----------
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 AND
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
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 001-12755
----------
DEAN FOODS COMPANY
(Exact name of the registrant as specified in its charter)
[DEAN FOODS(TM) LOGO]
DELAWARE 75-2559681
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
2515 McKINNEY AVENUE, SUITE 1200
DALLAS, TEXAS 75201
(214) 303-3400
(Address, including zip code, and telephone number, including area
code, of the registrant's principal executive offices)
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 [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
As of November 11, 2002 the number of shares outstanding of each class
of common stock was:
Common Stock, par value $.01, 91,266,570
----------
TABLE OF CONTENTS
<Table>
<Caption>
Page
-----
PART I--FINANCIAL INFORMATION
Item 1--Financial Statements.............................................. 1
Item 2--Management's Discussion and Analysis of Financial
Condition and Results of Operations............................... 20
Item 3--Quantitative and Qualitative Disclosures About Market Risk........ 36
Item 4--Controls and Procedures........................................... 37
PART II--OTHER INFORMATION
Item 6--Exhibits and Reports on Form 8-K.................................. 38
</Table>
i
PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DEAN FOODS COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
<Table>
<Caption>
SEPTEMBER 30, 2002 DECEMBER 31, 2001
------------------ -----------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents ........................................... $ 49,153 $ 78,260
Accounts receivable, net ............................................ 689,238 775,824
Inventories ......................................................... 435,700 440,247
Refundable income taxes ............................................. 32 3,375
Deferred income taxes ............................................... 107,636 127,579
Prepaid expenses and other current assets ........................... 83,363 56,899
---------- ----------
Total current assets ...................................... 1,365,122 1,482,184
Property, plant and equipment, net ............................................ 1,633,701 1,668,592
Goodwill ...................................................................... 3,153,448 2,967,778
Intangible and other assets ................................................... 700,513 613,343
---------- ----------
Total ..................................................... $6,852,784 $6,731,897
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses ............................... $1,022,703 $1,044,409
Income taxes payable ................................................ 28,178 33,582
Current portion of long-term debt and subsidiary lines of credit .... 161,955 96,972
---------- ----------
Total current liabilities ................................. 1,212,836 1,174,963
Long-term debt ................................................................ 2,741,053 2,971,525
Other long-term liabilities ................................................... 243,846 243,695
Deferred income taxes ......................................................... 332,608 281,229
Mandatorily redeemable convertible trust issued preferred securities .......... 585,032 584,605
Commitments and contingencies (See Note 10)
Stockholders' equity:
Common stock, 91,084,959 and 87,872,980 shares issued and outstanding 911 879
Additional paid-in capital .......................................... 1,073,136 961,705
Retained earnings ................................................... 693,108 543,139
Accumulated other comprehensive income .............................. (29,746) (29,843)
---------- ----------
Total stockholders' equity ................................ 1,737,409 1,475,880
---------- ----------
Total ..................................................... $6,852,784 $6,731,897
========== ==========
</Table>
See notes to condensed consolidated financial statements.
DEAN FOODS COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
--------------------------------- ---------------------------------
2002 2001 2002 2001
------------- ------------- ------------- -------------
(UNAUDITED) (UNAUDITED)
Net sales .................................... $ 2,286,061 $ 1,547,785 $ 6,919,002 $ 4,530,397
Cost of sales ................................ 1,680,610 1,195,435 5,144,950 3,477,209
------------- ------------- ------------- -------------
Gross profit ................................. 605,451 352,350 1,774,052 1,053,188
Operating costs and expenses:
Selling and distribution ................. 333,735 199,983 993,398 595,985
General and administrative ............... 95,464 41,083 265,750 131,498
Amortization of intangibles .............. 2,308 13,117 6,390 39,914
Plant closing costs ...................... 4,921 12,820 843
------------- ------------- ------------- -------------
Total operating costs and expenses ... 436,428 254,183 1,278,358 768,240
------------- ------------- ------------- -------------
Operating income ............................. 169,023 98,167 495,694 284,948
Other (income) expense:
Interest expense, net ................ 49,674 23,258 153,865 76,494
Financing charges on trust issued
preferred securities .............. 8,394 8,395 25,184 25,186
Equity in (earnings) loss of
unconsolidated affiliates ......... (254) 5,424 (2,061) 2,565
Other expense, net ................... 348 1,097 801 1,600
------------- ------------- ------------- -------------
Total other (income) expense ..... 58,162 38,174 177,789 105,845
------------- ------------- ------------- -------------
Income before income taxes and
minority interest .......................... 110,861 59,993 317,905 179,103
Income taxes ................................. 42,137 20,803 120,579 65,452
Minority interest in earnings ................ 25 9,768 41 26,109
------------- ------------- ------------- -------------
Income before cumulative effect
of accounting change ...................... 68,699 29,422 197,285 87,542
Cumulative effect of accounting change ....... (47,316) (1,446)
------------- ------------- ------------- -------------
Net income ................................... $ 68,699 $ 29,422 $ 149,969 $ 86,096
============= ============= ============= =============
Average common shares: Basic ................. 90,570,378 55,721,464 89,835,475 55,189,198
Average common shares: Diluted ............... 109,050,890 73,207,934 108,673,733 72,360,334
Basic earnings per common share:
Income before cumulative effect
of accounting change .............. $ 0.76 $ 0.53 $ 2.20 $ 1.59
Cumulative effect of accounting change (0.53) (0.03)
------------- ------------- ------------- -------------
Net income ........................... $ 0.76 $ 0.53 $ 1.67 $ 1.56
============= ============= ============= =============
Diluted earnings per common share:
Income before cumulative effect of
accounting change ................. $ 0.68 $ 0.47 $ 1.96 $ 1.43
Cumulative effect of accounting change (0.43) (0.02)
------------- ------------- ------------- -------------
Net income ........................... $ 0.68 $ 0.47 $ 1.53 $ 1.41
============= ============= ============= =============
</Table>
See notes to condensed consolidated financial statements.
2
DEAN FOODS COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<Table>
<Caption>
NINE MONTHS ENDED
SEPTEMBER 30
-----------------------------
2002 2001
--------- ---------
(unaudited)
Cash flows from operating activities:
Net income .......................................................... $ 149,969 $ 86,096
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ................................... 136,668 113,467
Write-down of impaired assets ................................... 7,909
Minority interest ............................................... 41 42,829
Equity in (earnings) loss of unconsolidated affiliates .......... (2,061) 2,565
Cumulative effect of accounting change .......................... 47,316 1,446
Deferred income taxes ........................................... 30,910 21,638
Other, net ...................................................... 1,219 1,056
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable ......................................... 90,716 (21,473)
Inventories ................................................. (3,695) (22,903)
Prepaid expenses and other assets ........................... (6,767) (5,657)
Accounts payable, accrued expenses and other liabilities .... (51,025) (53,959)
Income taxes ................................................ 38,641 14,438
--------- ---------
Net cash provided by operating activities ............... 439,841 179,543
Cash flows from investing activities:
Net additions to property, plant and equipment ...................... (152,392) (89,368)
Cash outflows for acquisitions and investments ...................... (213,586) (32,442)
Net proceeds from divestitures ...................................... 2,561
Purchase of minority interest ....................................... (12,620)
Other ............................................................... 4,106 1,915
--------- ---------
Net cash used in investing activities ................... (359,311) (132,515)
Cash flows from financing activities:
Proceeds from issuance of debt ...................................... 193,729 113,789
Repayment of debt ................................................... (370,892) (182,585)
Issuance of common stock, net of expenses ........................... 68,288 30,221
Redemption of common stock .......................................... (6,056)
Distribution to minority interest ................................... (7,746)
Other................................................................ (762)
--------- ---------
Net cash used in financing activities ................... (109,637) (52,377)
--------- ---------
Decrease in cash and cash equivalents ................................... (29,107) (5,349)
Cash and cash equivalents, beginning of period .......................... 78,260 31,110
--------- ---------
Cash and cash equivalents, end of period ................................ $ 49,153 $ 25,761
========= =========
</Table>
See notes to condensed consolidated financial statements.
3
DEAN FOODS COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002
(unaudited)
1. GENERAL
Basis of Presentation -- The unaudited condensed consolidated financial
statements contained in this report have been prepared on the same basis as the
consolidated financial statements in our Annual Report on Form 10-K for the year
ended December 31, 2001. In our opinion, we have made all necessary adjustments
(which include only normal recurring adjustments) in order to present fairly, in
all material respects, our consolidated financial position, results of
operations and cash flows as of the dates and for the periods presented. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
omitted. The consolidated financial statements contained in this report should
be read in conjunction with our 2001 consolidated financial statements contained
in our Annual Report on Form 10-K as filed with the Securities and Exchange
Commission on April 1, 2002.
On April 23, 2002, we effected a two-for-one split of our common stock.
Pursuant to the split, all shareholders of record as of April 8, 2002 received
one additional share of common stock for each share held on that date. All share
numbers contained in our condensed consolidated financial statements and in
these notes have been adjusted for all periods to reflect the stock split as if
it had already occurred.
This Quarterly Report, including these notes, has been written in
accordance with the Securities and Exchange Commission's "Plain English"
guidelines. Unless otherwise indicated, references in this report to "we," "us"
or "our" refer to Dean Foods Company and its subsidiaries, taken as a whole.
Recently Issued Accounting Standards -- The Emerging Issues Task Force
(the "Task Force") of the Financial Accounting Standards Board ("FASB") has
reached a consensus on Issue No. 00-14, "Accounting for Certain Sales
Incentives," which became effective for us in the first quarter of 2002. This
Issue addresses the recognition, measurement and income statement classification
of sales incentives that have the effect of reducing the price of a product or
service to a customer at the point of sale. Our historical practice for
recording sales incentives within the scope of this Issue, which has been to
record estimated coupon expense based on historical coupon redemption
experience, is consistent with the requirements of this Issue. Therefore, our
adoption of this Issue has no impact on our consolidated financial statements.
The Task Force has also reached a consensus on Issue No. 00-25, "Vendor
Income Statement Characterization of Consideration Paid to a Reseller of the
Vendor's Products." We adopted this Issue in the first quarter of 2002. Under
this Issue, certain consideration paid to our customers (such as slotting fees)
is required to be classified as a reduction of revenue, rather than recorded as
an expense. Adoption of this Issue required us to reduce reported revenue and
selling and distribution expense for the third quarter and for the first nine
months of 2001 by $7.9 million and $26.8 million, respectively. There was no
change, however, in reported net income.
In June 2001, FASB issued Statement of Financial Accounting Standards
("SFAS") No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Other
Intangible Assets." SFAS No. 141 addresses financial accounting and reporting
for business combinations. Under the new standard, all business combinations
entered into after June 30, 2001 are required to be accounted for by the
purchase method. We have applied, and will continue to apply, the provisions of
SFAS No. 141 to all business combinations completed after June 30, 2001. SFAS
No. 142 addresses financial accounting and reporting for acquired goodwill and
other intangible assets. We adopted SFAS No. 142 in the first quarter of 2002.
SFAS No. 142 requires that goodwill no longer be amortized, but instead requires
a transitional goodwill impairment assessment and annual impairment tests
thereafter. Effective June 30, 2002, we completed the first phase of the
transitional goodwill impairment assessment, which indicated that the goodwill
related to our Puerto Rico reporting unit is impaired. In the fourth quarter of
2002, we will determine the amount of impairment that existed as of January 1,
2002, and record the impairment in our income statement as the cumulative effect
of a change in accounting principle retroactive to the first quarter of 2002. As
of January 1, 2002, we had approximately $67 million recorded as goodwill
related to our Puerto Rico reporting unit. See Note 12 for information related
to our fourth quarter agreement to sell our Puerto Rico operating unit. Our
annual impairment tests will be completed in the fourth quarter of 2002. SFAS
No. 142 also requires that recognized intangible assets be amortized over their
respective estimated useful lives. As part of the adoption, we have re-assessed
the useful lives and residual values of all recognized intangible assets. Any
recognized intangible asset determined to have an indefinite useful life was
tested for impairment in accordance with the standard. These impairment tests
were completed during the first quarter of 2002, and resulted in a charge of
$47.3 million, net of an income tax benefit of $29 million, which was
4
recorded during the first quarter of 2002 as a change in accounting principle.
The impairment related to certain trademarks in our Dairy Group and
Morningstar/White Wave segments. The fair value of these trademarks was
determined using a present value technique.
In June 2001, FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." This statement requires that the fair value of a
liability for an asset retirement obligation be recognized in the period in
which the associated legal obligation for the liability is incurred if a
reasonable estimate of fair value can be made. The associated asset retirement
costs are capitalized as part of the carrying amount of the long-lived asset and
amortized over the useful life of the asset. SFAS No. 143 will become effective
for us in 2003. We are currently evaluating the impact of adopting this
pronouncement on our consolidated financial statements.
FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" in August 2001 and it became effective for us in the first
quarter of 2002. SFAS No. 144, which supercedes SFAS No. 121, provides a single,
comprehensive accounting model for impairment and disposal of long-lived assets
and discontinued operations. Our adoption of this standard did not have a
material impact on our consolidated financial statements.
SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64,
Amendment of FASB Statement No. 13, and Technical Corrections," was issued in
April 2002 and is applicable to fiscal years beginning after May 15, 2002. One
of the provisions of this technical statement is the rescission of SFAS No. 4,
"Reporting Gains and Losses from Extinguishment of Debt," whereby any gain or
loss on the early extinguishment of debt that was classified as an extraordinary
item in prior periods in accordance with SFAS No. 4, which does not meet the
criteria of an extraordinary item as defined by APB Opinion 30, must be
reclassified. Adoption of this standard will require us to reclassify
extraordinary losses previously reported from the early extinguishment of debt
as a component of "other expense". For the year ended December 31, 2001, we
recorded an extraordinary loss of $4.3 million, net of an income tax benefit of
$3.0 million in connection with the early extinguishment of debt.
In June 2002, FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This statement addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." The statement requires that a liability for
a cost associated with an exit or disposal activity be recognized when the
liability is incurred, and is effective for exit or disposal activities that are
initiated after December 31, 2002. We are currently evaluating the impact of
adopting this pronouncement on our consolidated financial statements.
2. ACQUISITIONS AND DIVESTITURES
Acquisition of Dean Foods Company -- On December 21, 2001, we completed
our acquisition of Dean Foods Company ("Old Dean"). As a result of this
transaction, Old Dean was merged with and into our wholly-owned subsidiary,
Blackhawk Acquisition Corp. Blackhawk Acquisition Corp. survived the merger and
immediately changed its name to Dean Holding Company. Immediately after
completion of the merger, we changed our name to Dean Foods Company. As a result
of the merger, each share of common stock of Old Dean was converted into 0.858
shares of our common stock and the right to receive $21.00 in cash. The
aggregate purchase price recorded was $1.7 billion, including $756.8 million of
cash paid to Old Dean stockholders and common stock valued at $739.4 million.
The value of the approximately 31 million common shares issued was determined
based on the average market price of our common stock during the period from
April 2 through April 10, 2001 (the acquisition was announced on April 5, 2001).
In addition, each of the options to purchase Old Dean's common stock outstanding
on December 21, 2001 was converted into an option to purchase 1.504 shares of
our stock. As discussed in Note 6, the holders of these options had the right,
during the ninety day period following the acquisition, to surrender their stock
options to us, in lieu of exercise, in exchange for a cash payment. We paid
approximately $17.7 million to Old Dean's option holders as a result of such
surrenders.
We decided to acquire Old Dean for the above-described consideration
after considering a number of factors, including:
o The acquisition would result in us becoming the first truly
national dairy and specialty foods company with the geographic
reach, management depth and product mix necessary to meet the
needs of large customers, who can especially benefit from the
added services, convenience and value that a national dairy
company can provide;
5
o Combining our businesses would enable us to reduce our costs by
pursuing economies of scale in purchasing, product development and
manufacturing, and by eliminating duplicative costs; and
o Increasing our scale would provide us with greater resources to
invest in marketing and innovation.
Also on December 21, 2001, in connection with our acquisition of Old
Dean, we purchased Dairy Farmers of America's ("DFA") 33.8% stake in our Dairy
Group for consideration consisting of: (1) approximately $145.4 million in cash,
(2) a contingent promissory note in the original principal amount of $40
million, and (3) the operations of eleven plants (including seven of our plants
and four of Old Dean's plants) located in nine states where we and Old Dean had
overlapping operations. As additional consideration, we amended a milk supply
agreement with DFA to provide that if we do not, within a specified period
following the completion of our acquisition of Old Dean, offer DFA the right to
supply raw milk to certain of the Old Dean dairy plants, we could be required to
pay liquidated damages of up to $47 million. See Note 10 for further discussion
of these contingent obligations. As a result of this transaction, we now own
100% of our Dairy Group.
