1
EXHIBIT 13(a)
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 for purposes of the management's discussion and
analysis: (i) Branded products, which include historical sales of the Company's
seven nationally branded products -- International Delight(R), Mocha Mix(R),
Second Nature(R), Naturally Yours(TM), Jon Donaire(R), Lactaid(R) and Wacky
Willie(R); and (ii) 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.
PRESTO FOOD PRODUCTS, INC. ACQUISITION
On December 3, 1996, the Company acquired all of the issued and
outstanding shares of capital stock of Presto Food Products, Inc. ("Presto"), a
California corporation, from the shareholders of Presto pursuant to a stock
purchase agreement dated as of October 20, 1996, by and among the Company,
Presto and the Presto shareholders. Presto's sales for the year ended December
31, 1995, were approximately $139.5 million. Presto is a national manufacturer,
marketer and distributor of non-dairy and dairy products, such as Mocha Mix
non-dairy coffee creamers, Jon Donaire desserts and ice cream cakes, aerosols,
bakery toppings and icings, frozen pre-whipped toppings and creamers, serving
customers throughout the United States since 1937. The Company paid
approximately $123.5 million in cash for the stock acquired and assumed
approximately $37.4 million in related liabilities. In conjunction with the
consummation of the Presto acquisition, the Company renegotiated its credit
agreement. Funds provided by the renegotiated Senior Credit Agreement ("Senior
Credit Agreement") were utilized to pay off existing senior debt of
approximately $44.8 million, to acquire the capital stock of Presto for $123.5
million and to pay approximately $2.1 million in fees and expenses associated
with the Presto acquisition. The Company accounted for the acquisition as a
purchase and accordingly, Presto's results are included in the 1996
Consolidated Statement of Operations for the period December 3, 1996, through
December 31, 1996.
WACKY WILLIE ACQUISITION
On October 1, 1996, the Company completed the acquisition of the rights to
the Wacky Willie and Killer Shake trademarks for $300,000 in cash from Killer
Productions Company. There were no liabilities associated with the acquisition,
nor were there any other assets included in the transaction. The Company may at
its sole option, before August 1999, pay an additional $700,000 to Killer
Productions representing the final portion of the purchase price. In addition,
in the event net sales reach $5.0 million in any consecutive twelve-month
period ending on or before August 1999, the Company will be required to pay the
additional $700,000 representing the final portion of the purchase price. The
funding for this purchase was provided by the Company's operations. Sales of
Killer Shake are included in the 1996 Consolidated Statement of Operations for
the period January 1, 1996, through December 31, 1996. The Company manufactured
and sold this product under a license arrangement for the period January 1,
1996, through September 30, 1996.
CREAM PRODUCTS ACQUISITION
On August 1, 1996, the Company completed the purchase of substantially all
of the assets of Cream Products Company ("Cream Products"), located in Chicago,
Illinois. Cream Products' sales for the year ended December 31, 1995, were
approximately $24.6 million. Cream Products is a manufacturer and distributor
of dairy and non-dairy products primarily supplying food makers and food
service customers throughout the United States since 1938. The Company paid
approximately $5.9 million in cash for the assets acquired, and assumed
approximately $2.3 million in related liabilities. Funds for this acquisition
were provided by the Company's operations in conjunction with its revolving
credit facility. The Company accounted for the acquisition as a purchase and
accordingly, Cream Products' results are included in the 1996 Consolidated
Statement of Operations for the period August 1, 1996, through December 31,
1996.
30
2
LA CORONA ACQUISITION
On May 28, 1996, the Company completed the purchase of substantially all
of the assets of La Corona Foods, Inc. ("La Corona"), located in Glendale,
Arizona. La Corona's sales for the fiscal year ended September 30, 1995, were
approximately $6.9 million. The Company paid approximately $3.4 million in cash
for the assets purchased, and assumed approximately $2.5 million in related
liabilities. The funding for this acquisition was provided by the Company's
operations. The Company accounted for the acquisition as a purchase and
accordingly, La Corona's results are included in the 1996 Consolidated
Statement of Operations for the period May 29, 1996, through December 31, 1996.
MERKTS CHEESE ACQUISITION
On March 19, 1996, the Company completed the acquisition of substantially
all of the assets of Merkts Cheese Company ("Merkts"), located in Bristol,
Wisconsin. Merkts recorded approximately $10.3 million in sales for the fiscal
year ending June 30, 1995. The Company paid approximately $3.6 million in cash
for the assets purchased, and assumed approximately $0.4 million in
liabilities. The source of funding for this acquisition was provided by the
Company's operations. The Company accounted for the acquisition as a purchase
and accordingly, Merkts' results are included in the 1996 Consolidated
Statement of Operations for the period March 20, 1996, through December 31,
1996.
DISCONTINUED 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 $51.0 million, consisting
of $48.0 million in cash after working capital adjustments and $3.0 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.
1996 COMPARED TO 1995
Net sales from Continuing Operations for the year ended December 31, 1996,
totaled $394.3 million, an increase of $89.6 million or 29.4% from net sales
from Continuing Operations during 1995. The following table reflects net sales
from Continuing Operations by product category for each year:
PRODUCT CATEGORIES YEAR ENDED Year Ended
(Dollars in thousands) DECEMBER 31, 1996 December 31, 1995
----------------- -----------------
Branded products $ 151,513 $ 117,016
Specialty products 242,793 187,714
------------ ------------
Net Sales $ 394,306 $ 304,730
============ ============
Net sales of Branded products increased 29.5% to $151.5 million in 1996
from $117.0 million in 1995 primarily as a result of volume increases in the
International Delight, Naturally Yours and Lactaid product lines. The volume
for the Second Nature product line declined slightly from 1995 to 1996. Net
sales of Specialty products increased 29.3% from 1995 to 1996. This increase
was due to volume increases in the Company's cultured products, such as yogurt,
cottage cheese and sour cream, as well as its UHT products such as aerosol,
whipping cream, non-dairy, half and half, and bakery toppings and icings. The
Company's 1996 Branded and Specialty sales increased $4.2 million and $29.3
million, respectively, versus 1995, as a result of the acquisitions completed
during 1996.
