1
EXHIBIT 13
15
Financial content
Consolidated statement of operations 16
Consolidated balance sheet 17
Consolidated statement of changes in stockholders' equity 18
Consolidated statement of cash flows 19
Notes to consolidated financial statements 20
Report of independent accountants 32
Five-year summary of significant financial data 33
Management's discussion and analysis 34
2
16
Consolidated statement of operations
Year Ended
----------------------------------------------
($ in thousands, except per share amounts) Dec. 26, 1998 Dec. 27, 1997 Dec. 28, 1996
----------- ----------- -----------
Revenues:
Sales $ 1,022,335 $ 970,097 $ 791,841
Other income 3,653 2,994 4,354
----------- ----------- -----------
1,025,988 973,091 796,195
----------- ----------- -----------
Costs and expenses:
Cost of goods sold 827,862 764,551 629,285
Selling, general and administrative 212,151 183,390 146,003
Impairment of long-lived assets 44,564
Restructuring charges 3,300
Interest, net of interest capitalized 13,006 10,695 9,548
----------- ----------- -----------
1,100,883 958,636 784,836
----------- ----------- -----------
(Loss) income before income taxes and cumulative effect of change
in accounting principle (74,895) 14,455 11,359
Income tax (benefit) provision (28,385) 5,681 4,362
----------- ----------- -----------
(Loss) income before cumulative effect of change in accounting principle (46,510) 8,774 6,997
Cumulative effect of change in accounting principle 746
----------- ----------- -----------
Net (loss) income (46,510) 8,028 6,997
----------- ----------- -----------
Accretion of preferred stock to redemption value 424 424 424
Preferred stock dividends 696 3,636 4,573
----------- ----------- -----------
Net (loss) income applicable to common stock $ (47,630) $ 3,968 $ 2,000
=========== =========== ===========
Net (loss) income per common share:
Basic:
(Loss) income before cumulative effect of change in accounting principle $ (1.75) $ .18 $ .08
Cumulative effect of change in accounting principle .03
----------- ----------- -----------
Net (loss) income per common share $ (1.75) $ .15 $ .08
=========== =========== ===========
Diluted:
(Loss) income before cumulative effect of change in accounting principle $ (1.75) $ .17 $ .07
Cumulative effect of change in accounting principle .03
----------- ----------- -----------
Net (loss) income per common share $ (1.75) $ .14 $ .07
=========== =========== ===========
See accompanying Notes to consolidated financial statements
3
17
Consolidated balance sheet
($ in thousands, except per share amounts) Dec. 26, 1998 Dec. 27, 1997
--------- ---------
Assets
Current Assets:
Cash and cash equivalents $ 1,171 $ 3,626
Trade accounts receivable, net of allowance for doubtful accounts
of $5,710 in 1998 and $710 in 1997 83,053 82,011
Other accounts receivable 29,165 16,527
Inventories 49,472 49,720
Prepaid expenses and other 13,271 14,416
--------- ---------
Total current assets 176,132 166,300
Property, plant and equipment, net 207,772 232,826
Goodwill and distribution rights, net 67,226 89,932
Other assets 12,050 13,740
--------- ---------
Total assets $ 463,180 $ 502,798
========= =========
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable and accrued liabilities $ 87,273 $ 57,037
Accrued payroll and employee benefits 19,545 22,323
Current portion of long-term debt 8,255 8,364
--------- ---------
Total current liabilities 115,073 87,724
Long-term debt, less current portion 169,781 165,913
Deferred income taxes 16,039 40,591
--------- ---------
Total liabilities 300,893 294,228
--------- ---------
Commitments and contingencies
Redeemable convertible preferred stock, $1 par value--1,008,000 shares authorized;
1,008,000 shares issued and outstanding in 1998 and 1997 99,654 99,230
--------- ---------
Stockholders' Equity:
Preferred stock, $1 par value--8,992,000 shares authorized;
no shares issued or outstanding in 1998 and 1997
Common stock, $1 par value--60,000,000 shares authorized; 27,312,000 shares
and 27,020,000 shares issued and outstanding in 1998 and 1997, respectively 27,312 27,020
Capital in excess of par 46,722 42,822
(Accumulated deficit) retained earnings (11,401) 39,498
--------- ---------
Total stockholders' equity 62,633 109,340
--------- ---------
Total liabilities and stockholders' equity $ 463,180 $ 502,798
========= =========
See accompanying Notes to consolidated financial statements
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18
Consolidated statement of changes in
stockholders' equity
(Accumulated
Capital Deficit)
Common Stock in Excess Retained
(In thousands) Shares Amount of Par Earnings Total
------ --------- --------- --------- ---------
Balance at December 30, 1995 12,929 $ 12,929 $ 39,370 $ 39,964 $ 92,263
Net income for 1996 6,997 6,997
Accretion of preferred stock to redemption value (424) (424)
Preferred stock dividends declared (4,573) (4,573)
Common stock dividends declared (3,202) (3,202)
Issuance of common stock under employee stock plans 105 105 2,359 2,464
Repurchases and retirements of common stock (9) (9) (253) (262)
Common stock issued in acquisition of
M-K-D Distributors, Inc. 320 320 10,480 10,800
------ --------- --------- --------- ---------
Balance at December 28, 1996 13,345 13,345 51,956 38,762 104,063
Net income for 1997 8,028 8,028
Accretion of preferred stock to redemption value (424) (424)
Preferred stock dividends declared (3,636) (3,636)
Common stock dividends declared (3,232) (3,232)
Issuance of common stock under employee stock plans 177 177 4,639 4,816
Repurchases and retirements of common stock (7) (7) (268) (275)
Common stock split 13,505 13,505 (13,505)
------ --------- --------- --------- ---------
Balance at December 27, 1997 27,020 27,020 42,822 39,498 109,340
Net loss for 1998 (46,510) (46,510)
Accretion of preferred stock to redemption value (424) (424)
Preferred stock dividends declared (696) (696)
Common stock dividends declared (3,269) (3,269)
Issuance of common stock under employee stock plans 298 298 4,038 4,336
Repurchases and retirements of common stock (6) (6) (138) (144)
------ --------- --------- --------- ---------
Balance at December 26, 1998 27,312 $ 27,312 $ 46,722 $ (11,401) $ 62,633
====== ========= ========= ========= =========
See accompanying Notes to consolidated financial statements
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19
Consolidated statement of cash flows
Year Ended
------------------------------------------
($ in thousands) Dec. 26, 1998 Dec. 27, 1997 Dec. 28, 1996
------------- ------------- -------------
Cash flows from operating activities:
Net (loss) income $(46,510) $ 8,028 $ 6,997
Adjustments to reconcile net (loss) income to cash flows from operations:
Depreciation and amortization 36,176 31,946 27,549
Deferred income taxes (26,612) 1,846 2,364
Impairment of long-lived assets 44,564
Loss on disposal of property, plant and equipment 5,317
Reserve for independent distributor receivable 5,000
Reserve for restructuring charges 3,147
Cumulative effect of change in accounting principle 746
Changes in assets and liabilities, net of amounts acquired:
Trade accounts receivable (6,042) (8,958) (7,664)
Other accounts receivable (12,783) (2,889) 809
Inventories (1,137) (8,960) (5,389)
Prepaid expenses and other 3,192 3,545 3,116
Accounts payable and accrued liabilities 27,662 9,611 6,555
Accrued payroll and employee benefits (2,778) 4,125 (1,077)
-------- -------- --------
29,196 39,040 33,260
-------- -------- --------
Cash flows from investing activities:
Acquisition of property, plant and equipment (35,078) (38,470) (58,470)
Retirement of property, plant and equipment 284 677 2,152
Increase in goodwill and distribution rights (311) (146) (772)
Increase in other assets (547) (947) (3,600)
-------- -------- --------
(35,652) (38,886) (60,690)
-------- -------- --------
Cash flows from financing activities:
Proceeds from long-term debt 12,400 11,700 76,000
Repayments of long-term debt (8,641) (9,070) (43,858)
Issuance of common stock under employee stock plans 4,336 4,816 2,464
Repurchases and retirements of common stock (144) (275) (262)
Cash dividends paid (3,950) (7,833) (5,831)
-------- -------- --------
4,001 (662) 28,513
-------- -------- --------
(Decrease) increase in cash and cash equivalents (2,455) (508) 1,083
Cash and cash equivalents, beginning of year 3,626 4,134 3,051
-------- -------- --------
Cash and cash equivalents, end of year $ 1,171 $ 3,626 $ 4,134
======== ======== ========
Supplemental Cash Flow Information--
Cash paid during the year for:
Interest (net of amounts capitalized) $ 12,785 $ 10,634 $ 8,856
Income taxes (net of refunds) 881 1,070 398
Non-cash transactions:
Acquisition of M-K-D Distributors, Inc. 10,800
======== ======== ========
See accompanying Notes to consolidated financial statements
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20
Notes to consolidated financial statements
Note 1 Operations
- --------------------------------------------------------------------------------
Dreyer's Grand Ice Cream, Inc. and its subsidiaries (the Company) is a single
segment industry company engaged in manufacturing and distributing premium ice
cream and other frozen dessert products to grocery and convenience stores,
foodservice accounts and independent distributors in the United States.
The Company accounts for its operations geographically for management
reporting purposes. These geographic segments have been aggregated for financial
reporting purposes due to similarities in the economic characteristics of the
geographic segments and the similar nature of the products, production
processes, customer types and distribution methods throughout the United States.
