================================================================================
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 JUNE 29, 2002
OR
o 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 July 31, 2002, the registrant had outstanding 1,000 shares of
common stock.
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TABLE OF CONTENTS
<Table>
<Caption>
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Unaudited Condensed Consolidated Balance Sheets as of June 29, 2002
and December 29, 2001....................................................................... 1
Unaudited Condensed Consolidated Statements of Income for the three
months and six months ended June 29, 2002 and June 30, 2001................................. 2
Unaudited Condensed Consolidated Statement of Stockholder's Equity and
Comprehensive Income for the six months ended June 29, 2002................................. 3
Unaudited Condensed Consolidated Statements of Cash Flows for the
six months ended June 29, 2002 and June 30, 2001............................................ 4
Notes to Unaudited Condensed Consolidated Financial Statements.............................. 5
Independent Auditors' Review Report......................................................... 14
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations....................................................................... 15
Item 3. Quantitative and Qualitative Disclosures about Market Risk.................................. 22
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K............................................................ 23
Signatures........................................................................................... 24
</Table>
DOANE PET CARE COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PAR VALUE AMOUNTS)
<Table>
<Caption>
JUNE 29, DECEMBER 29,
2002 2001
------------ ------------
(AUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 6,250 $ 6,032
Accounts receivable, net 103,569 120,760
Inventories, net 55,625 54,841
Deferred tax asset 9,716 10,115
Prepaid expenses and other current assets 11,810 5,469
------------ ------------
Total current assets 186,970 197,217
Property, plant and equipment, net 252,699 249,379
Goodwill and other intangible assets, net 357,473 347,081
Other assets 44,444 42,868
------------ ------------
Total assets $ 841,586 $ 836,545
============ ============
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Current maturities of long-term debt $ 29,818 $ 28,488
Accounts payable 76,287 64,013
Accrued liabilities 50,414 57,721
------------ ------------
Total current liabilities 156,519 150,222
Long-term debt, excluding current maturities 519,018 559,335
Other long-term liabilities 15,093 10,805
Deferred tax liability 17,898 12,585
------------ ------------
Total liabilities 708,528 732,947
------------ ------------
Senior Preferred Stock, 3,000,000 shares authorized,
1,200,000 shares issued and outstanding 71,422 65,672
------------ ------------
Commitments and contingencies
Stockholder's equity:
Common stock, $0.01 par value; 1,000 shares authorized,
issued and outstanding -- --
Additional paid-in-capital 115,655 115,655
Accumulated other comprehensive income (loss) 8,193 (7,607)
Accumulated deficit (62,212) (70,122)
------------ ------------
Total stockholder's equity 61,636 37,926
------------ ------------
Total liabilities and stockholder's equity $ 841,586 $ 836,545
============ ============
</Table>
See accompanying notes to the unaudited condensed consolidated financial
statements and accompanying independent auditors' review report.
1
DOANE PET CARE COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
-------------------------- --------------------------
JUNE 29, JUNE 30, JUNE 29, JUNE 30,
2002 2001 2002 2001
---------- ---------- ---------- ----------
Net sales $ 204,298 $ 217,262 $ 424,404 $ 468,026
Cost of goods sold 155,532 176,710 324,724 395,727
---------- ---------- ---------- ----------
Gross profit 48,766 40,552 99,680 72,299
Operating expenses:
Promotion and distribution 13,344 13,882 26,933 29,632
Selling, general and administrative 11,470 12,306 22,540 25,491
Amortization of intangibles 856 3,445 1,688 6,897
Non-recurring expenses -- 6,662 -- 6,662
---------- ---------- ---------- ----------
Income from operations 23,096 4,257 48,519 3,617
Interest expense, net 16,518 14,539 29,825 28,874
Other income, net (467) (427) (635) (604)
---------- ---------- ---------- ----------
Income (loss) before income taxes 7,045 (9,855) 19,329 (24,653)
Income tax expense (benefit) 1,858 (3,693) 5,669 (9,714)
---------- ---------- ---------- ----------
Net income (loss) 5,187 (6,162) 13,660 (14,939)
Preferred stock dividends and accretion (2,920) (2,574) (5,750) (5,069)
---------- ---------- ---------- ----------
Net income (loss) available to common shares $ 2,267 $ (8,736) $ 7,910 $ (20,008)
========== ========== ========== ==========
Basic and diluted net income (loss)
per common share $ 2,267 $ (8,736) $ 7,910 $ (20,008)
========== ========== ========== ==========
Basic and diluted weighted-average common
shares outstanding 1,000 1,000 1,000 1,000
========== ========== ========== ==========
</Table>
See accompanying notes to the unaudited condensed consolidated financial
statements and accompanying independent auditors' 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)
<Table>
<Caption>
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER
----------------- PAID-IN COMPREHENSIVE ACCUMULATED
SHARES AMOUNT CAPITAL INCOME (LOSS) DEFICIT TOTAL
------ ------ ----------- ------------- ----------- ---------
Balances at December 29, 2001 (Audited) 1,000 $ -- $ 115,655 $ (7,607) $ (70,122) $ 37,926
Comprehensive income:
Net income -- -- -- -- 13,660 13,660
Foreign currency translation, net -- -- -- 14,843 -- 14,843
Unrealized gain, net of
deferred tax expense of $536 -- -- -- 957 -- 957
---------
Total comprehensive income 29,460
---------
Preferred stock dividends -- -- -- -- (5,211) (5,211)
Accretion of preferred stock -- -- -- -- (539) (539)
------ ------ ----------- ------------- ----------- ---------
Balances at June 29, 2002 1,000 $ -- $ 115,655 $ 8,193 $ (62,212) $ 61,636
====== ====== =========== ============= =========== =========
</Table>
See accompanying notes to the unaudited condensed consolidated financial
statements and accompanying independent auditors' review report.
3
DOANE PET CARE COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<Table>
<Caption>
SIX MONTHS ENDED
----------------------
JUNE 29, JUNE 30,
2002 2001
-------- --------
Cash flows from operating activities:
Net income (loss) $ 13,660 $(14,939)
Items not requiring (providing) cash:
Depreciation 13,804 14,208
Amortization of intangibles 1,688 6,897
Deferred income tax expense (benefit) 5,065 (10,302)
Non-cash interest expense 6,073 2,372
Equity in joint ventures (553) (579)
Net loss on divestitures -- 4,660
Other non-cash charges (credits), net 379 (302)
Changes in current assets and liabilities 18,460 (24,519)
-------- --------
Net cash provided by (used in) operating activities 58,576 (22,504)
-------- --------
Cash flows from investing activities:
Capital expenditures (6,533) (5,870)
Proceeds from sale of assets 573 19,459
Other, net (620) (1,173)
-------- --------
Net cash provided by (used in) investing activities (6,580) 12,416
-------- --------
Cash flows from financing activities:
Net borrowings (repayments) under revolving credit agreements (38,000) 4,000
Proceeds from issuance of long-term debt 9,738 17,055
Principal payments on long-term debt (21,506) (15,775)
Payments for debt issuance costs (2,695) (2,660)
Parent capital contribution -- 8,355
-------- --------
Net cash provided by (used in) financing activities (52,463) 10,975
Effect of exchange rate changes on cash and cash equivalents 685 (55)
-------- --------
Increase in cash and cash equivalents 218 832
Cash and cash equivalents, beginning of period 6,032 3,158
-------- --------
Cash and cash equivalents, end of period $ 6,250 $ 3,990
======== ========
</Table>
See accompanying notes to the unaudited condensed consolidated financial
statements and accompanying independent auditors' 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 2002 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 2001 Annual Report on Form 10-K for the
fiscal year ended December 29, 2001 (the "2001 10-K"), including related
exhibits. The accounting policies used in preparing these financial statements
are the same as those summarized in the 2001 10-K, except for the adoption of
Financial Accounting Standards Board's ("FASB's") Statement on Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets ("SFAS 142"),
as discussed in Note 3 -- "Recently Issued Accounting Pronouncement."