Gross profit totaled $91.5 million or 23.2% of net sales during 1996
compared to $71.8 million or 23.6% of net sales in 1995. The increase in gross
profit is primarily attributable to the increase in Branded and Specialty sales
in 1996. The slight decline in the gross margin percentage in 1996 resulted
from increased prices for several of the Company's raw ingredients.
Operating expenses were $65.3 million or 16.6% of net sales in 1996 versus
$51.4 million or 16.9% of net sales in 1995. Distribution expenses as a percent
of net sales declined to 4.3% in 1996 from 5.3% in 1995, despite the
31
3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION
increase in Branded sales. This reduction reflects the Company's continuing
efforts to optimize the efficiencies of its national distribution programs.
Selling and marketing expenses as a percent of net sales increased from 7.3% in
1995 to 8.3% in 1996. This increase resulted from increased marketing
expenditures for advertising and promotions as well as additional expenditures
for broker commissions due to increased sales. General and administrative
expenses, as a percent of net sales, decreased slightly from 4.3% in 1995 to
3.9% in 1996, due mainly to the fixed nature of some of these costs as well as
synergies realized from the consolidation of the Company's finance and
administration departments to the Company's corporate office.
The Company's income tax provision increased $1.7 million from $6.1
million in 1995 to $7.8 million in 1996. The effective income tax rate for the
year ended December 31, 1996, was 35.0% compared to an effective tax rate of
34.8% in 1995. As of December 31, 1996, the Company's net deferred tax assets
totaled $1.6 million. During 1996, the Company realized the benefit of all
previous carryforwards and tax credits. Without the benefit of the
carry-forwards and credits, the 1996 effective tax rate would have been
approximately 45.1%.
The Company's 1996 operating income increased $5.7 million, from $20.5
million in 1995 to $26.2 million in 1996. This increase resulted primarily from
increased Branded and Specialty sales and lower operating costs (as a percent
of net sales), offset in part by a slightly lower gross profit percentage.
The Company's net income for 1996 of $14.6 million compares to $11.5
million for 1995. The increase in 1996 resulted from the increase in Branded
and Specialty sales and gross margin dollars, reduced operating expenses (as a
percent of net sales), and reduced interest expense, offset in part by higher
income taxes and a reduction in other income.
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
from Continuing Operations during 1994. The following table reflects net sales
from Continuing Operations by product category for each year:
PRODUCT CATEGORIES YEAR ENDED Year Ended
(Dollars in thousands) DECEMBER 31, 1995 December 31, 1994
----------------- -----------------
Branded products $ 117,016 $ 102,159
Specialty products 187,714 190,155
------------ ------------
Net Sales $ 304,730 $ 292,314
============ ============
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.
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 and marketing
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 income tax provision increased $0.6 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.
32
4
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 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.
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 increase in Branded
sales and gross margin dollars, reduced operating expenses, and reduced
interest expense, offset in part by higher income taxes.
EARNINGS PER SHARE
The fully diluted, weighted average number of shares of common stock and
common stock equivalents outstanding decreased from 15,245,562 in 1995 to
15,133,887 in 1996. The decrease in 1996 resulted from the purchase of treasury
stock offset in part by the issuance and exercise of stock options.
LIQUIDITY AND CAPITAL RESOURCES
In 1996, the Company generated cash of $28.2 million from its operating
activities from Continuing Operations, which, coupled with $0.4 million
received from the exercise of stock options, $1.0 million from decreased cash
balances and $182.3 million received from borrowings under the renegotiated
Senior Credit Agreement, was used to repay debt of $50.8 million, fund capital
and other expenditures of $11.5 million, to acquire subsidiaries for $145.3
million, and provide $4.3 million for the purchase of treasury stock.
The Company believes that cash generated from its operations, together
with borrowings under the Senior Credit Agreement, will provide the cash
necessary to fund the Company's operations, debt service, and capital
expenditures for the foreseeable future. The Company estimates that it will
require cash of $28.0 million during 1997 to fund approximately $20.0 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, 1996, the Company had approximately $28.8 million
of unused borrowing capacity under the Revolver.
The Company has suspended the payment of its common stock dividends since
the first quarter of 1994.
The Company was in compliance with all financial covenants as of December
31, 1996.
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, the subsequent acquisition of Favorite Foods, Inc.
("Favorite") and the acquisitions completed in 1996. 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 its
estimate of undiscounted future cash flows (without interest charges) over the
remaining life of the asset.
FORWARD-LOOKING INFORMATION
In accordance with the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995, the Company notes that the statements in this
Annual Report and elsewhere, which are forward-looking and which provide other
than historical information, involve risks and uncertainties that may impact
the Company's actual results of operations. The Company continues to face risks
and uncertainties including without limitation: continuing its acquisition
program, the ability of the Company to realize benefits from continuing to
consolidate certain general and administrative functions, to retain management,
to execute its focused business strategies, and to continue product
enhancements and new product ideas. Although the Company believes that the
assumptions underlying the forward-looking statements contained herein are
reasonable, any of the assumptions could be inaccurate, and, therefore, there
can be no assurance that the forward-looking statements included in this Annual
Report will prove to be accurate. In light of the significant uncertainties
inherent in the forward-looking statements included herein, the inclusion of
such information should not be regarded as a representation by the Company or
any other person that the objectives and plans of the Company will be achieved.
33
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, 1996 and 1995, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1996. 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, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.
/s/ ARTHUR ANDERSON LLP
Dallas, Texas,
February 10, 1997
34
6
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 10, 1997
35
7
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, DECEMBER 31,
ASSETS 1996 1995
------------ ------------
(Dollars in thousands)
CURRENT ASSETS:
Cash $ 4,786 $ 5,811
Receivables, net of allowance for doubtful
accounts of $6,676 and $1,595, respectively 57,802 28,043
Inventories 25,400 11,123
Prepaids and other 3,015 1,597
Deferred tax assets 7,339 3,089
Net assets held for sale 676 836
------------ ------------
Total current assets 99,018 50,499
PROPERTY, PLANT AND EQUIPMENT:
Land 7,843 5,713
Buildings and improvements 29,507 18,804
Machinery and equipment 70,239 43,552
------------ ------------
Gross property, plant and equipment 107,589 68,069
Less: Accumulated depreciation (22,807) (17,748)
------------ ------------
Net property, plant and equipment 84,782 50,321
INTANGIBLE AND OTHER ASSETS:
Identifiable intangible assets 73,146 1,847
Goodwill 96,175 58,671
Deferred financing costs 2,731 1,259
Other assets 139 112
------------ ------------
Total intangible and other assets 172,191 61,889
------------ ------------
Total assets $ 355,991 $ 162,709
============ ============
The accompanying notes are an integral part of these consolidated statements.