The Company's products are also segregated between sales
of company branded products (company brands) and sales of other companies'
branded products (partner brands) for management reporting purposes. Sales of
company brands were $647,745,000, $618,401,000 and $493,625,000 in 1998, 1997
and 1996, respectively. Sales of partner brands were $374,590,000, $351,696,000
and $298,216,000 in 1998, 1997 and 1996, respectively. The Company had one
customer in 1998 that comprised 10 percent of sales and no customers accounted
for 10 percent or more of sales in 1997 or 1996.
Note 2 Summary of Significant Accounting Policies
- --------------------------------------------------------------------------------
Consolidation
The consolidated financial statements include the accounts of Dreyer's Grand Ice
Cream, Inc. and its subsidiaries. All intercompany transactions have been
eliminated.
Fiscal Year
The Company's fiscal year is a fifty-two or fifty-three week period ending on
the last Saturday in December. Fiscal years 1998, 1997 and 1996 each consisted
of fifty-two weeks.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions.
These estimates and assumptions 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.
Cash Equivalents
The Company classifies financial instruments as cash equivalents if the original
maturity of such investments is three months or less.
Inventories
Inventories are stated at the lower of cost (determined by the first-in,
first-out method) or market. Cost includes materials, labor and manufacturing
overhead.
Property, Plant and Equipment
The cost of additions and major improvements and repairs to property, plant and
equipment are capitalized, while maintenance and minor repairs are charged to
expense as incurred. Depreciation of property, plant and equipment is computed
using the straight-line method over the assets' estimated useful lives,
generally ranging from two to thirty-five years. Interest costs relating to
capital assets under construction are capitalized.
Goodwill and Distribution Rights
Goodwill and distribution rights are amortized using the straight-line method
over thirty to thirty-six years. Accumulated amortization was $30,212,000 and
$19,817,000 at December 26, 1998 and December 27, 1997, respectively.
Preoperating Costs
In April 1998, the Accounting Standards Executive Committee issued Statement of
Position 98-5, "Reporting on the Costs of Start-Up Activities" (SOP 98-5). SOP
98-5 requires that the costs of start-up activities, including preoperating
costs, be expensed as incurred. This new accounting standard is effective for
financial statements for periods beginning after December 15, 1998. The Company
has capitalized preoperating costs such as those incurred during both the
construction and start-up of new manufacturing and distribution facilities and
introductory allowances paid to customers. These costs are amortized over one to
three years. As a result of adopting SOP 98-5, the Company will expense
unamortized preoperating costs in the first quarter of 1999 as a cumulative
effect of a change in accounting principle. The Company's unamortized
preoperating cost balances were $987,000 and $1,623,000 at December 26, 1998 and
December 27, 1997, respectively.
During 1996, the Company capitalized $2,710,000 of preoperating costs associated
with the start-up of its Houston, Texas manufacturing facility. The unamortized
balance of $1,205,000 as of December 26, 1998 was determined to be unrecoverable
and was charged to expense. The charge is included in impairment of long-lived
assets on the Consolidated statement of operations (See Note 3).
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Notes to consolidated financial statements
Impairment of Long-Lived Assets
The Company reviews long-lived assets and certain identifiable intangibles,
including goodwill and distribution rights, for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. The assessment of impairment is based on the estimated
undiscounted future cash flows from operating activities compared with the
carrying value of the assets. If the undiscounted future cash flows of an asset
are less than the carrying value, a write-down will be recorded, measured by the
amount of the difference between the carrying value and the fair value of the
asset. Assets to be disposed of are recorded at the lower of carrying amount or
fair value less costs to sell. Such assets are not depreciated while held for
sale.
Advertising Costs
The Company defers production costs for media advertising and expenses these
costs in the period the advertisement is first run. All other advertising costs
are expensed as incurred. Advertising expense, including consumer promotion
spending, was $22,188,000, $28,849,000 and $28,770,000 in 1998, 1997 and 1996,
respectively.
Income Taxes
Income taxes are accounted for using the liability method. Under this method,
deferred tax assets and liabilities are recognized for the tax consequences of
temporary differences between the financial reporting basis and tax basis of
assets and liabilities.
Accounting for Stock-Based Compensation
The Company measures compensation cost for employee stock options and similar
equity instruments using the intrinsic value-based method of accounting.
Cumulative Effect of Change in Accounting Principle
On November 20, 1997, the Financial Accounting Standards Board's Emerging Issues
Task Force issued a pronouncement requiring that reengineering costs be expensed
as incurred. Furthermore, the pronouncement required that all previously
unamortized capitalized reengineering costs be written off and treated as a
cumulative effect of a change in accounting principle as of the beginning of the
quarter including November 20, 1997. In connection with this pronouncement, the
Company recorded an after-tax charge of $746,000 during the fourth quarter of
1997.
Net (Loss) Income Per Common Share
Basic net (loss) income per common share is computed using the weighted average
number of shares of common stock outstanding during the period. Diluted net
(loss) income per common share reflects the additional dilutive effect of the
Company's potentially dilutive securities, which include stock options, stock
warrants and redeemable convertible preferred stock.
The Company's potentially dilutive securities were anti-dilutive during 1998
due to the Company's net loss. Accordingly, 1998 basic and diluted net loss per
common share are computed using the same denominator of 27,189,000 shares. The
1997 and 1996 net income per common share calculations are as follows:
Income Shares Per Share
(In thousands, except per share amounts) (Numerator) (Denominator) Amount
- ---------------------------------------- ----------- ------------- ------
1997:
Income before cumulative
effect of change in
accounting principle $8,774
Less: Preferred stock
dividends and accretion 4,060
------
Basic: Income applicable to
common stock $4,714 26,872 $ .18
=======
Effect of dilutive securities:
Stock options 1,096
Stock warrants 500
------
Diluted: Income applicable to
common stock $4,714 28,468 $ .17
====== ====== =======
1996:
Income before cumulative
effect of change in
accounting principle $6,997
Less: Preferred stock
dividends and accretion 4,997
------
Basic: Income applicable to
common stock $2,000 26,496 $ .08
=======
Effect of dilutive securities:
Stock options 214
------
Diluted: Income applicable to
common stock $2,000 26,710 $ .07
====== ====== =======
Excluded from the above calculations of diluted net (loss) income per common
share are the following potentially dilutive securities as their inclusion would
have an anti-dilutive effect. These securities, stated in equivalent shares of
common stock, consisted of the following:
(In thousands) 1998 1997 1996
- -------------- ---- ---- ----
Stock options 4,361 925
Stock warrants 2,000 4,000
Preferred stock 5,800 5,800 5,800
8
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Notes to consolidated financial statements
Note 3 Restructuring Program and Other Actions
- --------------------------------------------------------------------------------
Background
In 1994 the Company adopted a strategic plan to accelerate the sales of its
brand throughout the country (the Strategic Plan). The key elements of this plan
are: 1) to build high margin brands with leading market shares through effective
consumer marketing activities, 2) to expand the Company's direct-store-delivery
distribution network to national scale and enhance this capability with
sophisticated information and logistics systems and 3) to introduce innovative
new products.
In accordance with the Strategic Plan, the Company embarked on an aggressive
national expansion. This expansion involved the entry into 34 new markets, which
included the opening of a major manufacturing and distribution center in Texas,
a significant increase in marketing spending and the introduction of several new
products. At the same time, the Company invested in its soft-serve equipment
manufacturing business (Grand Soft). The investments required to fund the brand
building actions and national expansion and to support the Grand Soft business
substantially increased the Company's cost structure.
Beginning in late 1997 and continuing into 1998, the cost of dairy, the
primary ingredient in ice cream, increased significantly. These costs peaked in
1998 at a rate more than double that experienced in the prior year. This
increase reduced the Company's 1998 gross margin by approximately $22,000,000
when compared to 1997. Aggressive discounting by the Company's competitors made
it difficult to raise prices by an amount sufficient to compensate for these
higher dairy costs. During this same period, sales volumes of the Company's
"better for you" products continued the significant decline that began in 1997,
consistent with an industry-wide trend. These "better for you" products enjoy a
higher margin than the Company's classic ice cream and the volume decline had a
significant impact on the Company's profitability in 1998. Finally, in August
1998, Ben & Jerry's Homemade, Inc. (Ben & Jerry's) informed the Company of its
intention to terminate its distribution contract. Subsequent negotiations with
Ben & Jerry's yielded revisions to the original contract terms which will reduce
the Company's distribution gross margin of Ben & Jerry's products by
approximately 54 percent starting September 1, 1999. The Company estimates that
the markets where it will stop distributing Ben & Jerry's products contributed
approximately 6 percent of its gross margin, or $13,000,000, in 1998.
The above factors: the higher dairy costs; the decline in "better for you"
volumes; and the reduction in future Ben & Jerry's sales; had and will have a
negative effect on the Company's gross margin and its ability to successfully
implement the Strategic Plan. The Company, therefore, concluded that a thorough
reassessment of its cost structure and strategy was necessary. This reassessment
yielded a restructuring program designed to improve profitability and accelerate
cost reductions by increasing focus on the core elements of the Strategic Plan.
The reassessment also addressed the need to review the valuation of certain
assets unfavorably impacted by Ben & Jerry's decision to change its distribution
agreement with the Company. On October 16, 1998, the board of directors approved
the restructuring program.
