1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
RESULTS OF OPERATIONS
The Company has presented information in its Consolidated Statements of
Operations in a manner which delineates the results of those operations
designated as Continuing Operations and of those operations designated as
Discontinued Operations. Net sales from Continuing Operations are further
classified into two categories: (i) Branded Products, which include historical
sales of the Company's four nationally branded products - International
Delight(R), Second Nature(R), Naturally Yours(TM) and Lactaid(R); and (ii)
Other Specialty Products, which includes all sales of the Company's specialty
foods business other than Branded Products. Discontinued Operations includes
the results of the Company's divested regional dairies and other divested
operations.
On April 13, 1994, the Company completed the divestiture of its
Florida-based fluid milk operation Velda Farms Inc. ("Velda") to Engles Dairy
Acquisition L.P. at an approximate selling price of $51 million consisting of
$48 million in cash after working capital adjustments and $3 million of 9%
Series A Preferred Stock. The sale of Velda completed the Company's
divestiture of its regional dairies. These regional dairy operations, along
with the Company's other divested operations, have been treated as discontinued
operations, and previously published financial statements have been restated to
conform with this presentation.
On January 6, 1994, the Company announced a restructuring plan to sharpen
its focus on the faster-growing value-added segments of its core specialty
food products business, while reorganizing its operations to be more efficient.
The plan, which resulted in a $7.1 million charge to Continuing Operations in
the fourth quarter of 1993, included provisions for reductions in work force,
relocation of the manufacturing for certain product lines to gain operating
efficiencies, and the abandonment of other product lines. The restructuring
also resulted in a $1.9 million charge to Discontinued Operations in the fourth
quarter of 1993, representing reserves established for certain supply
agreements and promissory notes received as part of the sale of certain of the
Company's regional dairies in 1991 and 1992. The total $9.0 million charge
included non-cash expenses of $4.4 million and cash expenses of $4.6 million.
The majority of the cash expenditures were made during 1994. The Company
suspended the payment of its common stock dividend immediately following the
$.0375 per share payment in the first quarter of 1994 to holders of record as
of December 31, 1993.
The Company acquired Favorite Foods Inc. ("Favorite") on March 31, 1993.
Favorite is a cultured and ultrapasteurized processor headquartered in
Fullerton, California. The consolidated results of operations for 1993 include
the results of Favorite from April 1 through December 31, 1993.
1995 COMPARED TO 1994
Net sales from Continuing Operations for the year ended December 31, 1995,
totaled $304.7 million, an increase of $12.4 million or 4.2% from net sales of
Continuing Operations during 1994. The following table reflects net sales from
Continuing Operations by product category for each year:
YEAR ENDED
PRODUCT CATEGORIES DECEMBER 31,
- ------------------ ----------------------
1994 1995
-------- --------
(Dollars in Thousands)
Branded Products..... $102,159 $117,016
Specialty Products... 190,155 187,714
-------- --------
Net Sales........ $292,314 $304,730
======== ========
Net sales of branded products increased 14.5% to $117.0 million in 1995
from $102.2 million in 1994 reflecting volume increases in the International
Delight and Lactaid product lines. The volumes for the Naturally Yours and
Second Nature product lines declined slightly from 1994 to 1995. Net sales of
specialty products declined 1.3% from 1994 to 1995. This reduction is
primarily due to the Company's selective withdrawal from certain marginally
profitable segments of this business.
The Morningstar Group 1995 Annual Report 13
2
Gross profit totaled $71.8 million or 23.6% of net sales during 1995
compared to $70.2 million or 24.0% of net sales in 1994. The increase in gross
profit is primarily attributable to the increase in branded sales in 1995. The
slight decline in the gross margin percentage in 1995 resulted from increased
prices for several of the Company's raw ingredients.
Operating expenses were $51.4 million or 16.9% of net sales in 1995 versus
$51.8 million or 17.7% of net sales in 1994. Distribution expenses as a
percent of net sales declined to 5.3% in 1995 from 6.4 % in 1994, despite the
increase in branded sales. This reduction reflects the Company's continuing
efforts to optimize the efficiencies of its distribution programs. Selling
expenses as a percent of net sales remained relatively level from 1994 to 1995.
General and administrative expenses, as a percent of net sales, increased
slightly from 4.0% in 1994 to 4.3% in 1995, due in part to additional
depreciation on enhancements to the Company's information systems.
The Company's 1995 operating income increased $2.0 million, from $18.4
million in 1994 to $20.4 million in 1995. This increase resulted primarily
from increased branded sales and lower operating costs, offset in part by a
slightly lower gross profit percentage.
Interest expense declined 11.8% from $4.4 million in 1994 to $3.9 million
in 1995. This reduction in expense is due to an overall decrease of the
Company's outstanding debt of $15.9 million during 1995, in conjunction with a
decline in the Company's average borrowing costs.
The Company's income tax provision increased $.6 million from $5.5 million
in 1994 to $6.1 million in 1995. The effective income tax rate for the year
ended December 31, 1995, was 34.8% compared to an effective tax rate of 37.2%
in 1994. As of December 31, 1995, the Company's net deferred tax assets
totaled $4.1 million, less a valuation allowance of $3.1 million. Future
reductions in the valuation allowance will result in reduced deferred tax
expense. At December 31, 1995, the Company had pretax net operating loss
carryforwards for federal income tax purposes of $1.1 million which are
available to offset future income tax liabilities. In addition, the Company
has approximately $2.1 million in alternative minimum tax credits which are
available to offset future income tax liabilities.
The Company's 1995 income from Continuing Operations of $11.3 million
compares to income in 1994 of $9.3 million. This 21.7% increase in 1995
resulted from increased branded sales, reduced operating costs, reduced
interest expense and a reduction in the effective income tax rate.
The Company's net income for 1995 of $11.5 million compares to $10.6
million for 1994. The increase in 1995 resulted from the items described in
the income from Continuing Operations section offset by a $1.1 million
reduction in income from Discontinued Operations.
1994 COMPARED TO 1993
Net sales from Continuing Operations for the year ended December 31, 1994,
totaled $292.3 million, an increase of $18.4 million (or 6.7%) from net sales
from Continuing Operations during 1993. The following table reflects net sales
from Continuing Operations by product category for each year:
Year Ended
Product Categories December 31,
- ------------------ ----------------------
1993 1994
-------- --------
(Dollars in Thousands)
Branded Products...... $ 82,556 $102,159
Specialty Products.... 191,393 190,155
-------- --------
Net Sales......... $273,949 $292,314
======== ========
The Morningstar Group 1995 Annual Report 14
3
Net sales of branded products increased 23.7% to $102.2 million in 1994
from $82.6 million in 1993 reflecting volume increases in all four branded
products. Net sales of specialty products remained relatively flat from 1993
to 1994, before considering the results of operations of Favorite for the first
quarter of 1993. On a pro forma basis, net sales of specialty products
declined 6.0% from $202.3 million in 1993 to $190.2 million in 1994. This
reduction is primarily related to the Company's selective withdrawal from
certain marginally profitable segments of this business.
Net sales from Discontinued Operations were $38.6 in 1994 versus $122.7
million in 1993. The 1994 decrease relates to the sale of Velda which was
completed on April 13, 1994.
Gross profit from Continuing Operations totaled $70.2 million or 24.0% of
net sales during 1994 compared to $62.5 million or 22.8% of net sales in 1993.
The increase in gross profit is attributable to the increase in sales of
branded products in 1994.
Operating expenses from Continuing Operations were $51.8 million or 17.7%
of net sales in 1994 versus $57.2 million (including $7.1 million in
restructuring and other charges) or 20.9% of net sales in 1993. 1993 operating
expenses before these charges were $50.1 million or 18.3% of net sales.