In connection with our acquisition of Old Dean, we entered into a new
credit facility and expanded our receivables-backed loan facility. See Note 5.
We used the proceeds from the credit facility and receivables-backed loan
facility to fund the cash portion of the merger consideration and the
acquisition of DFA's minority interest, to refinance certain indebtedness and to
pay certain transaction costs.
Old Dean's operations and the acquisition of DFA's minority interest
(and related divestitures) are reflected in our consolidated financial
statements after December 21, 2001.
The final allocation of the purchase price to the fair values of assets
and liabilities of Old Dean and the related business integration plans will be
completed during the fourth quarter of 2002. We expect that the ultimate
purchase price allocation may include additional adjustments to the fair values
of depreciable tangible assets, identifiable intangible assets (some of which
will have indefinite lives) and the carrying values of certain liabilities.
Accordingly, to the extent that such assessments indicate that the fair value of
the assets and liabilities differ from their preliminary purchase price
allocations, such difference would adjust the amounts allocated to those assets
and liabilities and would change the amounts allocated to goodwill.
The unaudited results of operations on a pro forma basis for the
three-month and nine-month periods ended September 30, 2001 as if the
acquisition of Old Dean, and the purchase of DFA's minority interest (including
the divestiture of the 11 plants transferred in partial consideration of that
interest) had occurred as of the beginning of 2001 are as follows:
<Table>
<Caption>
PRO FORMA
----------------------------------------
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, 2001 SEPTEMBER 30, 2001
------------------ ------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net sales .................................................. $ 2,513,896 $ 7,376,735
Income before income taxes and minority interest ........... 84,717 216,344
Income before cumulative effect of accounting change ....... 53,130 137,589
Net income ................................................. 53,130 136,143
Basic earnings per common share:
Income before cumulative effect of accounting change ... $ 0.61 $ 1.60
Net income ............................................. 0.61 1.58
Diluted earnings per share:
Income before cumulative effect of accounting change ... 0.56 1.48
Net income ............................................. 0.56 1.47
</Table>
Acquisition of White Wave -- On May 9, 2002, we acquired the 64% equity
interest in White Wave, Inc. that we did not already own. White Wave, based in
Boulder, Colorado, is the maker of Silk(R) soymilk and other soy-based products,
and had sales of approximately $125 million during the 12 months ended March 31,
2002. Prior to May 9, we owned approximately 36% of White Wave, as a result of
certain investments made by Old Dean beginning in 1999. We purchased the
remaining 64% equity interest for a total price of approximately $189 million.
Existing management of White Wave has remained in place after the acquisition.
We have agreed to pay White Wave's management team an incentive bonus based on
achieving certain sales growth targets by March 2004. The bonus amount will vary
depending on the level of two-year cumulative sales White Wave achieves by the
end of
6
March 2004, and is anticipated to range between $30 million and $40 million.
Amounts expected to be payable under the bonus plan are expensed each quarter
based on White Wave's performance during the quarter. See Note 10. For financial
reporting purposes, White Wave's financial results are aggregated with
Morningstar Foods' financial results.
Acquisition of Marie's -- On May 17, 2002, we bought the assets of
Marie's Quality Foods, Marie's Dressings, Inc. and Marie's Associates, makers of
Marie's(R) brand dips and dressings in the western United States, for an
aggregate purchase price of approximately $23 million. Prior to the acquisition,
we licensed the Marie's brand to Marie's Quality Foods and Marie's Dressings,
Inc. for use in connection with the manufacture and sale of dips and dressings
in the western United States. As a result of this acquisition, our
Morningstar/White Wave segment is now the sole owner, manufacturer and marketer
of Marie's brand products nationwide.
Divestitures of Non-Core Businesses -- During the first nine months of
2002, we completed the sale of two non-core businesses acquired as part of Old
Dean. On January 4, 2002, we completed the sale of the stock of DFC
Transportation Company, a contract hauler that was part of Old Dean's Specialty
Foods segment. On February 7, 2002, we completed the sale of the assets related
to the boiled peanut business of Dean Specialty Foods Company, also a part of
the Specialty Foods segment.
3. INVENTORIES
<Table>
<Caption>
AT SEPTEMBER 30, AT DECEMBER 31,
2002 2001
---------------- ---------------
(IN THOUSANDS)
Raw materials and supplies ....................... $ 158,970 $ 161,673
Finished goods ................................... 276,730 278,574
---------- ----------
Total .................................. $ 435,700 $ 440,247
========== ==========
</Table>
Approximately $112.8 million and $131.7 million of our inventory was
accounted for under the last-in, first-out (LIFO) method of accounting at
September 30, 2002 and December 31, 2001, respectively. There was no material
excess of current cost over the stated value of last-in, first-out inventories
at either date.
4. GOODWILL AND OTHER INTANGIBLE ASSETS
On January 1, 2002, we adopted SFAS No. 142, which requires, among
other things, that goodwill no longer be amortized, and that recognized
intangible assets with finite lives be amortized over their respective useful
lives. As required by SFAS No. 142, our results for the third quarter and first
nine months of 2001 have not been restated. The following sets forth a
reconciliation of net income and earnings per share information for the
three-month and nine-month periods ended September 30, 2002 and 2001,
eliminating goodwill amortization and amortizing recognized intangible assets
with finite useful lives. We expect to complete our goodwill impairment analysis
by December 31, 2002. See Note 1.
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
--------------------------- ---------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Reported net earnings before cumulative
effect of accounting change $ 68,699 $ 29,442 $ 197,285 $ 87,542
Reported net earnings ................................. 68,699 29,442 149,969 86,096
Goodwill amortization, net of tax and
minority interest.................................. 6,935 20,747
Trademark amortization, net of tax and
minority interest ................................. 591 1,780
Adjusted net earnings before cumulative
effect of accounting change ....................... 68,699 36,968 197,285 110,069
Adjusted net earnings ................................. 68,699 36,968 149,969 108,623
Basic earnings per share:
Reported net earnings before cumulative
effect of accounting change ....................... $ 0.76 $ 0.53 $ 2.20 $ 1.59
Adjusted net earnings ....................... $ 0.76 $ 0.66 $ 1.67 $ 1.97
Diluted earnings per share:
Reported net earnings before cumulative
effect of accounting change ............... $ 0.68 $ 0.47 $ 1.96 $ 1.43
Adjusted net earnings ....................... $ 0.68 $ 0.58 $ 1.53 $ 1.72
</Table>
7
The changes in the carrying amount of goodwill for the nine months
ended September 30, 2002 are as follows:
<Table>
<Caption>
MORNINGSTAR/ SPECIALTY
DAIRY GROUP WHITE WAVE FOODS OTHER TOTAL
----------- ------------ ---------- ---------- ----------
(IN THOUSANDS)
Balance at December 31, 2001 ........... $2,163,702 $ 389,572 $ 290,000 $ 124,504 $2,967,778
Acquisitions ........................... 3,977 101,722 105,699
Purchase accounting adjustments ........ 53,397 23,539 (4,856) 7,891 79,971
---------- ---------- ---------- ---------- ----------
Balance at September 30, 2002 .......... $2,221,076 $ 514,833 $ 285,144 $ 132,395 $3,153,448
========== ========== ========== ========== ==========
</Table>
The gross carrying amount and accumulated amortization of our
intangible assets other than goodwill as of September 30, 2002 and December 31,
2001 are as follows:
<Table>
<Caption>
SEPTEMBER 30, 2002 DECEMBER 31, 2001
-------------------------------------------- ---------------------------------------------
GROSS NET GROSS NET
CARRYING ACCUMULATED CARRYING CARRYING ACCUMULATED CARRYING
AMOUNT AMORTIZATION AMOUNT AMOUNT AMORTIZATION AMOUNT
---------- ------------ ----------- ---------- ---------- ----------
(IN THOUSANDS) (IN THOUSANDS)
Intangible assets with
indefinite lives:
Trademarks ......... $ 473,321 $(14,274) $ 459,047 $ 391,662 $ (14,274) $ 377,388
Intangible assets with
finite lives:
Customer-related ... 63,221 (16,294) 46,927 61,132 (10,496) 50,636
---------- ---------- ---------- ---------- ---------- ----------
Total other intangibles .... $ 536,542 $(30,568) $ 505,974 $ 452,794 $ (24,770) $ 428,024
========== ========== ========== ========== ========== ==========
</Table>
Amortization expense on intangible assets for the three months ended
September 30, 2002 and 2001 was $2.8 million and $1.7 million respectively, and
$5.8 million and $5.8 million for the nine months ended September 30, 2002 and
2001, respectively. Estimated aggregate intangible asset amortization expense
for the next five years is as follows:
<Table>
2003 ................ $5.2 million
2004 ................ $4.2 million
2005 ................ $3.2 million
2006 ................ $2.4 million
2007 ................ $1.8 million
</Table>
5. LONG-TERM DEBT
<Table>
<Caption>
SEPTEMBER 30, 2002 DECEMBER 31, 2001
------------------------------- -------------------------------------
AMOUNT INTEREST AMOUNT INTEREST
OUTSTANDING RATE OUTSTANDING RATE
------------- ---------- ------------- -----------
(DOLLARS IN THOUSANDS) (DOLLARS IN THOUSANDS)
Senior credit facility ...................... $ 1,880,825 4.05% $ 1,900,000 4.67%
Subsidiary debt obligations:
Senior notes ............................ 656,070 6.625-8.15 658,211 6.625-8.15
Receivables-backed loan ................. 258,000 2.40 400,000 2.29
Foreign subsidiary term loan ............ 33,631 5.13 35,172 6.25
Other lines of credit ................... 19,918 3.95-5.13 2,317 4.80
Industrial development revenue bonds .... 21,000 1.75-2.00 28,001 1.02-6.63
Capital lease obligations and other ..... 33,564 44,796
------------- -------------
2,903,008 3,068,497
Less current portion ........................ (161,955) (96,972)
------------- -------------
Total ....... $ 2,741,053 $ 2,971,525
============= =============
</Table>
8
Senior Credit Facility -- Simultaneously with the completion of our
acquisition of Old Dean, we entered into a new $2.7 billion credit agreement
with a syndicate of lenders, in replacement of our then existing credit
facilities. Our new senior credit facility provides an $800 million revolving
line of credit, a Tranche A $900 million term loan and a Tranche B $1 billion
term loan. Upon completion of the Old Dean acquisition, we borrowed $1.9 billion
under this facility's term loans. At September 30, 2002 there were outstanding
borrowings of $1.88 billion under this facility, in addition to $65.4 million of
issued but undrawn letters of credit. As of September 30, 2002, approximately
$699.4 million was available for future borrowings under the revolving credit
facility, subject to satisfaction of certain conditions contained in the loan
agreement. We are currently in compliance with all covenants contained in our
credit agreement.
Credit Facility Terms -- Amounts outstanding under the revolving line
of credit and the Tranche A term loan bear interest at a rate per annum equal to
one of the following rates, at our option:
o a base rate equal to the higher of the Federal Funds rate plus 50
basis points or the prime rate, plus a margin that varies from 25
to 150 basis points, depending on our leverage ratio (which is the
ratio of defined indebtedness to EBITDA), or
o the London Interbank Offering Rate ("LIBOR") computed as LIBOR
divided by the product of one minus the Eurodollar Reserve
Percentage, plus a margin that varies from 150 to 275 basis
points, depending on our leverage ratio.
On April 30, 2002, we entered into an amendment to our credit facility
pursuant to which the interest rate for amounts outstanding under the Tranche B
term loan was lowered by 50 basis points, to the following, at our option:
o a base rate equal to the higher of the Federal Funds rate plus 50
basis points or the prime rate, plus a margin that varies from 75
to 150 basis points, depending on our leverage ratio, or
o LIBOR divided by the product of one minus the Eurodollar Reserve
Percentage, plus a margin that varies from 200 to 275 basis
points, depending on our leverage ratio.
The blended interest rate in effect on borrowings under the senior
credit facility, including the applicable interest rate margin, was 4.05% at
September 30, 2002. However, we have interest rate swap agreements in place that
hedge $925 million of our borrowings under this facility at an average rate of
5.95%, plus the applicable interest rate margin. Interest is payable quarterly
or at the end of the applicable interest period.
Scheduled principal payments on the Tranche A term loan are due in the
following installments:
o $16.87 million quarterly from March 31, 2002 through December 31,
2002;
o $33.75 million quarterly from March 31, 2003 through December 31,
2004;
o $39.38 million quarterly from March 31, 2005 through December 31,
2005;
o $45.00 million quarterly from March 31, 2006 through December 31,
2006;
o $56.25 million quarterly from March 31, 2007 through June 30,
2007; and
o A final payment of $112.5 million on July 15, 2007.
Scheduled principal payments on the Tranche B term loan are due in the
following installments:
o $1.25 million quarterly from March 31, 2002 through December 31,
2002;
o $2.5 million quarterly from March 31, 2003 through December 31,
2007;
o A payment of $472.5 million on March 31, 2008; and
o A final payment of $472.5 million on July 15, 2008.
No principal payments are due on the revolving line of credit until
maturity on July 15, 2007.
The credit agreement also requires mandatory principal prepayments in
certain circumstances including without limitation: (1) upon the occurrence of
certain asset dispositions not in the ordinary course of business,
9
(2) upon the occurrence of certain debt and equity issuances when our leverage
ratio is greater than 3.0 to 1.0, and (3) beginning in 2003, annually when our
leverage ratio is greater than 3.0 to 1.0. The credit agreement requires that we
prepay 50% of defined excess cash flow for any fiscal year (beginning in 2003)
in which our leverage ratio at year end is greater than 3.0 to 1.0. As of
September 30, 2002, our leverage ratio was 3.4 to 1.0.
In consideration for the revolving commitments, we pay a commitment fee
on unused amounts of the $800 million revolving credit facility that ranges from
37.5 to 50 basis points, depending on our leverage ratio.
The senior credit facility contains various financial and other
restrictive covenants and requires that we maintain certain financial ratios,
including a leverage ratio (computed as the ratio of the aggregate outstanding
principal amount of defined indebtedness to EBITDA) and an interest coverage
ratio (computed as the ratio of EBITDA to interest expense). In addition, this
facility requires that we maintain a minimum level of net worth (as defined by
the agreement).
Our leverage ratio must be less than or equal to:
<Table>
<Caption>
PERIOD RATIO
------ -----
12-21-01 through 12-31-02 ................................ 4.25 to 1.00
01-01-03 through 12-31-03 ................................ 4.00 to 1.00
01-01-04 through 12-31-04 ................................ 3.75 to 1.00
01-01-05 and thereafter .................................. 3.25 to 1.00
</Table>
Our interest coverage ratio must be greater than or equal to 3.0 to
1.0.
Our consolidated net worth must be greater than or equal to $1.2
billion, as increased each quarter (beginning with the quarter ended March 31,
2002) by an amount equal to 50% of our consolidated net income for the quarter,
plus 75% of the amount by which stockholders' equity is increased by certain
equity issuances. As of September 30, 2002, the minimum net worth requirement
was $1.27 billion.
Our credit agreement permits us to complete acquisitions that meet the
following conditions without obtaining prior approval: (1) the acquired company
is involved in the manufacture, processing and distribution of food or packaging
products or any other line of business in which we are currently engaged, (2)
the total cash consideration is not greater than $100 million (which amount will
be increased to $300 million when our leverage ratio is less than 3.0 to 1.0),
(3) we acquire at least 51% of the acquired entity, and (4) the transaction is
approved by the Board of Directors or shareholders, as appropriate, of the
target. All other acquisitions must be approved in advance by the required
lenders.
Our credit agreement also permits us to repurchase stock under our open
market share repurchase program, provided that, until our leverage ratio is less
than 3.0 to 1.0, total Restricted Payments (as defined in the agreement, which
definition includes stock repurchases) cannot exceed $50 million per year, plus
the amount of payments required to be made on our outstanding convertible
preferred securities during that year.
The facility also contains limitations on liens, investments, the
incurrence of additional indebtedness and acquisitions, and prohibits certain
dispositions of property and restricts certain payments, including dividends.
The credit facility is secured by liens on substantially all of our domestic
assets (including the assets of our subsidiaries, but excluding the capital
stock of Old Dean's subsidiaries and the real property owned by Old Dean and its
subsidiaries).