Revision of Ben & Jerry's Distribution Agreement
During the third quarter of 1998, Ben & Jerry's notified the Company of its
intention to terminate the distribution contract between the Company and Ben &
Jerry's. The Company subsequently entered into negotiations with Ben & Jerry's
to resolve issues associated with the pending termination. In the first quarter
of 1999, the companies announced that they reached a resolution regarding these
issues by amending the existing distribution agreement and entering into a new
distribution agreement. As a result, the Company will continue to distribute Ben
& Jerry's products until August 31, 1999 in all existing markets, except the New
York metropolitan area (discussion follows in Restructuring Program and Other
Actions), and on terms and conditions different in some respects from those in
place prior to the amendment. The Company will stop distributing Ben & Jerry's
products in New York on April 1, 1999. Starting September 1, 1999, the Company's
distribution gross margin of Ben & Jerry's products will be reduced by
approximately 54 percent under the new distribution agreement. Additionally, Ben
& Jerry's notified the Company of its intention to terminate its separate
distribution agreement with the Company's independent distributor in Texas
(discussion follows in Restructuring Program and Other Actions).
In 1998, the distribution margin on Ben & Jerry's products contributed just
over 11 percent of the Company's total gross margin. The Company estimates that
the distribution gross margin in the markets where it will stop distributing Ben
& Jerry's products later in 1999 represented approximately 6 percent, or
$13,000,000, of its total gross margin in 1998.
9
23
Notes to consolidated financial statements
Restructuring Program and Other Actions
The implementation of the restructuring program and other actions resulted in a
pre-tax charge to earnings of $59,114,000 in 1998. This includes $10,590,000
recorded in the third quarter which related primarily to Ben & Jerry's actions
that occurred in September 1998 and to a severance program, which management had
already begun in advance of board approval of the remainder of the restructuring
program. The remainder of the charges, $48,524,000, was recorded in the fourth
quarter of 1998.
The five key elements of the restructuring program and other actions are as
follows:
- - The Company decided to exit the equipment manufacturing business associated
with its Grand Soft ice cream unit. The Grand Soft business consists of both ice
cream sales and equipment manufacturing operations. The Company will remain in
the profitable ice cream portion of this business, while exiting the
unprofitable equipment manufacturing operation. In the fourth quarter of 1998,
the Company recorded $8,696,000 in asset impairment charges and $2,258,000 in
estimated closing costs associated with the withdrawal from this business.
The Company expects to exit the equipment manufacturing operation by June 1999.
The $8,696,000 charge is included in impairment of long-lived assets in the
Consolidated statement of operations and is comprised of $5,714,000 of goodwill,
$1,956,000 of property, plant and equipment and $1,026,000 of inventory and
other assets. The remaining assets of Grand Soft total $1,762,000 and consist
primarily of trade accounts receivable, which are fully recoverable. The assets
were written down to net realizable value based on an estimate of what an
independent third party would pay for the assets of the business. The charge of
$2,258,000 for closing costs is included in restructuring charges in the
Consolidated statement of operations and a $2,258,000 liability is included in
accounts payable and accrued liabilities in the Consolidated balance sheet, as
no closing costs were paid in 1998. The closing costs are based on estimates of
legal fees, employee separation payments and expected settlements. The closing
costs include $576,000 of severance related costs for the 23 employees, from all
areas of responsibility, who were notified of their pending termination prior to
fiscal year end. The Grand Soft manufacturing operations generated revenues of
$3,093,000, $3,346,000 and $6,007,000 and incurred pre-tax operating losses of
$(2,335,000), $(2,274,000) and $(1,628,000) in 1998, 1997 and 1996,
respectively.
- The Company has implemented a program designed to reduce operating expenses
in manufacturing, sales and distribution and administration. Core pieces of this
program include outsourcing of certain non-strategic activities, consolidation
of warehouse facilities and selected reductions in sales and distribution
staffing. These actions were completed in the fourth quarter.
As part of this program, the Company reviewed operations at all of its
manufacturing facilities in order to identify and dispose of under-utilized
assets. As a result of this review, the Company recorded a charge to cost of
goods sold of $5,317,000 in the fourth quarter, related primarily to the write
down of manufacturing assets.
In connection with reducing operating expenses for sales and distribution,
the Company recorded $1,042,000 of severance and related charges in the fourth
quarter that are included in restructuring charges in the Consolidated statement
of operations. A total of 38 sales and distribution employees were to be
terminated under this program. Of this total, 16 were terminated in 1998 and
paid $153,000 in severance benefits. The remaining 22 employees were notified of
their pending termination prior to fiscal year end. An accrual for severance
benefits of $889,000 was outstanding at year end. The Company also recorded a
$933,000 charge to cost of goods sold in the third quarter for severance actions
begun in advance of board approval of the remainder of the restructuring
program. The Company paid $514,000 of these severance benefits in 1998, leaving
a liability of $419,000 at year end, which is included in accounts payable and
accrued liabilities in the Consolidated balance sheet.
In addition, the Company charged to expense $4,478,000 of previously
capitalized costs classified as property, plant and equipment associated with
the expansion of its headquarters, as the expansion plan was canceled in an
effort to reduce future administration costs. The $4,478,000 charge was based on
a third party independent appraisal of the fair market value of the related real
property and is included in impairment of long-lived assets in the Consolidated
statement of operations.
- - The Company, in carrying out its national expansion program, made significant
investments to support an aggressive expansion in Texas. These investments,
while building sales volume, delivered results below expectations. The Company
is now modifying this expansion strategy in order to concentrate on more
profitable opportunities. The objective in Texas will be to preserve volumes
while seeking margin improvement. As a result of this change in strategy, the
Company will realize substantially lower production volumes over the remaining
useful life of its Texas manufacturing plant than originally contemplated. The
Company has therefore concluded that its investment in the Texas plant is
non-recoverable and has recorded an impairment charge of $16,200,000 in the
10
24
Notes to consolidated financial statements
fourth quarter to reduce the net book value of the plant to its estimated fair
market value. The $16,200,000 impairment charge was based on a third party
independent appraisal and is included in impairment of long-lived assets in the
Consolidated statement of operations.
- - As previously mentioned, Ben & Jerry's indicated its intent to terminate its
separate distribution agreement with the Company's independent distributor in
Texas, (the Texas Distributor), in which the Company has a 16 percent minority
equity interest. Ben & Jerry's action placed at significant risk the
recoverability of the Company's equity investment, distribution rights, and
trade receivables relating to this distributor. In the third quarter of 1998,
the Company recorded a bad debt provision of $5,000,000 relating to the trade
receivables, when originally notified of the Ben & Jerry's decision. The
$5,000,000 bad debt provision is included in selling, general and administrative
expenses in the Consolidated statement of operations. In light of Ben & Jerry's
plans to terminate its relationship with the Texas Distributor and the
previously noted change in the Company's Texas strategy, the Company evaluated
the recoverability of all assets associated with the Texas Distributor.
Accordingly, in addition to the accounts receivable reserve recorded in the
third quarter, the Company recorded additional charges of $10,533,000 in the
fourth quarter related to the impairment of its minority equity investment and
distribution rights associated with the Company's contract with the Texas
Distributor. The Company concluded that these assets were unrecoverable due to
the substantially reduced profits and cash flow resulting from Ben & Jerry's
decision to terminate the Texas Distributor's distribution agreement. The
$10,533,000 charge is comprised of $9,449,000 of distribution rights and
$1,084,000 of the equity investment and is included in impairment of long-lived
assets in the Consolidated statement of operations.
- - Due to the notice of termination from Ben & Jerry's, the Company charged to
expense $4,657,000 of the unamortized portion of distribution rights related to
the acquisition of the Ben & Jerry's New York distributor. The Company acquired
this business in 1989, in the development of its long-standing relationship with
Ben & Jerry's. The other tangible assets of this business have been merged with
the Company's New York operations and are fully recoverable. This charge was
recorded in the third quarter of 1998 and is included in impairment of
long-lived assets in the Consolidated statement of operations.
The following table summarizes the classification of the charges in the
Consolidated statement of operations related to the restructuring program and
other actions:
1998
----------------------------------------------
(In thousands) Third Quarter Fourth Quarter Full Year
------------- -------------- ---------
Restructuring charges:
Grand Soft $ $ 2,258 $ 2,258
Sales and distribution
severance 1,042 1,042
------- ------- -------
3,300 3,300
------- ------- -------
Impairment of long-lived assets:
Grand Soft 8,696 8,696
Texas plant 16,200 16,200
Texas independent
distributor 10,533 10,533
Ben & Jerry's revision 4,657 4,657
Headquarters' expansion 4,478 4,478
------- ------- -------
4,657 39,907 44,564
------- ------- -------
Other charges:
Texas independent
distributor 5,000 5,000
Sales and distribution
severance 933 933
Asset disposals 5,317 5,317
------- ------- -------
5,933 5,317 11,250
------- ------- -------
$10,590 $48,524 $59,114
======= ======= =======
The following table summarizes the accruals included in accounts payable and
accrued liabilities in the Consolidated balance sheet related to the
restructuring program and other actions:
(In thousands) 1998
- -------------- ----
Restructuring accruals:
Grand Soft $2,258
Sales and distribution severance 889
------
3,147
------
Other accruals:
Sales and distribution severance 419
------
$3,566
======
11
25
Notes to consolidated financial statements
Note 4 Inventories
- --------------------------------------------------------------------------------
Inventories at December 26, 1998 and December 27, 1997 consisted of the
following:
(In thousands) 1998 1997
------- -------
Raw materials $ 4,840 $ 7,411
Finished goods 44,632 42,309
------- -------
$49,472 $49,720
======= =======
Note 5 Property, Plant and Equipment
- --------------------------------------------------------------------------------
Property, plant and equipment at December 26, 1998 and December 27, 1997
consisted of the following:
(In thousands) 1998 1997
-------- --------
Machinery and equipment $198,122 $181,628
Buildings and improvements 92,287 84,409
Capital leased assets 16,836 18,993
Office furniture and fixtures 6,672 6,484
-------- --------
313,917 291,514
Less: Accumulated depreciation
and amortization 129,782 112,839
-------- --------
184,135 178,675
Land 15,436 11,838
Construction in progress 8,201 42,313
-------- --------
$207,772 $232,826
======== ========
Accumulated amortization of the Company's capital leased assets was
$8,118,000 and $5,837,000 at December 26, 1998 and December 27, 1997,
respectively.
