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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 29, 2001
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 0-27818
DOANE PET CARE COMPANY
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 43-1350515
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)
210 WESTWOOD PLACE SOUTH, SUITE 400
BRENTWOOD, TN 37027
(Address of Principal Executive Office, Including Zip Code)
(615) 373-7774
(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. Yes [X] No [ ]
As of November 2, 2001, registrant had outstanding 1,000 shares of
common stock.
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TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
PAGE
Item 1. Financial Statements
Unaudited Condensed Consolidated Balance Sheets as of September 29, 2001
and December 30, 2000....................................................................... 1
Unaudited Condensed Consolidated Statements of Income for the three
months and nine months ended September 29, 2001 and September 30, 2000...................... 2
Unaudited Condensed Consolidated Statement of Stockholder's Equity and
Comprehensive Income for the nine months ended September 29, 2001........................... 3
Unaudited Condensed Consolidated Statements of Cash Flows for the
nine months ended September 29, 2001 and September 30, 2000................................. 4
Notes to Unaudited Condensed Consolidated Financial Statements.............................. 5
Independent Accountants' Review Report...................................................... 8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations....................................................................... 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk.................................. 13
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K............................................................ 14
Signatures........................................................................................... 15
</Table>
DOANE PET CARE COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PAR VALUE AMOUNTS)
SEPTEMBER 29, DECEMBER 30,
2001 2000
------------- ------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 5,602 $ 3,158
Accounts receivable, net 112,565 125,135
Inventories, net 63,198 73,013
Deferred tax assets 10,558 12,841
Prepaid expenses and other current assets 5,156 5,796
--------- ---------
Total current assets 197,079 219,943
Property, plant and equipment, net 257,676 284,705
Goodwill and other intangible assets, net 351,803 364,108
Other assets 39,673 38,306
--------- ---------
Total assets $ 846,231 $ 907,062
========= =========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Current maturities of long-term debt $ 28,265 $ 29,826
Accounts payable 83,365 110,696
Accrued liabilities 56,199 53,609
--------- ---------
Total current liabilities 167,829 194,131
Long-term debt, excluding current maturities 534,425 543,339
Other long-term liabilities 9,832 8,098
Deferred tax liabilities 20,237 35,408
--------- ---------
Total liabilities 732,323 780,976
--------- ---------
Senior Preferred Stock, 3,000,000 shares authorized,
1,200,000 shares issued and outstanding 62,931 55,205
--------- ---------
Commitments and contingencies
Stockholder's equity:
Common stock, $0.01 par value; 1,000 shares authorized,
issued and outstanding -- --
Additional paid-in-capital 115,655 107,280
Accumulated other comprehensive income (loss) (4,312) 1,318
Accumulated deficit (60,366) (37,717)
--------- ---------
Total stockholder's equity 50,977 70,881
--------- ---------
Total liabilities and stockholder's equity $ 846,231 $ 907,062
========= =========
See accompanying notes to the unaudited condensed consolidated financial
statements and accompanying independent accountants' review report.
1
DOANE PET CARE COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------- ---------------------------
SEPTEMBER 29, SEPTEMBER 30, SEPTEMBER 29, SEPTEMBER 30,
2001 2000 2001 2000
------------- ------------- ------------- -------------
Net sales $ 211,622 $ 225,723 $ 690,130 $ 640,878
Cost of goods sold 166,099 173,328 560,903 487,566
--------- --------- --------- ---------
Gross profit 45,523 52,395 129,227 153,312
Operating expenses:
Promotion and distribution 18,941 18,863 59,978 52,776
Selling, general and administrative 10,021 13,014 35,512 35,489
Amortization of intangibles 3,421 3,379 10,318 9,228
Non-recurring expenses -- -- 6,662 9,028
--------- --------- --------- ---------
Income from operations 13,140 17,139 16,757 46,791
Interest expense, net 14,464 14,441 43,338 36,878
Other income, net (44) (225) (648) (1,046)
--------- --------- --------- ---------
Income (loss) before income taxes (1,280) 2,923 (25,933) 10,959
Income tax expense (benefit) (1,296) 1,331 (11,010) 6,385
--------- --------- --------- ---------
Net income (loss) 16 1,592 (14,923) 4,574
Preferred stock dividends and accretion (2,657) (2,345) (7,726) (6,822)
--------- --------- --------- ---------
Net loss available to common shares $ (2,641) $ (753) $ (22,649) $ (2,248)
========= ========= ========= =========
Basic and diluted net loss per common share $ (2,641) $ (753) $ (22,649) $ (2,248)
========= ========= ========= =========
Basic and diluted weighted-average common
shares outstanding 1,000 1,000 1,000 1,000
========= ========= ========= =========
See accompanying notes to the unaudited condensed consolidated financial
statements and accompanying independent accountants' review report.