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 second quarters
of fiscal 2001 and 2002 ending on June 30, 2001 and June 29, 2002, respectively.
(2) PROMOTIONAL ACCOUNTING RECLASSIFICATION
In fiscal 2001, the Company adopted FASB's Emerging Issues Task Force
Issue No. 01-9, Accounting for Consideration Given by a Vendor to a Customer
("EITF 01-9"), which provides guidance on when to record certain sales
incentives as well as the classification of certain sales incentives in the
statement of income. As a result of adopting EITF 01-9, the Company records
volume-based rebates and certain sales incentives as a component of net sales,
and free-goods promotions as a component of cost of goods sold. Prior to
adopting EITF 01-9, the Company recorded these costs as a component of promotion
and distribution expense.
Previously issued quarterly results of fiscal 2001 have been
reclassified, as disclosed in the Company's 2001 10-K, to reflect the proper
classification of sales incentives in the statement of income. This change was
made based on a year end review of the Company's policies and procedures
relating to EITF 01-9. The reclassification resulted in a reduction in net sales
of $5.4 million and $10.5 million and an increase in cost of goods sold of $0.4
million and $0.9 million offset by a decrease in promotion and distribution
expense of $5.8 million and $11.4 million for the three months and six months
ended June 30, 2001, respectively.
(3) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENT
Effective December 30, 2001, the Company adopted SFAS 142 which
requires that goodwill and other intangible assets with indefinite lives no
longer be amortized and further requires that the fair value of goodwill and
other intangible assets with indefinite lives be tested for impairment upon
adoption of SFAS 142, annually and upon the occurrence of certain events, and be
written down to fair value if considered impaired. In the first quarter of
fiscal 2002, the Company reassessed the useful lives and residual values of all
intangible assets acquired in purchase business combinations, which resulted in
no impact on its accompanying unaudited condensed consolidated financial
statements. As of June 29, 2002, the Company completed the required impairment
tests of goodwill and other intangible assets with indefinite lives and, based
on the results of the tests, determined no impairment to the carrying values of
these assets was needed. The adoption of SFAS 142 resulted in the elimination of
annual amortization expense related to goodwill and other intangible assets of
approximately $10.3 million, or $7.6 million net of income tax benefit.
5
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Results of operations of the Company adjusted to give effect to SFAS
142 as if it were adopted on December 31, 2000 follows (in thousands, except per
share amounts):
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
--------------------- ---------------------
JUNE 29, JUNE 30, JUNE 29, JUNE 30,
2002 2001 2002 2001
-------- -------- -------- --------
Net income (loss), as reported $ 5,187 $ (6,162) $ 13,660 $(14,939)
Add back: amortization,
net of income tax benefit -- 1,886 -- 3,702
-------- -------- -------- --------
Net income (loss), as adjusted $ 5,187 $ (4,276) $ 13,660 $(11,237)
======== ======== ======== ========
Basic and diluted net income (loss)
per common share, as adjusted $ 2,267 $ (6,850) $ 7,910 $(16,306)
======== ======== ======== ========
</Table>
(4) INVENTORIES
A summary of inventories, net of valuation allowances, follows (in
thousands):
<Table>
<Caption>
JUNE 29, DECEMBER 29
2002 2001
------------ ------------
(AUDITED)
Raw materials $ 11,799 $ 12,312
Packaging materials 14,954 16,139
Finished goods 28,872 26,390
------------ ------------
Total $ 55,625 $ 54,841
============ ============
</Table>
(5) LONG-TERM DEBT
In March 2002, the Company amended its senior credit facility to
provide, among other things: 1) for an increase in interest rates on all loans
to the Euro dollar rate plus 4.75%, or the prime rate plus 3.75%, until maturity
and an increase in the commitment fee rate on its revolving credit facility to
1.00%; 2) a grant to the Company's lenders of a lien on its material operating
accounts; 3) a limit on the amount of future capital expenditures up to a total
of $25.0 million for 2002 and $7.0 million for the first quarter of 2003; 4) a
limit on certain permitted investments; 5) an amendment to the Company's
existing financial covenants through March 31, 2003; 6) a new minimum EBITDA
covenant; and 7) for the issuance of new senior subordinated notes if the net
proceeds of such new senior subordinated notes are used to repay the loans under
the senior credit facility. In addition, the amendment provides that an Excess
Leverage Fee will accrue if the "senior leverage" ratio exceeds 3.25 to 1.00 as
of March 31, 2003 at a rate equal to 2.5% of the sum of the daily average of the
aggregate unpaid principal amount of the loans from March 31, 2002 to March 31,
2003. As of June 29, 2002, the Company has $2.3 million accrued for the Excess
Leverage Fee in other long-term liabilities in the accompanying unaudited
condensed consolidated financial statements. If the Excess Leverage Fee is
earned, it will generally be payable only from any future asset sales and debt
and equity offerings, but in any event not later than March 31, 2005.
6
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(6) ACCRUALS FOR RESTRUCTURING COSTS
A roll-forward of the Company's accrued restructuring costs for fiscal
2002 through June 29, 2002 follows (in thousands):
<Table>
<Caption>
SIX MONTHS
ENDED
JUNE 29,
2002
----------
Balance at December 29, 2001 (Audited) $ 4,784
Cash payments (607)
----------
Balance at June 29, 2002 $ 4,177
==========
</Table>
The future expected payout of the Company's accrued restructuring costs
as of June 29, 2002 follows (in thousands):
<Table>
<Caption>
FISCAL YEARS ENDING PAYOUT
- --------------------- --------
2002 $ 1,827
2003 2,170
2004 180
--------
Total $ 4,177
========
</Table>
(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.
(8) FINANCIAL INFORMATION RELATED TO GUARANTOR SUBSIDIARIES
Condensed consolidated financial information related to the Company and
its guarantor subsidiaries and non-guarantor subsidiaries as of December 29,
2001 and June 29, 2002 and for the three months and six months ended June 30,
2001 and June 29, 2002 is disclosed to comply with the reporting requirements of
the Company's guarantor subsidiaries. The guarantor subsidiaries are
wholly-owned domestic subsidiaries of the Company which have fully and
unconditionally guaranteed the Company's 9 3/4% Senior Subordinated Notes due
May 15, 2007. See Note 9 -- "Long-Term Debt" in the Company's 2001 10-K.