Distribution expenses as a percent of net sales remained level from 1993 to
1994 at 6.4%. Selling expenses as a percent of net sales increased slightly
during 1994, as a result of increased marketing and promotional activities and
increased brokerage commissions related to the increase in branded sales.
General and administrative expenses, as a percent of net sales, declined in
1994 primarily as a result of the 1993 restructuring plan.
The Company's operating income from Continuing Operations for 1994 was
$18.4 million, an increase of $13.1 million from 1993. Prior to the 1993
restructuring and other charges, the Company's operating income from Continuing
Operations increased 48.0% in 1994, from $12.4 million in 1993.
Interest expense declined 11.8% from $5.0 million in 1993 to $4.4 million
in 1994. This reduction was due to an overall decrease in debt of $11.8
million (exclusive of the reduction in debt from the proceeds of the sale of
Velda) offset by an increase in the Company's average borrowing costs.
The Company's income tax provision increased $4.7 million from $.8 million
in 1993 to $5.5 million in 1994. The effective income tax rate for the year
ended December 31, 1994 was 37.2% compared to an effective tax rate of 144.0%
in 1993. As of December 31, 1994, the Company's net deferred tax assets
totaled $8.9 million, less a valuation allowance of the same amount. Future
reductions in the valuation allowance totaling $4.7 million will result in a
reduction of goodwill associated with the Company's financial restructuring
transaction which occurred on March 1, 1991. The reductions in the remaining
$4.2 million of valuation allowance will result in reduced deferred tax
expense. The allocation of future reductions in the valuation allowance will
be determined by the ratio of deferred tax attributes that existed as of the
financial restructuring date to those deferred tax attributes created
subsequent to the financial restructuring date. At December 31, 1994, the
Company had pretax net operating loss carryforwards for federal income tax
purposes of $15.1 million which are available to offset future income tax
liabilities. In addition, the Company has approximately $.8 million in
alternative minimum tax credits which are also available to offset future
income tax liabilities.
The Company's 1994 income from Continuing Operations of $9.3 million
compares to a loss in 1993 of $.3 million. Included in the 1993 loss is $7.1
million in restructuring and other charges. Excluding the restructuring and
other charges, the 1994 income from Continuing Operations increased $4.9
million or 111.4% from $4.4 million in 1993.
The Morningstar Group 1995 Annual Report 15
4
The Company's net income for 1994 of $10.6 million compares to net income
of $.8 million for 1993. The increase in 1994 is primarily related to the
increase in gross profit, reduced interest expense and the absence of the
restructuring and other charges.
EARNINGS PER SHARE
The fully diluted, weighted average number of shares of common stock and
common stock equivalents outstanding increased from 15,050,538 in 1994 to
15,245,562 in 1995. A majority of the increase in 1995 resulted from the
exercise of outstanding stock options.
LIQUIDITY AND CAPITAL RESOURCES
In 1995, the Company generated cash of $26.7 million from its operating
activities from Continuing Operations, which, coupled with $3.0 million of net
cash provided by Discontinued Operations and $.8 million received from the
exercise of stock options, was used to repay debt of $15.9 million, fund
capital and other expenditures of $9.1 million, provide $1.8 million for the
purchase of treasury stock and increase cash balances by $3.7 million.
The Company believes that cash generated from its operations, together with
borrowings under the Revolver, will provide the cash necessary to fund the
Company's operations, debt service, stock repurchases and capital expenditures
for the foreseeable future. The Company estimates that it will require cash of
$16.0 million during 1996 to fund approximately $8.0 million in capital
expenditures and approximately $8.0 million in senior bank debt reduction;
funding will be obtained from operations and short-term borrowings, if
necessary. At December 31, 1995, the Company had approximately $15.5 million of
unused borrowing capacity under the Revolver. The Company suspended the
payment of its common stock dividend immediately following the payment of its
quarterly dividend of $.0375 per common share in the first quarter of 1994 to
holders of record as of December 31, 1993.
The Company was in compliance with all financial covenants as of December
31, 1995. Based upon the Company's projections for 1996, management does not
anticipate any violation of the financial covenants contained in the Senior
Credit Agreement. The Senior Credit Agreement contains numerous covenants
pertaining to management and operations of the Company including limitations on
the amount of capital expenditures as well as specification of certain leverage
ratios, interest coverage ratios, fixed charge coverage ratios and minimum net
worth. The Senor Credit Agreement also limits the amount of the annual common
stock dividends to the greater of $2.5 million or seven and one-half percent of
the prior year earnings before interest, taxes, depreciation and amortization,
not to exceed $5.0 million.
The Company's consolidated balance sheet includes significant goodwill and
intangible assets as a result of its financial restructuring transaction which
occurred on March 1, 1991, and the subsequent acquisition of Favorite. The
Company continually evaluates whether events and circumstances indicate the
remaining estimated useful life of goodwill warrants revision or that the
remaining balance of goodwill may not be recoverable. To make this evaluation,
the Company uses an estimate of undiscounted future cash flows (without
interest charges) over the remaining life of the goodwill.
The Morningstar Group 1995 Annual Report 16
5
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and
Board of Directors of
The Morningstar Group Inc.:
We have audited the accompanying consolidated balance sheets of The
Morningstar Group Inc. (a Delaware corporation) and subsidiaries as of December
31, 1995 and 1994, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1995. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of The Morningstar Group Inc.
and subsidiaries as of December 31, 1995 and 1994, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1995, in conformity with generally accepted accounting principles.
/s/ ARTHUR ANDERSEN LLP
Dallas, Texas,
February 16, 1996
MANAGEMENT'S REPORT ON FINANCIAL RESPONSIBILITY
To Our Stockholders:
Management is responsible for the preparation and integrity of the
consolidated financial statements of The Morningstar Group Inc. and
subsidiaries and all other information contained in this Annual Report. The
accompanying consolidated financial statements have been prepared in accordance
with generally accepted accounting principles applied on a consistent basis.
These financial statements reflect informed judgments and estimates which
management believes to be reasonable.
The Company maintains an effective system of internal accounting controls
which are modified periodically as the Company's operations change.
Additionally, the Company is receptive to suggestions made by Arthur Andersen
LLP, its independent public accountants, regarding enhancements and changes to
the Company's existing internal accounting controls. Overall, management
believes that its system of internal accounting controls is adequate to provide
reasonable assurance as to the integrity and reliability of its financial
statements and the safeguarding of assets.
The Board of Directors, acting through its Audit Committee, monitors the
accounting affairs of the Company and has approved the accompanying
consolidated financial statements. The Audit Committee, consisting of two
outside directors, reviews the results of the annual financial statement audit
and the actions taken by management and the independent public accountants to
assure that each is carrying out its responsibilities.
/s/ C. DEAN METROPOULOS /s/ L. HOLLIS JONES /s/ DARRON K. ASH
C. Dean Metropoulos L. Hollis Jones Darron K. Ash
Chairman and President and Vice President and
Chief Executive Officer Chief Operating Officer Chief Financial Officer
February 16, 1996
The Morningstar Group 1995 Annual Report 17
6
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
------------------------------
ASSETS 1994 1995
- --------------------------------------------------------------------------------------------------------
(Dollars In Thousands)
Current Assets:
Cash $ 2,152 $ 5,811
Receivables, Net of Allowance for Doubtful
Accounts of $1,495 and $1,595, Respectively 30,469 28,043
Inventories 10,540 11,123
Prepaids and Other 5,062 1,597
Deferred Tax Assets - 3,089
Net Assets Held for Sale - 836
----------- -----------
Total Current Assets 48,223 50,499
Property, Plant and Equipment:
Land 6,062 5,713
Buildings and Improvements 17,938 18,804
Machinery and Equipment 36,041 43,552
----------- -----------
Gross Property, Plant and Equipment 60,041 68,069
Less: Accumulated Depreciation (13,404) (17,748)
----------- -----------
Net Property, Plant and Equipment 46,637 50,321
Intangible and Other Assets:
Identifiable Intangible Assets 2,512 1,847
Goodwill 65,951 58,671
Deferred Financing Costs 1,540 1,259
Other Assets 402 112
----------- -----------
Total Intangible and Other Assets 70,405 61,889
----------- -----------
Total Assets $ 165,265 $ 162,709
=========== ===========
- --------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated statements.