2
DOANE PET CARE COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF
STOCKHOLDER'S EQUITY AND COMPREHENSIVE INCOME
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER
---------------- PAID-IN COMPREHENSIVE ACCUMULATED
SHARES AMOUNT CAPITAL INCOME (LOSS) DEFICIT TOTAL
----- ------ -------- ------------- --------- ---------
Balances at December 30, 2000 1,000 $ -- $107,280 $ 1,318 $ (37,717) $ 70,881
Comprehensive loss:
Net loss -- -- -- -- (14,923) (14,923)
Foreign currency translation, net -- -- -- (3,056) -- (3,056)
Unrealized holding loss, net of
deferred tax benefit of $1,641 -- -- -- (2,574) -- (2,574)
---------
Total comprehensive loss (20,553)
---------
Preferred stock dividends -- -- -- -- (6,918) (6,918)
Accretion of preferred stock -- -- -- -- (808) (808)
Parent capital contribution -- -- 8,375 -- -- 8,375
----- ------ -------- ------- --------- ---------
Balances at September 29, 2001 1,000 $ -- $115,655 $(4,312) $ (60,366) $ 50,977
===== ====== ======== ======= ========= =========
See accompanying notes to the unaudited condensed consolidated financial
statements and accompanying independent accountants' review report.
3
DOANE PET CARE COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
NINE MONTHS ENDED
-----------------------------
SEPTEMBER 29, SEPTEMBER 30,
2001 2000
------------- -------------
Cash flows from operating activities:
Net income (loss) $ (14,923) $ 4,574
Items not requiring (providing) cash:
Depreciation 20,792 16,843
Amortization of intangibles 10,318 9,228
Deferred income tax expense (benefit) (11,104) 5,979
Non-cash interest expense 4,165 1,724
Equity in joint ventures (692) (741)
Other non-cash charges, net 6,716 608
Changes in current assets and liabilities (20,170) (1,076)
--------- ---------
Net cash provided by (used in) operating activities (4,898) 37,139
--------- ---------
Cash flows from investing activities:
Capital expenditures (9,673) (22,114)
Proceeds from sale of assets 20,884 --
Acquisition related payments, net of cash received -- (143,893)
Other, net (2,071) (2,343)
--------- ---------
Net cash provided by (used in) investing activities 9,140 (168,350)
--------- ---------
Cash flows from financing activities:
Net payments under revolving credit agreements (3,500) (9,000)
Proceeds from issuance of long-term debt 17,055 158,619
Principal payments on long-term debt (20,914) (16,226)
Payments for debt issuance costs (2,831) (2,501)
Parent capital contribution 8,375 411
--------- ---------
Net cash provided by (used in) financing activities (1,815) 131,303
Effect of exchange rate changes on cash and cash equivalents 17 (613)
--------- ---------
Increase (decrease) in cash and cash equivalents 2,444 (521)
Cash and cash equivalents, beginning of period 3,158 7,194
--------- ---------
Cash and cash equivalents, end of period $ 5,602 $ 6,673
========= =========
See accompanying notes to the unaudited condensed consolidated financial
statements and accompanying independent accountants' review report.
4
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
of Doane Pet Care Company and Subsidiaries (the "Company") do not include all
the information and footnotes required by generally accepted accounting
principles for complete financial statements. The year end condensed
consolidated balance sheet data was derived from audited financial statements.
In the opinion of management, all material adjustments, consisting of normal and
recurring adjustments, have been made which were considered necessary to present
fairly the financial position and the results of operations and cash flows at
the dates and for the periods presented. Certain reclassifications have been
made to previously reported consolidated financial statements to conform with
the fiscal 2001 presentation.
The accompanying unaudited condensed consolidated financial statements
should be read in conjunction with the audited consolidated financial statements
and notes contained in the Company's 2000 annual report on Form 10-K/A for the
fiscal year ended December 30, 2000 (the "2000 10-K/A"), including related
exhibits. The accounting policies used in preparing these financial statements
are the same as those summarized in the 2000 10-K/A.
The Company's fiscal year ends on the Saturday nearest to the end of
December. Each month and quarter also end on a Saturday with the third quarters
of fiscal 2000 and 2001 ending on September 30, 2000 and September 29, 2001,
respectively.