Interest capitalized was $1,244,000, $2,254,000 and $2,627,000 in 1998, 1997
and 1996, respectively.
Depreciation expense for property, plant and equipment, including
amortization expense for capital leased assets, was $32,375,000, $27,799,000 and
$23,510,000 in 1998, 1997 and 1996, respectively.
Construction in progress at December 26, 1998 included $3,513,000 of costs
associated with the upgrade of the Company's computer systems and at December
27, 1997 included $29,130,000 of costs associated with the expansion of
manufacturing and distribution capacity.
Note 6 Goodwill and Distribution Rights
- --------------------------------------------------------------------------------
On March 27, 1996, the Company acquired the remaining 50.3 percent of the
outstanding common stock of M-K-D Distributors, Inc. (M-K-D) for 320,000 newly
issued shares of the Company's common stock* having a value of $10,800,000. The
acquisition was accounted for as a purchase and the amount by which the purchase
price exceeded the fair value of the net identifiable assets acquired of
$8,144,000 was recorded as goodwill and distribution rights. The Company
consolidated the results of operations of M-K-D since the beginning of fiscal
1996. That portion of M-K-D's 1996 pre-acquisition earnings before income taxes,
which was attributable to the former stockholders' interest, approximately
$148,000, was recorded as a charge to selling, general and administrative
expenses.
Note 7 Income Taxes
- --------------------------------------------------------------------------------
The (benefit) provision for federal and state income taxes consisted of the
following:
(In thousands) 1998 1997 1996
-------- -------- --------
Current:
Federal $ (2,147) $ 3,644 $ 1,683
State 374 191 315
-------- -------- --------
(1,773) 3,835 1,998
-------- -------- --------
Deferred:
Federal (24,218) 1,267 2,003
State (2,394) 579 361
-------- -------- --------
(26,612) 1,846 2,364
-------- -------- --------
$(28,385) $ 5,681 $ 4,362
======== ======== ========
The 1997 cumulative effect of change in accounting principle
of $746,000 is net of an income tax benefit of $484,000, comprised of federal
and state income taxes, which is not reflected in the above table.
* The share information is presented before the effect of the 1997 common
stock split. (See Note 11.)
12
26
Notes to consolidated financial statements
The net deferred income tax liability as of December 26, 1998 and December
27, 1997 consisted of the following:
(In thousands) 1998 1997
-------- --------
Deferred tax assets:
Net operating loss (NOL)
carryforwards $ 1,770 $
Tax credit carryforwards 6,732
-------- --------
8,502
-------- --------
Deferred tax liabilities:
Intangible assets and related
amortization (10,249) (15,773)
Depreciation (9,248) (19,814)
Deferred costs (4,657) (4,063)
Other (387) (941)
-------- --------
(24,541) (40,591)
-------- --------
$(16,039) $(40,591)
======== ========
The federal statutory income tax rate is reconciled to the Company's effective
income tax rate as follows:
1998 1997 1996
----- ---- ----
Federal statutory
income tax rate (35.0)% 35.0% 35.0%
Tax credits (1.9)
State income taxes, net
of federal tax benefit (1.8) 3.5 3.9
Reversal of income taxes
provided in prior periods (3.7)
Other 0.8 0.8 3.2
----- ---- ----
(37.9)% 39.3% 38.4%
===== ==== ====
As of December 26, 1998, the Company had deferred tax assets relating to NOL
carryforwards, alternative minimum tax and research credit carryforwards. The
pre-tax federal NOL carryforwards of $3,647,000 expire in 2018. The research
credit carryforwards of $2,334,000 expire between 2012 and 2018. The alternative
minimum tax carryforwards of $4,398,000 can be carried forward indefinitely, as
they do not expire. Utilization of these carryforwards may be limited in the
event of a change in ownership of the Company. No valuation allowance for these
assets has been recorded because the Company believes that it is more likely
than not that these carryforwards will be used in future years to offset taxable
income.
Note 8 Long-Term Debt
- --------------------------------------------------------------------------------
Long-term debt at December 26, 1998 and December 27, 1997 consisted of the
following:
(In thousands) 1998 1997
-------- --------
Revolving line of credit with banks,
due 2000 with interest payable
at three different rate options $ 99,800 $ 87,400
Senior notes, with principal due through
2008 and interest payable semi-
annually at rates ranging from
7.68 percent to 8.34 percent 50,000 50,000
Capital lease obligation, with payments
due through 2000 and interest
payable quarterly at a floating rate 13,136 18,177
Senior notes, with principal due
through 2001 and interest payable
semiannually at 9.3 percent 10,600 14,200
Industrial revenue bonds, with principal
due through 2001 and interest
payable quarterly at a floating rate
based upon a tax-exempt note index 4,500 4,500
-------- --------
178,036 174,277
Less: Current portion 8,255 8,364
-------- --------
$169,781 $165,913
======== ========
The aggregate annual maturities of long-term debt, including the capital
lease obligation, as of December 26, 1998 are as follows:
(In thousands)
- --------------
Year ending:
1999 $ 8,255
2000 119,024
2001 15,043
2002 7,143
2003 2,143
Later years 26,428
--------
$178,036
========
13
27
Notes to consolidated financial statements
Line of Credit
The Company has a credit agreement with certain banks for a total revolving line
of credit of $175,000,000. The total available under the line decreases to
$149,286,000 on December 31, 1999 and the line expires on December 31, 2000.
This line is available at three different interest rate options, which are
defined as the agent bank's offshore rate, same day funding rate plus an
applicable margin, or the bank's reference rate. The interest rate on the line
of credit was 6.20 percent at December 26, 1998.
Senior Notes
On June 6, 1996, the Company completed a private placement of $50,000,000 of
senior notes, due 2000 through 2008. Proceeds from the senior notes were used to
repay a portion of existing bank borrowings under the Company's line of credit
and to fund capital expenditures.
Lease Transaction
On March 29, 1996, the Company entered into a capital lease transaction
involving the majority of its direct-store-delivery truck fleet. The $26,000,000
proceeds received by the Company from the lease transaction were used to both
repay a portion of existing borrowings under the Company's line of credit and to
fund capital expenditures. The interest rate on the capital lease obligation was
6.06 percent at December 26, 1998. The four-year lease has been classified as a
capital lease and the related assets are recorded in property, plant and
equipment.
The excess of the lease transaction proceeds over the carrying value of the
fleet of approximately $9,095,000 was deferred and netted against the carrying
value of the capital leased assets. This deferred gain is being credited to
income in proportion to the amortization of the capital leased assets.
Fair Value of Financial Instruments
As of December 26, 1998 and December 27, 1997, the fair value of the Company's
long-term debt was determined to approximate the carrying amount. The fair value
was based on quoted market prices for the same or similar issues or on the
current rates offered to the Company for a term equal to the same remaining
maturities. It is not practicable to estimate the fair value of the redeemable
convertible preferred stock due to the unique terms and conditions of this
security.
The Company is subject to the requirements of various financial covenants,
including dividend restrictions, under its long-term debt obligations.
Note 9 Leasing Arrangements
- --------------------------------------------------------------------------------
The Company conducts certain of its operations from leased facilities, which
include land and buildings, production equipment and certain vehicles. All of
these leases, except one that has 89 years remaining, including renewal options,
expire within a period of twenty-four years, including renewal options. Certain
of these leases include non-bargain purchase options.
The minimum rental payments required under non-cancelable leases at December
26, 1998 are as follows:
(In thousands) Capital Operating
------- -------
Year ending:
1999 $ 5,383 $ 2,872
2000 8,624 2,524
2001 1,979
2002 1,613
2003 1,536
Later years 4,348
------- -------
14,007 $14,872
=======
Less: Amounts representing interest 871
-------
Present value of minimum lease payments 13,136
Less: Current portion 4,655
-------
$ 8,481
=======
Rental expense for operating leases was $12,447,000, $13,994,000 and
$11,665,000 in 1998, 1997 and 1996, respectively.
Note 10 Redeemable Convertible Preferred Stock
- --------------------------------------------------------------------------------
On October 3, 1997, the Company's Series B preferred stock was converted into a
total of 1,008,000 shares of redeemable convertible Series A preferred stock
(Series A), redeemable on June 30, 2001. The Series A preferred stock is
convertible, under certain conditions, at an initial conversion price of $17.37
into a total of 5,800,000 shares of common stock.
In preference to shares of common stock, the Series A preferred stockholders
are entitled to receive cumulative cash dividends, payable quarterly in arrears.
Dividends on the Series A preferred stock are payable at a dividend rate equal
to the amount that would be received as if the shares were converted into
comparable shares of common stock. Series A preferred stockholders have common
stock voting rights equal to the number of common shares into which their
preferred stock is convertible. The Company is recording accretion to increase
the carrying value to the redemption value of $100,752,000 by June 30, 2001.
14
28
Notes to consolidated financial statements
Note 11 Common Stock
- --------------------------------------------------------------------------------
The Company paid a regular quarterly dividend of $.03 per share of common stock
for each quarter of 1998, 1997 and 1996.
During 1987, the Board of Directors declared a dividend of one Preferred
Stock Purchase Right (the Rights) for each outstanding share of common stock.
Under certain conditions, the Rights become exercisable for the purchase of the
Company's preferred or common stock.