The Morningstar Group 1995 Annual Report 18
7
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
-------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY 1994 1995
- --------------------------------------------------------------------------------------------------------
(Dollars In Thousands, Except Share Amounts)
Current Liabilities:
Accounts Payable $ 17,263 $ 21,488
Accrued Liabilities 19,345 15,869
Current Maturities of Long-Term Debt 6,000 8,000
------------ ------------
Total Current Liabilities 42,608 45,357
Long-Term Debt (Net of Current Maturities) 53,892 36,000
Other Long-Term Liabilities 1,963 4,029
Commitments and Contingencies
Stockholders' Equity:
Common Stock, $.01 Par Value, 50,000,000 Shares Authorized;
14,920,797 Shares Issued in 1994 and 15,244,261 Shares Issued in 1995 149 152
Additional Paid-In Capital 71,157 71,991
Treasury Stock, at Cost (0 Shares in 1994 and 230,000 Shares in 1995) - (1,840)
Retained Earnings (Deficit) (4,504) 7,020
------------ ------------
Total Stockholders' Equity 66,802 77,323
------------ ------------
Total Liabilities and Stockholders' Equity $ 165,265 $ 162,709
============ ============
- --------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated statements.
The Morningstar Group 1995 Annual Report 19
8
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
----------------------------------------
1993 1994 1995
- ---------------------------------------------------------------------------------------------------------
(Dollars In Thousands, Except Per Share Amounts)
Net Sales $ 273,949 $ 292,314 $ 304,730
Cost of Goods Sold 211,418 222,145 232,948
---------- ----------- -----------
Gross Profit 62,531 70,169 71,782
Operating Costs and Expenses:
Distribution 17,661 18,689 16,120
Selling 19,008 21,295 22,233
General and Administrative 13,427 11,778 13,001
Restructuring and Other Charges 7,100 - -
---------- ----------- -----------
Total Operating Costs and Expenses 57,196 51,762 51,354
---------- ----------- -----------
Operating Income 5,335 18,407 20,428
Interest Expense 4,984 4,446 3,921
Amortization of Deferred Financing Costs 493 351 381
Dividend Income - - (268)
Other Income, Net (726) (1,244) (1,008)
---------- ----------- -----------
Income Before Income Taxes 584 14,854 17,402
Provision for Income Taxes 841 5,533 6,062
---------- ----------- -----------
Income (Loss) from Continuing Operations (257) 9,321 11,340
Discontinued Operations:
Income from Discontinued Operations 1,241 (a) 903 (a) -
Gain on Disposal - 423 (b) 184 (b)
---------- ----------- -----------
Income from Discontinued Operations 1,241 1,326 184
---------- ----------- -----------
Income Before Extraordinary Item 984 10,647 11,524
Extraordinary Item (164) (c) - -
---------- ----------- -----------
Net Income $ 820 $ 10,647 $ 11,524
=========== =========== ===========
Earnings (Loss) Per Common Share:
Continuing Operations $ (.02) $ .62 $ .74
Discontinued Operations .08 .09 .02
---------- ----------- -----------
Earnings Before Extraordinary Item .06 .71 .76
Extraordinary Item (.01) - -
---------- ----------- -----------
Earnings Per Common Share $ .05 $ .71 $ .76
========== =========== ===========
Weighted Average Common and
Common Equivalent Shares Outstanding 15,011,607 15,050,538 15,245,562
- ---------------------------------------------------------------------------------------------------------
(a) Net of applicable tax provision of $1,044 and $507.
(b) Net of applicable tax provision of $2,865 and $216.
(c) Loss on purchase of senior subordinated debentures, net of applicable tax
benefit of $71.
The accompanying notes are an integral part of these consolidated statements.
The Morningstar Group 1995 Annual Report 20
9
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON STOCK RETAINED
AND ADDITIONAL TREASURY EARNINGS
PAID-IN CAPITAL STOCK (DEFICIT) TOTAL
- ----------------------------------------------------------------------------------------------------------
(Dollars In Thousands, Except Share Amounts)
Balance, December 31, 1992 $ 69,610 $ - $ (13,831) $ 55,779
Exercise of Stock Options 74 - - 74
Cash Dividends on Common Stock - - (2,140) (2,140)
($.15 Per Share)
Net Income - - 820 820
--------- ---------- ---------- ---------
Balance, December 31, 1993 69,684 - (15,151) 54,533
Exercise of Stock Options 1,622 - - 1,622
Net Income - - 10,647 10,647
--------- ---------- ---------- ---------
Balance, December 31, 1994 71,306 - (4,504) 66,802
Exercise of Stock Options 837 - - 837
Purchase of Treasury Stock - (1,840) - (1,840)
Net Income - - 11,524 11,524
--------- ---------- ---------- ---------
Balance, December 31, 1995 $ 72,143 $ (1,840) $ 7,020 $ 77,323
========= ========== ========== =========
- ---------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated statements.
The Morningstar Group 1995 Annual Report 21
10
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
---------------------------------------------
1993 1994 1995
- ----------------------------------------------------------------------------------------------------------
(Dollars In Thousands)
Cash Flows from Operating Activities:
Cash Received from Customers $ 274,751 $ 284,605 $ 306,918
Interest Received 238 134 224
Income Tax Refund 6 - -
Cash Paid to Suppliers and Employees (257,501) (259,147) (272,992)
Interest Paid (6,240) (4,395) (4,220)
Income Taxes Paid (453) (2,663) (3,199)
---------- ----------- -----------
Net Cash Provided by Continuing Operations 10,801 18,534 26,731
Net Cash Provided (Used) by Discontinued Operations 5,896 (3,403) -
---------- ----------- -----------
Net Cash Provided by Operating Activities 16,697 15,131 26,731
Cash Flows from Investing Activities:
Acquisition of Subsidiary:
Working Capital (2,936) - -
Property, Plant and Equipment (12,255) - -
Other Assets (15,190) - -
Other Long-Term Liabilities 354 - -
---------- ----------- -----------
(30,027) - -
Capital Expenditures (5,520) (7,622) (10,705)
Proceeds from Sale of Assets 209 32 2
Dividends Received from Velda Preferred Stock - - 268
Other (2,175) 682 1,258
---------- ----------- -----------
Net Cash Used by Continuing Operations (37,513) (6,908) (9,177)
Discontinued Operations:
Sale of Discontinued Operations 125 50,237 -
Sale of Velda Preferred Stock - - 3,000
Capital and Other Expenditures (1,198) (482) -
---------- ----------- -----------
Net Cash Provided (Used) by Discontinued Operations (1,073) 49,755 3,000
---------- ----------- -----------
Net Cash Provided (Used) by Investing Activities (38,586) 42,847 (6,177)
Cash Flows from Financing Activities:
Proceeds from Issuance of Common Stock 74 1,622 837
Purchase of Treasury Stock - - (1,840)
Proceeds from Issuance of Long-Term Debt 35,000 - -
Net Borrowings (Repayments) Under
Revolving Credit Facility 6,675 (14,783) (1,892)
Principal Payments on Long-Term Debt (18,231) (45,470) (14,000)
Dividends Paid (2,140) (535) -
---------- ----------- -----------
Net Cash Provided (Used) by Financing Activities 21,378 (59,166) (16,895)
Net Increase (Decrease) in Cash (511) (1,188) 3,659
Cash, Beginning of Period 3,851 3,340 2,152
---------- ----------- -----------
Cash, End of Period $ 3,340 $ 2,152 $ 5,811
========== =========== ===========
- ---------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated statements.