(2) INVENTORIES
A summary of inventories, net of valuation allowances, follows (in
thousands):
SEPTEMBER 29, DECEMBER 30,
2001 2000
------------- ------------
(UNAUDITED)
Raw materials $13,402 $18,889
Packaging materials 21,700 25,142
Finished goods 28,096 28,982
------- -------
Total $63,198 $73,013
======= =======
(3) AROVIT ACQUISITION
On May 10, 2000, the Company acquired A/S Arovit Petfood ("Arovit"),
headquartered in Esbjerg, Denmark, for approximately DKK 1.2 billion ($144.4
million) and assumed indebtedness, net of cash, of approximately DKK 97.0
million ($11.8 million). Arovit manufactures and sells a full range of pet food
products, throughout Europe, for dogs and cats, including wet, dry and treats,
primarily through private label programs.
Set forth below is certain unaudited pro forma consolidated financial
information of the Company for the nine months ended September 30, 2000 that has
been adjusted to reflect the Company's acquisition of Arovit as if such
transaction occurred at January 2, 2000 (in thousands, except per share
amount):
NINE MONTHS ENDED
SEPTEMBER 30, 2000
------------------
Net sales $ 691,297
Net income 2,647
Basic and diluted net loss
per common share (4,175)
5
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
The pro forma financial data above is based on certain assumptions and
estimates; and therefore, does not purport to be indicative of the results that
would actually have been obtained had the acquisition of Arovit been completed
as of such dates or indicative of future results of operations and financial
position.
(4) ISSUANCE OF LONG-TERM DEBT
In March 2001, the Company refinanced $25.0 million of indebtedness
under its existing senior credit facility with loans and warrants from
shareholders of its parent, Doane Pet Care Enterprises, Inc. (the "Sponsor
Facility"). The Sponsor Facility was used to pay down the senior credit
facility, and permanently reduced the commitment under the revolving credit
facility from $100.0 million to $75.0 million. In connection with the
refinancing, the Company also entered into an amendment of its senior credit
facility (the "Amendment"). The Amendment reduced the financial covenant
requirements for the two years ended December 31, 2002. The Company is in
compliance with the revised covenants as of September 29, 2001.
The Amendment also contained the following new provisions: 1) a $15.0
million reduction in the commitments under the revolving credit facility until
certain financial performance tests are achieved, which the Company does not
believe will be met in 2001; 2) a restriction whereby the Company can incur no
more than $2.5 million of indebtedness incremental to the current availability
under its debt agreements; 3) a limit on the amount of future capital
expenditures to $22.5 million per year for the calendar years 2001 and 2002; 4)
a limit on other investing activities; 5) a 0.5% increase in the interest rate
under the senior credit facility until certain financial performance targets are
achieved and once achieved, a 0.25% reduction in the interest rate; 6) payment
of certain fees and expenses associated with the Amendment; and 7) restrictions
on repayments under the Sponsor Facility.
The Sponsor Facility is a senior unsecured loan bearing interest at
15.0%. Principal and accrued interest under the loan are due on March 15, 2007.
The Amendment restricts the payment of any interest or principal on the Sponsor
Facility until the ratio of the Company's Average Senior Debt to EBITDA, as
defined in the Amendment, calculated on a pro forma basis giving effect to any
such principal or interest payments, is no greater than 2.75 to 1.00 and the
Company maintains at least $35.0 million of credit availability (the "Payment
Test"). The Sponsor Facility requires that all unpaid interest and principal be
paid at the end of each quarter in which the Payment Test is achieved, to the
extent allowed by the senior credit facility. The Company has not made any
payments and does not believe any payments will be made on the Sponsor Facility
in fiscal 2001. The Company's Parent issued warrants in connection with the
Sponsor Facility that give the warrantholders the right to purchase 30.0% of the
outstanding stock of the Company's Parent on a fully diluted basis for a nominal
amount.
(5) SALE OF CERTAIN BUSINESS ASSETS
In the second quarter of fiscal 2001, the Company sold its Perham,
Minnesota dry dog and cat food facility and related assets, including the
Tuffy's brand, for approximately $7.0 million. In addition, the Company also
sold its Deep Run domestic wet pet food business and related assets, other than
real estate, for approximately $13.9 million. The Company recognized a $4.5
million net loss on the sale of these assets, which is included as a portion of
non-recurring expenses in fiscal 2001.