The agreement contains standard default triggers including without
limitation: failure to maintain compliance with the financial and other
covenants contained in the agreement, default on certain of our other debt, a
change in control and certain material adverse changes in our business. The
agreement does not contain any default triggers based on our debt rating.
Senior Notes -- Old Dean had certain senior notes outstanding at the
time of the acquisition which remain outstanding. The notes carry the following
interest rates and maturities:
o $96.5 million ($100 million face value), at 6.75% interest,
maturing in 2005;
o $250.5 million ($250 million face value), at 8.15% interest,
maturing in 2007;
o $183.9 million ($200 million face value), at 6.625% interest,
maturing in 2009; and
10
o $125.1 million ($150 million face value), at 6.9% interest,
maturing in 2017.
The related indentures do not contain financial covenants but they do
contain certain restrictions including a prohibition against Old Dean and its
subsidiaries granting liens on their respective real estate interests and a
prohibition against Old Dean granting liens on the stock of its subsidiaries.
The indentures also place certain restrictions on Old Dean's ability to divest
assets not in the ordinary course of business.
Receivables-Backed Loan -- We have entered into a receivables
securitization facility pursuant to which certain of our subsidiaries sell their
accounts receivable to three wholly-owned special purpose entities intended to
be bankruptcy-remote. The special purpose entities then transfer the receivables
to third party asset-backed commercial paper conduits sponsored by major
financial institutions. The assets and liabilities of these three special
purpose entities are fully reflected on our balance sheet, and the
securitization is treated as a borrowing for accounting purposes. During the
first nine months of 2002, we made net payments of $142 million on this
facility leaving an outstanding balance of $258 million at September 30, 2002.
The receivables-backed loan bears interest at a variable rate based on
the commercial paper yield as defined in the agreement.
Foreign Subsidiary Term Loan -- In connection with our acquisition of
Leche Celta in February 2000, our Spanish subsidiary obtained a 42.1 million
euro (as of September 30, 2002, approximately $41.6 million) non-recourse term
loan from a Spanish lender, all of which was borrowed at closing and used to
finance a portion of the purchase price. The loan, which is secured by the stock
of Leche Celta, will expire on February 21, 2007, bears interest at a variable
rate based on the ratio of Leche Celta's debt to EBITDA (as defined in the
corresponding loan agreement), and requires semi-annual principal payments. At
September 30, 2002, a total of $33.6 million was outstanding under this
facility.
Other Lines of Credit -- Leche Celta, our Spanish subsidiary, is our
only subsidiary with its own lines of credit separate from the credit facilities
described above. Leche Celta's primary line of credit, which is in the principal
amount of 15 million euros (as of September 30, 2002 approximately $14.8
million), was obtained on July 12, 2000, bears interest at a variable interest
rate based on the ratio of Leche Celta's debt to EBITDA (as defined in the
corresponding loan agreement), is secured by our stock in Leche Celta and will
expire in June 2007. Leche Celta also utilizes other local commercial lines of
credit. At September 30, 2002, a total of $19.9 million was drawn on these lines
of credit.
Industrial Development Revenue Bonds -- Certain of our subsidiaries
have revenue bonds outstanding, some of which require nominal annual sinking
fund redemptions. Typically, these bonds are secured by irrevocable letters of
credit issued by financial institutions, along with first mortgages on the
related real property and equipment. Interest on these bonds is due semiannually
at interest rates that vary based on market conditions.
Other Subsidiary Debt -- Other subsidiary debt includes various
promissory notes for the purchase of property, plant and equipment and capital
lease obligations. The various promissory notes payable provide for interest at
varying rates and are payable in monthly installments of principal and interest
until maturity, when the remaining principal balances are due. Capital lease
obligations represent machinery and equipment financing obligations which are
payable in monthly installments of principal and interest and are collateralized
by the related assets financed.
Letters of Credit -- At September 30, 2002 there were $65.4 million of
issued but undrawn letters of credit secured by our senior credit facility. In
addition to the letters of credit secured by our credit facility, an additional
$38 million of letters of credit were outstanding at September 30, 2002. These
letters of credit were required by various utilities and government entities for
performance and insurance guarantees.
Interest Rate Agreements -- We have interest rate swap agreements in
place that have been designated as cash flow hedges against variable interest
rate exposure on a portion of our debt, with the objective of minimizing our
interest rate risk and stabilizing cash flows. These swap agreements provide
hedges for loans under our senior credit facility by limiting or fixing the
LIBOR interest rates specified in the senior credit facility at the interest
rates noted below until the indicated expiration dates of these interest rate
swap agreements.
11
The following table summarizes our various interest rate agreements in
effect as of September 30, 2002 and December 31, 2001:
<Table>
<Caption>
FIXED INTEREST RATES EXPIRATION DATE NOTIONAL AMOUNTS
- ----------------------------------------- --------------- ----------------
(IN MILLIONS)
4.90% to 4.93% .......................... December 2002 $275.0
6.07% to 6.24% .......................... December 2002 325.0
6.23% ................................... June 2003 50.0
6.69% ................................... December 2004 100.0
6.69% to 6.74% .......................... December 2005 100.0
6.78% ................................... December 2006 75.0
</Table>
In March and June of 2002, we entered into forward-starting swaps that
begin in December 2002 with a notional amount of $750 million and fixed interest
rates of 4.005% to 5.315%. These swaps have been designated as hedges against
interest rate exposure on loans under our senior credit facility and under one
of our subsidiary's term loans.
<Table>
<Caption>
FIXED INTEREST RATES EXPIRATION DATE NOTIONAL AMOUNTS
- ---------------------------------------- --------------- ----------------
(IN MILLIONS)
4.290% to 4.6875% ....................... December 2003 $275.0
4.005% to 4.855% ........................ December 2004 175.0
5.190% to 5.315% ........................ December 2005 300.0
</Table>
We have also entered into interest rate swap agreements that provide
hedges for loans under Leche Celta's term loan. The following table summarizes
these agreements:
<Table>
<Caption>
FIXED
INTEREST
RATES EXPIRATION DATE NOTIONAL AMOUNTS
- ---------------- --------------- -----------------------------------------------------------------------
5.54% November 2003 9 million euros (approximately $8.9 million as of September 30, 2002)
5.60% November 2004 12 million euros (approximately $11.9 million as of September 30, 2002)
</Table>
These swaps are required to be recorded as an asset or liability on our
consolidated balance sheet at fair value, with an offset to other comprehensive
income to the extent the hedge is effective. Derivative gains and losses
included in other comprehensive income are reclassified into earnings as the
underlying transaction occurs. Any ineffectiveness in our hedges is recorded as
an adjustment to interest expense.
As of September 30, 2002, our derivative liability totaled $53.8
million on our consolidated balance sheet including approximately $28.9 million
recorded as a component of accounts payable and accrued expenses and $24.9
million recorded as a component of other long-term liabilities. There was no
hedge ineffectiveness, as determined in accordance with SFAS No. 133, for the
quarter or the nine months ended September 30, 2002. Approximately $6.2 million
and $17.7 million of losses (net of taxes) were reclassified to interest expense
from other comprehensive income during the quarter and the nine months ended
September 30, 2002, respectively. We estimate that approximately $18.2 million
of net derivative losses (net of income taxes) included in other comprehensive
income will be reclassified into earnings within the next 12 months. These
losses will partially offset the lower interest payments recorded on our
variable rate debt.
We are exposed to market risk under these arrangements due to the
possibility of interest rates on the credit facilities falling below the rates
on our interest rate swap agreements. Credit risk under these arrangements is
remote since the counterparties to our interest rate swap agreements are major
financial institutions.
6. STOCKHOLDERS' EQUITY
Stock Options - The following table summarizes activity during the
first three quarters of 2002 under our stock-based compensation programs:
12
<Table>
<Caption>
WEIGHTED
AVERAGE
AWARDS EXERCISE PRICE
---------- --------------
Options outstanding at December 31, 2001 .................. 14,063,860 $ 21.16
Options granted during first quarter(1) ............... 4,826,170 30.53
Options canceled or surrendered during first quarter(2) (1,644,002) 22.46
Options exercised during first quarter ................ (1,830,268) 20.80
----------
Options outstanding at March 31, 2002 ..................... 15,415,760 23.98
Options granted during second quarter(1) .............. 121,000 36.61
Options canceled during second quarter ................ (1,155,679) 22.13
Options exercised during second quarter ............... (463,967) 21.71
----------
Options outstanding at June 30, 2002 ...................... 13,917,114 24.31
Options granted during third quarter(1) ............... 187,800 36.70
Options canceled during third quarter ................. (32,185) 25.57
Options exercised during third quarter ................ (786,351) 20.05
----------
Options outstanding at September 30, 2002 ................. 13,286,378 24.75
==========
</Table>
- ----------
(1) Options granted vest as follows: one-third on the first anniversary of
the grant date, one-third on the second anniversary of the grant date,
and one-third on the third anniversary of the grant date.
(2) The acquisition of Old Dean triggered certain "change in control"
rights contained in the Old Dean option agreements, which consisted of
the right to surrender the options to us, in lieu of exercise, in
exchange for cash, provided the options were surrendered prior to March
21, 2002. Options to purchase approximately 1.6 million shares were
surrendered.
During the first 9 months of 2002, we issued the following shares of
restricted stock, all of which were granted to independent members of our Board
of Directors as compensation for services rendered as directors during the
immediately preceding quarter. Directors' shares of restricted stock vest
one-third on grant, one-third on the first anniversary of grant and one-third on
the second anniversary of grant.
<Table>
<Caption>
Period # of Shares
-------------- -----------
First quarter 1,876
Second quarter 2,968
Third quarter 2,670
</Table>
Earnings Per Share - Basic earnings per share is based on the weighted
average number of common shares outstanding during each period. Diluted earnings
per share is based on the weighted average number of common shares outstanding
and the effect of all dilutive common stock equivalents during each period. The
following table reconciles the numerators and denominators used in the
computations of both basic and diluted earnings per share ("EPS"):
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
----------------------------- ----------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Basic EPS computation:
Numerator:
Income before cumulative effect
of accounting change ............................. $ 68,699 $ 29,422 $ 197,285 $ 87,542
------------ ------------ ------------ ------------
Income applicable to common stock .................... $ 68,699 $ 29,422 $ 197,285 $ 87,542
============ ============ ============ ============
Denominator:
Average common shares ................................ 90,570,378 55,721,464 89,835,475 55,189,198
============ ============ ============ ============
Basic EPS before cumulative effect of accounting change ...... $ 0.76 $ 0.53 $ 2.20 $ 1.59
============ ============ ============ ============
Diluted EPS computation:
Numerator:
Income before cumulative effect of
accounting change ................................ $ 68,699 $ 29,422 $ 197,285 $ 87,542
Net effect on earnings from conversion of
mandatorily redeemable convertible preferred
securities ....................................... 5,331 5,331 15,993 15,993
------------ ------------ ------------ ------------
Income applicable to common stock .................. $ 74,030 $ 34,753 $ 213,278 $ 103,535
============ ============ ============ ============
Denominator:
Average common shares - basic ...................... 90,570,378 55,721,464 89,835,475 55,189,198
Stock option conversion ............................ 3,147,340 2,152,962 3,504,973 1,837,524
Dilutive effect of conversion of mandatorily
redeemable convertible
preferred securities .......................... 15,333,172 15,333,508 15,333,285 15,333,612
------------ ------------ ------------ ------------
Average common shares - diluted .................... 109,050,890 73,207,934 108,673,733 72,360,334
============ ============ ============ ============
Diluted EPS before cumulative effect of accounting change .... $ 0.68 $ 0.47 $ 1.96 $ 1.43
============ ============ ============ ============
</Table>
13
7. COMPREHENSIVE INCOME
Comprehensive income consists of net income plus all other changes in
equity from non-owner sources. Consolidated comprehensive income was $65.9
million and $150.1 million for the three-month and nine-month periods ended
September 30, 2002. The amounts of income tax (expense) benefit allocated to
each component of other comprehensive income during the nine months ended
September 30, 2002 are included below.
<Table>
<Caption>
PRE-TAX
INCOME TAX BENEFIT NET
(LOSS) (EXPENSE) AMOUNT
-------- ----------- ------
(IN THOUSANDS)
Accumulated other comprehensive income, December 31, 2001 ............ $(51,021) $ 21,178 $(29,843)
Cumulative translation adjustment arising during period .......... (1,402) 533 (869)
Net change in fair value of derivative instruments ............... (7,177) 2,938 (4,239)
Amounts reclassified to income statement related to derivatives .. 9,716 (3,973) 5,743
-------- -------- --------
Accumulated other comprehensive income, March 31, 2002 ............... $(49,884) $ 20,676 $(29,208)
Cumulative translation adjustment arising during period .......... 9,273 (3,404) 5,869
Net change in fair value of derivative instruments ............... (15,283) 5,885 (9,398)
Amounts reclassified to income statement related to derivatives .. 9,391 (3,616) 5,775
-------- -------- --------
Accumulated other comprehensive income, June 30, 2002 ................ $(46,503) $ 19,541 $(26,962)
Cumulative translation adjustment arising during period .......... 1,124 (426) 698
Net change in fair value of derivative instruments ............... (15,388) 5,702 (9,686)
Amounts reclassified to income statement related to derivatives .. 9,850 (3,646) 6,204
-------- -------- --------
Accumulated other comprehensive income, September 30, 2002 .......... $(50,917) $ 21,171 $(29,746)
======== ======== ========
</Table>
8. PLANT CLOSING COSTS
Plant Closing Costs -- As part of our overall integration and cost
reduction program, we recorded plant closing costs during the first quarter of
2002 in the amount of $1.2 million related to the closing of our Port Huron,
Michigan, Dairy Group plant during the fourth quarter of 2001.
During the second quarter of 2002, we recorded plant closing costs in
the amount of $6.7 million related to the closing of one plant in Puerto Rico,
one Dairy Group plant in Bennington, Vermont, and one Dairy Group distribution
facility in Winchester, Virginia.
During the third quarter of 2002, we recorded plant closing costs in
the amount of $4.9 million related to the closing of a Morningstar plant in
Tempe, Arizona.
The principal components of the cost reduction plans included within
this program include the following:
o Workforce reductions as a result of plant closings, plant
rationalizations and consolidation of administrative functions.
To date, we have identified 422 employees, who were primarily
plant employees associated with the plant closings and
rationalization, for termination pursuant to the plans. Costs
are charged to our earnings in the period that the plan is
established in detail and employee severance and benefits are
appropriately communicated. As of September 30, 2002, 336
employees had been terminated under the program;
o Shutdown costs, including those costs that are necessary to
prepare plant facilities for re-sale or closure;
o Costs incurred after shutdown, such as lease obligations or
termination costs, utilities and property taxes; and
o Write-downs of property, plant and equipment and other assets,
primarily for asset impairments as a result of facilities that
are no longer used in operations. The impairments relate
primarily to owned building, land and equipment at the
facilities which are being sold and were written down to their
estimated fair value. The effects of suspending depreciation on
the buildings and equipment related to the closed facilities
were not significant. The carrying value of closed facilities
held for sale at September 30, 2002 was approximately $8.0
million. We are marketing these properties for sale.
Divestitures of closed facilities has not resulted in
significant modifications to the estimate of fair value.
14
Activity with respect to plant closing costs for 2002 to date is
summarized below:
<Table>
<Caption>
NINE MONTHS ENDED
SEPTEMBER 30, 2002
BALANCE AT ------------------------ BALANCE AT
DECEMBER 31, 2001 CHARGES PAYMENTS SEPTEMBER 30, 2002
----------------- ------- -------- ------------------
(IN THOUSANDS)
Cash charges:
Workforce reduction costs .......... $ 668 $ 2,523 $(1,819) $ 1,372
Shutdown costs ..................... 460 549 (470) 539
Lease obligations after shutdown ... 119 132 251
Other .............................. 253 1,707 (77) 1,883
------- ------- ------- -------
Subtotal ............................... $ 1,500 4,911 $(2,366) $ 4,045
======= ======= =======
Noncash charges:
Write-down of assets ............... 7,909
-------
Total charges .......................... $12,820
=======
</Table>
There have not been significant adjustments to any plan included within
our integration and cost reduction program, and the majority of future cash
requirements to reduce the liabilities under the plans are expected to be
completed within one year.
Acquired Facility Closing Costs -- As part of our purchase price
allocations, we accrue costs from time to time pursuant to plans to exit certain
activities and operations of acquired businesses in order to rationalize
production and reduce costs and inefficiencies.
