasury in consideration for the Company
assuming North Star's net indebtedness, which is estimated to be approximately
$27 million. Following the reorganization, North Star will be renamed Michael
Foods, Inc. and will be comprised of the present operations and management of
the Company. It is expected that the transactions will close in the first
quarter of 1997.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1996 VS THREE MONTHS ENDED SEPTEMBER 30, 1995
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:
Three Months Ended September 30,
--------------------------------
1996 1995
---------- ----------
Eggs and Egg Products 42% 42%
Refrigerated Distribution 32 32
Potato Products 13 16
Dairy Products 18 15
Intercompany Sales (5) (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,
-------------------------------
1996 1995
---------- ----------
Eggs and Egg Products 61% 61%
Refrigerated Distribution 35 15
Potato Products (38) 6
Dairy Products 42 18
--- ---
TOTAL 100% 100%
=== ===
The Eggs and Egg Products Division had higher dollar sales and lower dollar
earnings in the period ended September 30, 1996, as compared to the results of
the same period in 1995. The shell egg category operated at a loss in both
periods. Profitability was lower for most egg products, but increased for
certain egg products. Feed costs, which typically represent roughly
two-thirds of the cost of producing an egg, were approximately 70% higher in
the 1996 period than in the 1995 period, reflecting substantially higher market
prices for corn and soybean meal. This more than offset an approximate 20%
year-over-year increase in egg prices as reported by Urner Barry Publications -
a widely quoted industry pricing service. Significant sales increases were
recorded for certain non-commodity, and less commodity-sensitive, egg products,
notably Easy Eggs (R)(extended shelf-life liquid whole eggs), MicroFresh (frozen
omelets, patties and curds) and dried products, which helped mitigate the
impact of high feed costs on earnings.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
THREE MONTHS ENDED SEPTEMBER 30, 1996 VS THREE MONTHS ENDED SEPTEMBER 30, 1995
RESULTS OF OPERATIONS, CONT.
The Refrigerated Distribution Division had higher dollar sales and higher
dollar earnings in the period ended September 30, 1996, as compared to the
results of the same period in 1995. Unit sales in core refrigerated items rose
significantly. Profit margins expanded mainly as a result of this volume
improvement, with additional positive impacts seen from improved pricing in
certain lines and effective expense control.
The Potato Products Division had slightly lower dollar sales and operated at a
loss in the period ended September 30, 1996, as compared to the results of the
same period in 1995. A competitive environment in the french fry processing
industry resulted in a loss of market share and depressed unit sales for frozen
potato products. This sharply reduced the production efficiencies of the main
potato products processing facility. Additionally, cost pressures from
procuring more expensive open market potatoes to complement potatoes delivered
under contract and processing yield pressures, from the utilization of large
amounts of under-sized potatoes, resulted in further divisional earnings
pressure.
The Dairy Products Division had higher dollar sales and higher dollar earnings
in the period ended September 30, 1996, as compared to the results of the same
period in 1995. Unit sales rose significantly, due to favorable weather
throughout much of the Division's trade territory, excellent volume growth at a
satellite plant, growth in shelf-stable coffee creamer sales and the addition
of major new customers. Dairy ingredient costs rose sharply during the
quarter, reflecting a tight milk supply in the United States, which somewhat
reduced overall operating profit margins.
The decline in the gross profit margin of the Company for the period ended
September 30, 1996, as compared to the results of the same period in 1995,
reflected the factors discussed above, particularly the significant raw
material issues evident in the Egg Products and Potato Products divisions. 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. However, in the 1996 period finished
product pricing did not increase rapidly enough to offset the pressures from
raw material cost and potato quality issues. Selling, general and
administrative expenses decreased as a percent of sales in the period ended
September 30, 1996, as compared to the results of the same period in 1995, due
to the significant sales increase and effective management of operating
expenses across the Company.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
NINE MONTHS ENDED SEPTEMBER 30, 1996 VS NINE MONTHS ENDED SEPTEMBER 30, 1995
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,
------------------------------
1996 1995
---------- ----------
Eggs and Egg Products 43% 41%
Refrigerated Distribution 33 33
Potato Products 14 16
Dairy Products 16 15
Intercompany Sales (6) (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:
Nine Months Ended September 30,
-------------------------------
1996 1995
---------- ----------
Eggs and Egg Products 60% 57%
Refrigerated Distribution 24 15
Potato Products (7) 13
Dairy Products 23 15
--- ---
TOTAL 100% 100%
=== ===
The Eggs and Egg Products Division had higher dollar sales and lower dollar
earnings in the nine months ended September 30, 1996, as compared to the
results of the same period in 1995. The shell egg category operated at a loss
in both periods. Feed costs, which typically represent roughly two-thirds of
the cost of producing an egg, were sharply higher in the 1996 period than in
the 1995 period, more than offsetting increased egg prices, which were
approximately 24% higher in the first nine months of 1996 as compared to the
same period in 1995, as reported by Urner Barry Publications - a widely quoted
industry pricing service. Sales increased for certain value-added egg
products, notably Easy Eggs (R) and MicroFresh, which helped mitigate the
impact of high feed costs on earnings.