(6) ACCRUALS FOR RESTRUCTURING COSTS
As of December 30, 2000, the Company had $6.5 million of accruals for
restructuring costs. In the second quarter of fiscal 2001, the Company accrued
$5.1 million associated with the sale of certain business assets and corporate
restructuring costs. The Company sold two businesses, closed three plants,
completed certain corporate restructuring and as a result, terminated 312
employees in the nine months ended September 29, 2001. During the three months
and nine months ended September 29, 2001, the Company made cash payments of
approximately $1.5 million and $4.6 million, respectively, related to
6
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
restructuring charges. At September 29, 2001, the Company had $7.0 million of
remaining restructuring accruals of which it expects to pay $2.2 million in
fiscal 2001, $3.8 million in fiscal 2002 and the remainder in fiscal 2003.
(7) COMMITMENTS AND CONTINGENCIES
The Company is party, in the ordinary course of business, to claims and
litigation. In management's opinion, the resolution of such matters is not
expected to have a material impact on the future financial condition, results of
operations or cash flows of the Company.
7
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
The Board of Directors
Doane Pet Care Company
We have reviewed the condensed consolidated balance sheet of Doane Pet Care
Company and Subsidiaries as of September 29, 2001, the related condensed
consolidated statements of income for the three-month and nine-month periods
ended September 29, 2001 and September 30, 2000, the condensed consolidated
statement of stockholder's equity and comprehensive income for the nine-month
period ended September 29, 2001 and the condensed consolidated statements of
cash flows for the nine-month periods ended September 29, 2001 and September 30,
2000. These condensed consolidated financial statements are the responsibility
of the Company's management.
We have conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with auditing standards generally accepted in the United States of
America, the objective which is the expression of an opinion regarding the
financial statements taken as a whole. Accordingly, we do not express such an
opinion.
Based on our review, we are not aware of any material modifications that should
be made to the condensed consolidated financial statements referred to above for
them to be in conformity with accounting principles generally accepted in the
United States of America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of
Doane Pet Care Company and Subsidiaries as of December 30, 2000, and the related
consolidated statements of income, stockholder's equity and comprehensive income
and cash flows for the year then ended (not presented herein); and in our report
dated March 29, 2001, we expressed an unqualified opinion on those consolidated
financial statements. In our opinion, the information set forth in the
accompanying consolidated balance sheet as of December 30, 2000 is fairly
stated, in all material respects, in relation to the consolidated balance sheet
from which it has been derived.
/s/ KPMG LLP
Houston, Texas
October 31, 2001
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This quarterly report on Form 10-Q contains certain "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21B of the Securities Exchange Act of 1934, as amended,
which are based on management's current views and assumptions regarding future
events and financial performance. All statements other than statements of
historical facts included in this report are forward-looking statements. Readers
should not place undue reliance on any forward-looking statements, which speak
only as of the date made. Although the Company believes the expectations
reflected in such forward-looking statements are reasonable, it can give no
assurance that such expectations will prove to have been correct. It is
important to note that results could differ materially from those projected in
such forward-looking statements. Information concerning factors that could cause
actual results to differ materially from those in such forward-looking
statements is contained in sections "Forward-Looking Statements" and "Risk
Factors" in Item 1 of our 2000 10-K/A.