Condensed consolidated financial information follows (in thousands):
7
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET
FOR THE GUARANTOR AND NON-GUARANTOR SUBSIDIARIES
<Table>
<Caption>
JUNE 29, 2002
------------------------------------------------------------
NON- INTERCOMPANY
GUARANTOR GUARANTOR ELIMINATIONS CONSOLIDATED
--------- --------- ------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 72 $ 6,178 $ -- $ 6,250
Accounts receivable, net 67,778 35,791 -- 103,569
Inventories, net 36,474 19,151 -- 55,625
Deferred tax asset 9,716 -- -- 9,716
Prepaid expenses and other current assets 9,743 2,067 -- 11,810
--------- --------- ------------ ------------
Total current assets 123,783 63,187 -- 186,970
Property, plant and equipment, net 158,000 94,699 -- 252,699
Goodwill and other intangible assets, net 267,376 90,097 -- 357,473
Other assets 234,027 12,253 (201,836) 44,444
--------- --------- ------------ ------------
Total assets $ 783,186 $ 260,236 $ (201,836) $ 841,586
========= ========= ============ ============
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Current maturities of long-term debt $ 23,678 $ 6,140 $ -- $ 29,818
Accounts payable 47,692 28,595 -- 76,287
Accrued liabilities 38,798 11,426 190 50,414
--------- --------- ------------ ------------
Total current liabilities 110,168 46,161 190 156,519
Long-term debt, excluding current maturities 505,365 175,118 (161,465) 519,018
Other long-term liabilities 15,093 -- -- 15,093
Deferred tax liability 15,614 2,284 -- 17,898
--------- --------- ------------ ------------
Total liabilities 646,240 223,563 (161,275) 708,528
--------- --------- ------------ ------------
Senior Preferred Stock 71,422 -- -- 71,422
--------- --------- ------------ ------------
Commitments and contingencies
Stockholder's equity:
Common stock -- -- -- --
Additional paid-in-capital 115,655 40,026 (40,026) 115,655
Accumulated other comprehensive income (loss) (9,180) 17,908 (535) 8,193
Accumulated deficit (40,951) (21,261) -- (62,212)
--------- --------- ------------ ------------
Total stockholder's equity 65,524 36,673 (40,561) 61,636
--------- --------- ------------ ------------
Total liabilities and stockholder's equity $ 783,186 $ 260,236 $ (201,836) $ 841,586
========= ========= ============ ============
</Table>
8
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
AUDITED CONDENSED CONSOLIDATED BALANCE SHEET
FOR THE GUARANTOR AND NON-GUARANTOR SUBSIDIARIES
<Table>
<Caption>
DECEMBER 29, 2001
------------------------------------------------------------
NON- INTERCOMPANY
GUARANTOR GUARANTOR ELIMINATIONS CONSOLIDATED
--------- --------- ------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 1,950 $ 4,082 $ -- $ 6,032
Accounts receivable, net 81,916 38,844 -- 120,760
Inventories, net 38,566 16,275 -- 54,841
Deferred tax asset 10,115 -- -- 10,115
Prepaid expenses and other current assets 4,226 1,243 -- 5,469
--------- --------- ------------ ------------
Total current assets 136,773 60,444 -- 197,217
Property, plant and equipment, net 162,324 87,055 -- 249,379
Goodwill and other intangible assets, net 267,376 79,705 -- 347,081
Other assets 227,654 10,741 (195,527) 42,868
--------- --------- ------------ ------------
Total assets $ 794,127 $ 237,945 $ (195,527) $ 836,545
========= ========= ============ ============
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Current maturities of long-term debt $ 22,708 $ 5,780 $ -- $ 28,488
Accounts payable 33,088 30,925 -- 64,013
Accrued liabilities 44,674 12,857 190 57,721
--------- --------- ------------ ------------
Total current liabilities 100,470 49,562 190 150,222
Long-term debt, excluding current maturities 547,405 174,906 (162,976) 559,335
Other long-term liabilities 10,744 61 -- 10,805
Deferred tax liability 9,505 3,080 -- 12,585
--------- --------- ------------ ------------
Total liabilities 668,124 227,609 (162,786) 732,947
--------- --------- ------------ ------------
Senior Preferred Stock 65,672 -- -- 65,672
--------- --------- ------------ ------------
Commitments and contingencies
Stockholder's equity:
Common stock -- -- -- --
Additional paid-in-capital 115,655 31,181 (31,181) 115,655
Accumulated other comprehensive loss (1,805) (4,242) (1,560) (7,607)
Accumulated deficit (53,519) (16,603) -- (70,122)
--------- --------- ------------ ------------
Total stockholder's equity 60,331 10,336 (32,741) 37,926
--------- --------- ------------ ------------
Total liabilities and stockholder's equity $ 794,127 $ 237,945 $ (195,527) $ 836,545
========= ========= ============ ============
</Table>
9
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF INCOME
FOR THE GUARANTOR AND NON-GUARANTOR SUBSIDIARIES
<Table>
<Caption>
THREE MONTHS ENDED JUNE 29, 2002
------------------------------------------
NON-
GUARANTOR GUARANTOR CONSOLIDATED
--------- --------- ------------
Net sales $ 161,594 $ 42,704 $ 204,298
Cost of goods sold 123,953 31,579 155,532
--------- --------- ------------
Gross profit 37,641 11,125 48,766
Operating expenses:
Promotion and distribution 8,231 5,113 13,344
Selling, general and administrative 7,929 3,541 11,470
Amortization of intangibles 692 164 856
--------- --------- ------------
Income from operations 20,789 2,307 23,096
Interest expense, net 11,706 4,812 16,518
Other income, net (222) (245) (467)
--------- --------- ------------
Income (loss) before income taxes 9,305 (2,260) 7,045
Income tax expense (benefit) 2,028 (170) 1,858
--------- --------- ------------
Net income (loss) 7,277 (2,090) 5,187
Preferred stock dividends and accretion (2,920) -- (2,920)
--------- --------- ------------
Net income (loss) available to common shares $ 4,357 $ (2,090) $ 2,267
========= ========= ============
</Table>
<Table>
<Caption>
THREE MONTHS ENDED JUNE 30, 2001
------------------------------------------
NON-
GUARANTOR GUARANTOR CONSOLIDATED
--------- --------- ------------
Net sales $ 170,537 $ 46,725 $ 217,262
Cost of goods sold 139,235 37,475 176,710
--------- --------- ------------
Gross profit 31,302 9,250 40,552
Operating expenses:
Promotion and distribution 8,885 4,997 13,882
Selling, general and administrative 9,171 3,135 12,306
Amortization of intangibles 2,773 672 3,445
Non-recurring expenses 6,662 -- 6,662
--------- --------- ------------
Income from operations 3,811 446 4,257
Interest expense, net 9,724 4,815 14,539
Other income, net (359) (68) (427)
--------- --------- ------------
Loss before income taxes (5,554) (4,301) (9,855)
Income tax benefit (2,743) (950) (3,693)
--------- --------- ------------
Net loss (2,811) (3,351) (6,162)
Preferred stock dividends and accretion (2,574) -- (2,574)
--------- --------- ------------
Net loss available to common shares $ (5,385) $ (3,351) $ (8,736)
========= ========= ============
</Table>
10
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF INCOME
FOR THE GUARANTOR AND NON-GUARANTOR SUBSIDIARIES
<Table>
<Caption>
SIX MONTHS ENDED JUNE 29, 2002
------------------------------------------
NON-
GUARANTOR GUARANTOR CONSOLIDATED
--------- --------- ------------
Net sales $ 337,494 $ 86,910 $ 424,404
Cost of goods sold 259,569 65,155 324,724
--------- --------- ------------
Gross profit 77,925 21,755 99,680
Operating expenses:
Promotion and distribution 17,344 9,589 26,933
Selling, general and administrative 16,075 6,465 22,540
Amortization of intangibles 1,364 324 1,688
--------- --------- ------------
Income from operations 43,142 5,377 48,519
Interest expense, net 19,531 10,294 29,825
Other (income) expense, net (816) 181 (635)
--------- --------- ------------
Income (loss) before income taxes 24,427 (5,098) 19,329
Income tax expense (benefit) 6,109 (440) 5,669
--------- --------- ------------
Net income (loss) 18,318 (4,658) 13,660