The Refrigerated Distribution Division had higher dollar sales and higher
dollar earnings in the nine months ended September 30, 1996, as compared to the
results of the same period in 1995. Unit sales increased compared to the
levels of the first nine months of 1995. The combination of volume growth,
pricing improvements in certain product lines and effective expense control
allowed for divisional profit improvement.
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12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
NINE MONTHS ENDED SEPTEMBER 30, 1996 VS NINE MONTHS ENDED SEPTEMBER 30, 1995
RESULTS OF OPERATIONS, CONT.
The Potato Products Division had higher dollar sales and operated at a loss in
the nine months ended September 30, 1996, as compared to the results of the
same period in 1995. A competitive environment in the french fry processing
industry resulted in a loss of market share and depressed unit sales for frozen
potato products. This sharply reduced the production efficiencies of the main
potato products processing facility. Additionally, cost pressures from
procuring more expensive open market potatoes to complement potatoes delivered
under contract and processing yield pressures, from the utilization of large
amounts of under-sized potatoes, resulted in further divisional earnings
pressure.
The Dairy Products Division had higher dollar sales and higher dollar earnings
in the nine months ended September 30, 1996, as compared to the results of the
same period in 1995. Unit sales rose significantly, due to favorable weather
throughout much of the Division's trade territory, excellent volume growth at a
satellite plant, growth in shelf-stable coffee creamer sales and the addition
of major new customers. Dairy ingredient costs rose sharply during the period,
reflecting a tight milk supply in the United States, which reduced overall
operating profit margins.
The decline in the gross profit margin of the Company for the nine months ended
September 30, 1996, as compared to the results of the same period in 1995,
reflected the factors discussed above, particularly the significant raw
material issues evident in the Egg Products and Potato Products divisions. 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. However, in the 1996 period finished
product pricing did not increase rapidly enough to offset the pressures from
raw material cost and potato quality issues. Selling, general and
administrative expenses decreased as a percent of sales in the nine month
period ended September 30, 1996, as compared to the results of the same period
in 1995, due to the significant sales increase and effective management of
operating expenses across the Company.
GENERAL
Certain of the Company's products are sensitive to changes in commodity prices.
The Company's egg operations derive approximately 15% - 20% of that division's
net sales from shell eggs, which are sensitive to commodity price swings. A
value-added egg product line, Easy Eggs(R), accounts for approximately 45% of
Egg Products Division net sales and was a comparable percent of sales in the
first nine months of 1995. The remainder of divisional sales are derived from
other egg products, which vary from highly value-added to quite
commodity-sensitive. 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
1996 was approximately 24% higher than 1995 levels as measured by a widely
quoted pricing service. Gross profit margins from value-added egg products are
less sensitive to commodity price fluctuations.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
GENERAL, CONT.
The Company's Refrigerated Distribution Division derives approximately 70% of
its net sales from refrigerated products produced by others, thereby reducing
the effect of commodity price swings. The balance of divisional 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 derives approximately 65% of its net sales from
the refrigerated potato products line. The division typically purchases
80%-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 division has been reduced in recent years due to significant
increases in higher value-added refrigerated potato products sales.
The Dairy Products Division sells its products primarily on a cost-plus basis
and, therefore, the division's earnings are not typically affected 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 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.
In December, 1995, the Company entered into a Reorganization Agreement with
North Star Universal, Inc. ("North Star") and NSU Merger Co. (the "North Star
Transaction"). Michael Foods, Inc. will merge with a subsidiary of North Star
created for the transaction. After North Star completes certain distributions
of all of the assets unrelated to the Company to its shareholders, North Star
will change its name to Michael Foods, Inc. This Company will be comprised of
the current operations and management of the Company and the effects of the
North Star Transaction will not change the business of the Company. However,
as a result of the North Star Transaction, the Company will have an increased
debt level of approximately $27 million, and attendant interest expense, with a
reduced number of outstanding Common Stock shares. The North Star Transaction
is expected to be accretive to earnings per share.