RESULTS OF OPERATIONS
Readers are encouraged to consider carefully the accompanying unaudited
condensed consolidated financial statements and related notes contained
elsewhere in this quarterly report on Form 10-Q and our consolidated financial
statements and related notes contained in our 2000 10-K/A as they read the
discussion below (table in thousands, except percentages):
THREE MONTHS ENDED NINE MONTHS ENDED
---------------------------------------- ----------------------------------------
SEPTEMBER 29, 2001 SEPTEMBER 30, 2000 SEPTEMBER 29, 2001 SEPTEMBER 30, 2000
------------------ ------------------ ------------------ ------------------
Net sales $211,622 100.0% $225,723 100.0% $690,130 100.0% $640,878 100.0%
Cost of goods sold 166,099 78.5 173,328 76.8 560,903 81.3 487,566 76.1
-------- ----- -------- ----- -------- ----- -------- -----
Gross profit 45,523 21.5 52,395 23.2 129,227 18.7 153,312 23.9
Operating expenses:
Promotion and distribution 18,941 9.0 18,863 8.4 59,978 8.7 52,776 8.2
Selling, general and
administrative 10,021 4.7 13,014 5.8 35,512 5.1 35,489 5.5
Amortization of intangibles 3,421 1.6 3,379 1.4 10,318 1.5 9,228 1.5
Non-recurring expenses -- -- -- -- 6,662 1.0 9,028 1.4
-------- ----- -------- ----- -------- ----- -------- -----
Income from operations 13,140 6.2 17,139 7.6 16,757 2.4 46,791 7.3
Interest expense, net 14,464 6.8 14,441 6.4 43,338 6.3 36,878 5.8
Other income, net (44) -- (225) (0.1) (648) (0.1) (1,046) (0.2)
-------- ----- -------- ----- -------- ----- -------- -----
Income (loss) before income
taxes (1,280) (0.6) 2,923 1.3 (25,933) (3.8) 10,959 1.7
Income tax expense (benefit) (1,296) (0.6) 1,331 0.6 (11,010) (1.6) 6,385 1.0
-------- ----- -------- ----- -------- ----- -------- -----
Net income (loss) $ 16 --% $ 1,592 0.7% $(14,923) (2.2)% $ 4,574 0.7%
======== ===== ======== ===== ======== ===== ======== =====
THREE MONTHS ENDED SEPTEMBER 29, 2001 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 2000
Net sales. Our net sales in the third quarter of 2001 decreased 6.2% to
$211.6 million from $225.7 million in the comparable 2000 period. The decrease
was primarily due to lower sales volumes, in part resulting from the sale of our
Deep Run domestic wet pet food business and our dry pet food operation located
in Perham, Minnesota (collectively, the "Divestitures"), partially offset by a
price increase implemented in the first quarter of 2001. See Note 5 - "Sale of
Certain Business Assets" to our unaudited condensed consolidated financial
statements included herein and "Inflation and Changes in Prices."
Gross profit. Our gross profit in the third quarter of 2001 decreased
$6.9 million to $45.5 million from $52.4 million in the comparable 2000 period
primarily due to higher ingredient, natural gas and healthcare costs as well as
lower sales volumes and an unfavorable global sales mix. These factors were
partially offset by a price increase and the closure of certain inefficient
manufacturing facilities and manufacturing efficiencies achieved at our
remaining plants. In addition, the decrease also resulted from $2.0 million
unfavorable impact caused by the volatility of commodity prices under the SFAS
133 fair value accounting of our commodity derivative instruments. Such
accounting resulted in a $0.1 million
9
decrease in our cost of goods sold for the third quarter of 2001 compared to a
$2.1 million decrease in our cost of goods sold in the same 2000 period.
Selling, general and administrative. Selling, general and
administrative expenses for the third quarter decreased 23.0% to $10.0 million
from $13.0 million in the comparable 2000 period primarily due to lower costs
resulting from corporate restructuring and other cost savings initiatives. These
favorable items were partially offset by annual wage increases and higher
healthcare costs.
Income tax expense (benefit). We recognized an income tax benefit of
$1.3 million in the third quarter of 2001 and income tax expense of $1.3 million
in the comparable 2000 period. Our effective tax rate is different from the
combined U.S. federal and state statutory rate of 38.9% due to the difference
between U.S. and foreign effective tax rates and items which are not deductible
for tax purposes, primarily certain goodwill amortization.
NINE MONTHS ENDED SEPTEMBER 29, 2001 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 2000
Net sales. Our net sales in the nine months ended September 29, 2001
increased 7.7% to $690.1 million from $640.9 million in the comparable 2000
period primarily due to the impact of the Arovit acquisition in May 2000.
Excluding the impact of this acquisition, net sales for the 2001 period were
comparable to the 2000 period due to the price increase implemented in the first
quarter of 2001 being offset by the impact of the Divestitures. See Note 5 -
"Sale of Certain Business Assets" to our unaudited condensed consolidated
financial statements included herein and "Inflation and Changes in Prices."
Gross profit. Our gross profit in the nine months ended September 29,
2001 decreased $24.1 million to $129.2 million from $153.3 million in the
comparable 2000 period, in part resulting from the unfavorable impact caused by
the volatility of commodity prices under the SFAS 133 fair value accounting of
our commodity derivative instruments. Such accounting resulted in a $10.0
million increase in our cost of goods sold in the 2001 period compared to a $3.2
million reduction in our cost of goods sold in the same 2000 period, which
accounts for $13.2 million of the $24.1 million reduction in gross profit. In
addition, our gross margin was affected by significantly higher ingredient costs
in the 2001 period (primarily due to the impact of the BSE, or "mad cow
disease", scare in Europe), a substantial increase in natural gas and healthcare
costs, increases in annual wages, as well as an unfavorable global sales mix.