36
8
DECEMBER 31, DECEMBER 31,
LIABILITIES AND STOCKHOLDERS' EQUITY 1996 1995
------------ ------------
(Dollars in thousands)
CURRENT LIABILITIES:
Accounts payable $ 32,968 $ 21,488
Accrued liabilities 39,923 15,869
Current maturities of long-term debt 8,000 8,000
------------ ------------
Total current liabilities 80,891 45,357
LONG-TERM DEBT (net of current maturities) 177,349 36,000
OTHER LONG-TERM LIABILITIES 3,269 1,959
DEFERRED TAX LIABILITIES 5,694 2,070
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value, 50,000,000 shares
authorized; 15,298,111 shares in 1996 and
15,244,261 shares in 1995 issued 153 152
Additional paid-in capital 73,179 71,991
Treasury stock, at cost (767,000 shares in 1996 and
230,000 shares in 1995) (6,140) (1,840)
Retained earnings 21,596 7,020
------------ ------------
Total stockholders' equity 88,788 77,323
------------ ------------
Total liabilities and stockholders' equity $ 355,991 $ 162,709
============ ============
The accompanying notes are an integral part of these consolidated statements.
37
9
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1996 1995 1994
------------ ------------ ------------
(Dollars in thousands, except per share and share amounts)
NET SALES $ 394,306 $ 304,730 $ 292,314
COST OF GOODS SOLD 302,801 232,948 222,145
------------ ------------ ------------
GROSS PROFIT 91,505 71,782 70,169
OPERATING COSTS AND EXPENSES:
Distribution 17,056 16,120 18,689
Selling and marketing 32,839 22,233 21,295
General and administrative 15,450 13,001 11,778
------------ ------------ ------------
Total operating costs and expenses 65,345 51,354 51,762
------------ ------------ ------------
OPERATING INCOME 26,160 20,428 18,407
INTEREST EXPENSE 3,647 3,921 4,446
AMORTIZATION OF DEFERRED FINANCING COSTS 379 381 351
DIVIDEND INCOME -- (268) --
OTHER INCOME, NET (286) (1,008) (1,244)
------------ ------------ ------------
INCOME BEFORE INCOME TAXES 22,420 17,402 14,854
PROVISION FOR INCOME TAXES 7,844 6,062 5,533
------------ ------------ ------------
INCOME FROM CONTINUING OPERATIONS 14,576 11,340 9,321
DISCONTINUED OPERATIONS:
Income from discontinued operations -- -- 903(a)
Gain on disposal -- 184(b) 423(b)
------------ ------------ ------------
INCOME FROM DISCONTINUED OPERATIONS -- 184 1,326
NET INCOME $ 14,576 $ 11,524 $ 10,647
============ ============ ============
EARNINGS PER COMMON SHARE:
Continuing operations $ .96 $ .74 $ .62
Discontinued operations -- .02 .09
------------ ------------ ------------
Earnings per common share $ .96 $ .76 $ .71
============ ============ ============
WEIGHTED AVERAGE COMMON AND COMMON
EQUIVALENT SHARES OUTSTANDING 15,133,887 15,245,562 15,050,538
- --------------
(a)Net of applicable tax provision of $507.
(b)Net of applicable tax provision of $216 and $2,865.
The accompanying notes are an integral part of these consolidated statements.
38
10
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON COMMON STOCK TREASURY RETAINED
SHARES AND ADDITIONAL STOCK, EARNINGS
ISSUED PAID-IN CAPITAL AT COST (DEFICIT) TOTAL
---------- --------------- ---------- ---------- --------
(Dollars in thousands)
Balance, December 31, 1993 14,287,212 $ 69,684 $ -- $ (15,151) $ 54,533
Exercise of stock options 633,585 1,622 -- -- 1,622
Net income -- -- -- 10,647 10,647
---------- --------------- ---------- ---------- --------
Balance, December 31, 1994 14,920,797 71,306 -- (4,504) 66,802
Exercise of stock options 323,464 837 -- -- 837
Purchase of treasury stock -- -- (1,840) -- (1,840)
Net income -- -- -- 11,524 11,524
---------- --------------- ---------- ---------- --------
Balance, December 31, 1995 15,244,261 72,143 (1,840) 7,020 77,323
Exercise of stock options 53,850 381 -- -- 381
Income tax benefits of stock options -- 808 -- -- 808
Purchase of treasury stock -- -- (4,300) -- (4,300)
Net income -- -- -- 14,576 14,576
---------- --------------- ---------- ---------- --------
Balance, December 31, 1996 15,298,111 $ 73,332 $ (6,140) $ 21,596 $ 88,788
========== =============== ========== ========== ========
The accompanying notes are an integral part of these consolidated statements.