Preferred stock dividends and accretion (5,750) -- (5,750)
--------- --------- ------------
Net income (loss) available to common shares $ 12,568 $ (4,658) $ 7,910
========= ========= ============
</Table>
<Table>
<Caption>
SIX MONTHS ENDED JUNE 30, 2001
------------------------------------------
NON-
GUARANTOR GUARANTOR CONSOLIDATED
--------- --------- ------------
Net sales $ 369,716 $ 98,310 $ 468,026
Cost of goods sold 317,295 78,432 395,727
--------- --------- ------------
Gross profit 52,421 19,878 72,299
Operating expenses:
Promotion and distribution 19,370 10,262 29,632
Selling, general and administrative 18,918 6,573 25,491
Amortization of intangibles 5,523 1,374 6,897
Non-recurring expenses 6,662 -- 6,662
--------- --------- ------------
Income from operations 1,948 1,669 3,617
Interest expense, net 19,458 9,416 28,874
Other income, net (485) (119) (604)
--------- --------- ------------
Loss before income taxes (17,025) (7,628) (24,653)
Income tax benefit (8,324) (1,390) (9,714)
--------- --------- ------------
Net loss (8,701) (6,238) (14,939)
Preferred stock dividends and accretion (5,069) -- (5,069)
--------- --------- ------------
Net loss available to common shares $ (13,770) $ (6,238) $ (20,008)
========= ========= ============
</Table>
11
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE GUARANTOR AND NON-GUARANTOR SUBSIDIARIES
<Table>
<Caption>
SIX MONTHS ENDED JUNE 29, 2002
------------------------------------------
NON-
GUARANTOR GUARANTOR CONSOLIDATED
--------- --------- ------------
Cash flows from operating activities:
Net income (loss) $ 18,318 $ (4,658) $ 13,660
Items not requiring (providing) cash:
Depreciation and amortization of intangibles 9,907 5,585 15,492
Deferred income tax expense (benefit) 6,109 (1,044) 5,065
Other non-cash charges, net 5,660 239 5,899
Changes in current assets and liabilities (excluding
amounts acquired) 10,184 8,276 18,460
--------- --------- ------------
Net cash provided by operating activities 50,178 8,398 58,576
--------- --------- ------------
Cash flows from investing activities:
Capital expenditures (3,580) (2,953) (6,533)
Proceeds from sale of assets 3 570 573
Other, net 3,652 (4,272) (620)
--------- --------- ------------
Net cash provided by (used in) investing activities 75 (6,655) (6,580)
--------- --------- ------------
Cash flows from financing activities:
Net repayments under revolving credit agreements (38,000) -- (38,000)
Proceeds from issuance of long-term debt -- 9,738 9,738
Principal payments on long-term debt (11,571) (9,935) (21,506)
Payments for debt issuance costs (2,695) -- (2,695)
--------- --------- ------------
Net cash used in financing activities (52,266) (197) (52,463)
Effect of exchange rate changes on cash and cash equivalents 135 550 685
--------- --------- ------------
Increase (decrease) in cash and cash equivalents (1,878) 2,096 218
Cash and cash equivalents, beginning of period 1,950 4,082 6,032
--------- --------- ------------
Cash and cash equivalents, end of period $ 72 $ 6,178 $ 6,250
========= ========= ============
</Table>
12
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE GUARANTOR AND NON-GUARANTOR SUBSIDIARIES
<Table>
<Caption>
SIX MONTHS ENDED JUNE 30, 2001
------------------------------------------
NON-
GUARANTOR GUARANTOR CONSOLIDATED
--------- --------- ------------
Cash flows from operating activities:
Net loss $ (8,701) $ (6,238) $ (14,939)
Items not requiring (providing) cash:
Depreciation and amortization of intangibles 14,811 6,294 21,105
Deferred income tax benefit (8,575) (1,727) (10,302)
Other non-cash charges, net 6,074 77 6,151
Changes in current assets and liabilities (excluding
amounts acquired) (32,610) 8,091 (24,519)
--------- --------- ------------
Net cash provided by (used in) operating activities (29,001) 6,497 (22,504)
--------- --------- ------------
Cash flows from investing activities:
Capital expenditures (3,792) (2,078) (5,870)
Proceeds from sale of assets 19,459 -- 19,459
Other, net (3,618) 2,445 (1,173)
--------- --------- ------------
Net cash provided by investing activities 12,049 367 12,416
--------- --------- ------------
Cash flows from financing activities:
Net borrowings under revolving credit agreements 4,000 -- 4,000
Proceeds from issuance of long-term debt 16,667 388 17,055
Principal payments on long-term debt (9,426) (6,349) (15,775)
Payments for debt issuance costs (2,660) -- (2,660)
Parent capital contribution 8,355 -- 8,355
--------- --------- ------------
Net cash provided by (used in) financing activities 16,936 (5,961) 10,975
Effect of exchange rate changes on cash and cash equivalents 55 (110) (55)
--------- --------- ------------
Increase in cash and cash equivalents 39 793 832
Cash and cash equivalents, beginning of period 42 3,116 3,158
--------- --------- ------------
Cash and cash equivalents, end of period $ 81 $ 3,909 $ 3,990
========= ========= ============
</Table>
13
INDEPENDENT AUDITORS' 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 June 29, 2002, the related condensed consolidated
statements of income for the three-month and six-month periods ended June 29,
2002 and June 30, 2001, the condensed consolidated statement of stockholder's
equity and comprehensive income for the six-month period ended June 29, 2002 and
the condensed consolidated statements of cash flows for the six-month periods
ended June 29, 2002 and June 30, 2001. 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 29, 2001, 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 22, 2002, 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 29, 2001 is fairly
stated, in all material respects, in relation to the consolidated balance sheet
from which it has been derived.
As discussed in Note 3 to the condensed consolidated financial statements,
effective December 30, 2001, Doane Pet Care Company and Subsidiaries adopted
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets."
/s/ KPMG LLP
Houston, Texas
July 26, 2002
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The reader is encouraged to refer to the accompanying unaudited
condensed consolidated financial statements and related notes included elsewhere
in this Quarterly Report on Form 10-Q and our audited consolidated financial
statements and related notes in our 2001 Annual Report on Form 10-K for the
fiscal year ended December 29, 2001 ("2001 10-K").
FORWARD-LOOKING STATEMENTS
Certain of the statements set forth below, in Item 3 -- "Quantitative
and Qualitative Disclosures about Market Risk," and elsewhere in this Quarterly
Report on Form 10-Q are "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Some of these statements can be
identified by terms and phrases such as "anticipate," "believe," "assume,"
"intend," "estimate," "expect," "continue," "could," "may," "plan," "project,"
"predict," "will" and similar expressions. These statements address activities,
events or developments that we expect, believe, anticipate or estimate will or
may occur in the future, including statements regarding, among other things:
o reliance on a few customers for a large portion of our sales and
our ability to maintain our relationships with these customers;
o future capital expenditures and our ability to finance these
capital expenditures;
o our ability to finance our debt service requirements under our
senior credit facility and our other debt;
o our future financial condition and results of operations;
o our business strategy, and other plans and objectives for future
operations;
o business opportunities that may be presented to and pursued by us
from time to time;
o our exposure to, and ability to manage, our market risks;
o the impact of existing accounting pronouncements; and
o risks related to our international operations.