The shortfall was partially offset by the favorable impact of the Arovit
acquisition on the 2001 period, a price increase implemented in the first
quarter of 2001, as well as the closure of certain inefficient manufacturing
facilities and manufacturing efficiencies achieved at our remaining plants.
Promotion and distribution. Promotion and distribution expenses for the
nine months ended September 29, 2001 increased 13.6% to $60.0 million from $52.8
million in the comparable 2000 period primarily due to the Arovit acquisition.
Selling, general and administrative. Selling, general and
administrative expenses for the nine months ended September 29, 2001 were
comparable to the 2000 period. Excluding the impact of the Arovit acquisition,
selling, general and administrative expenses decreased due to lower costs
resulting from corporate restructurings and other cost savings initiatives.
These favorable items were partially offset by annual wage increases and higher
healthcare costs.
Amortization of intangibles. Amortization expense for the nine months
ended September 29, 2001 increased 11.8% to $10.3 million from $9.2 million in
the comparable 2000 period primarily due to the Arovit acquisition.
Non-recurring expenses. Non-recurring expenses of $6.7 million for the
nine months ended September 29, 2001 consist of a $4.5 million net loss on the
sale of certain business assets related to the Divestitures and a $2.2 million
charge associated with a workforce reduction following the Divestitures. See
Note 5 - "Sale of Certain Business Assets" to our unaudited condensed
consolidated financial statements included herein.
10
Interest expense, net. Interest expense, net of interest income, for
the nine months ended September 29, 2001 increased 17.5% to $43.3 million from
$36.9 million in the comparable 2000 period primarily due to the borrowings
obtained in May 2000 to finance the Arovit acquisition. In addition, this
increase was partially due to the issuance of long-term debt in March 2001. See
Note 4 - "Issuance of Long-Term Debt" to our unaudited condensed consolidated
financial statements included herein. The impact of this increase in our
outstanding indebtedness on interest expense was partially offset by a decrease
in interest rates associated with our floating rate debt in the 2001 period
compared to the 2000 period.
Income tax expense (benefit). We recognized an income tax benefit of
$11.0 million in the nine months ended September 29, 2001 and income tax expense
of $6.4 million in the comparable 2000 period. Our effective tax rate is
different from the combined U.S. federal and state statutory rate of 38.9% due
to the difference between U.S. and foreign effective tax rates and items which
are not deductible for tax purposes, primarily certain goodwill amortization.
LIQUIDITY AND CAPITAL RESOURCES
We have historically funded our operations, capital expenditures and
working capital requirements from cash flows from operations, bank borrowings
and industrial development revenue bonds. We had working capital of $29.3
million at September 29, 2001. As of September 29, 2001, we had borrowing
capacity of $53.3 million under our revolving credit agreements, which was net
of $2.6 million for outstanding letters of credit.
The net cash used in our operating activities was $4.9 million in the
nine months ended September 29, 2001 compared to $37.1 million provided by our
operating activities in the 2000 period. This decrease was primarily due to
lower earnings before income taxes and higher working capital utilization.
The net cash provided by our investing activities was $9.1 million in
the nine months ended September 29, 2001 compared to $168.4 million net cash
used in the 2000 period. The change results from proceeds received on the sale
of assets in the 2001 period, acquisition related payments in the 2000 period
and lower capital expenditures in the 2001 period when compared to the 2000
period. See Note 5 - "Sale of Certain Business Assets" to our unaudited
condensed consolidated financial statements included herein.
The net cash used in our financing activities was approximately $1.8
million in the nine months ended September 29, 2001 compared to $131.3 million
net cash provided by our financing activities in the 2000 period. See "Note 4 -
Issuance of Long-Term Debt" to our unaudited condensed consolidated financial
statements included herein.
In October 2001, we initiated an organizational change ("Project
Focus") to provide more focused service to our customers through SKU
rationalization, detailed planning and marketing support, and simplified
pricing. We believe the changes will benefit our customers by simplifying and
distinguishing their product offerings, where appropriate. In addition, the
changes will reduce the complexity in our operations so that we can assure our
customers we are a low cost provider in our highly competitive business
environment. The first phase of complexity reduction from Project Focus resulted
in the closure of one plant and a workforce reduction in the corporate office
resulting in the termination of 45 employees in the fourth quarter. The fourth
quarter charge associated with these actions is approximately $1.7 million of
which $1.0 million is a cash outlay, primarily severance. As we continue to
reduce complexity in our business under Project Focus, possible impairment of
assets associated with discontinued SKU's could result. We do not expect any
impairment to have a material effect on our operating cash flows or liquidity.