39
11
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, 1996 1995 1994
---------- ---------- ----------
(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Cash received from customers $ 389,101 $ 306,918 $ 284,605
Interest received 129 224 134
Income tax refund 156 -- --
Cash paid to suppliers and employees (354,037) (272,992) (259,147)
Interest paid (2,971) (4,220) (4,395)
Income taxes paid (4,171) (3,199) (2,663)
---------- ---------- ----------
Net cash provided by Continuing Operations 28,207 26,731 18,534
Net cash used by Discontinued Operations -- -- (3,403)
---------- ---------- ----------
Net cash provided by operating activities 28,207 26,731 15,131
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of subsidiaries:
Working capital (3,268) -- --
Property, plant and equipment (29,926) -- --
Other assets (111,809) -- --
Other long-term (assets) liabilities (311) -- --
---------- ---------- ----------
(145,314) -- --
---------- ---------- ----------
Capital expenditures (11,462) (10,705) (7,622)
Proceeds from sale of assets -- 2 32
Dividends received from Preferred Stock -- 268 --
Other (52) 1,258 682
---------- ---------- ----------
Net cash used by Continuing Operations (156,828) (9,177) (6,908)
Discontinued Operations:
Sale of Discontinued Operations -- -- 50,237
Sale of Preferred Stock -- 3,000 --
Capital and other expenditures -- -- (482)
---------- ---------- ----------
Net cash provided by Discontinued Operations -- 3,000 49,755
---------- ---------- ----------
Net cash provided (used) by investing activities (156,828) (6,177) 42,847
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 381 837 1,622
Purchase of treasury stock (4,300) (1,840) --
Proceeds from issuance of long-term debt 160,000 -- --
Net borrowings (repayments) under
revolving credit facility 22,349 (1,892) (14,783)
Principal payments on long-term debt (50,834) (14,000) (45,470)
Dividends paid -- -- (535)
---------- ---------- ----------
Net cash provided (used) by financing activities 127,596 (16,895) (59,166)
NET INCREASE (DECREASE) IN CASH (1,025) 3,659 (1,188)
CASH, BEGINNING OF PERIOD 5,811 2,152 3,340
---------- ---------- ----------
CASH, END OF PERIOD $ 4,786 $ 5,811 $ 2,152
========== ========== ==========
The accompanying notes are an integral part of these consolidated statements.
40
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CONSOLIDATED STATEMENTS OF CASH FLOWS
RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES
YEAR ENDED DECEMBER 31, 1996 1995 1994
-------- -------- --------
(Dollars in thousands)
NET INCOME $ 14,576 $ 11,524 $ 10,647
ADJUSTMENTS TO RECONCILE NET INCOME
TO NET CASH PROVIDED BY OPERATIONS:
Discontinued Operations net income -- (184) (1,326)
Depreciation 6,378 5,122 4,344
Amortization of intangibles 3,291 2,700 2,632
(Gain) loss on fixed asset retirements -- -- (243)
Increase in deferred tax assets (4,250) 3,635 4,222
Change in assets and liabilities net of
effects from acquisitions and
divestitures of subsidiaries:
Accounts receivable (5,205) 2,426 (3,707)
Inventories (1,243) (583) 987
Prepaids and other 1,493 151 3,569
Accounts payable 1,747 4,225 (655)
Accrued liabilities 8,011 (4,076) (1,986)
Other long-term liabilities 3,409 1,791 50
-------- -------- --------
Total adjustments 13,631 15,207 7,887
-------- -------- --------
Net cash provided by Continuing Operations 28,207 26,731 18,534
Discontinued Operations:
Discontinued Operations net income -- 184 1,326
Gain on disposal -- (184) (423)
Change in working capital -- -- (4,914)
Depreciation and amortization -- -- 608
-------- -------- --------
Net cash used by Discontinued Operations -- -- (3,403)
-------- -------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 28,207 $ 26,731 $ 15,131
======== ======== ========
The accompanying notes are an integral part of these consolidated statements.
41
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THE MORNINGSTAR GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) ORGANIZATION AND BUSINESS
BACKGROUND
The Morningstar Group Inc., a Delaware corporation (together with its
subsidiaries, the "Company" or "Morningstar") 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.
BUSINESS
The Company's Continuing Operations include its specialty operations which
manufacture and market shelf stable, refrigerated and frozen food products
including nationally branded products, other specialty, dairy-based cultured
and ultra-pasteurized products and non-dairy based food products. Discontinued
Operations include all previously divested regional dairy operations and other
divested operations.
(2) PRESTO FOOD PRODUCTS, INC. ACQUISITION
On December 3, 1996, the Company acquired all of the issued and
outstanding shares of capital stock of Presto Food Products, Inc. ("Presto"), a
California corporation, from the shareholders of Presto pursuant to a stock
purchase agreement dated as of October 20, 1996, by and among the Company,
Presto and the Presto shareholders. Presto's sales for the year ended December
31, 1995, were approximately $139.5 million. Presto is a national manufacturer,
marketer and distributor of non-dairy and dairy products, such as Mocha Mix
non-dairy coffee creamers, Jon Donaire desserts and ice cream cakes, aerosols,
bakery toppings and icings, frozen pre-whipped toppings and creamers, serving
customers throughout the United States since 1937. The Company paid
approximately $123.5 million in cash for the stock acquired and assumed
approximately $37.4 million in related liabilities. The allocation of the
purchase price was based on preliminary estimates of fair value. The final
allocation may be revised if the appraised values are significantly different
from the preliminary estimates. Included in the assumed liabilities is
approximately $3.2 million related to costs associated with the involuntary
termination and/or relocation of certain employees of the acquired company. The
terminated employees represent redundant and excess personnel in the
operations, marketing, selling, and general and administrative areas. This
termination plan will likely be completed by the second quarter of 1997. In
conjunction with the consummation of the Presto acquisition, the Company
renegotiated its credit agreement. Funds provided by the renegotiated Senior
Credit Agreement ("Senior Credit Agreement") were utilized to pay off existing
senior debt of approximately $44.8 million, to acquire the capital stock of
Presto for $123.5 million and to pay approximately $2.1 million in fees and
expenses associated with the Presto acquisition. The Company accounted for the
acquisition as a purchase and accordingly, Presto's results are included in the
1996 Consolidated Statement of Operations for the period December 3, 1996,
through December 31, 1996.
Unaudited pro forma operating results of the Company, assuming the
acquisition had been made as of January 1, 1995, follow. Such information
includes adjustments to reflect additional goodwill and intangible
amortization, a reduction in redundant and excess personnel related costs,
additional interest expense, additional amortization of deferred financing
costs and additional income tax expense.