During the first nine months of 2002, we closed four Old Dean plants,
and we are currently evaluating whether to close others. In addition, we have
restructured Old Dean's administrative offices. We will finalize and implement
our initial integration and rationalization plan, and refine our estimate of
amounts in our purchase price allocations associated with this plan, during the
fourth quarter of 2002.
The principal components of the plan include the following:
o Workforce reductions as a result of plant closings, plant
rationalizations and consolidation of administrative functions and
offices, resulting in an overall reduction of 704 plant and
administrative personnel which have been terminated or identified
for termination. The costs incurred are charged against our
acquisition liabilities for these costs. As of September 30, 2002,
55 employees identified for termination had not yet been
terminated;
o Shutdown costs, including those costs that are necessary to clean
and prepare the plant facilities for re-sale or closure; and
o Costs incurred after shutdown such as lease obligations or
termination costs, utilities and property taxes after shutdown of
the plant or administrative office.
Activity with respect to these acquisition liabilities during the first
nine months of 2002 is summarized below:
<Table>
<Caption>
ACCRUED ACCRUED
CHARGES AT CHARGES AT
DECEMBER 31, SEPTEMBER 30,
2001 ACCRUALS PAYMENTS 2002
------------ -------- -------- -------------
(IN THOUSANDS)
Workforce reduction costs $20,029 $ 8,672 $(17,601) $11,100
Shutdown costs .......... 12,621 6,279 (6,350) 12,550
------- ------- -------- -------
Total ................... $32,650 $14,951 $(23,951) $23,650
======= ======= ======== =======
</Table>
15
9. SHIPPING AND HANDLING FEES
Our shipping and handling costs are included in both cost of sales and
selling and distribution expense, depending on the nature of such costs.
Shipping and handling costs reflected in cost of sales include inventory
warehouse costs and product loading and handling costs. Shipping and handling
costs included in selling and distribution expense are related to shipping
products to customers, and consist primarily of (i) delivery costs for
company-owned delivery routes, (ii) independent distributor routes (to the
extent that such independent distributors are paid a delivery fee), and (iii)
third party carrier expenses. Shipping and handling costs that were recorded as
a component of selling and distribution expense were approximately $244.8
million and $722.4 million during the third quarter and first nine months of
2002, respectively, compared to $164 million and $486.6 million during the third
quarter and first nine months, respectively, of 2001.
10. COMMITMENTS AND CONTINGENCIES
Guaranty of Certain Indebtedness of Consolidated Container Company --
We own a 43.1% interest in Consolidated Container Company ("CCC"), the nation's
largest manufacturer of rigid plastic containers and our primary supplier of
plastic bottles and bottle components. During 2001, as a result of various
operational difficulties, CCC became unable to comply with the financial
covenants in its credit facility. In February 2002, CCC's lenders agreed to
restructure the credit agreement to modify the financial covenants, subject to
the agreement of CCC's primary shareholders to guarantee certain of CCC's debt.
Because CCC is an important and valued supplier of ours, and in order to protect
our interest in CCC, we agreed to provide a limited guaranty. The guaranty,
which expires on January 5, 2003, is limited in amount to the lesser of (1) 49%
of the principal, interest and fees of CCC's "Tranche 3" revolver, and (2) $10
million. CCC's "Tranche 3" revolver can only be drawn upon by CCC when its
Tranche 1 and Tranche 2 revolvers are fully drawn. As of September 30, 2002,
Tranche 1 was partially drawn, Tranche 2 had been converted to a term loan, and
nothing was borrowed under Tranche 3. If CCC draws on the Tranche 3 revolver, no
voluntary pre-payments may be made on the Tranche 1 and 2 revolvers until the
Tranche 3 revolver is fully re-paid. Our guaranty cannot be drawn upon until the
Tranche 3 loan is due and payable (whether at its January 5, 2003 maturity or by
acceleration), and no more than one demand for payment may be made by the banks.
We have entered into an agreement with Alan Bernon (who is a member of our Board
of Directors) and his brother, Peter Bernon, who collectively own 6% of CCC,
pursuant to which, collectively, they have agreed to reimburse us for 12% of any
amounts paid by us under the guaranty.
Contingent Obligations Related to Milk Supply Arrangements -- On
December 21, 2001, in connection with our acquisition of Old Dean, we purchased
Dairy Farmers of America's ("DFA") 33.8% stake in our Dairy Group for
consideration consisting of (1) approximately $145.4 million in cash, (2) a
contingent promissory note in the original principal amount of $40 million, and
(3) the operations of 11 plants located in nine states where we and Old Dean had
overlapping operations (which plants were actually transferred to National Dairy
Holdings, L.P., as assignee of DFA). As additional consideration, we amended a
milk supply agreement with DFA to provide that if we do not, within a certain
period of time after the completion of the Old Dean acquisition, offer DFA the
right to supply raw milk to certain of the Old Dean dairy plants, we could be
required to pay liquidated damages of up to $47 million. Specifically, the
liquidated damages to DFA provision provides that:
o If we have not offered DFA the right to supply all of our raw milk
requirements for certain of Old Dean's plants by either (i) the
end of the 18th full month after December 21, 2001, or (ii) with
respect to certain other plants, the end of the 6th full calendar
month following the expiration of milk supply agreements in
existence at those plants on December 21, 2001, or
o If DFA is prohibited from supplying those plants because of an
injunction, restraining order or otherwise as a result of or
arising from a milk supply contract to which we are party,
we must pay DFA liquidated damages determined and paid on a plant-by-plant
basis, based generally on the amount of raw milk used by that plant. Liquidated
damages would be payable in arrears in equal, quarterly installments over a
5-year period, without interest. If we are required to pay any such liquidated
damages, the principal amount of the $40 million contingent promissory note will
be reduced by an amount equal to 25% of the liquidated damages paid.
The contingent promissory note is designed to ensure that DFA, one of
our primary suppliers of raw milk, has the opportunity to continue to supply raw
milk to certain of our plants until 2021, or be paid for the loss of that
business. The contingent promissory note has a 20-year term and bears interest
based on the consumer price index. Interest will not be paid in cash. Instead,
interest will be added to the principal amount of the note annually, up to a
maximum principal amount of $96 million. We may prepay the note in whole or in
part at any time, without penalty. The note will only become payable if we ever
materially breach or terminate one of our milk supply agreements
16
with DFA without renewal or replacement. Otherwise, the note will expire at the
end of 20 years, without any obligation to pay any portion of the principal or
interest.
Contingent Obligations Related to Divested Operations -- We retained
certain liabilities of the businesses of the 11 plants divested to National
Dairy Holdings, where those liabilities were deemed to be "non-ordinary course"
liabilities. We also have the obligation to indemnify National Dairy Holdings
for any damages incurred by it in connection with those retained liabilities, or
in connection with any breach of the divestiture agreement. We do not expect any
liability that we may have for these retained liabilities, or any
indemnification liability, to be material. We believe we have adequate reserves
for any such potential liability.
Enron -- In 1999, we entered into an Energy Program Agreement with
Enron Energy Services pursuant to which we contracted to purchase electricity
for certain of our plants at a discounted rate for a ten-year period. Under the
agreement, Enron (i) supplied (or arranged for the supply of) utilities to our
facilities and paid the costs of such utilities directly to the utility
suppliers, and (ii) made certain capital improvements at certain of our
facilities in an effort to reduce our utility consumption, all in exchange for
one monthly payment from us. In November 2001, Enron stopped performing under
the agreement and in December 2001, Enron filed for bankruptcy protection.
Shortly thereafter, Enron formally terminated our contract. In order to
compensate us for our lost savings, the Energy Program Agreement provided for
formula-based liquidated damages in the event of termination of the agreement as
a result of Enron's breach. We have filed a claim in Enron's bankruptcy for our
damages. On September 30, 2002, we received a letter from Enron demanding
payment of certain amounts that Enron alleges we owe under the agreement. We
have disputed the validity of Enron's claim and are in the process of attempting
to negotiate an agreement with Enron for the settlement of our claims against
each other. We cannot estimate the amount that we may be required to pay Enron
pursuant to a settlement, if any. However, we do not expect the settlement to
have a material adverse impact on our financial position, results of operations
or cash flows.
Leases -- We lease certain property, plant and equipment used in our
operations under both capital and operating lease agreements. Such leases, which
are primarily for machinery, equipment and vehicles (including airplanes), have
lease terms ranging from 1 to 20 years. Certain of the operating lease
agreements require the payment of additional rentals for maintenance, along with
additional rentals based on miles driven, hours used or units produced.
Contingent Obligations Related to White Wave Acquisition -- On May 9,
2002, we completed the acquisition of White Wave, Inc. In connection with the
acquisition, we established a Performance Bonus Plan pursuant to which we have
agreed to pay performance bonuses to certain employees of White Wave if certain
performance targets are achieved. Specifically, we agreed that if the cumulative
net sales (as defined in the plan) of White Wave equal or exceed $382.5 million
during the period beginning April 1, 2002 and ending March 31, 2004 (the
"Incentive Period") and White Wave does not exceed the budgetary restrictions
set forth in the plan by more than $1 million during the Incentive Period, we
will pay employee bonuses as follows:
o If cumulative net sales during the Incentive Period are between
$382.5 million and $450 million, the bonus paid will scale ratably
(meaning $129,630 for each $1 million of net sales) between
$26.025 million and $35.0 million; and
o If cumulative net sales exceed $450 million during the Incentive
Period, additional amounts will be paid as follows:
- First $50 million above $450 million net sales: 10% of amount
in excess of $450 million, plus
- Second $50 million above $450 million net sales: 15% of
amount in excess of $500 million, plus
- In excess of $550 million net sales: 20% of amount in excess
of $550 million.
Key employees of White Wave are also entitled to receive certain
payments if they are terminated without cause (or as a result of death or
incapacity) during the Incentive Period.
Litigation, Investigations and Audits -- We and our subsidiaries are
parties, in the ordinary course of business, to certain other claims,
litigation, audits and investigations. We believe we have adequate reserves
for any liability we may incur in connection with any such currently
pending or threatened matter. In our opinion, the settlement of any such
currently pending or threatened matter is not expected to have a material
adverse impact on our financial position, results of operations or cash flows.
17
11. BUSINESS AND GEOGRAPHIC INFORMATION AND MAJOR CUSTOMERS
We currently have three reportable segments: Dairy Group, Morningstar/White
Wave and Specialty Foods. Our Dairy Group segment manufactures and distributes
fluid milk, ice cream and novelties, half-and-half, whipping cream, sour cream,
cottage cheese, yogurt and dips, as well as fruit juices, flavored drinks and
bottled water. Our Morningstar/White Wave segment manufactures dairy and
non-dairy coffee creamers, whipping cream and pre-whipped toppings, dips and
dressings, cultured dairy products, and specialty products such as
lactose-reduced milk and extended shelf-life flavored milks and milk-based
beverages, soymilk and other soy products.
We obtained Specialty Foods as part of our acquisition of Old Dean on
December 21, 2001. Specialty Foods processes and markets pickles, powdered
products such as non-dairy coffee creamers, and sauces and puddings.
Neither our Puerto Rico nor our Spanish operations meet the definition of a
reportable segment. Therefore, they are both reported in the "Corporate/Other"
line.
The accounting policies of our segments are the same as those described in
the summary of significant accounting policies set forth in Note 1 to our 2001
consolidated financial statements contained in our 2001 Annual Report on Form
10-K. We evaluate performance based on operating profit not including
non-recurring gains and losses and foreign exchange gains and losses.
We do not allocate income taxes, management fees or unusual items to
segments. In addition, there are no significant non-cash items other than
depreciation and amortization in reported segment income.
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------------------ -------------------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
(IN THOUSANDS)
Net sales from external customers:
Dairy Group .................. $1,763,726 $1,269,727 $5,339,943 $3,710,500
Morningstar/White Wave ....... 261,099 178,912 763,475 524,539
Specialty Foods .............. 164,103 502,681
Corporate/Other .............. 97,133 99,146 312,903 295,358
---------- ---------- ---------- ----------
Total ........ $2,286,061 $1,547,785 $6,919,002 $4,530,397
========== ========== ========== ==========
Intersegment sales:
Dairy Group .................. $ 7,290 $ 3,630 $ 22,169 $ 11,724
Morningstar/White Wave ....... 19,889 24,185 77,257 66,582
Specialty Foods .............. 3,571 11,345
Corporate/Other ..............
---------- ---------- ---------- ----------
Total ........ $ 30,750 $ 27,815 $ 110,771 $ 78,306
========== ========== ========== ==========
Operating income:
Dairy Group(1) ............... $ 134,835 $ 76,143 $ 398,182 $ 218,458
Morningstar/White Wave(2)..... 19,862 21,825 73,801 68,090
Specialty Foods .............. 28,321 74,475
Corporate/Other(3) ........... (13,995) 199 (50,764) (1,600)
---------- ---------- ---------- ----------
Total ........ $ 169,023 $ 98,167 $ 495,694 $ 284,948
========== ========== ========== ==========
</Table>
<Table>
<Caption>
Assets at September 30: 2002 2001
---------- ----------
(IN THOUSANDS)
Dairy Group ...................... $4,481,355 $2,903,566
Morningstar/White Wave ........... 1,046,306 451,073
Specialty Foods .................. 645,946
Corporate/Other .................. 679,177 478,139
---------- ----------
Total ........ $6,852,784 $3,832,778
========== ==========
</Table>
18
- ----------
(1) Operating income includes plant closing costs of $6.5 million and $0.8
million in the first nine months of 2002 and 2001, respectively.
(2) Operating income includes plant closing costs of $4.9 million in the
third quarter and first nine months of 2002.
(3) Operating income includes plant closing costs of $1.4 million in the
first nine months of 2002.
Geographic information for the three-month and nine-month periods ended
September 30:
<Table>
<Caption>
NET SALES
----------------------------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED LONG-LIVED ASSETS AT
SEPTEMBER 30 SEPTEMBER 30 SEPTEMBER 30
------------------------------ ------------------------------ ------------------------------
2002 2001 2002 2001 2002 2001
---------- ---------- ---------- ---------- ---------- ----------
(IN THOUSANDS) (IN THOUSANDS) (IN THOUSANDS)
United States ..... $2,184,356 $1,448,639 $6,593,100 $4,235,039 $5,154,436 $2,699,219
Puerto Rico ....... 56,334 55,164 167,813 167,112 121,925 125,004
Europe ............ 45,371 43,982 158,089 128,246 120,578 105,033
---------- ---------- ---------- ---------- ---------- ----------
Total ............. $2,286,061 $1,547,785 $6,919,002 $4,530,397 $5,396,939 $2,929,256
========== ========== ========== ========== ========== ==========
</Table>
We have no single customer within any segment which represents greater
than ten percent of our consolidated revenues.
12. SUBSEQUENT EVENTS
In order to more closely align both our assets and our management
resources with our strategic direction, part of our strategy in 2002 has been to
divest certain assets. Accordingly, on November 8, 2002, we entered into an
agreement to sell our operations in Puerto Rico for a cash purchase price equal
to approximately $122 million. Completion of the transaction is subject to the
receipt of certain regulatory approvals, the buyer's ability to obtain financing
for the transaction and certain other customary closing conditions. We expect
the transaction to be completed on or before December 31, 2002. As of September
30, 2002, our Puerto Rico reporting unit had current assets of $45.8 million,
long-term assets of $121.9 million, current liabilities of $11.8 million and
long-term liabilities of $7.5 million.
On October 11, 2002, we completed the sale of our 94% interest in EBI
Foods, a U.K.-based subsidiary of our Specialty Foods Group. We received
aggregate proceeds of approximately $29 million for our interest. No gain or
loss will be recognized, as EBI was acquired in the acquisition of Old Dean.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
We are the leading processor and distributor of fresh dairy products in the
United States and a leader in the specialty foods industry.
We currently have three reportable segments: Dairy Group, Morningstar/White
Wave and Specialty Foods. Our Dairy Group segment manufactures and sells fluid
milk, ice cream and novelties, half-and-half, whipping cream, sour cream,
cottage cheese, yogurt and dips, as well as fruit juices, flavored drinks and
bottled water. Our Morningstar/White Wave segment consists of our Morningstar
Foods division and, as of May 9, 2002, our White Wave, Inc. subsidiary. It
manufactures and sells dairy and non-dairy coffee creamers, whipping cream and
pre-whipped toppings, dips and dressings, cultured dairy products, specialty
products such as lactose-reduced milks and extended shelf-life milks and
milk-based beverages, soymilks and other soy products. Specialty Foods
manufactures and sells pickles, powdered products such as non-dairy coffee
creamers, and sauces and puddings. We also have operations in Puerto Rico and
Spain that are aggregated in our segment discussions into the "Corporate/Other"
category.