We are highly leveraged and have significant cash requirements for debt
service relating to our senior credit facility, Sponsor Facility, senior
subordinated notes, foreign debt and industrial development revenue bonds. See
"Note 9 - Long-Term Debt" to our 2000 10-K/A. Our ability to borrow is limited
by the senior credit facility and the limitations on the incurrence of
additional indebtedness in the indenture governing our senior subordinated
notes. We anticipate our operating cash flows, together with amounts
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available to us under our senior credit facility, will be sufficient to finance
working capital requirements, debt service requirements and capital expenditures
through fiscal 2001.
We believe the credit availability under the amended senior credit
facility provides the necessary liquidity for operational and investment
requirements in the current operating environment. We also believe the capital
expenditures permitted under the amended senior credit facility will provide us
with the necessary flexibility to spend required maintenance capital and at the
same time fund planned expansion and customer requirements through fiscal 2002.
COMMITMENTS AND CONTINGENCIES
We believe our operations are in material compliance with
environmental, safety and other regulatory requirements; however, we cannot
provide assurance these requirements will not change in the future or we will
not incur material costs in the future to comply with these requirements or in
connection with the effect of these matters on our business.
EURO
Effective January 1, 1999, 11 of the 15 countries comprising the
European Union began a transition to a single monetary unit, the "Euro," which
is to be completed by July 1, 2002. Our European operations are in the process
of converting to the Euro. Some of our operations in Europe are now invoicing in
Euros, and as of January 1, 2002, all of our operations and information
technology systems, in the European countries involved, will be converted to the
Euro. These systems are currently being modified to meet the requirements. We do
not believe the conversion to the Euro will have a material effect on our
operations or financial condition taken as a whole.
INFLATION AND CHANGES IN PRICES
Our financial results depend to a large extent on the costs of raw
materials and packaging and our ability to pass along increased costs to our
customers. Historically, market prices for commodity grains and food stocks have
fluctuated in response to a number of factors, including changes in government
farm support programs, changes in international agricultural trading policies,
impacts of disease outbreaks on protein sources and the potential effect on
supply and demand as well as weather conditions during the growing and related
harvesting seasons. Fluctuations in paper prices, which affect our costs for
packaging materials, have resulted from changes in supply and demand, general
economic conditions and other factors. In addition, we have exposure to changes
in pricing of natural gas, which affects our manufacturing costs. We cannot
assure you that our results of operations will not be exposed to volatility in
the commodity and natural gas market.
In the event of any increases in raw materials, packaging and natural
gas costs, we may be required to increase sales prices for our products to avoid
margin deterioration. We cannot assure you of the timing or extent of our
ability to implement future price adjustments in the event of increased raw
materials, packaging and natural gas costs or of whether any price increases
implemented by us may affect the volumes of future shipments to our customers.
In the first nine months of fiscal 2001, the Company implemented a
price increase consistent with recent industry announcements, which covered
non-commodity inflationary increases.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In July 2001, the FASB issued Statement on Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets," (SFAS 142) which will
be effective for our Company as of the beginning of fiscal 2002. SFAS 142
requires goodwill and other intangible assets with indefinite lives no longer be
amortized. SFAS 142 further requires the fair value of goodwill and other
intangible assets with indefinite lives be tested for impairment upon adoption
of this statement, annually and upon the occurrence of certain events, and be
written down to fair value if considered impaired. The adoption of SFAS 142 will
result in
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the elimination of annual amortization expense related to goodwill of
approximately $10.0 million, or $7.5 million net of tax; however, the impact of
related impairment, if any, on our financial position or results of operations
has not yet been determined.
In August 2001, the FASB issued Statement on Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," (SFAS 144) which will be effective for our Company as of the beginning
of fiscal 2002. SFAS 144 requires that long-lived assets to be disposed of by
sale be measured at the lower of carrying amount or fair value less cost to
sell, whether reported in continuing operations or in discontinued operations.
SFAS 144 broadens the reporting of discontinued operations to include all
components of an entity with operations that can be distinguished from the rest
of the entity and that will be eliminated from the ongoing operations of the
entity in a disposal transaction. The impact, if any, of SFAS 144 on our
financial position or results of operations has not yet been determined.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks, which are the potential losses arising
from adverse changes in market prices and rates. Our market risks could arise
from changes in commodity and natural gas prices, interest rates and foreign
currency exchange rates.