YEAR ENDED DECEMBER 31, 1996 1995
-------- --------
(Dollars in thousands, except per share amounts) (Unaudited)
Pro forma net sales $528,056 $444,202
======== ========
Pro forma net income from Continuing Operations $ 18,325 $ 13,799
======== ========
Pro forma net income $ 18,325 $ 13,983
======== ========
Pro forma earnings per share from Continuing Operations $ 1.21 $ 0.91
======== ========
Pro forma earnings per share $ 1.21 $ 0.92
======== ========
42
14
(3) OTHER ACQUISITIONS
WACKY WILLIE ACQUISITION
On October 1, 1996, the Company completed the acquisition of the rights to
the Wacky Willie and Killer Shake trademarks for $300,000 in cash from Killer
Productions Company. There were no liabilities associated with the acquisition,
nor were there any other assets included in the transaction. The Company may at
its sole option, before August 1999, pay an additional $700,000 to Killer
Productions representing the final portion of the purchase price. In addition,
in the event net sales reach $5.0 million in any consecutive twelve-month
period ending on or before August 1999, the Company will be required to pay the
additional $700,000 representing the final portion of the purchase price. The
funding for this purchase was provided by the Company's operations. Sales of
Killer Shake are included in the 1996 Consolidated Statement of Operations for
the period January 1, 1996, through December 31, 1996. The Company manufactured
and sold this product under a license arrangement for the period January 1,
1996, through September 30, 1996.
CREAM PRODUCTS ACQUISITION
On August 1, 1996, the Company completed the purchase of substantially all
of the assets of Cream Products Company ("Cream Products"), located in Chicago,
Illinois. Cream Products' sales for the year ended December 31, 1995, were
approximately $24.6 million. Cream Products is a manufacturer and distributor
of dairy and non-dairy products primarily supplying food makers and food
service customers throughout the United States since 1938. The Company paid
approximately $5.9 million in cash for the assets acquired, and assumed
approximately $2.3 million in related liabilities. Funds for this acquisition
were provided by the Company's operations in conjunction with its revolving
credit facility. The Company accounted for the acquisition as a purchase and
accordingly, Cream Products' results are included in the 1996 Consolidated
Statement of Operations for the period August 1, 1996, through December 31,
1996.
LA CORONA ACQUISITION
On May 28, 1996, the Company completed the purchase of substantially all
of the assets of La Corona Foods, Inc. ("La Corona"), located in Glendale,
Arizona. La Corona's sales for the fiscal year ended September 30, 1995, were
approximately $6.9 million. The Company paid approximately $3.4 million in cash
for the assets purchased, and assumed approximately $2.5 million in related
liabilities. The funding for this acquisition was provided by the Company's
operations. The Company accounted for the acquisition as a purchase and
accordingly, La Corona's results are included in the 1996 Consolidated
Statement of Operations for the period May 29, 1996, through December 31, 1996.
MERKTS CHEESE ACQUISITION
On March 19, 1996, the Company completed the acquisition of substantially
all of the assets of Merkts Cheese Company ("Merkts"), located in Bristol,
Wisconsin. Merkts recorded approximately $10.3 million in sales for the fiscal
year ending June 30, 1995. The Company paid approximately $3.6 million in cash
for the assets purchased, and assumed approximately $0.4 million in
liabilities. The funding for this acquisition was provided by the Company's
operations. The Company accounted for the acquisition as a purchase and
accordingly, Merkts' results are included in the 1996 Consolidated Statement of
Operations for the period March 20, 1996, through December 31, 1996.
(4) 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") for $51.0 million, consisting of $48.0 million in cash after working
capital adjustments and $3.0 million of 9% Series A Preferred Stock (the
"Preferred Stock"). The Company deferred the gain on the 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
43
15
THE MORNINGSTAR GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
the sale. 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 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 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 $0.5 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 $38.6 million in 1994.
Interest expense of $0.4 million was allocated to Discontinued Operations
during 1994. 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.
(5) 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, 1996 1995
-------- --------
Raw materials and supplies $ 11,767 $ 5,975
Finished goods 13,633 5,148
-------- --------
Total $ 25,400 $ 11,123
======== ========
Finished goods inventories include the costs of materials, labor and plant
overhead.
44
16
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:
Asset Category Useful 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. Identifiable intangible assets of approximately $72.3
million were recorded in connection with the acquisitions consummated in 1996.
These assets are being amortized on a straight-line basis over a range of 5-40
years. Amortization costs totaled $1.0 million in 1996, $0.7 million in 1995,
and $0.7 million in 1994. Accumulated amortization was $2.8 million and $1.8
million at December 31, 1996 and 1995, respectively.
GOODWILL
Goodwill is amortized on a straight-line basis over a range of 25-40 years
and is recorded at cost less accumulated amortization. Goodwill of
approximately $39.4 million was recorded in connection with the acquisitions
consummated in 1996. Amortization costs totaled $1.9 million in 1996, $1.7
million in 1995, and $1.7 million in 1994. Accumulated amortization was $10.4
million and $8.5 million at December 31, 1996 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. In
conjunction with renegotiating its Senior Credit Agreement in December 1996,
the Company incurred deferred financing costs of approximately $2.7 million.
Accumulated amortization was $87,000 and $1.5 million at December 31, 1996 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 to Be Disposed Of."
This statement is effective for financial statements beginning after December
15, 1995. The Company 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 its estimate of undiscounted future cash flows (without interest
charges) over the remaining life of the asset.
45
17
THE MORNINGSTAR GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ACCRUED LIABILITIES
Accrued liabilities consisted of the following (in thousands):
AT DECEMBER 31, 1996 1995
-------- --------
Accrued interest $ 1,140 $ 407
Payroll and benefits (accrued wages,
vacation and profit sharing) 8,315 4,080
Restructuring accruals 60 230
Insurance accruals 5,527 5,195
Income and property taxes 5,791 1,491
Marketing and advertising 6,863 2,017
Acquisition related accruals 6,290 --
Other accrued liabilities 5,937 2,449
-------- --------
Total $ 39,923 $ 15,869
======== ========
FAIR VALUE OF FINANCIAL INSTRUMENTS
The financial position of the Company at December 31, 1996 and 1995,
includes certain financial instruments which may have a fair value that is
different from 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, 1996.
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 PER COMMON SHARE
The earnings 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.