The Morningstar Group 1995 Annual Report 22
11
CONSOLIDATED STATEMENTS OF CASH FLOWS
RECONCILIATION OF NET INCOME TO NET CASH
PROVIDED BY OPERATING ACTIVITIES
YEAR ENDED DECEMBER 31,
--------------------------------------------
1993 1994 1995
- ----------------------------------------------------------------------------------------------------------
(Dollars In Thousands)
Net Income $ 820 $ 10,647 $ 11,524
Adjustments to Reconcile Net Income to Net Cash
Provided by Operations:
Discontinued Operations Net Income (1,241) (1,326) (184)
Depreciation 3,810 4,344 5,122
Amortization of Intangibles 4,288 2,632 2,700
Restructuring and Other Charges 7,100 - -
(Gain) Loss on Fixed Asset Retirements 82 (243) -
Increase in Deferred Taxes 1,040 4,222 3,635
Loss on Extinguishment of Debentures 164 - -
Change in Assets and Liabilities Net of
Effects from Acquisitions and
Divestitures of Subsidiaries:
Accounts Receivable (1,208) (3,707) 2,426
Inventories (2,792) 987 (583)
Prepaids and Other (2,969) 3,569 151
Accounts Payable 1,455 (655) 4,225
Accrued Liabilities 2,466 (1,986) (4,076)
Other Long-Term Liabilities (2,214) 50 1,791
--------- ---------- ---------
Total Adjustments 9,981 7,887 15,207
Net Cash Provided by Continuing Operations 10,801 18,534 26,731
Discontinued Operations:
Discontinued Operations Net Income 1,241 1,326 184
Gain on Disposal - (423) (184)
Change in Working Capital 1,584 (4,914) -
Depreciation and Amortization 3,071 608 -
--------- ---------- ---------
Net Cash Provided (Used) by Discontinued Operations 5,896 (3,403) -
Net Cash Provided by Operating Activities $ 16,697 $ 15,131 $ 26,731
========= ========== =========
- ---------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated statements.
The Morningstar Group 1995 Annual Report 23
12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) ORGANIZATION AND BUSINESS
BACKGROUND
The Morningstar Group Inc., a Delaware corporation (together with its
subsidiaries, the "Company", "Morningstar", or "Successor") was formed in March
1991. On April 1, 1988, the Company's predecessor, MorningStar Foods Inc.,
acquired substantially all of the net assets and operations of the Dairy Group
of The Southland Corporation.
Due to a change of ownership, the Company adopted a new basis of accounting
on March 1, 1991. In accordance with generally accepted accounting principles,
the assets and liabilities of the Company were adjusted to their appraised fair
market values as of this date.
The Company announced on January 6, 1994, a new growth strategy which
included $9.0 million in restructuring and other charges recognized in the
fourth quarter of 1993 and the cessation of the payment of dividends on its
common stock. This restructuring plan also contemplated the sale of Velda
Farms Inc. ("Velda") which was completed on April 13, 1994, for $48.0 million
in cash after working capital adjustments and $3.0 million of 9% Series A
Preferred Stock (the "Velda Preferred Stock"). The Company deferred the
recognition of the gain on the Velda Preferred Stock pending realization of the
gain. The majority of the cash proceeds were used to pay down external bank
debt and to fund federal and state taxes generated by the gain on the sale.
BUSINESS
The Company's Continuing Operations include its specialty operations which
manufacture and market refrigerated food products including nationally branded
products and other specialty, dairy-based cultured and ultrapasteurized
products. Discontinued Operations include all previously divested regional
dairy operations and other divested operations.
(2) ACQUISITIONS AND DISCONTINUED OPERATIONS
DISCONTINUED OPERATIONS
The Company has made significant divestitures since its inception, and as a
result, the size and scope of the Company's operations have changed
significantly. In 1991, the Company divested a novelty/ice cream operation in
Texas and closed a novelty/ice cream operation in Missouri. In 1992, the
Company divested a regional dairy operation and a novelty/ice cream operation,
both located in Maryland. On April 13, 1994, the Company completed the
divestiture of its Florida-based fluid milk operation Velda Farms Inc.
("Velda"). The sale of Velda concluded the divestiture of the Company's
regional dairies which were considered a major and distinct segment of its
business. As such, the operations of the regional dairies and other divested
operations have been restated and presented in the consolidated financial
statements to conform with discontinued operations treatment ("Discontinued
Operations").
On March 31, 1995, the Velda Preferred Stock was redeemed by its issuer at
face value plus accrued dividends. The $3.0 million gain on the stock, less
applicable taxes and other reserves of $2.3 million, was reflected in
Discontinued Operations in the Consolidated Statements of Operations during the
first quarter of 1995. The Company also recognized $268,000 in dividends,
related to the Velda Preferred Stock, during the first quarter of 1995 which
was recorded in Continuing Operations. The Company recorded an additional loss
from Discontinued Operations of approximately $.5 million, net of tax benefits,
during the second quarter of 1995, related to Discontinued Operations reserves
and other liabilities.
Net sales of the Discontinued Operations were $122.7 million in 1993 and
$38.6 million in 1994. Interest expense of $1.4 million and $.4 million was
allocated to Discontinued Operations during 1993 and 1994, respectively. The
allocation method was based upon the ratio of net assets of Discontinued
Operations to the sum of consolidated net assets plus consolidated debt, less
debt specifically allocated to certain of the Company's subsidiaries.
The Morningstar Group 1995 Annual Report 24
13
FAVORITE FOODS ACQUISITION
On March 31, 1993, the Company completed its purchase of Favorite Foods,
Inc., formerly a subsidiary of Nestle USA, Inc., for approximately $28 million
plus expenses. Simultaneously with the purchase, the acquired corporation was
merged into Favorite Foods Inc., a Delaware corporation (collectively
"Favorite"). Favorite, headquartered in Fullerton, California, is a processor
of cultured and ultrapasteurized products and recorded approximately $31.0
million in sales during the nine months ended December 31, 1993. Favorite's
results are included in the 1993 Consolidated Statement of Operations for the
period April 1 through December 31, 1993.
(3) SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All significant intracompany
transactions and balances have been eliminated.
CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially expose the Company to
concentrations of credit risk consist primarily of trade accounts receivable.
The Company sells its products to supermarkets, convenience stores, dairies,
food service and institutional organizations, club stores and private label
suppliers located in all 50 states and over 20 foreign countries, with a
concentration of customers located in California. The Company performs ongoing
credit evaluations of its customers' financial condition. The Company
establishes an allowance for doubtful accounts based upon factors surrounding
the credit risk of specific customers, historical trends and other relevant
information.
CASH AND CASH EQUIVALENTS
The Company considers overnight investments to be cash.
INVENTORIES
Inventories are valued at the lower of cost or
market. Cost is determined using the first-in, first-out method. Inventories
are summarized as follows (in thousands):
AT DECEMBER 31,
---------------------
1994 1995
---------- ---------
Raw Materials and Supplies... $ 6,757 $ 5,975
Finished Goods .............. 3,783 5,148
---------- ---------
Total ................... $ 10,540 $ 11,123
========== =========
Finished goods inventories include the costs of materials, labor and plant
overhead.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is recorded at cost and is depreciated on a
straight-line basis over the estimated useful lives of the assets, as follows:
USEFUL
ASSET CATEGORY LIFE (YEARS)
- -------------- ------------
Machinery and Equipment .......... 3 - 10
Buildings and Improvements ....... 25
Property sold or retired is eliminated from the accounts in the year of
disposition. Major expenditures for renewals and betterments are capitalized
while maintenance and repairs are charged against income.