In June, 1996, the Company entered into an agreement to purchase Papetti's
Hygrade Egg Products, Inc. and its affiliates ("Papetti's"), a producer of
further processed egg products, for cash, stock and other consideration valued
at approximately $91 million. The cash portion of the purchase price is
approximately $48 million and the Common Stock portion is payable with 3.4
million shares. This acquisition transaction will also resolve the patent
litigation presently pending between the parties. Additionally, the Company is
to assume approximately $28 million in debt issued by Papetti's. Pending
satisfactory completion of the due diligence review process and securing of
financing to fund the proposed transaction, it is expected that the acquisition
will close late in the fourth quarter of 1996 or the first quarter of 1997.
Papetti's had 1995 annual sales in excess of $275 million, has total assets of
approximately $100 million and has been consistently profitable throughout its
history. Assuming completion of the Papetti's transaction, approximately 60% -
65% of the Company's annual net sales will be derived from egg products, in
contrast to approximately 43% of net sales for the nine months ended September
30, 1996. Management believes the Company will be the largest
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14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
CAPITAL RESOURCES AND LIQUIDITY, CONT.
producer of further-processed egg products in the world. The transaction will
significantly increase the Company's involvement in the egg products industry.
Inherent in the industry are exposures to commodity-related variances in feed
costs and commodity-related variances in pricing for certain egg products.
Besides adding significantly to net sales, the acquisition is expected to
increase the Company's operating profits, net interest expense and net
earnings. Shares outstanding will also increase by approximately 3.4 million
shares.
The Papetti's acquisition and the North Star Transaction will leave the Company
with a substantially increased debt level. Management anticipates that at
least 50% of the Company's capitalization will be comprised of debt upon
completion of these transactions. Free cash flow will be applied to reducing
this level of debt in coming years. Because of the increased financial
leverage, management anticipates that equity may be considered as a means to
fund any significant acquisitions over the next 1 - 3 years. Additionally,
management expects that annual capital spending levels may be held within the
range which has prevailed in recent years due to this increased leverage.
The Company invested approximately $20,600,000 in capital expenditures during
the nine months ended September 30, 1996. The Company's 1996 plan calls for
approximately $32,000,000 in total capital expenditures.
The Company has an unsecured line of credit for $65,000,000 with its principal
banks. As of September 30, 1996, approximately $38,700,000 was borrowed under
the 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, the Refrigerated
Distribution Division experiences 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. 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.
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PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.108 Seventh Amendment to Revolving Note Agreement between Bank of America
National Trust and Savings Association, as Agent, and Michael Foods,
Inc., dated as of October 30, 1996
10.109 Revolving Note between Michael Foods, Inc. and Norwest Bank Minnesota,
N. A. dated October 30, 1996
10.110 Revolving Note between Michael Foods, Inc. and Boatmen's National Bank
dated October 30, 1996
10.111 Agreement and Plan of Reorganization, and Amendment Number 1, by and
among Michael Foods, Inc., M. G. Waldbaum Company and Papetti's Hygrade
Egg Products, Inc., and Quaker State Farms, Inc., Papetti's of Iowa
Food Products, Inc., Monark Egg Corporation, Egg Specialties, Inc.,
Papetti Foods, Inc., Casa Trucking Limited Partnership, Papetti
Transport Leasing Limited Partnership, and Papetti Equipment Leasing
Partnership
27.1 Financial Data Schedule
(b) There was one report on Form 8-K filed during the quarter ended September
30, 1996. Under Item 5, the Company reported on July 10, 1996 that it had
entered into an Agreement and Plan of Reorganization with Papetti's Hygrade Egg
Products, Inc. ("Papetti's") and other entities related to Papetti's, pursuant
to which, through a series of transactions, the Company will acquire the assets
of Papetti's through a merger and the assets of the related entities through
merger or asset purchase.
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 7, 1996 By: /s/ Gregg A. Ostrander
-------------------------------
Gregg A. Ostrander
(President and Chief
Executive Officer)
Date: November 7, 1996 By: /s/ John D. Reedy
-------------------------------
John D. Reedy
(Vice President - Finance,
Treasurer, Chief Financial
Officer and Principal
Accounting Officer)
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