46
18
(6) INCOME TAXES
The components of the provision for income taxes from Continuing
Operations are as follows (in thousands):
YEAR ENDED DECEMBER 31, 1996 1995 1994
-------- -------- --------
Current $ 6,271 $ 1,879 $ 272
Deferred (340) 3,448 4,163
State 1,913 735 1,098
-------- -------- --------
Provision for income taxes $ 7,844 $ 6,062 $ 5,533
======== ======== ========
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, 1996 1995
-------- --------
Deferred tax assets:
Net operating loss carryforward $ -- $ 385
Accrued vacation 588 504
Accrued workers' compensation 1,671 1,397
Acquisition reserves 2,394 --
Other insurance reserves 666 657
Restructuring reserves 350 396
Other accrued expenses and reserves 2,182 1,454
Other deferred tax assets 600 2,340
-------- --------
Total deferred tax assets 8,451 7,133
Deferred tax liabilities:
Accelerated depreciation and amortization 6,759 2,901
Other deferred tax liabilities 47 140
-------- --------
Total deferred tax liabilities 6,806 3,041
Valuation allowance -- (3,073)
-------- --------
Net deferred tax assets 1,645 1,019
Noncurrent deferred tax liabilities (5,694) (2,070)
-------- --------
Current deferred tax assets $ 7,339 $ 3,089
======== ========
The Company reduced goodwill by approximately $21,000, $5.6 million and
$4.2 million for the years ended December 31, 1996, 1995 and 1994,
respectively, representing realization of deferred tax assets created prior to
the Company's financial restructuring transaction.
47
19
THE MORNINGSTAR GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The provision for income taxes was different from the amount computed
using the statutory income tax rate for the reasons set forth in the following
table (in thousands):
YEAR ENDED DECEMBER 31,
--------------------------------
1996 1995 1994
-------- -------- --------
Provision computed at statutory rate $ 7,846 $ 5,917 $ 5,050
State income taxes 1,243 1,025 905
Tax on non-deductible goodwill amortization 486 473 516
Utilization of previously unrecognized
deferred tax assets (2,265) (1,405) (1,107)
Other 534 52 169
-------- -------- --------
Provision for income taxes $ 7,844 $ 6,062 $ 5,533
======== ======== ========
(7) LONG-TERM DEBT
The Company's long-term debt consists of the following (in thousands):
AT DECEMBER 31, 1996 1995
---------- ----------
Senior term loan $ 160,000 $ 41,000
Revolving credit facility 22,349 --
Industrial development revenue bonds 3,000 3,000
---------- ----------
Total long-term debt 185,349 44,000
Less: Current maturities (8,000) (8,000)
---------- ----------
Long-term debt, net of current maturities $ 177,349 $ 36,000
========== ==========
Maturities of long-term debt at December 31, 1996, are as follows (in
thousands):
1997 $ 8,000
1998 15,000
1999 20,000
2000 30,000
2001 35,000
Thereafter 77,349
--------
Total maturities $185,349
========
SENIOR TERM LOAN AND REVOLVING CREDIT FACILITY
On December 2, 1996, in conjunction with the Presto acquisition, the
Company renegotiated a $220.0 million credit agreement ("Senior Credit
Agreement"). Funding provided by the Senior Credit Agreement was utilized to
acquire the capital stock of Presto for approximately $123.5 million, to pay
off the existing senior debt of approximately $44.8 million and to pay $2.1
million in fees and expenses associated with the Presto acquisition.
The base interest rate on the Term Loan and the Revolver is the prime rate
plus an applicable margin spread. Both facilities have alternative rate options
based upon applicable margin spreads above the London Interbank Offered Rate
("LIBOR"). At December 31, 1996, $160.0 million in borrowings under the Term
Loan were outstanding at an interest rate of 6.95% and $22.4 million in
borrowings were outstanding under the Revolver at an interest rate of
48
20
6.99%. Borrowings under these lending facilities are secured by virtually all
of the assets of the Company. Up to $15.0 million in letters of credit may be
issued under the Revolver, of which $8.8 million was issued and outstanding at
December 31, 1996. As of December 31, 1996, approximately $28.8 million was
additionally available to the Company under the $60.0 million Revolver. A fee
of 1.5% per year is charged on outstanding letters of credit. A 0.42% per year
commitment fee on uncommitted funds is payable quarterly. The Revolver matures
on December 1, 2002, coincident with the scheduled maturity of the Term Loan.
The Senior Credit Agreement contains numerous covenants pertaining to
management and operations of the Company including, among other restrictions,
limitations on the amount of annual capital expenditures as well as
specification of certain maximum leverage ratios, minimum fixed charge coverage
ratios and minimum net worth. The Senior Credit Agreement also requires
mandatory prepayment 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.
During April 1994, the Company completed the sale of Velda for
approximately $51.0 million, consisting of $48.0 million in cash after working
capital adjustments 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 then existing senior term loan and $11.8 million of its then existing
revolver.
The Company was in compliance with all financial covenants as of December
31, 1996.
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, 1996, was 4.30%.
(8) 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, 1996, eligible employees totaled 363, of which 214 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 1996 the Company also
contributed to two single-employer and five multi-employer pension/retirement
plans under the terms of various union contracts, which covered 778 of its
1,403 employees at December 31, 1996. 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, 1996 1995 1994
------ ------ ------
Defined contribution profit sharing plan $ 416 $ 250 $ 230
Union pension plans 1,445 1,182 1,122
POST-RETIREMENT BENEFIT PLANS
In December 1990, the Financial Accounting Standards Board issued its
standard on accounting for post retirement benefits other than pensions. This
standard requires that the expected cost of these benefits must be charged to
expense during the years that the employees render service. The cost of
providing these benefits has been primarily paid by non-union retirees and the
Company's calculation of its obligation is not material as of December 31,
1996.
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 $2.0 million in 1996,
$2.0 million in 1995, and $2.6 million in 1994. Having made these payments, no
remaining obligations exist for these years under the union plans.
49
21
THE MORNINGSTAR GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(9) 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 $4.3 million in 1996, $3.2 million in 1995, and
$3.0 million in 1994.
The following is a summary of future minimum annual lease payments under
noncancelable operating lease obligations as of December 31, 1996 (in
thousands):
YEAR ENDING DECEMBER 31,
- ------------------------
1997 $ 3,893
1998 3,469
1999 2,557
2000 1,965
2001 693
Thereafter 1,383
-------
Total $13,960
=======
EMPLOYMENT AGREEMENTS
As of December 31, 1996, the Company had 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). As of December 31, 1996, the maximum amount
payable under these employment agreements was approximately $4.6 million in the
aggregate.