Commodity and natural gas price risk. We manage our commodity and
natural gas price risk associated with market fluctuations by using derivative
instruments for portions of our corn, protein and natural gas purchases,
principally through exchange traded futures and options contracts. The terms of
these contracts are generally less than one year. We settle positions either by
financial settlement with the exchanges or by exchange for the physical
commodity, in which case, we deliver the contract against the acquisition of the
physical commodity. We do not enter into derivative instruments for trading or
speculative purposes.
Based upon an analysis we completed as of September 29, 2001 in which
we utilized our actual derivative contractual volumes and assumed a 5% adverse
movement in commodity and natural gas prices, we determined the potential
decrease in the fair value of our derivative instruments would not have a
material adverse effect on our financial position, results of operations or cash
flows.
Interest rate risk. We are subject to market risk exposure related to
changes in interest rates. We periodically use interest rate swap and cap
contracts (hedges) to limit our exposure to the interest rate risk associated
with our floating rate debt, which was $376.9 million at September 29, 2001. At
September 29, 2001, $175.2 million of our floating rate debt was hedged by
interest rate hedge contracts. Changes in market values of these financial
instruments are highly correlated with changes in market values of the hedged
item both at inception and over the life of the contract. Gains and losses on
interest rate hedge contracts are recorded in accumulated other comprehensive
income (loss) in the accompanying unaudited condensed consolidated financial
statements included herein. Amounts received or paid under interest rate hedge
contracts are recorded as reductions or additions to interest expense. We had a
cumulative deferred loss on our interest rate hedge contracts of $2.8 million,
net of deferred tax benefit of $1.8 million, at September 29, 2001.
Accordingly, our net income is affected by changes in interest rates.
Assuming our current level of floating rate debt and interest rate hedge
contracts, a 100 basis point increase in interest rates would increase our net
loss by approximately $0.3 million and $0.9 million for the three months and
nine months ended September 29, 2001, respectively. In addition, such a change
would result in a decrease of approximately $8.4 million in the fair value of
our fixed rate debt at September 29, 2001. In the event of an adverse change in
interest rates, we could take action to mitigate our exposure; however, due to
the uncertainty of the actions that would be taken and their possible effects,
this analysis assumes no such actions. Furthermore, this analysis does not
consider the effects of the change in the level of overall economic activity
that could exist in such an environment.
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Foreign currency exchange risk. Our earnings and financial position are
affected by foreign currency exchange rate fluctuations. We currently have
operations in Europe that sell pet food products throughout Europe and export to
Japan. In connection with our acquisition of Arovit, we funded a portion of the
acquisition with Euro-denominated debt and designated our Euro-denominated debt
as a hedge of our net investment in Europe. As of September 29, 2001, the
cumulative translation adjustment for the net investment in our foreign
operations was a net loss of $2.0 million, which includes a loss of $0.8 million
for the translation of our Euro-denominated debt to U.S. dollars. The cumulative
translation adjustment is recorded in accumulated other comprehensive income
(loss) in the accompanying unaudited condensed consolidated financial statements
included herein.
We are exposed to foreign currency exchange risk arising from
transactions in the normal course of business within Europe. To mitigate the
risk from foreign currency exchange rate fluctuations in those transactions, we
enter into foreign currency forward contracts for the purchase or sale of a
currency. Accordingly, changes in market values of these financial instruments
are highly correlated with the changes in market values of the hedged item both
at inception and over the life of the contracts. Gains and losses on foreign
currency forward contracts are recorded in accumulated other comprehensive
income (loss) in the accompanying unaudited condensed consolidated financial
statements included herein. At September 29, 2001, we had a cumulative deferred
gain on foreign currency forward contracts of $0.5 million, net of deferred tax
expense of $0.2 million. We had open foreign currency forward contracts at
September 29, 2001 maturing within the next 12 months with a notional value of
$6.0 million and a fair value loss of $0.5 million.
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
None.
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SIGNATURES
Pursuant to the requirements 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.
DOANE PET CARE COMPANY
Dated: November 8, 2001 By: /s/ PHILIP K. WOODLIEF
------------------------------
Philip K. Woodlief
Vice President Finance and
Chief Financial Officer
Dated: November 8, 2001 By: /s/ STEPHEN P. HAVALA
------------------------------
Stephen P. Havala
Corporate Controller and
Principal Accounting Officer
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