IDENTIFIABLE INTANGIBLE ASSETS
Identifiable intangible assets related to the acquisition of Favorite were
added in 1993, and are being amortized over their estimated useful lives which
is generally five years. Amortization costs totaled $1,933,000 in 1993,
$665,000 in 1994 and $665,000 in 1995. The 1993 amortization does not include
the write-down of certain identifiable intangibles associated with the 1993
restructuring and other charges. Accumulated amortization was $1,178,000 and
$1,843,000 at December 31, 1994 and 1995, respectively.
The Morningstar Group 1995 Annual Report 25
14
GOODWILL
Goodwill is amortized on a straight-line basis over 40 years and is
recorded at cost less accumulated amortization. Amortization costs totaled
$1,654,000 in 1993, $1,660,000 in 1994 and $1,652,000 in 1995. Accumulated
amortization was $6,860,000 and $8,512,000 at December 31, 1994 and 1995,
respectively.
DEFERRED FINANCING COSTS
Costs incurred that relate to the issuance of indebtedness and the
corresponding accumulated amortization are included in deferred financing costs
in the accompanying consolidated balance sheets. Deferred financing costs
related to existing debt are amortized over the life of the related debt.
Accumulated amortization was $1,118,000 and $1,499,000 at December 31, 1994 and
1995, respectively.
ACCOUNTING FOR LONG-LIVED ASSETS
In March 1995, the Financial Accounting Standards Board issued "SFAS" No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of." This statement is effective for financial statements
beginning after December 15, 1995. The Company has elected to adopt the
statement effective December 31, 1995. The adoption of SFAS No. 121 had no
material effect on the Company's financial statements.
The Company continually evaluates whether events and circumstances indicate
that the remaining carrying amount of an asset may not be recoverable or the
remaining useful life may warrant revision. To make this evaluation, the
Company uses an estimate of undiscounted future cash flows (without interest
charges) over the remaining life of the asset.
ACCRUED LIABILITIES
Accrued liabilities consisted of the following (in thousands):
AT DECEMBER 31,
--------------------
1994 1995
--------- ---------
Accrued Interest ............. $ 706 $ 407
Payroll and Benefits
(Accrued Wages,
Vacation, and
Profit Sharing) .......... 3,472 4,080
Restructuring Accruals ....... 717 230
Insurance Accruals ........... 3,559 5,195
Income Tax ................... 3,042 1,491
Marketing and Advertising .... 2,689 2,017
Other Accrued Liabilities .... 5,160 2,449
------- -------
Total .................... $19,345 $15,869
======= =======
FAIR VALUE OF FINANCIAL INSTRUMENTS
The financial position of the Company at December 31, 1995, includes
certain financial instruments which may have a fair value that is different
than that which is currently reflected in the financial statements. However,
any variation in value is insignificant.
USE OF ESTIMATES
The preparation of these financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
REVENUE RECOGNITION
The Company recognizes revenue upon shipment to customers.
DERIVATIVE FINANCIAL INSTRUMENTS
The Company has not entered into any derivatives or other speculative
financial instruments as of December 31, 1995.
The Morningstar Group 1995 Annual Report 26
15
INCOME TAXES
Deferred income taxes reflect the tax effect of temporary differences
between the amount of assets and liabilities recognized for financial reporting
and tax purposes and are measured by applying currently enacted tax laws. The
effect on deferred income tax assets and liabilities of a change in tax rates
is recognized in income in the period that includes the enactment date.
OTHER INCOME
Other income primarily consists of royalty revenue.
EARNINGS (LOSS) PER COMMON SHARE
The earnings (loss) per common share is computed based on the fully diluted
weighted average number of shares of the Company's common stock and common
stock equivalents outstanding during the period. Common stock equivalents
represent the dilutive effect of the assumed exercise of certain outstanding
stock options.
FINANCIAL STATEMENT PRESENTATION
Certain prior year balances have been reclassified to conform to the
current year presentation.
PRO FORMA RESULTS FROM CONTINUING OPERATIONS
The following unaudited pro forma information is presented to illustrate
the estimated effects of the acquisition of Favorite as if the transaction had
occurred at January 1, 1993 (in thousands, except per share amounts):
YEAR ENDED
DECEMBER 31,
1993
------------
(Unaudited)
Pro Forma Net Sales from
Continuing Operations $ 285,136
===========
Pro Forma Net Loss from
Continuing Operations
Before Extraordinary Items $ (161)
===========
Pro Forma Net Loss from
Continuing Operations $ (325)
===========
Pro Forma Shares Outstanding 14,287,212
===========
Pro Forma Loss Per Share $ (.02)
===========
The pro forma information presented above does not eliminate the effect of
the Company's $7.1 million in restructuring and other charges recorded in the
fourth quarter of 1993.
(4) INCOME TAXES
The components of the provision for income taxes from Continuing Operations
are as follows (in thousands):
YEAR ENDED
DECEMBER 31,
-------------------
1993 1994 1995
---- ---- ----
Current $ 207 $ 272 $1,339
Deferred 388 4,163 3,448
State 246 1,098 1,275
------ ------ ------
Provision for
Income Taxes $ 841 $5,533 $6,062
====== ====== ======
Temporary differences and carryforwards which give rise to a significant
portion of net deferred income tax assets are as follows (in thousands):
AT DECEMBER 31,
---------------
1994 1995
---- ----
Deferred Tax Assets:
Net Operating Loss
Carryforward $ 5,130 $ 385
Accrued Vacation 525 504
Accrued Workers'
Compensation 1,030 1,397
Restructuring Reserves 501 396
Other Accrued Expenses
and Reserves 3,404 2,111
Other Deferred Tax Assets 1,011 2,340
------- -------
Total Deferred Tax Assets 11,601 7,133
Deferred Tax Liabilities:
Accelerated Depreciation
and Amortization 2,393 2,901
Other Deferred Tax
Liabilities 298 140
------- -------
Total Deferred Tax Liabilities 2,691 3,041
Valuation Allowance (8,910) (3,073)
------- -------
Net Deferred Tax Assets - 1,019
Noncurrent Deferred Tax
Liabilities - (2,070)
------- -------
Current Deferred Tax
Assets $ - $ 3,089
======= =======
The Company reduced goodwill by approximately $388,000, $4,163,000 and
$5,648,000 for the years ended December 31, 1993, 1994 and 1995, respectively,
representing realization of deferred tax assets created prior to the Company's
financial restructuring transaction.
The Morningstar Group 1995 Annual Report 27
16
The provision for income taxes was different than the amount computed
using the statutory income tax rate for the reasons set forth in the following
table (in thousands):
YEAR ENDED
DECEMBER 31,
-------------------
1993 1994 1995
---- ---- ----
Provision Computed
at Statutory Rate..... $ 199 $ 5,050 $ 5,917
State Income Taxes........ 162 905 1,025
Tax on Nondeductible
Goodwill Amortization. 539 516 473
Utilization of Previously
Unrecognized Deferred
Tax Assets............ (138) (1,107) (1,405)
Other..................... 79 169 52
----- ------- -------
Provision for Income
Taxes................... $ 841 $ 5,533 $ 6,062
===== ======= =======
AVAILABILITY AND AMOUNT OF NET OPERATING LOSS CARRYFORWARDS
At December 31, 1995, the Company had pretax net operating loss ("NOL")
carryforwards for federal income tax purposes of $1.1 million which are
available to offset future income tax liabilities. NOL carryforwards expire in
2007. In addition, the Company has approximately $2.1 million in alternative
minimum tax credits which are available to offset future income tax
liabilities.