LITIGATION
From time to time the Company is subject to 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.
(10) RELATED PARTY TRANSACTIONS
HICKS MUSE
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 $150,000 and $114,000
in 1995 and 1994, respectively, and reimbursed Hicks Muse approximately $28,000
and $37,000 for expenses for each year, respectively. Hicks Muse was also paid
a fee of $300,000 relating to the sale of Velda.
50
22
(11) EQUITY
EMPLOYEE AND DIRECTOR STOCK OPTIONS
The Company has several stock-based compensation plans, which are
described below. The Company applies Accounting Principles Board ("APB")
Opinion 25 and related Interpretations in accounting for its stock-based
compensation plans. In 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"), which, if fully adopted by the Company,
would change the methods the Company applies in recognizing the cost of its
stock-based compensation plans. Adoption of the cost recognition provisions of
SFAS 123 is optional and the Company has decided not to elect these provisions.
However, pro forma disclosures as if the Company had adopted these cost
recognition provisions in 1995 are required for fiscal years beginning after
December 15, 1995. The Company has elected to provide these disclosures for its
fiscal year which began on January 1, 1996.
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,
1996, 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 $1.1 million. 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
Stock 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,
1996, 175,000 options had been granted to employees. The exercise price for
25,000 of the options granted in 1992 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 of the 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. Under this plan, 14,000 options had been exercised
as of December 31, 1996.
1992 DIRECTOR STOCK OPTION PLAN
In April 1992, the Company established the 1992 Director Stock Option Plan
which provides for the issuance of options to purchase 39,062 shares of common
stock to non-employee directors of the Company. At December 31, 1996, 39,062
options had been granted to non-employee directors. The exercise price for
these options is $2.56 per share, which was the fair market value of the
options at the date of issuance. The options become exercisable over a
three-year period and expire ten years after the date of their issuance. As of
December 31, 1996, no options under this plan had been exercised.
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,
1996, 231,000 options had been granted to employees. The exercise price for
195,000 of the 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
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. An additional 12,000
options were granted in 1996 under this plan at exercise prices of $9.50 (6,000
options) and $10.00 (6,000 options), which were the fair market values of the
options on each issuance date. These options become exercisable over a
three-year period and expire ten years after the date of their issuance. Under
this plan, 26,000 options had been exercised as of December 31, 1996.
51
23
THE MORNINGSTAR GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1996 STOCK OPTION PLAN
In May 1996, the Company amended the 1994 Incentive and Nonstatutory Stock
Option Plan to provide for the issuance of options to purchase up to 1,440,000
shares of common stock to key employees of the Company. At December 31, 1996,
1,212,000 options had been granted to employees. The exercise price for these
options is $10.25 per share, which was the fair market value of the options at
the date of issuance. 387,000 of the options become exercisable over a
three-year period and 825,000 of the options became exercisable on the date of
issuance. These options expire ten years after the date of their issuance. As
of December 31, 1996, no options under this plan had been exercised.
1996 DIRECTOR STOCK OPTION PLAN
In May 1996, the Company established the 1996 Director Stock Option Plan
which provides for the issuance of options to purchase 50,000 shares of common
stock to non-employee directors of the Company. At December 31, 1996, 40,000
options had been granted to non-employee directors. The exercise price for
these options is $10.25 per share, which was the fair market value of the
options at the date of issuance. The options become exercisable over a
three-year period and expire ten years after the date of their issuance. As of
December 31, 1996, no options under this plan had been exercised.
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, 1996, 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 vested
in equal amounts over two years. The options expire ten years after the date of
their issuance. As of December 31, 1996, no options under this plan had been
exercised.
SUMMARY OF OPTIONS (NUMBER OF OPTIONS)
1992 1996
DIRECTOR CHAIRMAN DIRECTOR
1991 PLAN 1992 PLAN PLAN 1994 PLAN PLAN 1996 PLAN* PLAN
--------- --------- --------- --------- --------- --------- ---------
Outstanding at December 31, 1994 335,413 176,000 39,062 210,000 600,000 -- --
Granted in 1995 -- 30,000 -- 81,000 -- -- --
Canceled in 1995 (13,049) (31,000) -- (70,000) -- -- --
Exercised in 1995 (311,464) -- -- (2,000) -- -- --
--------- --------- --------- --------- --------- --------- ---------
Outstanding at December 31, 1995 10,900 175,000 39,062 219,000 600,000 -- --
Granted in 1996 -- -- -- 12,000 -- 1,212,000 40,000
Canceled in 1996 -- -- -- -- -- -- --
Exercised in 1996 (5,850) (14,000) -- (24,000) -- -- --
--------- --------- --------- --------- --------- --------- ---------
Outstanding at December 31, 1996 5,050 161,000 39,062 207,000 600,000 1,212,000 40,000
========= ========= ========= ========= ========= ========= =========
Exercisable at December 31, 1995 10,900 105,000 39,062 52,000 600,000 -- --
========= ========= ========= ========= ========= ========= =========
Exercisable at December 31, 1996 5,050 141,000 39,062 119,000 600,000 825,000 --
========= ========= ========= ========= ========= ========= =========
* Granted under 1994 Stock Option Plan as amended.
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PRO FORMA NET INCOME AND EARNINGS PER COMMON SHARE
Had the compensation cost for the Company's stock-based compensation plans
been determined consistent with SFAS 123, the Company's net income and earnings
per common share for 1996 and 1995 would approximate the pro forma amounts
below (in thousands, except per share data):
AS REPORTED PRO FORMA AS REPORTED PRO FORMA
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1996 1996 1995 1995
------------ ------------ ------------ ------------
Net income $ 14,576 $ 10,770 $ 11,524 $ 11,460
Earnings per common share .96 .72 .76 .75
Pro forma charges to expense for options granted in 1996 and 1995 are as
follows:
1996 1995 CHARGE
ANNUAL ANNUAL ALLOCABLE TO TOTAL
CHARGE CHARGE FUTURE YEARS CHARGE
-------- -------- -------- --------
(Dollars in thousands)
1995 Stock options $ 104 $ 64 $ 144 $ 312
1996 Stock options 3,702 -- 1,573 5,275
-------- -------- -------- --------
Total $ 3,806 $ 64 $ 1,717 $ 5,587
======== ======== ======== ========
The fair value of each option grant is estimated on the date of grant
using the Modified Black-Scholes option pricing model with the following
weighted average assumptions used for grants in 1996 and 1995, respectively:
risk free interest rates of 6.47% and 6.65%; expected dividend yields of 0.00%
and 0.00%; expected lives of 4.0 years and 4.0 years; expected volatility of
40.31% and 39.86%. The weighted average fair value of options granted in 1996
and 1995 was $10.31 and $6.93, respectively. The effects of applying SFAS 123
in this pro forma disclosure are not indicative of future amounts. SFAS 123
does not apply to awards prior to 1995.