These forward-looking statements are based on our assumptions and
analyses and are not guarantees of our future performance. These statements are
subject to risks, many of which are beyond our control, that could cause our
actual results to differ materially from those contained in our forward-looking
statements. Factors that could cause results to differ materially include
without limitation: decreases or changes in demand for our products, changes in
market trends, general competitive pressures from existing and new competitors,
price volatility of commodities, natural gas, other raw materials and packaging,
changes in laws and regulations, adverse changes in operating performance,
adverse economic conditions and other factors described under Item 1 --
"Business -- Risk Factors" of our 2001 10-K.
We undertake no obligation to revise the forward-looking statements to
reflect any future events or circumstances. All forward-looking statements
attributable to us are expressly qualified in their entirety by this cautionary
statement.
CRITICAL ACCOUNTING POLICIES
Accounts Receivable Allowance. At June 29, 2002, our gross accounts
receivable were $112.3 million. We had a valuation allowance of $8.7 million at
June 29, 2002, primarily for outstanding deductions with customers. Our
accounting policy is to estimate the allowance by applying a recovery percentage
based on historical collection experience and performing a specific
identification review of customer account balances. We may revise the allowance
against accounts receivable as we receive more information on this matter.
Inventories Valuation Allowance. At June 29, 2002, our gross
inventories were $60.5 million. We had a valuation allowance for obsolescence of
$4.9 million at June 29, 2002, primarily related to packaging inventories. Our
accounting policy is to estimate the obsolescence reserve based on specific
identification of obsolete products or potential products to be rationalized
with the estimate taking into account both the probability and timing of
rationalization. We may revise the allowance against inventories as we receive
more information on this matter.
15
Deferred Tax Assets. At June 29, 2002, our gross deferred tax assets
totaled $25.2 million, of which $10.2 million related to the deferred tax
benefit associated with our federal net operating loss carryforwards of $29.2
million that are available to offset future taxable income through 2021.
Realization of the deferred tax assets is dependent upon our ability to generate
sufficient taxable income prior to the expiration of the federal net operating
loss carryforwards. Our results of operations reflect net losses in fiscal 2000
and 2001, which are primarily due to non-recurring and Project Focus
implementation expenses. See "-- Results of Operations -- Expenses Related to
2001 Strategic Initiatives" for a discussion of Project Focus. Although
realization is not assured, we believe that it is more likely than not that our
deferred tax assets will be realized.
Goodwill and Other Intangible Assets. At June 29, 2002, our net
goodwill and other intangible assets totaled $357.5 million. Our accounting
policy is to test the fair value of goodwill and other intangible assets for
impairment in accordance with Financial Accounting Standards Board's ("FASB's")
Statement on Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets ("SFAS 142"), which we adopted as of the beginning of fiscal
2002. See "-- Recently Issued Accounting Pronouncements."
RESULTS OF OPERATIONS
General. We derive substantially all of our revenue from the sale of
dry and wet pet food. Historically, approximately 75% of our cost of goods sold
has been comprised of raw material and packaging costs with the remainder
primarily comprised of salaries, wages and related fringe benefits, utilities
and depreciation. Our operating expenses consist of promotion and distribution
expenses and selling, general and administrative expenses. Promotion and
distribution expenses are primarily comprised of promotions, freight, brokerage
fees and warehousing expenses. Selling, general and administrative expenses
primarily include salaries and related fringe benefits, amortization and other
corporate overhead costs, which typically do not increase proportionately with
increases in volume and product sales.
Our results of operations reflect the reclassification of volume-based
rebates and certain sales incentives as a reduction in net sales, and free-goods
promotions as an increase in cost of goods sold with the offset being a decrease
in promotion and distribution expense. Results for the three months and six
months ended June 30, 2001 have been reclassified, as discussed in our 2001
10-K. See Note 2 -- "Promotional Accounting Reclassification" to our
accompanying unaudited condensed consolidated financial statements included
herein.
Expenses Related to 2001 Strategic Initiatives. In April 2001, we sold
our Perham, Minnesota dry dog and cat food facility and related assets,
including the Tuffy's brand, for $7.0 million. In May 2001, we sold our Deep Run
domestic wet pet food business and related assets, other than real estate, for
$13.9 million. We recognized a $4.7 million net loss on the sale of these
businesses. In addition, we recognized $2.0 million of severance costs for the
elimination of certain corporate positions following these divestitures. Each of
these expenses was classified as a non-recurring expense. See Note 4 --
"Divestitures" to our audited consolidated financial statements included in our
2001 10-K.
In October 2001, we initiated a new market and operational strategy,
Project Focus, which is designed to better focus our resources on providing
"best-in-class" services and products to our customers. Our goal is to
permanently reduce our cost structure by streamlining our available product
offerings and thereby significantly reducing stock-keeping units, or SKUs,
increasing the efficiency of our production facilities and reducing our
workforce. We believe the changes will benefit our customers by simplifying and
distinguishing our product offerings and associated pricing, improving our
planning and marketing support services, and reducing the complexity of our
operations. We seek to be the high quality, low cost global producer of customer
branded pet food in our highly competitive markets. See Note 16 --
"Non-Recurring and Project Focus Implementation Expenses" to our audited
consolidated financial statements included in our 2001 10-K. We recorded a
charge of $10.2 million in the fourth quarter of fiscal 2001 related to our
Project Focus initiative. We have also experienced, and may experience in the
future, a decline in sales volumes with certain of our customers as a result of
reducing SKUs in connection with Project Focus.
Statement of Income Data. The following table sets forth our statement
of income data expressed as a percentage of net sales for the periods indicated
and, together with the discussion that follows the table, is based on
16
our accompanying unaudited condensed consolidated financial statements and notes
thereto included herein (table in thousands, except percentages):
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
--------------------------------------- ---------------------------------------
JUNE 29, 2002 JUNE 30, 2001 JUNE 29, 2002 JUNE 30, 2001
----------------- ----------------- ----------------- -----------------
Net sales $204,298 100.0% $217,262 100.0% $424,404 100.0% $468,026 100.0%
Cost of goods sold 155,532 76.1 176,710 81.3 324,724 76.5 395,727 84.6
-------- ----- -------- ----- -------- ----- -------- -----
Gross profit 48,766 23.9 40,552 18.7 99,680 23.5 72,299 15.4
Operating expenses:
Promotion and distribution 13,344 6.6 13,882 6.4 26,933 6.3 29,632 6.3
Selling, general and administrative 11,470 5.6 12,306 5.6 22,540 5.3 25,491 5.4
Amortization of intangibles 856 0.4 3,445 1.6 1,688 0.4 6,897 1.5
Non-recurring expenses -- -- 6,662 3.1 -- -- 6,662 1.4
-------- ----- -------- ----- -------- ----- -------- -----
Income from operations 23,096 11.3 4,257 2.0 48,519 11.5 3,617 0.8
Interest expense, net 16,518 8.1 14,539 6.7 29,825 7.0 28,874 6.2
Other income, net (467) (0.2) (427) (0.2) (635) (0.1) (604) (0.1)
-------- ----- -------- ----- -------- ----- -------- -----
Income (loss) before income taxes 7,045 3.4 (9,855) (4.5) 19,329 4.6 (24,653) (5.3)
Income tax expense (benefit) 1,858 0.9 (3,693) (1.7) 5,669 1.4 (9,714) (2.1)
-------- ----- -------- ----- -------- ----- -------- -----
Net income (loss) $ 5,187 2.5% $ (6,162) (2.8)% $ 13,660 3.2% $(14,939) (3.2)%
======== ===== ======== ===== ======== ===== ======== =====
</Table>
THREE MONTHS ENDED JUNE 29, 2002 COMPARED TO THREE MONTHS ENDED JUNE 30, 2001
Net sales. Our net sales in the second quarter of 2002 decreased 6.0%
to $204.3 million from $217.3 million in the comparable 2001 period. Net sales
in the 2002 second quarter were impacted by the divestitures of the Deep Run and
Perham businesses completed in the second quarter of 2001. Net sales in the 2001
second quarter included $3.1 million of net sales from Deep Run and Perham.