(5) LONG-TERM DEBT
The Company's long-term debt consists of the following (in thousands):
AT DECEMBER 31,
---------------
1994 1995
---- ----
Senior Term Loan........... $55,000 $41,000
Revolving Credit Facility.. 1,892 -
Industrial Development
Revenue Bonds.......... 3,000 3,000
------- -------
Total Long-Term Debt... 59,892 44,000
Less: Current Maturities.. (6,000) (8,000)
------- -------
Long-Term Debt, Net of
Current Maturities..... $53,892 $36,000
======= =======
Maturities of long-term debt at December 31, 1995, are as follows (in
thousands):
1996................................ $ 8,000
1997................................ 15,355
1998................................ 17,645
1999................................ -
2000................................ -
Thereafter.......................... 3,000
-------
Total Maturities................ $44,000
=======
SENIOR TERM LOAN AND REVOLVING CREDIT FACILITY
In March 1993, in conjunction with the acquisition of Favorite Foods Inc.,
the Company's existing credit agreement was amended and restated (the "Senior
Credit Agreement"). The Senior Credit Agreement includes a six-year term loan
(the "Senior Term Loan") and a $25 million revolving credit facility (the
"Revolver"). At December 31, 1995, there were no outstanding borrowings under
the Revolver and approximately $9.5 million was issued pursuant to letters of
credit.
The Senior Credit Agreement also requires mandatory prepayments of the
loans under certain conditions such as the sale of assets, excess cash flow,
the issuance of new debt or equity and the receipt of certain other cash
proceeds.
The base interest rate on the Senior Term Loan and the Revolver is the
prime rate. Both facilities have alternative rate options based upon spread
above the London Interbank Offered Rate ("LIBOR"). At December 31, 1995, $41.0
million in borrowings under the Senior Term Loan were outstanding at a weighted
average interest rate of 6.68%. Borrowings under these lending facilities are
secured by virtually all of the assets of the Company. Up to $17 million in
letters of credit may be issued under the Revolver. As of December 31, 1995,
approximately $15.5 million was additionally available to the Company under the
Revolver. A fee of .5% per year is charged on outstanding letters of credit.
A .25% per year commitment fee on uncommitted funds is payable quarterly. The
Revolver matures on March 20, 1999, coincident with the original scheduled
maturity of the Term Loan. The Senior Credit Agreement contains numerous
The Morningstar Group 1995 Annual Report 28
17
covenants pertaining to management and operations of the Company including
limitations on the amount of annual capital expenditures as well as
specification of certain leverage ratios, interest coverage ratios, fixed
charge coverage ratios and minimum net worth. The Senior Credit Agreement also
limits the amount of the annual common stock dividends to the greater of $2.5
million or seven and one-half percent of the prior year earnings before
interest, taxes, depreciation and amortization, not to exceed $5.0 million.
During April 1994, the Company completed the sale of Velda for
approximately $48.0 million in cash and $3.0 million in 9% Series A Preferred
Stock. In conjunction with the sale, the Company paid down approximately $36.7
million of its Senior Term Loan and $11.8 million of its Revolver. The Senior
Credit Agreement was also amended to change the amortization schedule of the
Senior Term Loan (see maturity schedule above.) Also, effective June 20, 1994,
the Company's Revolver commitment was reduced, as previously scheduled, from
$30 million to $25 million.
The Company was in compliance with all financial covenants as of December
31, 1995. Based upon the Company's projections for 1996, management does not
anticipate any violation of the financial covenants contained in the Senior
Credit Agreement.
INDUSTRIAL DEVELOPMENT REVENUE BONDS
The industrial development revenue bonds were issued on December 14, 1988,
to fund the construction of a waste water treatment facility at the Company's
Frederick, Maryland, processing plant. The bonds mature on December 1, 2003,
and bear interest that fluctuates weekly based upon market factors. The
interest rate in effect for these bonds on December 31, 1995, was 5.35%.
(6) RESTRUCTURING AND OTHER CHARGES
On January 6, 1994, the Company announced a restructuring plan to sharpen
its focus on the faster-growing value-added segments of its core specialty
food products business, while reorganizing its operations to be more efficient.
The plan, which resulted in a $9.0 million charge in the fourth quarter of
1993, included provisions for reductions in work force, relocation of the
manufacturing for certain product lines to gain operating efficiencies, and the
abandonment of other product lines. As of December 31, 1995, the Company had
abandoned two yogurt production lines and one ultrapasteurized ("UHT")
production line in connection with the restructuring plan. The Company has
also relocated two UHT production lines as well as several cultured production
lines as of December 31, 1995. The $9.0 million charge included non-cash
expenses of $4.4 million and cash expenses of $4.6 million. The majority of
the cash expenditures were paid during 1994. Approximately 100 employment
positions were eliminated as a part of the restructuring plan. The relocation
of product lines impacted each of the Company's six specialty dairy facilities.
The charge also included $1.9 million representing reserves established for
certain supply agreements and promissory notes received as part of the sale of
certain of the Company's regional dairies in 1991 and 1992. This charge has
been included in Discontinued Operations in the Consolidated Statements of
Operations.
The components of the 1993 charge include (in thousands):
YEAR ENDED
DECEMBER 31,
1993
------------
Restructuring Charge
Consulting, Severance and
Related Personnel Costs $2,500
Relocation of Product Lines 3,600
Excess Data Processing Conversion
Expenses 1,000
------
Subtotal 7,100
Other Charges
Loss on Divestitures(a) 1,900
------
Total $9,000
======
(a) Included in Discontinued Operations.
The Morningstar Group 1995 Annual Report 29
18
(7) EMPLOYEE BENEFIT PLANS
RETIREMENT PLANS
The Company has adopted a defined contribution profit sharing plan for the
purpose of providing retirement benefits for eligible non-union employees. At
December 31, 1995, eligible employees totaled 312, of which 189 were
participants in the plan. Contributions are made by the Company and by plan
participants. Company contributions are allocated to the participants on the
basis of individual contributions, the age of the participant and the number of
years that the participant has been in the plan. During 1995, the Company also
contributed to two single-employer and four multi-employer pension/retirement
plans under the terms of various union contracts, which covered 486 of its 792
employees at December 31, 1995. The number of union pension plans and the
portion of employees covered has varied from year to year. Contributions to
these pension plans are as follows (in thousands):
YEAR ENDED
DECEMBER 31,
-------------------------
1993 1994 1995
---- ---- ----
Defined Contribution
Profit Sharing Plan $ 414 $ 230 $ 250
Union Pension Plans 1,197 1,122 1,182
POST-RETIREMENT BENEFIT PLANS
The cost of providing post retirement benefits other than pensions for
non-union employees has been primarily paid by non-union retirees and the
Company's calculation of its obligation is not material as of December 31, 1995.
The Company's union employees participate in various defined contribution
union plans that provide health care and other welfare benefits during their
employment and after retirement. Amounts charged to expense and contributed to
these health and welfare plans totaled approximately $2,292,000 in 1993,
$2,608,000 in 1994 and $1,999,000 in 1995. Having made these payments, no
remaining obligations exist for these years under the union plans.
(8) COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases certain plant facilities and related equipment and
vehicles under operating lease arrangements. Lease expense pursuant to such
arrangements was approximately $5,012,000 in 1993, $3,009,000 in 1994 and
$3,151,000 in 1995.