Common Stock Split
On November 18, 1997, the Company issued shares of common stock to holders of
record on October 30, 1997 to effect a two-for-one common stock split. An amount
equal to the par value of the common stock issued was transferred from capital
in excess of par to common stock to reflect this split. Additionally, the number
of shares, stock price per share, and earnings and dividends per share
information appearing in these consolidated financial statements were restated
to reflect this stock split on a retroactive basis unless otherwise indicated.
Nestle Equity Issuance
Pursuant to a 1994 equity transaction (the Nestle Agreement), an affiliate of
Nestle USA, Inc. (Nestle) purchased 6,000,000 newly issued shares of common
stock and warrants to purchase an additional 4,000,000 shares at an exercise
price of $16 per share. Warrants for 2,000,000 shares expired unexercised on
June 14, 1997. Warrants for the other 2,000,000 shares are exercisable at any
time prior to their expiration on June 14, 1999.
The Company has the right to cause Nestle to exercise the remaining warrants
at any time through the warrant expiration date at $16 per share, if the average
trading price of the common stock exceeds $30 during a 130 trading day period
preceding the exercise, subject to certain conditions. Furthermore, if the
average trading price of the common stock equals or exceeds $30 during a 130
trading day period before June 14, 1999, Nestle will be required to pay an
additional $1 for each share purchased and each share purchased upon exercise of
the warrants.
In connection with the Nestle Agreement, the Company entered into a
distribution agreement with Nestle Ice Cream Company to distribute Nestle's
frozen novelty and ice cream products in certain markets.
Note 12 Employee Benefit Plans
- --------------------------------------------------------------------------------
The Company maintains a defined contribution retirement plan (pension plan) for
employees not covered by a collective bargaining agreement. The plan provides
retirement benefits based upon the assets of the plan held by the trustee. The
Company amended its pension plan during 1998 to reduce the percentage of
eligible participants' annual compensation it contributes to the plan from 7
percent to 5 percent. The Company also maintains a salary deferral plan (401(k)
plan) under which it may make a matching contribution of a percentage of each
participant's deferred salary amount.
Pension expense and 401(k) matching contributions under these plans were
$5,411,000, $7,500,000 and $7,683,000 in 1998, 1997 and 1996, respectively. The
Company's liability for accrued pension contributions and 401(k) matching
contributions was $5,648,000 and $7,841,000 at December 26, 1998 and December
27, 1997, respectively.
Pension expense for employees covered by multi-employer retirement plans
under collective bargaining agreements was $981,000, $1,056,000 and $956,000 in
1998, 1997 and 1996, respectively.
Note 13 Employee Stock Plans
- --------------------------------------------------------------------------------
The Company offers to certain employees various stock option plans, a Section
423 employee stock purchase plan and an employee secured stock purchase plan.
Stock Option Plans
The Company has three stock option plans under which options may be granted for
the purchase of the Company's common stock at a price not less than 100 percent
of the fair market value at the date of grant. The incentive stock option plan
(the 1982 Plan) provides that options are not exercisable until after two years
from the date of grant and generally expire six years from the date of grant.
The non-qualified stock option plan (the 1992 Plan) provides that options are
not exercisable until after two years from the date of grant and expire upon
death or termination of employment. In 1994, the stockholders approved an
additional stock option plan (the 1993 Plan) under which granted options may be
either incentive stock options or non-qualified stock options. This plan
provides that options expire no later than ten years from the date of grant.
This plan also provides that most of the terms of the options, such as vesting,
are within the discretion of the compensation committee, composed of certain
members of the Company's board of directors.
15
29
Notes to consolidated financial statements
No compensation expense has been recognized for these stock option plans. If
compensation expense for these plans had been determined based on the estimated
fair value at the grant dates, the Company's net (loss) income applicable to
common stock and net (loss) income per common share on a pro forma basis would
have been as follows:
(In thousands, except per share amounts) 1998 1997 1996
---------- --------- -------
Net (loss) income applicable
to common stock $ (50,530) $ 1,757 $ 249
Net (loss) income per
common share:
Basic (1.86) .07 .01
Diluted (1.86) .06 .01
The Company used the Black-Scholes option pricing model to estimate the fair
value of options granted during 1998, 1997 and 1996. The assumptions used to
compute compensation expense in the above pro forma presentation and to estimate
the weighted average fair market value of options granted are as follows:
1998 1997 1996
------ ------ ------
Risk-free interest rate 5.74% 6.59% 5.96%
Dividend yield .53% .78% .75%
Volatility 32.29% 31.51% 33.62%
Expected term (years) 5.9 5.7 4.5
Weighted average
fair market value $ 9.10 $ 6.07 $ 6.17
Stock options exercisable were 2,196,000, 1,719,000 and 1,236,000 at years
ended 1998, 1997 and 1996, respectively. These stock options were exercisable at
weighted average option prices of $13.69, $13.15 and $13.06 for 1998, 1997 and
1996, respectively.
The activity in the three stock option plans for each of the three years in
the period ended December 26, 1998 is summarized below.
Options Weighted
Available Options Average Price
(In thousands, except per share amounts) for Grant Outstanding Per Share
--------- ----------- -------------
Balance, December 30, 1995 920 2,730 $ 12.55
Authorized 2,000
Granted (902) 902 15.75
Exercised (106) 8.87
Canceled 106 (106) 13.46
------ ----- ---------
Balance, December 28, 1996 2,124 3,420 13.49
Granted (932) 932 15.35
Exercised (243) 12.58
Canceled 143 (143) 14.32
------ ----- ---------
Balance, December 27, 1997 1,335 3,966 13.97
Granted (714) 714 22.72
Exercised (181) 11.99
Canceled 138 (138) 16.42
------ ----- ---------
Balance, December 26, 1998 759 4,361 $ 15.41
====== ===== =========
Significant option groups outstanding at December 26, 1998 and related
weighted average price per share and life information follows:
(In thousands, except per share amounts)
- --------------------------------------------------------------------------------
Options Outstanding Options Exercisable
----------------------------------------------------------- -----------------------------------
Exercise Options Weighted Average Weighted Average Options Weighted Average
Price Range Outstanding Exercise Price Remaining Life(Years) Exercisable Exercise Price
- ----------- ----------- -------------- --------------------- ----------- --------------
$ 9.75-14.06 1,856 $ 12.58 5.2 1,461 $ 12.58
14.63-19.75 1,835 15.52 7.4 704 15.50
22.88-25.38 670 22.95 9.2 31 24.57
----- --------- --- ----- ---------
4,361 $ 15.41 2,196 $ 13.69
===== ========= ===== =========
16
30
Notes to consolidated financial statements
Section 423 Employee Stock Purchase Plan
Under the section 423 employee stock purchase plan, employees may authorize
payroll deductions of up to 10 percent of their compensation for the purpose of
acquiring shares at 85 percent of the market price determined at the beginning
of a specified twelve month period. Under this plan, employees purchased 34,000
shares at prices ranging from $13.15 to $19.87 per share in 1998, 30,000 shares*
at prices ranging from $24.65 to $25.93 per share* in 1997 and 24,000 shares* at
prices ranging from $22.00 to $32.94 per share* in 1996. Compensation expense
based on the fair value of the employees' purchase rights was not material in
1998, 1997 and 1996.
Employee Secured Stock Purchase Plan
Under the employee secured stock purchase plan, on specified dates, employees
may purchase shares at fair market value by paying 20 percent of the purchase
price in cash and the remaining 80 percent of the purchase price in the form of
a non-recourse promissory note with a term of 30 years. Under this plan,
employees purchased 83,000 shares at prices ranging from $13.38 to $20.13 per
share in 1998, 20,000 shares* at prices ranging from $30.25 to $48.25 per share*
in 1997 and 28,000 shares* at prices ranging from $28.50 to $31.75 per share* in
1996.
Note 14 Insurance Settlements and Trademark Sale
- --------------------------------------------------------------------------------
During 1998, 1997 and 1996, the Company recorded several gains relating to
claims filed under its insurance policies. These claims resulted from accidents
that contaminated certain finished goods inventories. Under the Company's
insurance policies, the Company is entitled to receive the value of the affected
finished goods inventories at their normal selling price, plus expenses incurred
in recovering from these accidents. These claims resulted in gains of
$1,300,000, $2,355,000 and $2,100,000 in 1998, 1997 and 1996, respectively,
which were recorded as reductions in cost of goods sold.
In December 1996, the Company sold trademark rights for the People's Republic
of China, Hong Kong and Macau to a third-party independent distributor for
$2,600,000. Also in December 1996, the Company recorded $1,043,000 of gross
margin relating to the sale of a three to five month supply of its products to
this same distributor.
In 1998, insurance claims decreased 1998 net loss by $807,000, or $0.03 per
diluted common share. In 1997, insurance claims increased 1997 net income by
$1,430,000, or $0.05 per diluted common share. The 1996 transactions, including
gains from insurance claims, increased 1996 net income by $3,538,000, or $0.13
per diluted common share.
Note 15 Contingencies
- --------------------------------------------------------------------------------
The Company is engaged in various legal actions as both plaintiff and defendant.
Management believes that the outcome of these actions, either individually or in
the aggregate, will not have a material adverse effect on the Company's
financial position, results of operations or cash flows.
* The share information is presented before the effect of the 1997 common
stock split. (See Note 11.)