Excluding the 2001 net sales associated with these divestitures, our net sales
for the second quarter of 2002 decreased 4.6%, or $9.9 million, from the same
2001 period primarily due to lower global sales volumes related to Project Focus
implementation.
Gross profit. Our gross profit in the second quarter of 2002 increased
$8.2 million to $48.8 million from $40.6 million in the comparable 2001 period
primarily due to the favorable impact caused by the volatility of commodity
prices under FASB's Statement on Financial Accounting Standards No. 133,
Accounting for Derivative Instruments and Hedging Activities ("SFAS 133") fair
value accounting of our commodity derivative instruments. Such accounting
resulted in a $7.0 million reduction in our cost of goods sold in the second
quarter of 2002 compared to a $2.3 million increase in our cost of goods sold in
the same 2001 period, which accounts for a $9.3 million increase in gross
profit. Excluding the impact of SFAS 133, gross profit decreased to $41.8
million, or 20.5% of net sales, from $42.9 million, or 19.7% of net sales. This
decrease is due to higher ingredient costs, higher medical costs, and salary and
wage rate inflation, partially offset by lower natural gas prices, the favorable
impact of the Deep Run and Perham divestitures and improved performance at our
European operations.
Promotion and distribution. Promotion and distribution expenses for the
second quarter of 2002 decreased 3.9% to $13.3 million from $13.9 million in the
comparable 2001 period primarily due to the reduction in sales volumes.
Selling, general and administrative. Selling, general and
administrative expenses for the second quarter of 2002 decreased 6.8% to $11.5
million from $12.3 million in the comparable 2001 period primarily due to lower
costs from restructuring and other cost saving initiatives achieved in fiscal
2001, partially offset by salary and wage rate inflation.
Amortization of intangibles. Amortization expense for the second
quarter of 2002 decreased 75.2% to $0.9 million from $3.4 million in the
comparable 2001 period primarily due to goodwill and other intangible assets
with indefinite lives no longer being amortized. See "-- Recently Issued
Accounting Pronouncements."
Non-recurring expenses. Non-recurring expenses of $6.7 million for the
second quarter of 2001 consisted of a $4.7 million net loss on the sale of
certain assets related to the divestitures of the Deep Run and Perham businesses
and a $2.0 million charge associated with a workforce reduction following the
divestitures.
17
Interest expense, net. Interest expense, net of interest income, for
the second quarter of 2002 increased 13.6% to $16.5 million from $14.5 million
in the comparable 2001 period primarily due to a $2.3 million accrual of
non-cash interest expense for the excess leverage fee associated with our
amended senior credit facility. See "-- Liquidity and Capital Resources."
Income tax expense (benefit). We recognized income tax expense of $1.9
million for the second quarter of 2002 and an income tax benefit of $3.7 million
in the comparable 2001 period. Our effective tax rates of 26.4% for the second
quarter of 2002 and 37.5% for the second quarter of 2001 are different from the
combined U.S. federal and state statutory rate of 38.9% primarily due to the
difference between U.S. and foreign effective tax rates. In addition, our
effective tax rate in the 2001 period was further impacted by certain goodwill
amortization that was not deductible for income tax purposes.
SIX MONTHS ENDED JUNE 29, 2002 COMPARED TO SIX MONTHS ENDED JUNE 30, 2001
Net sales. Our net sales in the first six months of 2002 decreased 9.3%
to $424.4 million from $468.0 million in the comparable 2001 period. Net sales
in the 2001 six month period included $16.6 million of net sales from the Deep
Run and Perham businesses prior to their divestiture in the second quarter of
2001. Excluding the 2001 net sales associated with these divestitures, our net
sales for the first six months of 2002 decreased 6.0%, or $27.0 million, from
the first six months of 2001 primarily due to lower global sales volumes related
to Project Focus implementation.
Gross profit. Our gross profit in the first six months of 2002
increased $27.4 million to $99.7 million from $72.3 million in the comparable
2001 period primarily due to the favorable impact caused by the volatility of
commodity prices under SFAS 133 fair value accounting of our commodity
derivative instruments. Such accounting resulted in a $13.8 million reduction in
our cost of goods sold in the first six months of 2002 compared to a $10.1
million increase in our cost of goods sold in the same 2001 period, which
accounts for $23.9 million of the $27.4 million increase in gross profit.
Excluding the impact of SFAS 133, gross profit increased to $85.9 million, or
20.2% of net sales, from $82.4 million, or 17.6% of net sales. This increase is
due to lower natural gas prices, the favorable impact of the Deep Run and Perham
divestitures, lower operating costs as a result of the closure of certain
inefficient manufacturing facilities in fiscal 2001, as well as efficiencies
achieved at our remaining plants in both fiscal 2001 and 2002, and improved
performance at our European operations, partially offset by higher medical
costs, and salary and wage rate inflation.
Promotion and distribution. Promotion and distribution expenses for the
first six months of 2002 decreased 9.1% to $26.9 million from $29.6 million in
the comparable 2001 period primarily due to the reduction in sales volumes.
Selling, general and administrative. Selling, general and
administrative expenses for the first six months of 2002 decreased 11.6% to
$22.5 million from $25.5 million in the comparable 2001 period primarily due to
lower costs from restructuring and other cost saving initiatives achieved in
fiscal 2001, partially offset by salary and wage rate inflation.
Amortization of intangibles. Amortization expense for the first six
months of 2002 decreased 75.5% to $1.7 million from $6.9 million in the
comparable 2001 period primarily due to goodwill and other intangible assets
with indefinite lives no longer being amortized. See "-- Recently Issued
Accounting Pronouncements."
Non-recurring expenses. Non-recurring expenses of $6.7 million for the
first six months of 2001 consisted of a $4.7 million net loss on the sale of
certain assets related to the divestitures of the Deep Run and Perham businesses
and a $2.0 million charge associated with a workforce reduction following the
divestitures.
Interest expense, net. Interest expense, net of interest income, for
the first six months of 2002 increased 3.3% to $29.8 million from $28.9 million
in the comparable 2001 period primarily due to a $2.3 million accrual of
non-cash interest expense for the excess leverage fee associated with our
amended senior credit facility, partially offset by a decrease in interest rates
associated with our floating rate debt. See "-- Liquidity and Capital
Resources."
18
Income tax expense (benefit). We recognized income tax expense of $5.7
million for the first six months of 2002 and an income tax benefit of $9.7
million in the comparable 2001 period. Our effective tax rates of 29.3% for the
2002 period and 39.4% for the 2001 period are different from the combined U.S.
federal and state statutory rate of 38.9% primarily due to the difference
between U.S. and foreign effective tax rates. In addition, our effective tax
rate in the 2001 period was further impacted by certain goodwill amortization
that was not deductible for income tax purposes.
LIQUIDITY AND CAPITAL RESOURCES
We have historically funded our operations, capital expenditures and
working capital requirements with cash flows from operations, bank borrowings
and industrial development revenue bonds. At June 29, 2002, we had working
capital of $30.5 million.