RESULTS OF OPERATIONS
The following table presents certain information concerning our results of
operations, including information presented as a percentage of net sales:
<Table>
<Caption>
THREE MONTHS ENDED SEPTEMBER 30
----------------------------------------------------------
2002 2001
------------------------- --------------------------
DOLLARS PERCENT DOLLARS PERCENT
---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Net sales ........................... $2,286,061 100.0% $1,547,785 100.0%
Cost of sales ....................... 1,680,610 73.5 1,195,435 77.2
---------- ---------- ---------- ----------
Gross profit ................... 605,451 26.5 352,350 22.8
Operating expenses
Selling and distribution ........ 333,735 14.6 199,983 12.9
General and administrative ...... 95,464 4.2 41,083 2.7
Amortization of intangibles ..... 2,308 0.1 13,117 0.8
Plant closing and other costs ... 4,921 0.2
---------- ---------- ---------- ----------
Total operating expenses . 436,428 19.1 254,183 16.4
---------- ---------- ---------- ----------
Total operating income ... $ 169,023 7.4% $ 98,167 6.4%
========== ========== ========== ==========
</Table>
<Table>
<Caption>
NINE MONTHS ENDED SEPTEMBER 30
--------------------------------------------------------
2002 2001
------------------------- --------------------------
DOLLARS PERCENT DOLLARS PERCENT
---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Net sales ........................... $6,919,002 100.0% $4,530,397 100.0%
Cost of sales ....................... 5,144,950 74.4 3,477,209 76.8
---------- ---------- ---------- ----------
Gross profit ................... 1,774,052 25.6 1,053,188 23.2
Operating expenses
Selling and distribution ........ 993,398 14.4 595,985 13.1
General and administrative ...... 265,750 3.8 131,498 2.9
Amortization of intangibles ..... 6,390 0.0 39,914 0.9
Plant closing and other costs ... 12,820 0.2 843 0.0
---------- ---------- ---------- ----------
Total operating expenses . 1,278,358 18.4 768,240 16.9
---------- ---------- ---------- ----------
Total operating income ... $ 495,694 7.2% $ 284,948 6.3%
========== ========== ========== ==========
</Table>
Note: We completed our acquisition of the former Dean Foods Company ("Old Dean")
on December 21, 2001. We obtained our Specialty Foods segment as part of our
acquisition of Old Dean. More complete segment data can be found in Note 11 to
our condensed consolidated financial statements. Effective January 1, 2002, we
adopted SFAS No. 142, "Goodwill and Other Intangible Assets," which eliminates
the amortization of goodwill and certain other intangible assets. As a result of
the acquisition of Old Dean and the adoption of SFAS No. 142, comparisons with
the first three quarters of 2001 are less meaningful than they would be
otherwise. Where appropriate, we have provided comparisons eliminating the
amortization of goodwill and amortizing our recognized intangible assets with a
finite useful life. See Notes 1 and 4 to our condensed consolidated financial
statements for more information regarding SFAS 142.
Third Quarter 2002 Compared to Third Quarter 2001
Net Sales -- Net sales increased $738.3 million, or 48%, to $2.29 billion
during the third quarter of 2002, from $1.55 billion in the third quarter of
2001.
Net sales for the Dairy Group increased $494 million, or 39%, in the third
quarter of 2002. The acquisition of Old Dean (net of the plants divested as part
of the transaction) contributed approximately $620 million to the Dairy Group's
third quarter sales. That increase was partly offset by the effects of decreased
raw milk and cream costs compared to the prior year third quarter, and also by
lower ice cream volumes. In general, we change the prices that we charge our
customers for our products on a monthly basis, as the costs of our raw materials
fluctuate. Therefore, sales generally decrease as raw material prices decrease.
The average monthly federal order minimum prices for raw skim milk and cream for
the third quarter of 2002 compared to the third quarter of 2001 are set forth
below:
<Table>
<Caption>
Three Months Ended
September 30*
----------------------------
%
2002 2001 Change
----------------------------
Class I Raw Skim Milk(1),(3) $6.88 $7.92 (13)%
Class I Butterfat(2),(3) 1.11 2.23 (50)
Class II Raw Skim Milk(1),(4) 7.58 8.24 (8)
Class II Butterfat(2),(4) 1.06 2.32 (54)
</Table>
* Prices noted in this table are the federal government's minimum prices,
which do not necessarily reflect our actual raw milk and butterfat
costs. Please see "- Known Trends and Uncertainties - Raw Material
Prices" for a more complete description of raw milk and butterfat
pricing.
(1) Prices are per hundredweight.
(2) Prices are per pound.
(3) We process Class I raw skim milk and butterfat into fluid milk
products.
(4) We process Class II raw skim milk and butterfat into products such as
cottage cheese, creams, ice cream and sour cream.
20
On a pro forma basis as if Old Dean had been acquired on January 1, 2001 (net of
the plants divested as part of the transaction), the Dairy Group's fluid milk
volumes during the third quarter of 2002 were relatively flat compared to the
third quarter of 2001, while ice cream volumes during the third quarter of 2002
were down approximately 6% compared to the third quarter of 2001. Our ice cream
products are sold under private labels and local brands, and we lost sales
during the quarter to nationally branded products, which were promoted more
aggressively than our products.
Net sales for Morningstar/White Wave increased $82.2 million or 46%, in the
third quarter of 2002, compared to the year earlier period. We estimate that the
acquisition of Old Dean added approximately $64 million of sales at our
Morningstar/White Wave segment during the third quarter of 2002. Precise
measurement of the impact of the Old Dean acquisition on Morningstar/White
Wave's sales is no longer possible because Old Dean's NRP group has now been
fully integrated into Morningstar, and is no longer accounted for separately.
The acquisition of White Wave contributed approximately $43 million in the third
quarter of 2002. These gains were offset by (i) lower raw milk and butterfat
prices, (ii) lower cultured dairy product volumes, and (iii) the
previously-announced phase-out of the Lactaid(R), Nestle Quik(R) and Nestle
Coffeemate(R) co-packing businesses. Sales of Morningstar/White Wave's strategic
brands, which include Hershey's(R) flavored milks, International Delight(R)
coffee creamers, Silk(R) soy products, SunSoy(R) soymilk, Folger's Jakada(R)
milk and coffee beverage, Land O'Lakes(R) Dairy Ease(R) lactose-free milk and
Marie's(R) dips and dressings and Dean's(R) dips, totaled approximately $135
million during the third quarter of 2002. Strategic brand volumes were up
approximately 25% in the third quarter of 2002 compared to the third quarter of
2001 (including the effect of brands acquired in both periods).
Our Specialty Foods segment reported net sales of $164.1 million in the
third quarter of 2002.
Cost of Sales -- Our cost of sales ratio was 73.5% in the third quarter of
2002 compared to 77.2% in the same period of 2001. The cost of sales ratio for
the Dairy Group decreased to 74.1% in the third quarter of 2002 from 77.6% in
the third quarter of 2001 due primarily to lower raw milk costs and also to
realized merger synergies. The cost of sales ratio for Morningstar/White Wave
decreased to 68.5% in the third quarter of 2002 from 72.2% in the same period of
2001, due primarily to lower butterfat costs in the third quarter of 2002
compared to the year earlier period and also to realized merger synergies.
Specialty Foods' cost of sales ratio was 71.7% in the third quarter of 2002.
Operating Costs and Expenses -- Our operating expense ratio was 19.1% in
the third quarter of 2002 compared to 16.4% in the third quarter of 2001. These
ratios were affected by our adoption of SFAS 142 on January 1, 2002. Excluding
2001 amortization, our operating expense ratio would have been 15.6% in 2001, as
compared to 19.1% in 2002.
The operating expense ratio at the Dairy Group was 18.3% in the third
quarter of 2002 compared to 16.4% in the same period last year. Excluding
approximately $9.9 million of amortization in the third quarter of 2001, the
Dairy Group's operating expense ratio would have been 15.7% in 2001, compared to
18.3% in 2002. In 2001, the Dairy Group eliminated certain discretionary
expenses as a result of the difficult operating environment. Operating expenses
have returned to more normal levels in 2002. The increase in the operating
expense ratio was primarily due to the effect of lower raw material prices in
2002. Lower raw material prices caused our sales, measured in dollars on a pro
forma basis as if Old Dean had been acquired on January 1, 2001, to decline,
which negatively affected the Dairy Group's operating expense ratio.
The operating expense ratio at Morningstar/White Wave was 23.9% in the
third quarter of 2002 compared to 15.6% in the third quarter of 2001. Excluding
approximately $1.8 million of amortization in the third quarter of 2001, the
operating expense ratio would have been 14.6% in 2001, compared to 23.9% in
2002. This increase was caused primarily by (i) significantly higher selling and
marketing expenses related to the planned introduction of new products and
additional promotions of existing products, (ii) the addition of White Wave,
which has higher selling, marketing and distribution costs due to its efforts
to build brand recognition through advertising and promotions, as well as
slotting for new product placement and (iii) plant closing costs of $4.9 million
related to the closing of the Tempe, Arizona plant.
21
The overall increase in 2002 was partly caused by corporate office
expenses, which increased approximately $14.4 million in the third quarter of
2002 compared to 2001 as a result of the acquisition of Old Dean.
The operating expense ratio for Specialty Foods was 11% in the third
quarter of 2002.
Operating Income -- Operating income in the third quarter of 2002 was $169
million, an increase of $70.8 million from 2001 operating income of $98.2
million. Our operating margin in the third quarter of 2002 was 7.4% compared to
6.4% in the same period of 2001. Excluding 2001 amortization that would have
been eliminated had SFAS 142 been in effect last year, our operating income
would have increased $58.2 million in the third quarter of 2002 and our
operating margin would have increased to 7.4% during the third quarter of 2002
versus 7.2% in the same period of 2001.
The Dairy Group's operating margin, after excluding amortization expense
from the third quarter of 2001, increased to 7.6% in the third quarter of 2002
from 6.8% in the third quarter of 2001. This increase was primarily due to lower
raw milk costs during 2002 and to realized synergies from our acquisition of Old
Dean, partly offset by higher operating expenses. The operating margin for our
Morningstar/White Wave segment, again excluding amortization expense from the
third quarter of 2001, declined to 7.6% in the third quarter of 2002 from 13.2%
in 2001. This decrease was due primarily to significantly higher operating
costs.
Specialty Foods' operating margin was 17.3% in the third quarter of 2002.
Other (Income) Expense -- Total other expense increased by $20 million in
the third quarter of 2002 compared to 2001. Interest expense increased to $49.7
million in the third quarter of 2002 from $23.3 million in 2001. This increase
was the result of higher debt used primarily to finance the acquisitions of Old
Dean and White Wave. Financing charges on preferred securities were $8.4 million
in both years.
Income from investments in unconsolidated affiliates increased to income of
$0.3 million in the third quarter of 2002 from a loss of $5.4 million in the
same period of 2001. The loss in 2001 related primarily to our 43.1% minority
interest in Consolidated Container Company ("CCC"). In the fourth quarter of
2001 we concluded that our investment in CCC was impaired and that the
impairment was not temporary, and as a result we wrote off our remaining
investment in CCC.
Income Taxes -- Income tax expense was recorded at an effective rate of 38%
in the third quarter of 2002 compared to 34.7% in 2001. In the third quarter of
2001, a contested state tax issue was resolved in our favor. Our tax rate varies
as the mix of earnings contributed by our various business units changes, and as
tax savings initiatives are adopted.
Minority Interest -- Minority interest in earnings decreased significantly
to $25 thousand in the third quarter of 2002 from $9.8 million in the third
quarter of 2001. In 2002, management of EBI Foods, a subsidiary of our Specialty
Foods segment, owned a small minority interest in that subsidiary. In 2001,
Dairy Farmers of America owned a 33.8% minority interest in our Dairy Group. On
December 21, 2001, in connection with our acquisition of Old Dean, we purchased
the 33.8% stake that was owned by Dairy Farmers of America. See Note 2 to our
condensed consolidated financial statements.
FIRST NINE MONTHS OF 2002 COMPARED TO FIRST NINE MONTHS OF 2001
Net Sales -- Net sales increased 53% to $6.92 billion during the first nine
months of 2002 from $4.53 billion in the first nine months of 2001.
Net sales for the Dairy Group increased 44%, or $1.63 billion, in the first
nine months of 2002 compared to the first nine months of 2001. The acquisition
of Old Dean (net of the plants divested as part of the transaction) contributed
a net increase of approximately $1.86 billion to the Dairy Group. That increase
was partly offset primarily by the effects of decreased raw milk costs compared
to the first nine months of the prior year, and also by lower ice cream volumes.
The average monthly federal order minimum prices for raw skim milk and cream
for the first nine months of 2002 compared to the first nine months of 2001 are
set forth below:
<Table>
<Caption>
Nine Months Ended
September 30*
-------------------------
%
2002 2001 Change
-------------------------
Class I Raw Skim Milk(1),(3) $7.00 $7.89 (11)%
Class I Butterfat(2),(3) 1.27 1.87 (32)
Class II Raw Skim Milk(1),(4) 7.61 8.47 (10)
Class II Butterfat(2),(4) 1.22 1.97 (38)
</Table>
* Prices noted in this table are the federal government's minimum prices,
which do not necessarily reflect our actual raw milk and butterfat
costs. Please see "- Known Trends and Uncertainties - Raw Material
Prices" for a more complete description of raw milk and butterfat
pricing.
(1) Prices are per hundredweight.
(2) Prices are per pound.
(3) We process Class I raw skim milk and butterfat into fluid milk
products.
(4) We process Class II raw skim milk and butterfat into products such as
cottage cheese, creams, ice cream and sour cream.
22
Net sales for Morningstar/White Wave increased 46%, or $238.9 million in
the first nine months of 2002, compared to the year earlier period. We estimate
that the acquisition of Old Dean added approximately $224.6 million of sales at
our Morningstar/White Wave segment during the first half of 2002. Precise
measurement of the impact of the acquisition of Old Dean on
Morningstar/White Wave's sales is no longer possible because Old Dean's NRP
segment has now been fully integrated into Morningstar and is no longer
accounted for separately. The acquisition of White Wave contributed
approximately $67 million in the first nine months of 2002. These gains were
offset by (i) lower raw milk and butterfat costs, (ii) cultured dairy product
volume declines, and (iii) the previously announced phase-out of the Lactaid,
Nestle Nesquik and Nestle Coffeemate co-packing businesses.
Our Specialty Foods segment reported net sales of $502.7 million in the
first nine months of 2002.
Cost of Sales -- Our cost of sales ratio was 74.4% in the first nine months
of 2002 compared to 76.8% in the same period of 2001. The cost of sales ratio
for the Dairy Group decreased to 74.6% in the first nine months of 2002 from
77.2% in the first nine months of 2001 due primarily to lower raw milk costs.
The cost of sales ratio for Morningstar/White Wave decreased to 69.6% in the
first nine months of 2002 from 70.9% in the same period of 2001. This decrease
in 2002 was due to lower butterfat costs, largely offset by higher sales
incentives and the addition of Old Dean's operations which had higher costs of
sales. Specialty Foods' cost of sales ratio was 73.9% in the first half of 2002.
Operating Costs and Expenses -- Our operating expense ratio was 18.4% in
the first nine months of 2002 compared to 16.9% in the same period of 2001.
These ratios were affected by our implementation of SFAS 142 on January 1, 2002.
Excluding 2001 amortization, our operating expense ratio would have been 16.1%
in 2001.
The operating expense ratio at the Dairy Group was 18% in the first nine
months of 2002 compared to 17.0% in the same period last year. Excluding
approximately $29.5 million of amortization in the first nine months of 2001,
the Dairy Group's operating expense ratio would have been 16.2% in 2001,
compared to 18% in 2002. In 2001, the Dairy Group eliminated certain
discretionary expenses as a result of the difficult operating environment.
Operating expenses have returned to more normal levels in 2002. Also, the
increase in 2002 was partially due to plant closing costs of $6.5 million in
2002 compared to only $0.8 million in 2001. The increase in the operating
expense ratio was primarily due to the effect of lower raw material prices in
2002. Lower raw material prices caused our sales, measured in dollars on a pro
forma basis as if Old Dean had been acquired on January 1, 2002, to decline,
which negatively affected the Dairy Group's operating expense ratio.