17
Notes to consolidated financial statements
Note 16 Selected Quarterly Financial Data (Unaudited)
- --------------------------------------------------------------------------------
(Loss) Income Before
Cumulative Effect Cumulative Effect Net (Loss) Income Price Range Per
(In thousands, except per Gross of Change in of Change in Applicable to Common Share
share amounts) Sales Margin Accounting Principle(1) Accounting Principle Common Stock (NASDAQ)(2)
- ------------------------- ---------- --------- -------------------- -------------------- ----------------- -------------
1998
1st Quarter $ 215,082 $ 36,114 $ (5,905) $ (5,905) $20.00-25.38
2nd Quarter 280,273 62,502 4,255 4,255 19.38-26.75
3rd Quarter 302,972 64,054 (6,261) (6,261) 9.44-21.50
4th Quarter 224,008 31,803 (39,719) (39,719) 9.00-17.38
---------- -------- -------- -------- ------------
$1,022,335 $194,473 $(47,630) $(47,630)
========== ======== ======== ========
1997
1st Quarter $ 200,438 $ 38,187 $ (1,300) $ (1,300) $14.50-17.25
2nd Quarter 271,972 59,255 4,937 4,937 14.88-20.13
3rd Quarter 286,256 65,641 3,715 3,715 18.75-27.50
4th Quarter 211,431 42,463 (2,638) $ 746 (3,384) 18.50-26.50
---------- -------- -------- -------- -------- ------------
$ 970,097 $205,546 $ 4,714 $ 746 $ 3,968
========== ======== ======== ======== =========
Basic Net (Loss) Income Per Common Share(2) Diluted Net (Loss) Income Per Common Share(2)
------------------------------------------------ --------------------------------------------------
(Loss) Income (Loss) Income
Before Cumulative Cumulative Before Cumulative Cumulative
Effect of Change Effect of Change Effect of Change Effect of Change
in Accounting in Accounting Net (Loss) in Accounting in Accounting Net (Loss)
Principle(3) Principle Income(3) Principle(3) Principle Income(3)
----------------- ---------------- ----------- ----------------- ----------------- ----------
1998
1st Quarter $ (.22) $ (.22) $ (.22) $ (.22)
2nd Quarter .16 .16 .13 .13
3rd Quarter (.23) (.23) (.23) (.23)
4th Quarter (1.45) (1.45) (1.45) (1.45)
1997
1st Quarter $ (.05) $ (.05) $ (.05) $ (.05)
2nd Quarter .18 .18 .18 .18
3rd Quarter .14 .14 .13 .13
4th Quarter (.10) $ (.03) (.13) (.10) $ (.03) (.13)
(1) (Loss) income has been reduced by preferred stock dividends and accretion
of preferred stock to redemption value.
(2) Retroactively restated to reflect the effects of the common stock split in
1997.
(3) The number of weighted average shares outstanding used in the computation
of net (loss) income per common share increases and decreases as shares are
issued and repurchased during the year. For this reason, the sum of net
(loss) income per common share for the quarters may not be the same as the
net (loss) income per common share for the year.
18
32
Report of independent accountants
To the Board of Directors and Stockholders of
Dreyer's Grand Ice Cream, Inc.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, of changes in stockholders' equity and of
cash flows present fairly, in all material respects, the financial position of
Dreyer's Grand Ice Cream, Inc. and its subsidiaries at December 26, 1998 and
December 27, 1997, and the results of their operations and their cash flows for
each of the three years in the period ended December 26, 1998, in conformity
with generally accepted accounting principles. 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 of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audits 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
As discussed in Note 2 to the consolidated financial statements, the Company
changed its method of accounting for reengineering costs in the fourth quarter
of 1997.
/s/ PRICEWATERHOUSECOOPERS LLP
- ------------------------------
PricewaterhouseCoopers LLP
San Francisco, California
February 22, 1999
19
33
Five-year summary of significant financial data
Fiscal Year Ended December
-------------------------------------------------------------------------
(In thousands, except per share amounts) 1998 1997 1996 1995 1994
------- ------- ------- ------- -------
Operations:
Sales and other income $ 1,025,988 $ 973,091 $ 796,195 $ 681,052 $ 566,602
(Loss) income before cumulative effect of
change in accounting principle (46,510) 8,774 6,997 (1,524) 1,001
Net (loss) income (46,510) 8,028 6,997 (1,524) 1,001
Net (loss) income applicable to common stock (47,630) 3,968 2,000 (3,496) 1,001
Per Common Share:
Basic:
(Loss) income before cumulative effect of
change in accounting principle(1) (1.75) .18 .08 (.13) .03
Net (loss) income(1) (1.75) .15 .08 (.13) .03
Diluted:
(Loss) income before cumulative effect of
change in accounting principle(1) (1.75) .17 .07 (.13) .03
Net (loss) income(1) (1.75) .14 .07 (.13) .03
Dividends declared(1) .12 .12 .12 .12 .12
Balance Sheet:
Total assets 463,180 502,798 478,907 414,105 362,026
Working capital 61,059 78,576 70,136 69,361 48,403
Long-term debt, including convertible
subordinated debentures 169,781 165,913 163,135 134,000 146,852
Redeemable convertible preferred stock 99,654 99,230 98,806 98,382
Stockholders' equity 62,633 109,340 104,063 92,263 135,921
(1) Retroactively restated to reflect the effects of the common stock split in
1997.
20
34
Management's discussion and analysis
Results of Operations
- --------------------------------------------------------------------------------
Forward-Looking Statements
The Company may from time to time make written or oral forward-looking
statements. Written forward-looking statements may appear in documents filed
with the Securities and Exchange Commission, in press releases and in reports to
stockholders. The Private Securities Litigation Reform Act of 1995 contains a
"safe harbor" for forward-looking statements upon which the Company relies in
making such disclosures. In accordance with this "safe harbor" provision, we
have identified that forward-looking statements are contained in this Annual
Report. The Company undertakes no obligation to publicly revise these
forward-looking statements to reflect subsequent events or circumstances.
Also, in connection with this "safe harbor" provision, the Company identifies
important factors that could cause the Company's actual results to differ
materially from those contained in any forward-looking statement made by or on
behalf of the Company. Those factors include but are not limited to those
discussed in the section Risks and Uncertainties in Management's discussion and
analysis. Any such statement is qualified by reference to the cautionary
statements set forth in the section Risks and Uncertainties and in the Company's
other filings with the Securities and Exchange Commission.
Financial Summary
The Company recorded a net loss applicable to common stock of $(47,630,000), or
$(1.75) per common share for fiscal 1998. These results represent a substantial
decrease from the net income applicable to common stock of $3,968,000, or $0.14
per diluted common share reported for fiscal 1997. Consolidated net sales
increased 5 percent over fiscal 1997 to $1,022,335,000, surpassing $1 billion
for the first time in the Company's history. The results for fiscal 1998 reflect
the effects of the Company's previously announced restructuring program and
other actions, and certain charges related to changes in its distribution
arrangement with Ben & Jerry's Homemade, Inc. (Ben & Jerry's).
Background
In fiscal 1994 the Company adopted a strategic plan to accelerate
the sales of its brand throughout the country (the Strategic Plan). The key
elements of this plan are: 1) to build high margin brands with leading market
shares through effective consumer marketing activities, 2) to expand the
Company's direct-store-delivery distribution network to national scale and
enhance this capability with sophisticated information and logistics systems and
3) to introduce innovative new products. The potential benefits of the Strategic
Plan are increased market share and future earnings above those levels that
would be attained in the absence of the Strategic Plan.
In accordance with the Strategic Plan, the Company embarked on an aggressive
national expansion. This expansion involved the entry into 34 new markets, which
included the opening of a major manufacturing and distribution center in Texas,
a significant increase in marketing spending and the introduction of several new
products. At the same time, the Company invested in its soft-serve equipment
manufacturing business (Grand Soft). The investments required to fund the brand
building actions and national expansion and to support the Grand Soft business
substantially increased the Company's cost structure.
Beginning in late fiscal 1997 and continuing into fiscal 1998, the cost of
dairy, the primary ingredient in ice cream, increased significantly. These costs
peaked in fiscal 1998 at a rate more than double that experienced in the prior
year. This increase reduced the Company's fiscal 1998 gross margin by
approximately $22,000,000 when compared to fiscal 1997. Aggressive discounting
by the Company's competitors made it difficult to raise prices by an amount
sufficient to compensate for these higher dairy costs. During this same period,
sales volumes of the Company's "better for you" products continued the
significant decline that began in fiscal 1997, consistent with an industry-wide
trend. These "better for you" products enjoy a higher margin than the Company's
classic ice cream and the volume decline had a significant impact on the
Company's profitability in 1998. Finally, in August 1998, Ben & Jerry's informed
the Company of its intention to terminate its distribution contract. Subsequent
negotiations with Ben & Jerry's yielded revisions to the original contract terms
which will reduce the Company's distribution gross margin of Ben & Jerry's
products by approximately 54 percent starting September 1, 1999. The Company
estimates that the markets where it will stop distributing Ben & Jerry's
products contributed approximately 6 percent of its gross margin, or
$13,000,000, in fiscal 1998.
The above factors: the higher dairy costs; the decline in "better for you"
volumes; and the reduction in future Ben & Jerry's sales; had and will have a
negative effect on the Company's gross margin and its ability to successfully
implement the Strategic Plan. The Company, therefore, concluded that a thorough
reassessment of its cost structure and strategy was necessary. This reassessment
yielded a restructuring program designed to improve profitability and accelerate
cost reductions by increasing focus on the core elements of the Strategic Plan.
The reassessment also addressed the need to review the valuation of certain
assets unfavorably impacted by Ben & Jerry's decision to change its distribution
agreement with the Company. On October 16, 1998, the board of directors approved
the restructuring program.