The following is a summary of future minimum annual lease payments under
noncancelable operating lease obligations as of December 31, 1995
(in thousands):
YEAR ENDING
DECEMBER 31,
- ------------
1996 $ 2,391
1997 2,169
1998 2,064
1999 1,483
2000 1,131
Thereafter 510
--------
Total $ 9,748
========
EMPLOYMENT AGREEMENTS
The Company had previously entered into employment agreements with its
former Chief Executive Officer, Chief Operating Officer and Chief Financial
Officer. The former Chief Executive Officer, James A. Bach, resigned on March
17, 1994. Pursuant to his employment agreement, Mr. Bach is to receive
approximately $1,175,000 over a period of two and one-half years from the date
of his resignation. The agreement with the former Chief Financial Officer,
Tracy L. Noll, terminated with his resignation
The Morningstar Group 1995 Annual Report 30
19
on June 17, 1994. The agreement with the Chief Operating Officer, Clifford L.
Marquart, terminated on February 28, 1995. For the years ended December 31,
1994 and 1995, the combined salaries and bonuses for these executives was
approximately $1,400,000 and $337,000, respectively.
In 1995, the Company entered into employment agreements with certain key
management personnel which provide for annual compensation and benefits and
also provide for certain severance payments to be made to such individuals in
the event of a change in control (as defined) of the Company or the involuntary
termination of such individuals for reasons other than cause (as defined).
None of the agreements provide for payments exceeding 18 months of
compensation and benefits. The maximum amount payable under these employment
agreements is approximately $2,386,000 in the aggregate.
LITIGATION
The Company received a "target letter" dated December 31, 1991, from the
United States Department of Justice informing it that Morningstar was a target
of a federal grand jury investigation of suspected bid-rigging and market
allocation in the dairy industry in the State of Texas. The investigation
related to activities conducted in the fluid milk industry in Texas. Oak Farms
and Cabell's (collectively the "Texas Dairy Subsidiaries") were formed by the
Company in March 1988 in connection with the acquisition of substantially all
of the assets of Southland's dairy operations. The Texas Dairy Subsidiaries
conducted fluid milk operations in Texas and were sold to Southern Foods Group,
Inc. ("Southern Foods") in September 1990, which merged them into its
subsidiary, Schepps-Foremost, Inc.
The investigation by the Department of Justice concluded in 1994. The
Company was not made a party to legal action commenced by the Department.
The Company has agreed to indemnify purchasers of its divested operations
with regard to certain potential liabilities arising out of the acquisition of
such operations. In connection therewith, the Company has indemnified Southern
Foods, the purchaser of the Oak Farms and Cabell's dairy subsidiaries, against
claims related to compliance with environmental regulations and fair trade
practices arising out of the prior operation of Oak Farms and Cabell's through
March 2000.
Southern Foods made claim against the Company in 1994 pursuant to the
indemnification provisions noted above to recover certain sums that Southern
Foods paid as a result of the Department of Justice investigation. In February
1995, the Company reached an agreement with Southern Foods to pay the sum of
$425,000 to settle all claims between the companies relating to the aforesaid
investigation. This agreement did not have a material adverse effect on the
results of operations or the financial position of the Company.
From time to time, the Company is subject to other litigation in the
ordinary course of its business. In connection with the divestitures of
certain of the Company's operations, the Company assumed certain obligations of
indemnification, none of which is believed to be material to the Company. The
Company maintains insurance in respect of certain losses that may result from
its current or future operations. The Company believes that the outcome of any
existing litigation, after considering the indemnities and insurance related to
such litigation, would not have a material impact on its business, financial
condition or results of operations.
(9) RELATED-PARTY TRANSACTIONS
HICKS, MUSE, TATE & FURST
The Company had previously entered into a financial advisory agreement
dated March 1, 1991, as amended, pursuant to which Hicks Muse provided
financial advisory services to the Company. Effective September 30, 1995, this
agreement was terminated. As compensation for such services, the Company paid
Hicks Muse an advisory fee, together with all reasonable expenses incurred in
connection therewith. The Company paid advisory fees of $200,000, $114,000
and $150,000 in 1993, 1994 and 1995, and reimbursed Hicks Muse approximately
$21,000, $37,000 and $28,000 for expenses for each year, respectively. Hicks
Muse was also paid a fee of $420,000 relating to the acquisition of Favorite
and $300,000 relating to the sale of Velda.
ADVISORY AGREEMENT
The Company entered into an advisory agreement dated October 1, 1993,
pursuant to which C. Dean Metropoulos will provide advisory services to the
Company in implementing its new growth strategy and accomplishing its 1993
restructuring plan. The term of this agreement is three years and is
cancelable by either party at any time. Subsequent to execution of the
advisory agreement, Mr. Metropoulos was named to the additional positions of
President and
The Morningstar Group 1995 Annual Report 31
20
Chief Executive Officer in April 1994. As compensation for all services
rendered, the Company paid Mr. Metropoulos $290,000 and $350,000 in salary,
$450,000 and $450,000 in bonus and approximately $6,000 and $22,000 in
reimbursed expenses for 1994 and 1995, respectively.
(10) EQUITY
1991 STOCK OPTION PLAN
In March 1991, the Company established the 1991 Incentive and Nonstatutory
Stock Option Plan which provides for the issuance of options to purchase
999,999 shares of common stock to key employees of the Company. At December
31, 1995, 769,941 tenure options and 228,258 incentive options had been granted
to employees. Upon completion of the common stock offering in 1992, the
incentive options became vested, resulting in compensation expense of
$1,093,000. The exercise price for all options granted was $2.56 per share,
which was the fair market value of the options at the date of issuance. The
options expire ten years after the date of their issuance.
1992 STOCK OPTION PLAN
In July 1992, the Company established the 1992 Incentive and Nonstatutory
Option Plan which provides for the issuance of options to purchase 181,818
shares of common stock to key employees of the Company. At December 31, 1995,
175,000 options had been granted to employees. The exercise price for 25,000
of these options granted is $9.00 per share, which was the fair market value of
the options at the date of issuance. The exercise price for 120,000 options
granted in 1994 is $7.00 per share, which was the fair market value of the
options at the date of issuance. The exercise price for 30,000 of the options
granted in 1995 is $6.75 per share, which was the fair market value of the
options at the date of issuance. The options granted in 1992 become exercisable
over a three-year period and expire ten years after the date of their issuance.
One-third of the options granted in 1994 became exercisable on the date of
issuance, while the remaining options vest in equal amounts over two years.
The options granted in 1995 vest ratably over a three-year period. The options
granted in 1994 and 1995 expire ten years after the date of their issuance. No
options under the 1992 plan had been exercised as of December 31, 1995.
1994 STOCK OPTION PLAN
In June 1994, the Company established the 1994 Incentive and Nonstatutory
Stock Option Plan which provides for the issuance of options to purchase 250,000
shares of common stock to key employees of the Company. At December 31, 1995,
219,000 options had been granted to employees. The exercise price for 195,000
of these options granted is $7.00 per share, which was the fair market value of
the options at the date of issuance. The exercise price for 24,000 of the
options granted in 1995 is $8.00 per share, which was the fair market value of
the options at the date of issuance. These options become exercisable over a
three-year period and expire ten years after the date of their issuance. Under
this plan, 2,000 options had been exercised as of December 31, 1995.
CHAIRMAN OPTION PLAN
On February 15, 1994, the Compensation Committee of the Company's Board of
Directors approved the issuance of options to purchase 600,000 shares of common
stock of the Company to C. Dean Metropoulos, Chairman and CEO of the
Company. As of December 31, 1995, 600,000 options had been granted to Mr.
Metropoulos. The exercise price for these options is $6.50 per share, which
was the fair market value of the options at the date of issuance. One-third of
these options became exercisable on the date of issuance, while the remaining
options vest in equal amounts over two years. The options expire ten years
after the date of their issuance. As of December 31, 1995, no options had been
exercised.