The operating expense ratio at Morningstar/White Wave was 20.7% in the
first nine months of 2002 compared to 16.1% in the first nine months of 2001.
Excluding approximately $5.4 million of amortization in the first nine months of
2001, the operating expense ratio would have been 15.1% in 2001, compared to
20.7% in 2002. This increase was caused by higher distribution, selling and
marketing expenses related to (i) the introduction of new products and increased
spending on promotions of existing products, (ii) higher plant closing costs and
(iii) the addition of White Wave, which has higher selling, marketing and
distribution costs due to its efforts to build brand recognition through
advertising and promotion as well as slotting for new product placement.
The operating expense ratio for Specialty Foods was 11.3% in the first nine
months of 2002.
Operating Income -- Operating income in the first nine months of 2002 was
$495.7 million, an increase of $210.8 million from 2001 operating income of
$284.9 million. Our operating margin in the first nine months of 2002 was 7.2%
compared to 6.3% in the same period of 2001. Excluding 2001 amortization that
would have been eliminated had SFAS 142 been in effect last year, our operating
income would have increased $172.8 million in the first nine months of 2002 and
our operating margin would have been 7.2% in the first nine months of 2002 as
compared to 7.1% in the same period of 2001.
The Dairy Group's operating margin, excluding amortization expense from the
first nine months of 2001, increased to 7.5% in the first nine months of 2002
from 6.7% in the same period of 2001. This increase was primarily due to lower
raw milk costs during 2002 and to realized synergies from our acquisition of Old
Dean, partly offset by increased operating expenses. The operating margin for
our Morningstar/White Wave segment, again excluding amortization expense from
the first nine months of 2001, declined to 9.7% in the first nine months of 2002
from 14.0% in 2001. This decrease was due to the planned phase-out of the
Lactaid, Nestle Quik and Nestle Coffeemate co-packing businesses, higher
selling, distribution and marketing expense, higher plant closing costs and the
addition of Old Dean's operations which had higher costs of sales, offset by
certain realized merger synergies.
Specialty Foods' operating margin was 14.8% in the first nine months of
2002.
23
Other (Income) Expense -- Total other expense increased by $71.9 million in
the first nine months of 2002 compared to 2001. Interest expense increased to
$153.9 million in the first nine months of 2002 from $76.5 million in 2001. This
increase was the result of higher debt used primarily to finance the
acquisitions of Old Dean and White Wave. Financing charges on preferred
securities were $25.2 million in both years.
Income from investments in unconsolidated affiliates increased to income of
$2.1 million in the first nine months of 2002 from a loss of $2.6 million in the
same period of 2001. The income in 2002 primarily related to our 36% interest in
White Wave through May 9, 2002. On May 9, 2002 we acquired the remaining equity
interest in White Wave and began consolidating White Wave's results with our
financial results. Our loss in 2001 related primarily to our 43.1% minority
interest in Consolidated Container Company ("CCC"). In the fourth quarter of
2001 we concluded that our investment in CCC was impaired and that the
impairment was not temporary, and as a result we wrote off our remaining
investment in CCC.
Income Taxes -- Income tax expense was recorded at an effective rate of
37.9% in the first nine months of 2002 compared to 36.5% in 2001. In the third
quarter of 2001, a contested state tax issue was resolved in our favor. Our tax
rate varies as the mix of earnings contributed by our various business units
changes, and as tax savings initiatives are adopted.
Minority Interest -- Minority interest in earnings decreased significantly
to $41 thousand in the first nine months of 2002 from $26.1 million in the same
period of 2001. In 2002, management of EBI Foods, a subsidiary of our Specialty
Foods segment, owned a small minority interest in that subsidiary. In 2001,
Dairy Farmers of America owned a 33.8% minority interest in our Dairy Group. On
December 21, 2001, in connection with our acquisition of Old Dean, we purchased
the 33.8% stake that was owned by Dairy Farmers of America. See Note 2 to our
condensed consolidated financial statements.
Cumulative Effect of Accounting Change -- As part of our adoption of SFAS
142 on January 1, 2002 we wrote down the value of certain trademarks which our
analysis indicated were impaired, and recorded a charge during the first quarter
of 2002 of $47.3 million, net of an income tax benefit of $29 million. Effective
January 1, 2001 we adopted Statement of Financial Accounting Standards (SFAS)
No. 133, Accounting for Derivative Instruments and Hedging Activities (as
amended). Our adoption of this accounting standard resulted in the recognition
of $1.4 million, net of an income tax benefit of $1.5 million and minority
interest benefit of $0.7 million, as a charge to earnings.
2002 DEVELOPMENTS
Integration and Rationalization Activities
We have realized significant synergies in the first nine months of 2002 as
a result of our acquisition of Old Dean in December 2001. We realized
approximately $27 million and $77 million in merger synergies during the third
quarter and first nine months of 2002, respectively, including such items as
purchasing savings, headcount reduction savings, pension elimination savings,
new business, manufacturing synergies and various depreciation savings. As part
of our integration activities, we have closed or announced the closure of 10
facilities since completion of the Old Dean acquisition and reduced (or intend
to reduce) our workforce accordingly. Facilities that have been closed or
identified for closing include:
24
<Table>
<Caption>
DAIRY GROUP MORNINGSTAR/WHITE WAVE SPECIALTY FOODS OTHER
- ----------- ---------------------- --------------- ----------------------
Bennington, Vermont Tempe, Arizona Atkins, Arkansas Aguadilla, Puerto Rico
Port Huron, Michigan Cairo, Georgia
Escondido, California
Fort Worth, Texas
Parker Ford, Pennsylvania
Winchester, Virginia
</Table>
As part of our overall integration and rationalization strategy, we
recorded plant closing costs of $12.8 million during the first nine months of
2002. These charges included the following costs:
o Workforce reductions, which were charged to our earnings in the period
that the plan was established in detail and employee severance and
benefits had been appropriately communicated;
o Shutdown costs, including those costs necessary to prepare the plant
facilities for re-sale or closure;
o Costs incurred after shutdown such as lease obligations or termination
costs, utilities and property taxes; and
o Write-downs of property, plant and equipment and other assets,
primarily for asset impairments as a result of facilities no longer
used in operations. The impairments related primarily to owned
building, land and equipment at the facilities that were sold and
written down to their estimated fair value.
Acquisitions
White Wave - In May 2002, we completed the acquisition of the 64% equity
interest in White Wave, Inc. which we did not already own. White Wave, based in
Boulder, Colorado, is the maker of Silk(R) soymilk and other soy-based products,
and had sales of approximately $125 million during the twelve months ended March
31, 2002. Prior to May 9, we owned approximately 36% of White Wave as a result
of certain investments made by Old Dean beginning in 1999. We purchased the
remaining equity interests for a total price of approximately $189 million.
Existing management of White Wave has remained in place. We have agreed to pay
White Wave's management team an incentive bonus based on achieving certain sales
growth targets by March 2004. The bonus amount will vary depending on the level
of two-year cumulative sales White Wave achieves by March 2004, and is
anticipated to range between $30 million and $40 million. See Note 2 and Note 10
to our condensed consolidated financial statements. For financial reporting
purposes, White Wave's financial results are now aggregated with Morningstar
Foods' financial results.
Marie's - We acquired the Marie's(R) brand as a result of our acquisition
of Old Dean in December 2001. Old Dean had licensed the brand to Marie's Quality
Foods and Marie's Dressings, Inc. for use in connection with the manufacture and
sale of dips and dressings in the western United States. On May 17, 2002, we
acquired the assets of those licensees, including the licenses. See Note 2 to
our condensed consolidated financial statements. As a result of this
acquisition, we are now the sole owner, manufacturer and marketer of Marie's
brand products nationwide.
Morningstar/White Wave Product Initiatives
International Delight(R) Coffee Creamers - In the fourth quarter of 2002,
we introduced our International Delight coffee creamers in a newly-designed
plastic bottle. The product is currently in test market in Ohio, and we expect
to launch it nationwide in January 2003. In August, we launched Canela, the
newest flavor of International Delight non-dairy coffee creamers. Morningstar
Foods now manufactures and distributes ten flavors in the International Delight
brand family.
Silk(R) Soymilk - During the third quarter of 2002, we introduced an
aseptic Silk soymilk, to better serve the dry grocery and foodservice channels.
Also during the third quarter, we introduced two new Silk flavors, including
coffee and unsweetened.
Hershey's(R) Milks and Milkshakes - In October, we launched Hershey's
Vanilla Cream Milkshake, adding another flavor to our current Creamy Chocolate
and Cookies 'n Cream offerings. The product introduction is part of
25
Morningstar's collaborative effort with Hershey Foods Corp. whereby Morningstar
manufactures, markets, sells and distributes Hershey brand name dairy products
nationally.
Land O'Lakes(R) Dairy Ease(R) Lactose-Free Milks - On July 31, 2002, we
entered into a licensing agreement with Land O'Lakes, pursuant to which we
acquired a license to use the Land O'Lakes brand nationally on a broad
range of fluid milk, juices and cultured dairy products, including ice cream,
sour cream, creams and creamers, and on certain other value-added products, such
as aseptic dairy products and extended shelf-life products, including soy
beverages. In August 2002, we launched Land O'Lakes Dairy Ease lactose-free
milk, our first new product under our new Land O'Lakes license agreement.
Jakada(R) Coffee and Milk Beverage - In the first quarter of 2002, we
launched Folger's Jakada, a new coffee and milk-based beverage. The product is
now sold in single-serve plastic bottles and is available in three flavors:
French Roast, Vanilla and Mocha. Pursuant to our licensing agreement with
Procter & Gamble, we produce, promote and distribute Folger's Jakada, while
Procter & Gamble receives royalties related to Folger's Jakada sales and retains
rights to the Folger's trademark.
New Technology - We are currently in the final stages of obtaining FDA
approval to produce aseptic packaging on our second Stork line in Mt. Crawford,
Virginia. Upon certification, we will be able to store and ship single serve
Hershey's and Jakada products processed on this line without refrigeration.
Divestitures
Part of our strategy since completion of the Old Dean acquisition has been
to carefully analyze our portfolio of assets and make divestitures where
appropriate, in order to ensure that our financial and management resources are
closely aligned with our strategic direction. Since completion of the Old Dean
acquisition, we have sold three small non-core businesses that we acquired as
part of old Dean's Specialty Foods division, including a contract hauling
business, a boiled peanut business and a powdered coating business. In addition,
on November 11, 2002, we announced that we had entered into an agreement to sell
our Puerto Rico dairy operations for a purchase price of approximately $122
million. Completion of the sale of our Puerto Rico business is subject to the
receipt of certain regulatory approvals, the buyer's ability to obtain financing
and certain other customary closing conditions. We expect the transaction to be
completed on or before December 31, 2002.
Stock Split
On February 21, 2002, our Board of Directors declared a two-for-one split
of our common stock, which entitled shareholders of record on April 8, 2002 to
receive one additional share of common stock for each share held on that date.
The new shares were issued after the market closed on April 23, 2002. As a
result of the split, the total number of shares of our common stock outstanding
increased from approximately 45 million to approximately 90 million. All of the
share numbers in this Quarterly Report on Form 10-Q have been adjusted for all
periods to reflect the stock split, as if it had already occurred.
LIQUIDITY AND CAPITAL RESOURCES
Historical Cash Flow
Cash flow provided by operating activities was $439.8 million in the first
nine months of 2002 compared to $179.5 million in the first nine months of 2001.
This increase was primarily due to changes in working capital components, which
improved by $157.4 million, and higher earnings in 2002 after adjusting for the
cumulative accounting change, which was a non-cash item.
Net cash used in investing activities was $359.3 million in the first nine
months of 2002 compared to $132.5 million in the first nine months of 2001. We
spent $152.4 million during the first nine months of 2002 for capital
expenditures, which were funded using cash flow from operations. We also spent
approximately $213.6 million in the first nine months of 2002 primarily on the
acquisitions of White Wave, Marie's and stock option surrenders related to our
acquisition of Old Dean. See Notes 2 and 6 to our condensed consolidated
financial statements.
26
Current Debt Obligations
Effective December 21, 2001, in connection with our acquisition of Old
Dean, we replaced our former credit facilities with a new $2.7 billion credit
facility provided by a syndicate of lenders. This facility provides us with a
revolving line of credit of up to $800 million and two term loans in the amounts
of $900 million and $1 billion, respectively. Both term loans were fully funded
upon closing of the Old Dean acquisition. The senior credit facility contains
various financial and other restrictive covenants and requires that we maintain
certain financial ratios, including a leverage ratio (computed as the ratio of
the aggregate outstanding principal amount of defined indebtedness to EBITDA)
and an interest coverage ratio (computed as the ratio of EBITDA to interest
expense). In addition, this facility requires that we maintain a minimum level
of net worth (as defined by the agreement). The agreement contains standard
default triggers including without limitation: failure to maintain compliance
with the financial and other covenants contained in the agreement, default on
certain of our other debt, a change in control and certain other material
adverse changes in our business. The agreement does not contain any default
triggers based on our debt rating. See Note 5 to our condensed consolidated
financial statements for more detailed information regarding the terms of our
credit agreement, including interest rates, principal payment schedules and
mandatory prepayment provisions.
At September 30, 2002 we had outstanding borrowings of $1.88 billion under
our senior credit facility. In addition, $65.4 million of letters of credit
secured by the credit facility were issued but undrawn. As of September 30,
2002, approximately $699.4 million was available for future borrowings under the
revolving credit facility, subject to satisfaction of certain conditions
contained in the loan agreement. We are currently in compliance with all
covenants contained in our credit agreement.
We also have a $400 million receivables securitization facility. During the
first nine months of 2002 we made net payments of $142 million on this facility
and at September 30, 2002 had a balance of $258 million outstanding. See Note 5
to our condensed consolidated financial statements for more information about
our receivables securitization facility.
In addition, certain of Old Dean's indebtedness remains outstanding after
the acquisition, including $700 million (face value) of outstanding indebtedness
under certain senior notes, approximately $18 million of industrial
development revenue bonds, and certain capital lease obligations. See Note 5 to
our condensed consolidated financial statements.
In addition to the letters of credit secured by our credit facility, we had
at September 30, 2002 approximately $38 million of letters of credit that were
issued but undrawn. These letters of credit were required by various utilities
and government entities for performance and insurance guarantees.
The table below summarizes our obligations for indebtedness and lease
obligations at September 30, 2002:
<Table>
<Caption>
Payments Due By Period
-----------------------------------------------------------------------------------
Indebtedness & Lease Obligations 10/1/02 to 10/1/03 to 10/1/04 to 10/1/05 to 10/1/06 to
TOTAL 9/30/03 9/30/04 9/30/05 9/30/06 9/30/07 Thereafter
----- ----------- ------------ ----------- ---------- ----------- ----------
(in thousands)
Senior credit facility ..... $1,880,825 $ 126,875 $ 145,000 $ 161,875 $ 184,375 $ 280,000 $ 982,700
Senior notes(1) ............ 700,000 100,000 250,000 350,000
Receivables-backed loan .... 258,000 258,000
Foreign subsidiary term loan 33,631 6,679 8,050 7,752 7,439 3,711
Other lines of credit ...... 19,918 19,918
Industrial development
revenue bonds ............ 21,000 300 300 300 300 300 19,500
Capital lease obligations
and other ................ 33,564 8,201 19,665 5,057 361 107 173
Operating leases ........... 368,906 73,836 63,316 50,207 43,337 33,790 104,420
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total ............ $3,315,844 $ 235,809 $ 236,331 $ 583,191 $ 235,812 $ 567,908 $1,456,793
========== ========== ========== ========== ========== ========== ==========
</Table>
- ----------
(1) Represents face value of notes.
27
Other Commitments and Contingencies
In connection with our purchase of the minority interest in our Dairy
Group, we entered into an agreement with Dairy Farmers of America ("DFA"), the
nation's largest dairy farmers' cooperative and our primary supplier of raw
milk, pursuant to which we have agreed to pay to DFA liquidated damages in an
amount of up to $47 million if we fail to offer them the right, within a
specified period of time after completion of the Old Dean acquisition, to supply
raw milk to certain of Old Dean's plants. The amount of damages to be paid, if
any, would be determined on a plant-by-plant basis for each Old Dean plant's
milk supply that is not offered to DFA, based generally on the amount of raw
milk used by the plants. We would be required to pay the liquidated damages even
if we were prohibited from offering the business to DFA by an injunction,
restraining order or contractual obligation. See Note 10 to our condensed
consolidated financial statements for further information regarding this
agreement. Old Dean currently has milk supply agreements with several raw milk
suppliers other than DFA. If any such supplier believes that it has rights to
continue to supply Old Dean's plants beyond the deadline dates contained in our
agreement with DFA, and is successful in legally establishing any such rights,
we may be prohibited from offering DFA the right to supply certain of the Old
Dean plants and, therefore, be required to pay all or a portion of the
liquidated damages to DFA.