21
35
Management's discussion and analysis
Revision of Ben & Jerry's Distribution Agreement
During the third quarter of fiscal 1998, Ben & Jerry's notified the Company of
its intention to terminate the distribution contract between the Company and Ben
& Jerry's. The Company subsequently entered into negotiations with Ben & Jerry's
to resolve issues associated with the pending termination. In the first quarter
of fiscal 1999, the companies announced that they reached a resolution regarding
these issues by amending the existing distribution agreement and entering into a
new distribution agreement. As a result, the Company will continue to distribute
Ben & Jerry's products until August 31, 1999 in all existing markets, except the
New York metropolitan area (discussion follows in Restructuring Program and
Other Actions), and on terms and conditions different in some respects from
those in place prior to the amendment. The Company will stop distributing Ben &
Jerry's products in New York on April 1, 1999. Starting September 1, 1999, the
Company's distribution gross margin of Ben & Jerry's products will be reduced by
approximately 54 percent under the new distribution agreement. Additionally, Ben
& Jerry's notified the Company of its intention to terminate its separate
distribution agreement with the Company's independent distributor in Texas
(discussion follows in Restructuring Program and Other Actions).
In 1998, the distribution margin on Ben & Jerry's products contributed just
over 11 percent of the Company's total gross margin. The Company estimates that
the distribution gross margin in the markets where it will stop distributing Ben
& Jerry's products later in fiscal 1999 represented approximately 6 percent, or
$13,000,000, of its total gross margin in fiscal 1998. Ultimately the Company
expects to recoup this lost margin through the introduction of its own, higher
margin branded products. The Company does anticipate some transitional negative
financial impact in late fiscal 1999 as the Ben & Jerry's relationship changes
and the Company incurs costs associated with launching its own new products.
Restructuring Program and Other Actions
The implementation of the restructuring program and other actions resulted in a
pre-tax charge to earnings of $59,114,000 in fiscal 1998. This includes
$10,590,000 recorded in the third quarter which related primarily to Ben &
Jerry's actions that occurred in September 1998 and to a severance program,
which management had already begun in advance of board approval of the remainder
of the restructuring program. The remainder of the charges, $48,524,000, was
recorded in the fourth quarter of fiscal 1998.
The five key elements of the restructuring program and other actions are as
follows:
- - The Company decided to exit the equipment manufacturing business associated
with its Grand Soft ice cream unit. The Grand Soft business consists of both ice
cream sales and equipment manufacturing operations. The Company will remain in
the profitable ice cream portion of this business, while exiting the
unprofitable equipment manufacturing operation. In the fourth quarter of fiscal
1998, the Company recorded $8,696,000 in asset impairment charges and $2,258,000
in estimated closing costs associated with the withdrawal from this business.
The Company expects to exit the equipment manufacturing operation by June 1999.
The $8,696,000 charge is included in impairment of long-lived assets in the
Consolidated statement of operations and is comprised of $5,714,000 of goodwill,
$1,956,000 of property, plant and equipment and $1,026,000 of inventory and
other assets. The remaining assets of Grand Soft total $1,762,000 and consist
primarily of trade accounts receivable, which are fully recoverable. The assets
were written down to net realizable value based on an estimate of what an
independent third party would pay for the assets of the business. The charge of
$2,258,000 for closing costs is included in restructuring charges in the
Consolidated statement of operations and a $2,258,000 liability is included in
accounts payable and accrued liabilities in the Consolidated balance sheet, as
no closing costs were paid in fiscal 1998. The closing costs are based on
estimates of legal fees, employee separation payments and expected settlements.
The closing costs include $576,000 of severance related costs for the 23
employees, from all areas of responsibility, who were notified of their pending
termination prior to fiscal year end. The Grand Soft manufacturing operations
generated revenues of $3,093,000, $3,346,000 and $6,007,000 and incurred pre-tax
operating losses of $(2,335,000), $(2,274,000) and $(1,628,000) in fiscal years
1998, 1997 and 1996, respectively.
- - The Company has implemented a program designed to reduce operating expenses
in manufacturing, sales and distribution and administration. Core pieces of this
program include outsourcing of certain non-strategic activities, consolidation
of warehouse facilities and selected reductions in sales and distribution
staffing. The Company completed these actions in the fourth quarter, and
believes that they will improve operating margins without sacrificing market
coverage or sales effectiveness.
- As part of this program, the Company reviewed operations at all of its
manufacturing facilities in order to identify and dispose of under-utilized
assets. As a result of this review, the Company recorded a charge to cost of
goods sold of $5,317,000 in the fourth quarter, related primarily to write down
of manufacturing assets.
In connection with reducing operating expenses for sales and distribution,
the Company recorded $1,042,000 of severance and related charges in the fourth
quarter that are included in the restructuring charges in the Consolidated
statement of operations. A total
22
36
Management's discussion and analysis
of 38 sales and distribution employees were to be terminated under this program.
Of this total, 16 were terminated in fiscal 1998 and paid $153,000 in severance
benefits. The remaining 22 employees were notified of their pending termination
prior to fiscal year end. An accrual for severance benefits of $889,000 was
outstanding at year end. The Company also recorded a $933,000 charge to cost of
goods sold in the third quarter for severance actions begun in advance of board
approval of the remainder of the restructuring program. The Company paid
$514,000 of these severance benefits in fiscal 1998, leaving a liability of
$419,000 at fiscal year end which is included in accounts payable and accrued
liabilities in the Consolidated balance sheet.
In addition, the Company charged to expense $4,478,000 of previously
capitalized costs classified as property, plant and equipment associated with
the expansion of its headquarters, as the expansion plan was canceled in an
effort to reduce future administration costs. The $4,478,000 charge was based on
a third party independent appraisal of the fair market value of the related real
property and is included in impairment of long-lived assets on the Consolidated
statement of operations.
- - The Company, in carrying out its national expansion program, made significant
investments to support an aggressive expansion in Texas. These investments,
while building sales volume, delivered results below expectations. The Company
is now modifying this expansion strategy in order to concentrate on more
profitable opportunities. The objective in Texas will be to preserve volumes
while seeking margin improvement. As a result of this change in strategy, the
Company will realize substantially lower production volumes over the remaining
useful life of its Texas manufacturing plant than originally contemplated. The
Company has therefore concluded that its investment in the Texas plant is
non-recoverable and has recorded an impairment charge of $16,200,000 in the
fourth quarter to reduce the net book value of the plant to its estimated fair
market value. The $16,200,000 impairment charge was based on a third party
independent appraisal and is included in impairment of long-lived assets in the
Consolidated statement of operations.
- - Ben & Jerry's indicated its intent to terminate its separate distribution
agreement with the Company's independent distributor in Texas, (the Texas
Distributor), in which the Company has a 16 percent minority equity interest.
Ben & Jerry's action placed at significant risk the recoverability of the
Company's equity investment, distribution rights, and trade receivables relating
to this distributor. In the third quarter of fiscal 1998, the Company recorded a
bad debt provision of $5,000,000 relating to the trade receivables, when
originally notified of the Ben & Jerry's decision. The $5,000,000 bad debt
provision is included in selling, general and administrative expenses in the
Consolidated statement of operations. In light of Ben & Jerry's plans to
terminate its relationship with the Texas Distributor and the previously noted
change in the Company's Texas strategy, the Company evaluated the recoverability
of all assets associated with the Texas Distributor. Accordingly, in addition to
the accounts receivable reserve recorded in the third quarter, the Company
recorded additional charges of $10,533,000 in the fourth quarter related to the
impairment of its minority equity investment and distribution rights associated
with the Company's contract with the Texas Distributor. The Company concluded
that these assets were unrecoverable due to the substantially reduced profits
and cash flow resulting from Ben & Jerry's decision to terminate the Texas
Distributor's distribution agreement. The $10,533,000 charge is comprised of
$9,449,000 of distribution rights and $1,084,000 of the equity investment and is
included in impairment of long-lived assets in the Consolidated statement of
operations.
- - Due to the notice of termination from Ben & Jerry's, the Company charged to
expense $4,657,000 of unamortized portion of distribution rights related to the
acquisition of the Ben & Jerry's New York distributor. The Company acquired this
business in fiscal 1989, in the development of its long-standing relationship
with Ben & Jerry's. The other tangible assets of this business have been merged
with the Company's New York operations and are fully recoverable. This charge
was recorded in the third quarter of fiscal 1998 and is included in impairment
of long-lived assets in the Consolidated statement of operations.
23
37
Management's discussion and analysis
The following table summarizes the classification of the charges in the
Consolidated statement of operations related to the restructuring program and
other actions:
1998
--------------------------------------------
(In thousands) Third Quarter Fourth Quarter Full Year
------------- -------------- ---------
Restructuring charges:
Grand Soft $ $ 2,258 $ 2,258
Sales and distribution
severance 1,042 1,042
------- ------- -------
3,300 3,300
------- ------- -------
Impairment of long-lived assets:
Grand Soft 8,696 8,696
Texas plant 16,200 16,200
Texas independent
distributor 10,533 10,533
Ben & Jerry's revision 4,657 4,657
Headquarters' expansion 4,478 4,478
------- ------- -------
4,657 39,907 44,564
------- ------- -------
Other charges:
Texas independent
distributor 5,000 5,000
Sales and distribution
severance 933 933
Asset disposals 5,317 5,317
5,933 5,317 11,250
------- ------- -------
$10,590 $48,524 $59,114
======= ======= =======
The following table summarizes the accruals included in accounts payable and
accrued liabilities in the Consolidated balance sheet related to the
restructuring program and other actions:
(In thousands) 1998
------
Restructuring accruals:
Grand Soft $2,258
Sales and distribution severance 889
------
3,147
------
Other accruals:
Sales and distribution severance 419
------
$3,566
======
The Company anticipates an improvement in pre-tax income of approximately
$14,000,000 in fiscal 1999 as a result of the restructuring program and other
actions. The $14,000,000 will be realized through reduced depreciation and
amortization expense of approximately $5,300,000 and reduced salaries and
operating expenses of approximately $9,700,000. In addition, the Company
anticipates that cash inflows from tax deductions and proceeds from asset sales
will more than offset the cash costs of the restructuring program and other
actions.