The Morningstar Group 1995 Annual Report 32
21
SUMMARY OF OPTIONS
(number of options)
1992 PLAN 1994 PLAN
OPTION OPTION
1991 PLAN 1992 PLAN PRICE 1994 PLAN PRICE CHAIRMAN PLAN
---------- --------- ------------- --------- ---------- -------------
Outstanding at December 31, 1993 . . . . 970,999 160,000 $ 9.00 - $ - -
Granted in 1994 . . . . . . . . . . . . - 120,000 7.00 210,000 7.00 600,000
Cancelled in 1994 . . . . . . . . . . . (1,800) (104,000) 9.00 - - -
Exercised in 1994 . . . . . . . . . . . (633,786) - - - - -
--------- --------- ------------- --------- ----------- -------------
Outstanding at December 31, 1994 . . . . 335,413 176,000 $7.00 - $9.00 210,000 $ 7.00 600,000
--------- --------- ------------- --------- ----------- -------------
Granted in 1995 . . . . . . . . . . . . - 30,000 6.75 81,000 7.00-8.00 -
Cancelled in 1995 . . . . . . . . . . . (13,049) (31,000) 9.00 (70,000) 7.00 -
Exercised in 1995 . . . . . . . . . . . (311,464) - - (2,000) 7.00 -
--------- --------- ------------- --------- ----------- -------------
Outstanding at December 31, 1995 . . . . 10,900 175,000 $6.75 - $9.00 219,000 $7.00-$8.00 600,000
========= ========= ============= ========= =========== =============
Exercisable at December 31, 1994 . . . . 355,413 78,654 $9.00 - - 400,000
========= ========= ============= ========= =========== =============
Exercisable at December 31, 1995 . . . . 10,900 105,000 $7.00 - $9.00 52,000 $ 7.00 600,000
========= ========= ============= ========= =========== =============
Stock Repurchase Program
On June 21, 1995, the Company's Board of Directors announced that it had
approved a plan pursuant to which the Company may repurchase up to $20 million
of its common stock. The purchases will be effected through open market
transactions or negotiated transactions from time to time, depending on the
market price of the stock and other factors. As of December 31, 1995, 230,000
shares had been repurchased by the Company at a cost of $1.8 million. As of
January 31, 1996, the Company had purchased an additional 487,000 shares at a
cost of $3.9 million.
The Morningstar Group 1995 Annual Report 33
22
(11) QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Quarterly financial information for the years ended December 31, 1994
and 1995, is as follows:
FIRST SECOND THIRD FORTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
DOLLARS IN THOUSANDS:
Net Sales 1994 $ 70,739 $ 73,667 $ 70,429 $ 77,479
1995 71,893 74,882 73,167 84,788
Gross Profit 1994 16,344 17,363 15,750 20,712
1995 17,269 17,718 16,250 20,545
Income from Continuing Operations 1994 1,764 2,539 1,857 3,161
1995 2,269 2,846 2,316 3,909
Income (Loss) from Discontinued Operations 1994 827 709 (295) 85
1995 694 (510) - -
Net Income 1994 2,591 3,248 1,562 3,246
1995 2,963 2,336 2,316 3,909
PER COMMON SHARE:
Income from Continuing Operations 1994 $ 0.12 $ 0.17 $ 0.12 $ 0.21
1995 0.15 0.19 0.15 0.25
Income (loss) from Discontinued Operations 1994 0.05 0.05 (0.02) -
1995 0.05 (0.03) - -
Net Income 1994 0.17 0.22 0.10 0.21
1995 0.20 0.16 0.15 0.25
Market Price Range:
High 1994 $ 8.00 $ 7.75 $ 7.75 $ 7.25
Low 1994 6.50 6.50 6.75 6.50
High 1995 7.50 8.00 9.25 9.00
Low 1995 5.50 6.38 6.38 7.50
The Morningstar Group 1995 Annual Report 34
23
SELECTED FINANCIAL DATA 1991 THROUGH 1995
(Dollars in Thousands, Except Per Share Amounts)
Predecessor (a) Successor
--------------- -------------------------------------------------------------------------
Two Ten
Months Months
Ended Ended
February December Year Ended December 31,
28, 31, ------------------------------------------------------------
1991 1991 1992 1993 1994 1995
---------- ---------- ----------- ----------- ------------ -----------
STATEMENTS OF OPERATIONS DATA
Net Sales $ 28,037 $ 152,497 $ 230,220 $ 273,949 $ 292,314 $ 304,730
Gross Profit 6,793 42,042 56,090 62,531 70,169 71,782
Operating Income 1,542 13,753 15,493 5,335 18,407 20,428
Income (loss) from Continuing Operations (529) 783 (1,640) (257) 9,321 11,340
Income (loss) from Discontinued Operations (564) (56) (3,359) 1,241 1,326 184
Extraordinary Item, Net of Tax 58,115(b) - (5,676)(c) (164)(d) - -
Net Income (Loss) 57,022 727 (10,675) 820 10,647 11,524
Dividends on Preferred Stock - 1,875 939 - - -
Net Income (loss) to Common Stockholders $ 57,022 $ (1,148) $ (11,614) $ 820 $ 10,647 $ 11,524
========== =========== ============= ============ ============ ===========
Earnings (Loss) per Common and Common
Equivalent Share:
Continuing Operations $ (.06) $ (.14) $ (.21) $ (.02) $ .62 $ .74
Discontinued Operations (.06) (.01) (.28) .08 .09 .02
---------- ----------- ------------- ------------ ------------ -----------
Earnings (Loss) before
Extraordinary Item (.12) (.15) (.49) .06 .71 .76
Extraordinary Item 6.57 - (.47) (.01) - -
---------- ----------- ------------ ------------ ------------ -----------
Earnings (Loss) $ 6.45(b) $ (.15) $ (.96)(c) $ .05 (d) $ .71 $ .76
========== =========== ============= ============ ============ ===========
Weighted Average Common and
Common Equivalent
Shares Outstanding 8,843,301 7,825,473 12,128,343 15,011,607 15,050,538 15,245,562
DIVIDENDS DECLARED PER COMMON SHARE $ - $ - $ .075 $ .15 $ - $ -
========== =========== ============ ============ ============ ===========
BALANCE SHEET DATA
Working Capital $ (1,916) $ 7,210 $ 14,996 $ 15,635 $ 11,615 $ 13,142
Total Assets 213,999 204,249 180,786 212,134 165,265 162,709
Current Maturities of Long-term Debt - 7,000 10,167 14,750 6,000 8,000
Long-term Debt 167,294 132,794 86,329 105,425 53,892 36,000
Preferred Stock 17,307 16,875 - - - -
Common Stockholders' Equity (12,619) 17,088 55,779 54,533 66,802 77,323
(a) The Company was formed in 1988 to acquire several regional dairies
novelty/ice cream operations and specialty food operations. On March
1, 1991, the financial restructuring transaction resulted in a change
in control of the Company. The statements of operations data, other
data and balance sheet data of the predecessors and successor are not
comparable due to the application of purchase accounting in
connection with the 1988 acquisition and 1991 financial restructuring
transaction. See Note 1 to the Notes to Consolidated Financial
Statements.
(b) The Company reported a net gain of $58.1 million on the purchase of
approximately $110.2 million in subordinated debt at a discount.
(c) The Company reported a net loss of $5.7 million on the purchase of
approximately $34 million in subordinated debt at a premium. See Note
1 to the Notes to Consolidated Financial Statements.
(d) Loss on purchase of senior subordinated debentures, net of applicable
tax benefit of $71 thousand.
The Morningstar Group 1995 Annual Report 35