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 $20.0
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
December 31, 1996, the Company had purchased an additional 537,000 shares at a
cost of $4.3 million.
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THE MORNINGSTAR GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(12) QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Quarterly financial information for the years ended December 31, 1996 and
1995, is as follows:
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
DOLLARS IN THOUSANDS:
Net sales 1996 $81,724 $85,693 $99,869 $127,020
1995 71,893 74,882 73,167 84,788
Gross profit 1996 19,386 19,996 20,588 31,535
1995 17,269 17,718 16,295 20,500
Income from Continuing Operations 1996 2,831 3,463 3,027 5,255
1995 2,269 2,846 2,316 3,909
Income (loss) from Discontinued Operations 1996 -- -- -- --
1995 694 (510) -- --
Net income 1996 2,831 3,463 3,027 5,255
1995 2,963 2,336 2,316 3,909
PER COMMON SHARE:
Income from Continuing Operations 1996 $ 0.19 $ 0.23 $ 0.20 $ 0.34
1995 0.15 0.19 0.15 0.25
Income (loss) from Discontinued Operations 1996 -- -- -- --
1995 0.05 (0.03) -- --
Net income 1996 0.19 0.23 0.20 0.34
1995 0.20 0.16 0.15 0.25
Market price range:
High 1996 10.00 12.25 11.88 20.00
Low 1996 7.88 9.13 10.25 11.88
High 1995 7.50 8.00 9.25 9.00
Low 1995 5.50 6.38 6.38 7.50
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SELECTED FINANCIAL DATA
1992 THROUGH 1996
YEAR ENDED DECEMBER 31, 1996 1995 1994 1993 1992
------------ ------------ ------------ ------------ ------------
(Dollars in thousands, except share and per share amounts)
STATEMENTS OF OPERATIONS DATA
Net sales $ 394,306 $ 304,730 $ 292,314 $ 273,949 $ 230,220
Gross profit 91,505 71,782 70,169 62,531 56,090
Operating income 26,160 20,428 18,407 5,335 15,493
Income (loss) from Continuing Operations 14,576 11,340 9,321 (257) (1,640)
Income (loss) from Discontinued Operations -- 184 1,326 1,241 (3,359)
Extraordinary item, net of tax -- -- -- (164)(a) (5,676)(b)
Net income (loss) 14,576 11,524 10,647 820 (10,675)
Dividends on preferred stock -- -- -- -- 939
Net income (loss) to common stockholders $ 14,576 $ 11,524 $ 10,647 $ 820 $ (11,614)
============ ============ ============ ============ ============
Earnings (loss) per common and common
equivalent share:
Continuing Operations $ .96 $ .74 $ .62 $ (.02) $ (.21)
Discontinued Operations -- .02 .09 .08 (.28)
------------ ------------ ------------ ------------ ------------
Earnings (loss) before extraordinary item .96 .76 .71 .06 (.49)
Extraordinary item -- -- -- (.01) (.47)
------------ ------------ ------------ ------------ ------------
Earnings (loss) $ .96 $ .76 $ .71 $ .05(a) $ (.96)(b)
============ ============ ============ ============ ============
Weighted average common and
common equivalent shares outstanding 15,133,887 15,245,562 15,050,538 15,011,607 12,128,343
Dividends declared per common share $ -- $ -- $ -- $ .150 $ .075
============ ============ ============ ============ ============
BALANCE SHEET DATA
Working capital $ 26,127 $ 13,142 $ 11,615 $ 15,635 $ 14,996
Total assets 355,991 162,709 165,265 212,134 180,786
Current maturities of long-term debt 8,000 8,000 6,000 14,750 10,167
Long-term debt 177,349 36,000 53,892 105,425 86,329
Common stockholders' equity 88,788 77,323 66,802 54,533 55,779
- ---------------
(a) Loss on purchase of senior subordinated debentures, net of applicable tax
benefit of $71 thousand.
(b) The Company reported a net loss of $5.7 million on the purchase of
approximately $34 million in subordinated debt at a premium.
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CORPORATE INFORMATION
CORPORATE OFFICERS
C. DEAN METROPOULOS
Chief Executive Officer
L. HOLLIS JONES
President and Chief Operating Officer
DARRON K. ASH
Vice President and Chief Financial Officer
MICHAEL J. CRAMER
Vice President and Secretary
JOSEPH B. ARMES
Vice President and General Counsel
EXECUTIVE OFFICE:
5956 Sherry Lane, Suite 1500
Dallas, Texas 75225-6522
(214) 360-4700, FAX (214) 360-9100
Web Site Address:
www.morningstar-group.com
INDEPENDENT PUBLIC ACCOUNTANTS:
Arthur Andersen LLP
Dallas, Texas
LEGAL COUNSEL:
Weil, Gotshal & Manges LLP
Dallas, Texas
TRANSFER AGENT:
KeyCorp Shareholder Services, Inc.
Dallas, Texas
FORM 10-K:
A copy of the Company's annual report to the Securities and Exchange Commission
on Form 10-K may be obtained without charge by writing to the Company's office,
Attention: Joseph B. Armes.
ANNUAL MEETING:
The annual meeting of shareholders will be held at 10:00 a.m., local time,
Thursday, April 24, 1997, at the Hotel Crescent Court, 400 Crescent Court,
Dallas, Texas.
MARKET PRICE INFORMATION:
The NASDAQ trading symbol for the Company's common stock is MSTR. There were
approximately 135 holders of record of the Company's common stock at December
31, 1996.
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