Cash Flows. Net cash provided by our operating activities was $58.6
million in the first six months of 2002 compared to net cash used in our
operating activities of $22.5 million in the 2001 period. This increase was
primarily due to (1) the increase in our income before income taxes,
depreciation and amortization, (2) lower deposit amounts in our commodity margin
accounts and (3) an increase in accounts payable in the first six months of 2002
compared to a decrease in accounts payable in the 2001 period. As of June 29,
2002, we had a $1.8 million liability in our margin accounts associated with our
derivative contracts for corn, soybean meal and natural gas commodity
requirements for fiscal 2002 compared to a $10.5 million deposit in the same
margin accounts as of December 29, 2001.
Net cash used in our investing activities was $6.6 million in the first
six months of 2002 compared to net cash provided by our investing activities of
$12.4 million in the 2001 period. This decrease is primarily associated with the
proceeds received in the first six months of 2001 related to the divestitures of
the Deep Run and Perham businesses. Budgeted capital expenditures for the full
year fiscal 2002 are $25.0 million. We spent $6.5 million on capital
expenditures in the six months ended June 29, 2002.
Net cash used in financing activities was $52.5 million in the first
six months of 2002 compared to net cash provided by financing activities of
$11.0 million in the 2001 period. This decrease is primarily due to using cash
provided by operating activities to reduce our revolving credit borrowings in
2002 and proceeds received from the sponsor facility in 2001. Our sponsor
facility is a senior unsecured loan from the shareholders of our parent company
and certain of our executive officers bearing interest at 15% per annum and
maturing on March 31, 2007. The proceeds from the sponsor facility were used to
refinance $25.0 million of indebtedness under our senior credit facility.
Debt. We are highly leveraged and have significant cash requirements
for debt service relating to our senior credit facility, our 9 3/4% senior
subordinated notes, industrial development revenue bonds and foreign debt. Our
ability to borrow is limited by our senior credit facility and the limitations
on the incurrence of additional indebtedness in the indenture governing our
9 3/4% senior subordinated notes.
We entered into an amended and restated senior credit facility dated as
of May 8, 2000 with a syndicate of banks and other institutional investors, as
lenders, and JPMorgan Chase Bank as administrative agent. Our senior credit
facility was amended in March 2001 and March 2002.
As of June 29, 2002, our senior credit facility provides for total
commitments of:
o Euro 71.1 million ($70.9 million) for a Euro term loan facility;
and
o $353.5 million, consisting of:
- a $278.5 million USD term loan facility; and
- a $75.0 million revolving credit facility with a $20.0 million
sub-limit for issuance of letters of credit.
19
The commitments under the revolving credit facility are limited to
$60.0 million until certain financial performance tests are achieved. These
tests were not met in fiscal 2001 and we do not believe they will be met in
fiscal 2002. Availability of funds under our senior credit facility is subject
to certain customary terms and conditions.
Effective March 25, 2002, all loans started bearing interest at the
Euro dollar rate plus 4.75%, or the prime rate plus 3.75%, until maturity. At
June 29, 2002, the Euro term loan facility bore interest at 7.79%, the USD term
loan facility bore interest at 8.02% and the revolving credit facility bore
interest at 7.54%.
As of June 29, 2002, the principal amounts due under the Euro term loan
facility were approximately: (i) Euro 8.7 million in 2002 and 2003; (ii) Euro
11.0 million in 2004; and (iii) Euro 47.0 million in 2005; and the principal
amounts due under the USD term loan facility were approximately: (i) $15.0
million in 2002, 2003 and 2004; (ii) $162.0 million in 2005; and (iii) $79.1
million in 2006. At June 29, 2002, we had no borrowings under our revolving
credit facility and we had $3.4 million letters of credit outstanding, resulting
in $56.6 million in availability under our revolving credit facility.
The Euro term loan facility has a final maturity of December 30, 2005.
The USD term loan facility consists of three tranches with final maturities of
March 31, 2005, December 31, 2005 and December 31, 2006, respectively, unless
terminated sooner upon an event of default. The revolving credit facility has a
final maturity of March 31, 2005. Our senior credit facility provides for
mandatory prepayments of our borrowings upon certain specified events and in
certain specified percentages, and we may also prepay borrowings under our
senior credit facility.
In March 2002, we amended the senior credit facility to provide, among
other things: 1) for an increase in interest rates, as described above, and an
increase in the commitment fee rate on our revolving credit facility to 1.00%;
2) a grant to our lenders of a lien on our material operating accounts; 3) a
limit on the amount of future capital expenditures up to a total of $25.0
million for 2002 and $7.0 million for the first quarter of 2003; 4) a limit on
certain permitted investments; 5) an amendment to our existing financial
covenants through March 31, 2003; 6) a new minimum EBITDA covenant; and 7) for
the issuance of new senior subordinated notes if the net proceeds of such new
senior subordinated notes are used to repay the loans under our senior credit
facility. In addition, the amendment provides that an excess leverage fee will
accrue if the "senior leverage" ratio exceeds 3.25 to 1.00 as of March 31, 2003
at a rate equal to 2.5% of the sum of the daily average of the aggregate unpaid
principal amount of the loans from March 31, 2002 to March 31, 2003. If the
excess leverage fee is earned, it will generally be payable only from any future
asset sales and debt and equity offerings, but in any event not later than March
31, 2005.
Our senior credit facility contains certain financial covenant
requirements. We have experienced difficulty in the past satisfying financial
covenants in our senior credit facility. The amendments to our senior credit
facility in 2001 and 2002 waived certain financial covenant requirements for the
fiscal years ended December 30, 2000 and December 29, 2001. Without such
waivers, fiscal would not have been in compliance with the waived covenants at
December 30, 2000 or December 29, 2001. We may experience difficulty satisfying
these financial covenants in the future, which, if we are unable to secure a
waiver from our lenders, could result in, among other things, an event of
default and acceleration of outstanding debt under our senior credit facility.
Liquidity. We believe the cash flows generated from our business,
together with future borrowings, will be sufficient to enable us to make
principal and interest payments on our debt and to provide us with the necessary
liquidity for operational and investment requirements in the current operating
environment. We also believe the capital expenditures permitted under the senior
credit facility are sufficient to provide us with the necessary flexibility to
spend required maintenance capital and fund our planned expansion and customer
requirements for fiscal 2002. We cannot assure you, however, that our business
will generate sufficient cash flows or that future borrowings will be available
in an amount sufficient to enable us to make principal and interest payments on
our debt or to fund our other liquidity needs. In addition, any future
acquisitions, joint ventures or similar transactions that we may consider will
likely require additional capital and we cannot assure you that any such capital
will be available to us on commercially reasonable terms, on terms acceptable to
us, or at all.
As of June 29, 2002, we expected the future payout of our accrued
restructuring cost of $4.2 million would be $1.8 million in 2002, $2.2 million
in 2003 and $0.2 million in 2004.
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Capitalization. During fiscal 2002, our goal is to improve our ability
to comply with the covenants in our credit agreements and ultimately reduce our
leverage. We are exploring several alternatives to achieve this goal, either
alone or in some combination. Some of these alternatives include raising
additional equity capital, restructuring our senior credit facility, strategic
acquisitions, sales of non-strategic assets and issuing longer term debt
securities. We cannot assure you that we will be able to achieve these goals or
that we will be able to comply with the financial covenants in our senior credit
facility. If we are unable to restructure our senior credit facility prior to
the expiration of the reduced financial covenant requirements that are in effect
through March 31, 2003, we do not believe that we will be able to comply with
the financial covenant requirements that would go into effect on that date.