In February 2002, we executed a limited guarantee of certain indebtedness
of Consolidated Container Company ("CCC"), in which we own a 43.1% interest. See
Note 10 to our condensed consolidated financial statements for information
concerning the terms of the guaranty. CCC has experienced various operational
difficulties in the past, which has adversely affected its financial
performance. CCC's ability to repay the guaranteed indebtedness will depend on a
variety of factors, including its ability to successfully implement its business
plan, of which there can be no assurance.
We do have certain other commitments and contingent obligations that are
not reflected on our balance sheet, all of which are described in Note 10 to our
condensed consolidated financial statements.
We do not have any ownership interests or relationships with any
special-purpose entities (or "bankruptcy remote" entities), other than our
ownership of the special purpose entities formed to facilitate our receivables
securitization program and our mandatorily redeemable preferred securities. The
assets and liabilities of those entities are fully reflected on our balance
sheet. We have no other significant off-balance sheet arrangements, special
purpose entities, financing partnerships or guaranties, nor any debt or equity
triggers based on our stock price or credit rating.
Preferred Securities
On March 24, 1998, we issued $600 million of company-obligated 5.5%
mandatorily redeemable convertible preferred securities of a Delaware business
trust in a private placement to "qualified institutional buyers" under Rule 144A
under the Securities Act of 1933. The 5.5% preferred securities, which are
recorded net of related fees and expenses, mature 30 years from the date of
issue. Holders of these securities are entitled to receive preferential
cumulative cash distributions at an annual rate of 5.5% of their liquidation
preference of $50 each. These distributions are payable quarterly in arrears on
January 1, April 1, July 1 and October 1 of each year. These trust issued
preferred securities are convertible at the option of the holders into an
aggregate of approximately 15.3 million shares of our common stock, subject to
adjustment in certain circumstances, at a conversion price of $39.125. These
preferred securities are also redeemable, at our option, at any time after April
2, 2001 at specified amounts and are mandatorily redeemable at their liquidation
preference amount of $50 per share at maturity or upon occurrence of certain
specified events.
Future Capital Requirements
We expect to invest a total of approximately $265 million in each of 2002
and 2003 on capital expenditures primarily related to our manufacturing and
distribution capabilities. We intend to fund these expenditures using cash flow
from operations.
In 2003, we expect to spend approximately $190 million in marketing and
distribution support of our strategic brands including International Delight
coffee creamers, Silk and SunSoy soy beverages, Hershey's milks and shakes and
Folger's Jakada, our single-serve beverage platforms; Marie's dressings and
Dean's dips; and Land O'Lakes, specifically the Dairy Ease lactose-free milk. We
intend to fund these expenditures using cash flow from operations.
We expect that cash flow from operations will be sufficient to meet our
requirements for our existing businesses for the foreseeable future.
In the future, we may pursue additional acquisitions that are compatible
with our core business strategy. We may also repurchase shares of our stock
pursuant to our open market share repurchase program. Any such acquisitions or
repurchases will be funded through cash flows from operations or borrowings
under our credit facility. If necessary, we believe that we have the ability to
secure additional financing for our future capital requirements.
CRITICAL ACCOUNTING POLICIES
28
"Critical accounting policies" are those that are both most important to
the portrayal of a company's financial condition and results, and that require
management's most difficult, subjective or complex judgments. In many cases the
accounting treatment of a particular transaction is specifically dictated by
generally accepted accounting principles with no need for the application of our
judgment. In certain circumstances, however, the preparation of our financial
statements in conformity with generally accepted accounting principles requires
us to use our judgment to make certain estimates and assumptions. These
estimates affect the reported amounts of assets and liabilities and disclosures
of contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period. We
have identified the policies described below as our critical accounting
policies. For a detailed discussion of these and other accounting policies see
Note 1 to our 2001 Consolidated Financial Statements contained in our Annual
Report on Form 10-K, as filed with the Securities and Exchange Commission on
April 1, 2002.
Revenue Recognition and Accounts Receivable
Revenue is recognized when persuasive evidence of an arrangement exists,
the price is fixed or determinable, the product has been shipped to the customer
and there is a reasonable assurance of collection of the sales proceeds. Revenue
is reduced by sales incentives that are estimated based on our historical
experience. We provide credit terms to customers generally ranging up to 30
days, perform ongoing credit evaluation of our customers and maintain allowances
for potential credit losses based on historical experience.
Insurance Accruals
We retain selected levels of property and casualty risks, primarily related
to employee health care, workers' compensation claims and other casualty losses.
Many of these potential losses are covered under conventional insurance programs
with third party carriers with high deductible limits. In other areas, we are
self-insured with stop-loss coverages. Accrued liabilities for incurred but not
reported losses related to these retained risks are calculated based upon loss
development factors provided by our external insurance brokers and actuaries.
The loss development factors are subject to change based upon actual history and
expected trends in costs, among other factors.
Valuation of Long-Lived and Intangible Assets and Goodwill
We adopted SFAS 142 effective January 1, 2002 and as a result, goodwill is
no longer amortized. In lieu of amortization, we are required to perform a
transitional impairment assessment of our goodwill in 2002 and annual impairment
tests thereafter. SFAS No. 142 also requires that recognized intangible assets
be amortized over their respective estimated useful lives. As part of the
adoption, we have reassessed the useful lives of all intangible assets. Any
recognized intangible asset determined to have an indefinite useful life is not
amortized, but instead tested for impairment in accordance with the standard.
For more information regarding the values assigned to our intangible assets and
to goodwill, see Note 1 and Note 4 to our condensed consolidated financial
statements.
Purchase Price Allocation
We allocate the cost of acquisitions to the assets acquired and liabilities
assumed. All identifiable assets acquired, including identifiable intangibles,
and liabilities assumed are assigned a portion of the cost of the acquired
company, normally equal to their fair values at the date of acquisition. The
excess of the cost of the acquired company over the sum of the amounts assigned
to identifiable assets acquired less liabilities assumed is recorded as
goodwill. We record the initial purchase price allocation based on evaluation of
information and estimates available at the date of the financial statements. As
final information regarding fair value of assets acquired and liabilities
assumed is evaluated and estimates are refined, appropriate adjustments are made
to the purchase price allocation. To the extent that such adjustments indicate
that the fair value of assets and liabilities differ from their preliminary
purchase price allocations, such difference would adjust the amounts allocated
to those assets and liabilities and would change the amounts allocated to
goodwill. The final purchase price allocation includes the consideration of a
number of factors to determine the fair value of individual assets acquired and
liabilities assumed including quoted market prices, forecast of expected cash
flows, net realizable values, estimates of the present value of required
payments and determination of remaining useful lives. For significant
acquisitions, we utilize valuation specialists and appraisers to assist in the
determination of the fair value of long-lived assets, including identifiable
intangibles.
29
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The Emerging Issues Task Force (the "Task Force") of the Financial
Accounting Standards Board has reached a consensus on Issue No. 00-14,
"Accounting for Certain Sales Incentives," which became effective for us in the
first quarter of 2002. This Issue addresses the recognition, measurement and
income statement classification of sales incentives that have the effect of
reducing the price of a product or service to a customer at the point of sale.
Our historical practice for recording sales incentives within the scope of this
Issue, which has been to record estimated coupon expense based on historical
coupon redemption experience, is consistent with the requirements of this Issue.
Therefore, our adoption of this Issue has no impact on our Condensed
Consolidated Financial Statements.
The Task Force has also reached a consensus on Issue No. 00-25, "Vendor
Income Statement Characterization of Consideration Paid to a Reseller of the
Vendor's Products." We adopted this Issue in the first quarter of 2002. Under
this Issue, certain consideration paid to our customers (such as slotting fees)
is required to be classified as a reduction of revenue, rather than recorded as
an expense. Adoption of this Issue required us to reduce reported revenue and
selling and distribution expense for the third quarter and the first nine
months of 2001 by $7.9 million and $26.8 million, respectively. There was no
change in reported net income.
In June 2001, FASB issued SFAS No. 141, "Business Combinations" and SFAS
No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 addresses
financial accounting and reporting for business combinations. Under the new
standard, all business combinations entered into after June 30, 2001 are
required to be accounted for by the purchase method. We have applied, and will
continue to apply, the provisions of SFAS No. 141 to all business combinations
completed after June 30, 2001, including the acquisition of Old Dean. SFAS No.
142 addresses financial accounting and reporting for acquired goodwill and other
intangible assets. We adopted SFAS No. 142 in the first quarter of 2002. SFAS
No. 142 requires that goodwill no longer be amortized, but instead requires a
transitional goodwill impairment assessment and annual impairment tests
thereafter. Effective June 30, 2002, we completed the first phase of the
transitional goodwill impairment assessment, which indicated that the goodwill
related to our Puerto Rico reporting unit is impaired. In the fourth quarter of
2002, we will determine the amount of impairment that existed as of January 1,
2002, and record the impairment in our income statement as the cumulative effect
of a change in accounting principle retroactive to the first quarter of 2002. As
of January 1, 2002, we had approximately $67 million recorded as goodwill
related to our Puerto Rico reporting unit. See Note 12 for information related
to our fourth quarter agreement to sell our Puerto Rico operating unit. Our
annual impairment tests will be completed in the fourth quarter of 2002. SFAS
No. 142 also requires that recognized intangible assets be amortized over their
respective estimated useful lives. As part of the adoption, we have re-assessed
the useful lives and residual values of all recognized intangible assets. Any
recognized intangible asset determined to have an indefinite useful life was
tested for impairment in accordance with the standard. These impairment tests
were completed during the first quarter of 2002, and resulted in a charge of
$47.3 million, net of an income tax benefit of $29.0 million, which was recorded
during the first quarter of 2002 as a change in accounting principle. The
impairment related to certain trademarks in our Dairy Group and
Morningstar/White Wave segments. The fair value of these trademarks was
determined using a present value technique. See Note 1 to our condensed
consolidated financial statements.
In June 2001, FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." This statement requires that the fair value of a liability for an
asset retirement obligation be recognized in the period in which the associated
legal obligation for the liability is incurred if a reasonable estimate of fair
value can be made. The associated asset retirement costs are capitalized as part
of the carrying amount of the long-lived asset and amortized over the life of
the asset. SFAS No. 143 will become effective for us in fiscal year 2003. We are
currently evaluating the impact of adopting this pronouncement on our
consolidated financial statements.
FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" in August 2001 and it became effective for us beginning
January 1, 2002. SFAS No. 144, which supercedes SFAS No. 121, provides a single,
comprehensive accounting model for impairment and disposal of long-lived assets
and discontinued operations. Our adoption of this standard did not have a
material impact on our consolidated financial statements.
SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of
FASB Statement No. 13, and Technical Corrections," was issued in April 2002 and
is applicable to fiscal years beginning after May 15, 2002. One of the
provisions of this technical statement is the rescission of SFAS No. 4,
"Reporting Gains and Losses from Extinguishment of Debt," whereby any gain or
loss on the early extinguishment of debt that was classified as an extraordinary
item in prior periods in accordance with SFAS No. 4, which does not meet the
criteria of an extraordinary item as defined by APB Opinion 30, must be
reclassified. Adoption of this standard will require us to reclassify
extraordinary losses previously reported from the early extinguishment of debt
as a component of "other
30
expense." For the year ended December 31, 2001, we recorded an extraordinary
loss of $4.3 million, net of an income tax benefit of $3.0 million.
In June 2002, FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." This statement addresses financial accounting
and reporting for costs associated with exit or disposal activities and
nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." The statement requires that a liability for
a cost associated with an exit or disposal activity be recognized when the
liability is incurred, and is effective for exit or disposal activities that are
initiated after December 31, 2002. We are currently evaluating the impact of
adopting this pronouncement on our consolidated financial statements.
KNOWN TRENDS AND UNCERTAINTIES
Acquisitions and Divestitures
We have announced that we intend to continue to make acquisitions in our
core businesses and, over the next several years, to divest non-core businesses.
Raw Material Prices
In our Dairy Group and Morningstar/White Wave segments, our raw milk and
butterfat cost changes are based on the federal government's minimum prices,
regional and national milk supply conditions and arrangements with our
suppliers. Generally, we pay the federal minimum prices for raw milk and
butterfat, plus certain producer premiums (or "over-order" premiums) and
location differentials. We also incur other raw milk and butterfat procurement
costs in some locations (such as hauling, field personnel, etc.). A change in
the federal minimum price does not necessarily mean an identical change in our
total raw material cost, as over-order premiums may increase. This relationship
is different in every region of the country, and sometimes within a region based
on supplier arrangements. However, in general, the overall change in the
commodity environment can be linked to the change in federal minimum prices.
Bulk cream is also a significant raw material cost to the Dairy Group and
Morningstar. Cream is typically purchased based on a multiple of the AA butter
price on the Chicago Mercantile Exchange. Cream is used in our Class II products
such as ice cream, ice cream mix, creams and creamers, sour cream and cottage
cheese.
In 2002, prices for raw milk, butterfat and butter have been very low.
Although we cannot predict future raw material prices with accuracy, we do
expect prices to increase in 2003.
In general, we change the prices that we charge our customers for our
products on a monthly basis, as the costs of our raw materials fluctuate.
However, there can be a lag between the time of a raw material cost increase or
decrease and the effectiveness of a corresponding price change to our customers,
and in some cases we are contractually restrained with respect to the means and
timing of implementing price changes. Also, at some point price increases do
erode our volumes. These factors can cause volatility in our earnings. Our sales
and operating profit margin tend to fluctuate with the price of our raw
materials.
Interest Rates
We have hedged a portion of our variable interest rate exposure by entering
into interest rate swap agreements that have the effect of "converting" the
hedged debt from variable rate debt to fixed rate debt. Approximately 40% of our
variable rate debt is currently hedged. The percentage of our total debt that is
hedged fluctuates as our debt level fluctuates. Moveover, we constantly monitor
the prevailing interest rate environment, and may increase the percentage of our
debt that is hedged if interest rates threaten to increase to substantially
higher levels, or become more volatile.
Rationalization Activities
As part of our acquisition purchase price allocations, we accrue costs from
time to time pursuant to plans to exit certain activities and operations of
acquired businesses in order to rationalize production and reduce costs and
inefficiencies. We will finalize our initial integration and rationalization
plan related to the Old Dean acquisition during the fourth quarter of 2002 and
refine our estimate of amounts in our purchase price allocations associated with
31
this plan. We do not expect any of these costs to have a material adverse impact
on our results of operations. For more information, see Note 8 to our
Consolidated Financial Statements.
Tax Rate
Our tax rate in the first nine months of 2002 was approximately 37.9%. We
believe that our effective tax rate will range between approximately 37% to 38%
over the next several years, as Old Dean's tax rate was higher than our tax rate
prior to the Old Dean acquisition.
See "-- Risk Factors" for a description of various other risks and
uncertainties concerning our business.
RISK FACTORS
This report contains statements about our future that are not statements of
historical fact. Most of these statements are found in this report under the
following subheadings: "2002 Developments," "Liquidity and Capital Resources,"
"Known Trends and Uncertainties" and "Quantitative and Qualitative Disclosures
About Market Risk." In some cases, you can identify these statements by
terminology such as "may," "will," "should," "could," "expects," "seek to,"
"anticipates," "plans," "believes," "estimates," "intends," "predicts,"
"potential" or "continue" or the negative of such terms and other comparable
terminology. These statements are only predictions, and in evaluating those
statements, you should carefully consider the risks outlined below. Actual
performance or results may differ materially and adversely.
We May Have Difficulties Managing Our Growth
We have expanded our operations rapidly in recent years, particularly with
the acquisition of Old Dean in December 2001. This rapid growth places a
significant demand on our management and our financial and operational
resources, which subjects us to various risks, including among others:
o inability to successfully integrate or operate acquired businesses,
o inability to retain key customers of acquired or existing businesses,
and
o inability to realize or delays in realizing expected benefits from our
increased size.
The integration of businesses we have acquired or may acquire in the future
may also require us to invest more capital than we expected or require more time
and effort by management than we expected. If we fail to effectively manage the
integration of the businesses we have acquired, particularly Old Dean, our
operations and financial results will be affected, both materially and
adversely.