COMMITMENTS AND CONTINGENCIES
We believe our operations are in compliance in all material respects
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.
In 1996 and 1997, we entered into partial guarantees of certain
third-party loans made to 11 employees in connection with their purchase of our
parent's common stock under our parent's 1996 and 1997 Management Stock Purchase
Plans. We guaranteed to cover up to a maximum of $0.3 million of such loans in
the event one or more of the employees default in the loan repayment. None of
the individuals who received such loans currently serve as one of our executive
officers.
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 breakouts in protein sources and weather conditions during
the growing and 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 fiscal 2001, we implemented a price increase consistent with
industry announcements, which was intended to help offset non-commodity
inflationary increases. Domestic sales volumes were negatively impacted in
fiscal 2001 compared to fiscal 2000 due to competition resulting from the price
increase.
SEASONALITY
Our sales are moderately seasonal. We normally experience an increase
in net sales during the first and fourth quarters of each year, which is typical
in the pet food industry. Generally, cooler weather results in increased dog
food consumption.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Effective December 30, 2001, we adopted SFAS 142, which requires that
goodwill and other intangible assets with indefinite lives no longer be
amortized and further requires that the fair value of goodwill and other
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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. In the first quarter of
fiscal 2002, we reassessed the useful lives and residual values of all
intangible assets acquired in purchase business combinations which resulted in
no impact on our accompanying unaudited condensed consolidated financial
statements. As of June 29, 2002, we completed the required impairment tests of
goodwill and other intangible assets with indefinite lives and, based on the
results of the tests, determined no impairment to the carrying values of these
assets was needed. The adoption of SFAS 142 resulted in the elimination of
annual amortization expense related to goodwill and other intangible assets of
approximately $10.3 million, or $7.6 million net of income tax benefit. Our
results of operations in future periods could be adversely affected if our
goodwill and other intangible assets are determined to be impaired under SFAS
142.
Effective December 30, 2001, we adopted FASB's Statement on Financial
Accounting Standards No. 144, Accounting for the Impairment or Disposal of
Long-lived Assets, ("SFAS 144") which requires 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 also 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 adoption of SFAS 144 as
of the beginning of fiscal 2002 had no material impact on our financial position
or results of operations.
In April 2002, the FASB issued Statement on Financial Accounting
Standards No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of
FASB Statement No. 13, and Technical Corrections ("SFAS 145"), which amends
existing authoritative pronouncements to make various technical corrections,
clarify meanings and describe their applicability under changed conditions.
SFAS 145 requires gains and losses from the extinguishment of debt to be
classified as extraordinary items only if they meet the criteria of unusual or
infrequent or they meet the criteria for classification as an extraordinary
item. SFAS 145 will be effective for us as of the beginning of fiscal 2003. We
do not believe the adoption of SFAS 145 will have a material impact on our
financial position or results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks, which may give rise to losses from
adverse changes in market prices and rates. Our market risks could arise from
changes in commodity prices, interest rates and foreign currency exchange rates.
Commodity price risk. We manage our commodity price risk associated
with market fluctuations by using derivative instruments for portions of our
corn, soybean meal, alternative proteins and natural gas purchases, principally
through exchange traded futures and options contracts. The terms of such
contracts are generally less than one year. During the term of a contract, we
balance positions daily with cash payments to or from the exchanges. At the
termination of a contract, we have the ability to settle financially or by
exchange for the physical commodity, in which case, we would deliver the
contract against the acquisition of the physical commodity. Our policy does not
permit speculative commodity trading. At June 29, 2002, we had open commodity
contracts with a fair value gain of $4.1 million.
Based upon an analysis we completed as of June 29, 2002 in which we
utilized our actual derivative contractual volumes and assumed a 5.0% adverse
movement in commodity prices, we determined the potential decrease in the fair
value of our commodity derivative instruments would be approximately $3.3
million, or $2.0 million net of deferred tax benefit.
Although we manage the price risk of market fluctuations by hedging
portions of our primary commodity product purchases, our results of operations
have been adversely affected in the past by these fluctuations and we cannot
assure you that in the future we will be successful or that our results of
operations will not be exposed to volatility in the commodity markets. The use
of futures contracts also reduces our ability to take advantage of short term
reductions in raw material prices. If one or more of our competitors is able to
reduce their production costs by taking advantage of any reductions in raw
material prices, we may face pricing pressures from these competitors and
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may be forced to reduce our prices or face a decline in net sales either of
which could have a material adverse effect on our business, results of
operations and financial condition.
Our commodity derivative instruments are measured at fair value in our
unaudited condensed consolidated financial statements under SFAS 133. Our
results of operations have been adversely affected in the past by volatility in
commodity prices under the SFAS 133 fair value accounting of our commodity
derivative instruments and our results of operations may be adversely affected
in the future by SFAS 133 accounting.
Interest rate risk. We are exposed to market risk related to changes in
interest rates. We periodically use interest rate swap and cap contracts to
limit our exposure to the interest rate risk associated with our floating rate
debt, which totaled $349.4 million at June 29, 2002. Of that amount, $115.0
million of our floating rate debt was hedged by interest rate swap contracts and
$50.0 million was hedged by an interest rate cap contract. 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. Amounts received or paid under interest rate swap contracts and gains
and losses on interest rate cap contracts are recorded as interest income
(expense) in the accompanying unaudited condensed consolidated financial
statements included herein. Gains and losses on interest rate swap contracts are
recorded in accumulated other comprehensive income (loss) in the accompanying
unaudited condensed consolidated financial statements included herein. At June
29, 2002, we had a cumulative deferred loss on our interest rate swap contracts
of $3.5 million, or $2.1 million net of cumulative deferred tax benefit.
Accordingly, our net income is affected by changes in interest rates.
Assuming a 100 basis point increase in interest rates on our current floating
rate debt and interest rate swap and cap contracts, our net income would
decrease by approximately $0.5 million and $0.9 million, or $0.3 million and
$0.6 million net of income tax benefit, for the three months and six months
ended June 29, 2002, respectively. In addition, such a change would result in a
decrease of approximately $7.5 million in the fair value of our fixed rate debt
at June 29, 2002. In the event of an adverse change in interest rates, we could
take action to mitigate our exposure; however, due to the uncertainty of these
potential actions and their possible effects, our analysis assumes no such
actions. Furthermore, our analysis does not consider the effect of any changes
in the level of overall economic activity that may exist in such an environment.
Foreign currency exchange risk. Our financial position and results of
operations are affected by foreign currency exchange rate fluctuations. We
currently have European operations that sell pet food products throughout
Europe. In connection with our acquisition on May 10, 2000 of A/S Arovit
Petfood, which manufactures and sells throughout Europe a full range of pet food
products for dogs and cats, 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 June 29, 2002, the cumulative translation
adjustment for the net investment in our foreign operations was a net gain of
$9.7 million, which includes an unrealized cumulative gain of $7.0 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 in 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 changes in the market values of the hedged items 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 June 29, 2002, we had a cumulative deferred gain
on foreign currency forward contracts of $0.9 million, or $0.7 million net of
cumulative deferred tax expense. At June 29, 2002, we had open foreign currency
forward contracts that mature within the next 12 months with a notional value of
$0.5 million and no associated fair value gain or loss.
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
By: /s/ PHILIP K. WOODLIEF
------------------------------------
Philip K. Woodlief
Vice President, Finance and
Chief Financial Officer
By: /s/ STEPHEN P. HAVALA
------------------------------------
Stephen P. Havala
Corporate Controller and
Principal Accounting Officer
Date: August 13, 2002
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