Our Branding Efforts May Not Succeed
We have invested, and intend to continue to invest, significant resources
toward the growth of our branded, value-added portfolio of products,
particularly at our Morningstar/White Wave segment. We believe that sales of
these products could be a significant source of growth for our business.
However, the success of our efforts will depend on customer and consumer
acceptance of our branded products, of which there can be no assurance. If our
efforts do not succeed, we may not be able to continue to significantly increase
sales or profit margins.
Our Failure To Successfully Compete Could Adversely Affect Our Prospects
And Financial Results
Our businesses are subject to significant competition based on a number of
factors. Our failure to successfully compete against our competitors could have
a material adverse effect on our business. Many of our competitors, especially
those with nationally branded products that compete with our nationally branded
products, have significantly greater resources than we do. Also, in many cases,
those nationally branded products have significantly more name-recognition and
longer histories of success.
The consolidation trend is continuing in the retail grocery and foodservice
industries. As our customer base continues to consolidate, we expect competition
to intensify as we compete for the business of fewer customers. As the
consolidation continues, there can be no assurance that we will be able to keep
our existing customers, or to gain new customers. Although we do not have any
customers that represent more than 10% of revenues in any segment, loss of any
of our largest customers could have a material adverse impact on our financial
results. We do not have contracts with many of our largest customers. Winning
new customers is also important to the growth of our Dairy Group, as demand
tends to be relatively flat in the dairy industry. Moreover, as our customers
become larger, they will have greater purchasing leverage, and could force
prices and margins lower than current levels.
32
We could also be adversely affected by any expansion of capacity by our
existing competitors or by new entrants in our markets.
Changes in Raw Material and Other Input Costs Can Adversely Affect Us
The most important raw materials that we use in our operations are raw
milk, butterfat and cream, and high density polyethylene resin. The prices of
these materials increase and decrease depending on supply and demand and, in
some cases, governmental regulation. Weather affects the supply of raw milk,
cream and butterfat available. Also, our Specialty Foods segment purchases
cucumbers under seasonal grower contracts with a variety of growers located near
our plants. Bad weather in one of the growing areas can damage or destroy the
crop in that area. If we are not able to buy cucumbers from one of our local
growers due to bad weather, we are forced to purchase cucumbers from non-local
sources at substantially higher prices, which can have an adverse affect on
Specialty Foods' results of operations. Our White Wave operating unit is
sensitive to adverse weather due to its reliance on soy beans. In many cases we
are able to adjust our pricing to reflect changes in raw material costs.
Volatility in the cost of our raw materials can adversely affect our
performance, however, as price changes often lag changes in costs. These lags
tend to erode our profit margins. Extremely high raw material costs can also put
downward pressure on our margins and our volumes. We were adversely affected in
2001 by raw material costs. In 2002 to date, raw material prices have been very
low. Although we cannot predict future changes in raw material costs, we do
expect raw material prices to increase in 2003.
Because our Dairy Group delivers its products directly to our customers
through our "direct store delivery" system, we are a large consumer of fuel.
Increases in fuel prices can adversely affect our results of operations. Also,
since we lost our energy supply agreement with Enron as a result of Enron's
decision to reject our discounted-rate supply agreement in its bankruptcy, we
now pay market prices for electricity. As we are a significant consumer of
electricity, any significant increase in energy prices could adversely affect
our financial performance.
We Have Substantial Debt and Other Financial Obligations and We May Incur
Even More Debt
We have substantial debt and other financial obligations and significant
unused borrowing capacity. See "-- Liquidity and Capital Resources."
We have pledged substantially all of our assets (including the assets of
our subsidiaries) to secure our indebtedness. Our high debt level and related
debt service obligations:
o require us to dedicate significant cash flow to the payment of
principal and interest on our debt which reduces the funds we have
available for other purposes,
o may limit our flexibility in planning for or reacting to changes in our
business and market conditions,
o impose on us additional financial and operational restrictions, and
o expose us to interest rate risk since a portion of our debt obligations
are at variable rates.
Our ability to make scheduled payments on our debt and other financial
obligations depends on our financial and operating performance. Our financial
and operating performance is subject to prevailing economic conditions and to
financial, business and other factors, some of which are beyond our control. A
significant increase in interest rates could adversely impact our financial
results. If we do not comply with the financial and other restrictive covenants
under our credit facilities (see Note 5 to our condensed consolidated financial
statements), we may default under them. Upon default, our lenders could
accelerate the indebtedness under the facilities, foreclose against their
collateral or seek other remedies.
Loss of Rights to Any of Our Licensed Brands Could Adversely Affect Us
We sell certain of our products under licensed brand names such as
Hershey's(R), Borden(R), Pet(R), Folgers(R) Jakada(TM), Land-O-Lakes(R) and
others. In some cases, we have invested, and intend to continue to invest,
significant capital in product development and marketing and advertising related
to these licensed brands. Should our rights to manufacture and sell products
under any of these names be terminated for any reason, our financial performance
and results of operations could be materially and adversely affected.
Negative Publicity and/or Shortages of Milk Supply Related to Mad Cow
Disease and/or Foot and Mouth Disease Could Adversely Affect Us
Recent incidences of bovine spongiform encephalopathy ("BSE" or "mad
cow disease") in other countries have raised public concern about the safety of
eating beef and using or ingesting certain other animal-derived products. The
World Health Organization, the U.S. Food and Drug Administration and the United
States Department of Agriculture have all affirmed that BSE is not transmitted
to milk. However, we are still subject to risk as a result of public
misperception that milk products may be affected by mad cow disease. To date, we
have not seen
33
any measurable impact on our milk sales resulting from concerns about mad cow
disease. However, should public concerns about the safety of milk or milk
products escalate as a result of further occurrences of mad cow disease, we
could suffer a loss of sales, which could have a material and adverse affect on
our financial results.
Foot and Mouth Disease ("FMD") is a highly contagious disease of cattle,
swine, sheep, goats, deer and other cloven-hooved animals. FMD causes severe
losses in the production of meat and milk; however, FMD does not pose a health
risk to humans. While there have been several recent occurrences of FMD in
Europe, the United States has been free of FMD since 1929. To date, we have not
seen a measurable impact on our supply of raw milk in Spain as a result of FMD.
However, should FMD become widespread in Spain, a milk supply shortage could
develop, which would affect our ability to obtain raw milk for our Spanish
operations and the price that we are required to pay for raw milk in Spain. If
we are unable to obtain a sufficient amount of raw milk to satisfy our Spanish
customers' needs, and/or if we are forced to pay a significantly higher price
for raw milk in Spain, our financial results in Spain could be materially and
adversely affected. Likewise, if there is an outbreak of FMD in the United
States, a shortage of raw milk could develop in the United States, which would
affect our ability to obtain raw milk and the price that we are required to pay
for raw milk in the United States. If we are unable to obtain a sufficient
amount of raw milk to satisfy our U.S. customers' needs and/or if we are forced
to pay a significantly higher price for raw milk in the United States, our
consolidated financial results could be materially and adversely affected.
We May Be Subject to Product Liability Claims
We sell food products for human consumption, which involves risks such as:
o product contamination or spoilage,
o product tampering, and
o other adulteration of food products.
Consumption of an adulterated, contaminated or spoiled product may result
in personal illness or injury. We could be subject to claims or lawsuits
relating to an actual or alleged illness or injury, and we could incur
liabilities that are not insured or that exceed our insurance coverages.
Although we maintain quality control programs designed to address food
quality and safety issues, an actual or alleged problem with the quality, safety
or integrity of our products at any of our facilities could result in:
o product withdrawals,
o product recalls,
o negative publicity,
o temporary plant closings, and
o substantial costs of compliance or remediation.
Any of these events could have a material and adverse effect on our
financial condition, results of operations or cash flows.
Business
Our success depends to a large extent on the skills, experience and
performance of our key personnel. The loss of one or more of these persons could
hurt our business. We do not maintain key man life insurance on any of our
34
executive officers, directors or other employees. If we are unable to attract
and retain key personnel, our business will be adversely affected.
Certain Provisions of Our Certificate of Incorporation, Bylaws and Delaware
Law Could Deter Takeover Attempts
Some provisions in our certificate of incorporation and bylaws could delay,
prevent or make more difficult a merger, tender offer, proxy contest or change
of control. Our stockholders might view any such transaction as being in their
best interests since the transaction could result in a higher stock price than
the current market price for our common stock. Among other things, our
certificate of incorporation and bylaws:
o authorize our board of directors to issue preferred stock in series
with the terms of each series to be fixed by our board of directors,
o divide our board of directors into three classes so that only
approximately one-third of the total number of directors is elected
each year,
o permit directors to be removed only for cause, and
o specify advance notice requirements for stockholder proposals and
director nominations.
In addition, with certain exceptions, the Delaware General Corporation Law
restricts mergers and other business combinations between us and any stockholder
that acquires 15% or more of our voting stock.
We also have a stockholder rights plan. Under this plan, after the
occurrence of specified events, our stockholders will be able to buy stock from
us or our successor at reduced prices. These rights do not extend, however, to
persons participating in takeover attempts without the consent of our board of
directors. Accordingly, this plan could delay, defer, make more difficult or
prevent a change of control.
We Are Subject to Environmental Regulations
We, like others in similar businesses, are subject to a variety of federal,
foreign, state and local environmental laws and regulations including, but not
limited to, those regulating waste water and storm water, air emissions, storage
tanks and hazardous materials. We believe that we are in material compliance
with these laws and regulations. Future developments, including increasingly
stringent regulations, could require us to make currently unforeseen
environmental expenditures.
35
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE FLUCTUATIONS
In order to reduce the volatility of earnings that arises from changes in
interest rates, we manage interest rate risk through the use of interest rate
swap agreements.
These swaps have been designated as hedges against variable interest rate
exposure on loans under our senior credit facility. The following table
summarizes our various interest rate swap agreements in effect at September 30,
2002 and at December 31, 2001:
<Table>
<Caption>
FIXED INTEREST RATES EXPIRATION DATE NOTIONAL AMOUNTS
-------------------- --------------- ----------------
(IN MILLIONS)
4.90% to 4.93% .......................... December 2002 $275.0
6.07% to 6.24% .......................... December 2002 325.0
6.23% ................................... June 2003 50.0
6.69% ................................... December 2004 100.0
6.69% to 6.74% .......................... December 2005 100.0
6.78% ................................... December 2006 75.0
</Table>
In March and June of 2002, we entered into forward-starting swaps that begin
in December 2002 with a notional amount of $750 million and fixed interest rates
of 4.005% to 5.315%. These swaps have been designated as hedges against interest
rate exposure on loans under our senior credit facility and under one of our
subsidiary's term loans.
<Table>
<Caption>
FIXED INTEREST RATES EXPIRATION DATE NOTIONAL AMOUNTS
-------------------- --------------- ----------------
(IN MILLIONS)
4.290% to 4.6875%.......................... December 2003 $ 275.0
4.005% to 4.855%........................... December 2004 175.0
5.190% to 5.315%........................... December 2005 300.0
</Table>
These swap agreements provide hedges for loans under our credit
facility by limiting or fixing the LIBOR interest rates specified in the credit
facility at the interest rates noted above until the indicated expiration dates
of these interest rate derivative agreements.
We have also entered into interest rate swap agreements that provide
hedges for loans under Leche Celta's term loan. See Note 5 to our condensed
consolidated financial statements. The following table summarizes these
agreements:
<Table>
<Caption>
FIXED INTEREST RATES EXPIRATION DATE NOTIONAL AMOUNTS
-------------------- --------------- ----------------------------------------------------------------------------
5.54% November 2003 9 million euros (approximately $8.9 million as of September 30, 2002)
5.60% November 2004 12 million euros (approximately $11.9 million as of September 30, 2002)
</Table>
We are exposed to market risk under these arrangements due to the
possibility of interest rates on our credit facilities falling below the rates
on our interest rate derivative agreements. We incurred $6.2 million and $17.7
million of additional interest expense, net of income taxes, during the third
quarter and the first nine months of 2002, respectively as a result of interest
rates on our variable rate debt falling below the agreed-upon interest rate on
our existing swap agreements. Credit risk under these arrangements is remote
since the counterparties to our interest rate derivative agreements are major
financial institutions.
A majority of our debt obligations are currently at variable rates. We have
performed a sensitivity analysis assuming a hypothetical 10% adverse movement in
interest rates. As of September 30, 2002, the analysis indicated that such
interest rate movement would not have a material effect on our financial
position, results of operations or cash flows. However, actual gains and losses
in the future may differ materially from that analysis based on changes in the
timing and amount of interest rate movement and our actual exposure and hedges.
36
FOREIGN CURRENCY
We are exposed to foreign currency risk due to operating cash flows and
various financial instruments that are denominated in foreign currencies. Our
most significant foreign currency exposures relate to the euro. At this time, we
believe that potential losses due to foreign currency fluctuations would not
have a material impact on our consolidated financial position, results of
operations or operating cash flow.
ITEM 4. CONTROLS & PROCEDURES
Based on their evaluation, as of a date within 90 days of the filing of this
Form 10-Q, our Chief Executive Officer and Chief Financial Officer have
concluded that our disclosure controls and procedures (as defined in Rules
13a-14 and 15d-14 under the Securities Exchange Act of 1934) are effective.
There have been no significant changes in internal controls or in other factors
that could significantly affect these controls subsequent to the date of their
evaluation including any corrective actions with regard to significant
deficiencies and material weaknesses.
37
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
99.1 Certification of Chief Executive Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to
section 906 of the Sarbanes-Oxley Act of 2002*
99.2 Certification of Chief Financial Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to
section 906 of the Sarbanes-Oxley Act of 2002*
- ----------
* This certification accompanies this Report pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and shall not be deemed filed by the company for
purposes of Section 18 of the Securities Exchange Act of 1934, as amended,
except to the extent required by the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K and 8-K/A
o None
38
SIGNATURES
Pursuant to the requirement 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.
DEAN FOODS COMPANY
By: /s/ BARRY A. FROMBERG
BARRY A. FROMBERG
EXECUTIVE VICE PRESIDENT, CHIEF FINANCIAL OFFICER
(PRINCIPAL ACCOUNTING OFFICER)
By: /s/ GREGG L. ENGLES
GREGG L. ENGLES
CHAIRMAN OF THE BOARD AND
CHIEF EXECUTIVE OFFICER
Date: November 14, 2002
39
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Gregg Engles, Chairman of the Board and Chief Executive Officer of Dean Foods
Company, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Dean Foods
Company;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of Dean Foods Company as of, and for, the periods presented
in this quarterly report;
4. Dean Foods Company's other certifying officer and I are responsible
for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-14 and 15d-14) for Dean Foods
Company and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to Dean Foods Company, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b. evaluated the effectiveness of Dean Foods Company's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. Dean Foods Company's other certifying officer and I have disclosed,
based on our most recent evaluation, to Dean Foods Company's auditors
and the audit committee of Dean Foods Company's board of directors (or
persons performing the equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect Dean Foods Company's ability
to record, process, summarize and report financial data and have
identified for Dean Foods Company's auditors any material
weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in Dean Foods Company's
internal controls; and
6. Dean Foods Company's other certifying officer and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: November 14, 2002
/s/ Gregg L. Engles
Gregg L. Engles
Chairman of the Board and
Chief Executive Officer
40
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Barry A. Fromberg, Executive Vice President and Chief Financial Officer of
Dean Foods Company, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Dean Foods
Company;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of Dean Foods Company as of, and for, the periods presented
in this quarterly report;
4. Dean Foods Company's other certifying officer and I are responsible
for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-14 and 15d-14) for Dean Foods
Company and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to Dean Foods Company, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b. evaluated the effectiveness of Dean Foods Company's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. Dean Foods Company's other certifying officer and I have disclosed,
based on our most recent evaluation, to Dean Foods Company's auditors
and the audit committee of Dean Foods Company's board of directors (or
persons performing the equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect Dean Foods Company's ability
to record, process, summarize and report financial data and have
identified for Dean Foods Company's auditors any material
weaknesses in Dean Foods Company's internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in Dean Foods Company's
internal controls; and
6. Dean Foods Company's other certifying officer and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: November 14, 2002
/s/ Barry A. Fromberg
Barry A. Fromberg
Executive Vice President and Chief Financial Officer
41
EXHIBIT INDEX
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
- ------- ------------
99.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to section 906 of the
Sarbanes-Oxley Act of 2002
99.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to section 906 of the
Sarbanes-Oxley Act of 2002.
</Table>
42