Risks and Uncertainties
Certain statements contained in this Annual Report are forward-looking
statements made pursuant to the Private Securities Litigation Reform Act of
1995. Such forward-looking statements involve known and unknown risks and
uncertainties, which may cause the Company's actual actions or results to differ
materially from those contained in the forward-looking statements.
The Company believes that the benefits under the Strategic Plan will be
realized in future years, although no assurance can be given that the
expectations relative to future market share and earnings benefits of the
strategy will be achieved. Specific factors that might cause such a difference
include, but are not limited to, the Company's ability to achieve the cost
reductions anticipated from its restructuring program and to achieve
efficiencies in its manufacturing and distribution operations without negatively
affecting sales, the cost of dairy and other commodities used in the Company's
products, competitors' marketing and promotion responses, market conditions
affecting the price of the Company's products, the Company's ability to increase
sales of its own branded products, and responsiveness of the trade and consumers
to the Company's new products and increased marketing and promotional expenses.
Adoption of New Accounting Standard
The Company is required to adopt the Accounting Standards Executive Committee's
Statement of Position 98-5, "Reporting on the Costs of Start-Up Activities" (SOP
98-5) in the first quarter of fiscal 1999. SOP 98-5 requires that the costs of
start-up activities, including preoperating costs, should be expensed as
incurred. The Company has capitalized preoperating costs such as those incurred
during the construction and start-up of new manufacturing and distribution
facilities and introductory allowances paid to customers. These costs are
amortized over one to three years. As a result of adopting SOP 98-5, the Company
will expense unamortized preoperating costs in the first quarter of fiscal 1999
as a cumulative effect of a change in accounting principle. The Company does not
expect the adoption of SOP 98-5 to have a material adverse effect on its
financial position.
24
38
Management's discussion and analysis
Fiscal 1998 Compared with Fiscal 1997
Consolidated sales for fiscal 1998 increased 5 percent, or $52,238,000, to
$1,022,335,000 from $970,097,000 for fiscal 1997. Sales of the Company's branded
products were 5 percent, or $29,344,000, higher than fiscal 1997, as a result of
higher unit sales and increased selling prices. The products that led this
increase were Dreyer's and Edy's Homemade Ice Cream and Dreyer's and Edy's Grand
Ice Cream, offset by significant declines in the Company's "better for you"
frozen yogurt, sugar free, reduced fat and fat free products. The higher sales
were due in part to the effect of a significant increase in trade promotion
spending. The average national dollar market share of the Company's Dreyer's and
Edy's branded products was 15.5 percent, in the final quarters of 1998 and 1997.
Sales of other companies' branded products (partner brands) increased 7 percent,
led by Ben & Jerry's Homemade(R) superpremium products. Sales of partner brands
represented 37 percent of consolidated sales in fiscal 1998 compared with 36
percent in fiscal 1997. Wholesale prices for the Company's branded products
increased approximately 2 percent, before the effect of increased trade
promotion expense. The effect of price increases for partner brands was
approximately 4 percent.
Other income increased $659,000, or 22 percent, due to higher earnings from a
joint venture accounted for under the equity method.
Cost of goods sold increased $63,311,000, or 8 percent, over fiscal 1997,
while the overall gross margin decreased from 21.2 percent to 19.0 percent. The
gross margin decreased due to dairy costs that were approximately $22,000,000
higher than fiscal 1997 dairy costs.
Selling, general and administrative expenses increased from 19 percent of
sales for fiscal 1997 to 21 percent of sales for fiscal 1998. The increase of
$28,761,000, or 16 percent in fiscal 1998 compared with fiscal 1997, related
primarily to both significantly higher trade promotion and the establishment of
a $5,000,000 reserve for trade receivables relating to an independent
distributor. (See Note 3 of Notes to consolidated financial statements.)
Interest expense was $2,311,000, or 22 percent, higher in fiscal 1998 than
fiscal 1997, due primarily to higher average borrowings on the Company's line of
credit.
Fiscal 1997 Compared with Fiscal 1996
Consolidated sales for fiscal 1997 increased 23 percent, or $178,256,000, to
$970,097,000 from $791,841,000 for fiscal 1996. Sales of the Company's branded
products were 25 percent, or $124,776,000, higher than fiscal 1996 and accounted
for the majority of the overall sales increase. The increase in sales of the
Company's branded products related primarily to higher unit sales in all
markets. The products that led this increase were Dreyer's and Edy's Grand Ice
Cream, Dreyer's and Edy's Homemade Ice Cream, Starbucks(R) Ice Cream, and
Dreyer's and Edy's Grand Light(R) Ice Cream. These higher sales were due in part
to the effect of a significant increase in trade promotion spending. The average
national dollar market share of the Company's Dreyer's and Edy's branded
products increased to 15.5 percent in the final quarter of 1997 from 13.3
percent for the same period in 1996. Sales of other companies' branded products
(partner brands) increased 18 percent, led by Healthy Choice(R) low fat ice
cream from Con Agra, Inc., Ben & Jerry's Homemade(R) superpremium products, and
frozen novelty and ice cream products from Nestle Ice Cream Company. Sales of
partner brands represented 36 percent of consolidated sales in fiscal 1997
compared with 38 percent in fiscal 1996. Wholesale prices for the Company's
branded products increased approximately 3 percent, before the effect of
increased trade promotion expense. The effect of price increases for partner
brands was not significant.
Other income decreased $1,360,000, or 31 percent, due to the sale of
trademark rights for the People's Republic of China, Hong Kong and Macau to a
third-party distributor for $2,600,000 in fiscal 1996 (see Note 14 of Notes to
consolidated financial statements), partially offset in fiscal 1997 by higher
earnings from a joint venture accounted for under the equity method.
Cost of goods sold increased $135,266,000, or 22 percent, over fiscal 1996,
while the overall gross margin increased to 21.2 percent from 20.5 percent. The
gross margin increased due to higher margins on Company's branded products, and
a comparatively higher proportion of those sales (which carry a higher margin
than partner brands), offset slightly by a decrease in partner brand gross
margin due to changes in product mix. The improvement in the gross margin on the
Company's branded products was due to lower dairy costs in fiscal 1997 as
compared to fiscal 1996. The Company recorded a pre-tax gain of $2,355,000
resulting from various insurance claims during fiscal 1997, which was recorded
as a reduction in cost of goods sold. (See Note 14 of Notes to consolidated
financial statements.) These insurance gains are largely non-recurring and as
such may not be available in future periods.
Selling, general and administrative expenses increased from 18 percent of
sales for fiscal 1996 to 19 percent of sales for fiscal 1997. The increase of
$37,387,000, or 26 percent, related primarily to significantly higher trade
promotion expenses in fiscal 1997 compared with fiscal 1996.
Interest expense was $1,147,000, or 12 percent, higher in fiscal 1997 than
fiscal 1996 due primarily to additional interest expense from the issuance of
senior notes in the second quarter of fiscal 1996, partially offset by a
reduction in interest expense on the Company's line of credit due to lower
average borrowings.
25
39
Management's discussion and analysis
Tax Provisions
The Company's income tax provisions differ from tax provisions calculated using
the federal statutory tax rate primarily due to tax credits, state income taxes
and the reversal of income taxes provided in prior periods. (See Note 7 of Notes
to consolidated financial statements.)
Seasonality
The Company experiences more demand for its products during the spring and
summer than during the fall and winter. (See Note 16 of Notes to consolidated
financial statements.)
Effects of Inflation and Changing Prices
The largest component of the Company's cost of production is raw materials,
principally dairy products and sugar. Historically, the Company has been able to
compensate for increases in the price level of these commodities through
manufacturing and distribution operating efficiencies. However, in fiscal 1998,
unusually high dairy costs negatively impacted the Company's gross margin by
approximately $22,000,000 as compared to fiscal 1997. In fiscal 1997, dairy
prices decreased resulting in an improvement in gross margin of approximately
$3,800,000 when compared to fiscal 1996. Other cost increases such as labor and
general administrative costs have been offset by productivity gains and other
operating efficiencies.
Market Risk
The Company has long-term debt with both fixed and variable interest rates. As a
result, the Company is exposed to market risk caused by fluctuations in interest
rates. The following summarizes the Company's long-term debt interest rates at
December 26, 1998:
Balance at Interest
($ in thousands) Dec. 26, 1998 Rates
- ---------------- ------------- -----
Fixed Interest Rates:
Senior notes $50,000 7.68-8.34%
Senior notes 10,600 9.3%
Variable Interest Rates:
Revolving line of credit $99,800 6.20%
Capital lease obligation 13,136 6.06%
Industrial revenue bonds 4,500 3.40%
=======
If interest rates increased ten percent, the Company's annual interest
expense would increase approximately $714,000.
The Company does not have short-term or long-term investments. Additionally,
the Company does not transact business in foreign currencies. As such, the
Company is not at risk due to fluctuations in foreign exchange rates.
Financial Condition
- --------------------------------------------------------------------------------
Liquidity and Capital Resources
The Company's operations provided cash flow of $29,196,000 during fiscal 1998
compared with $39,040,000 and $33,260,000 provided in fiscal 1997 and fiscal
1996, respectively. Working capital of the Company decreased to $61,059,000 in
fiscal 1998 compared with $78,576,000 and $70,136,000 during fiscal 1997 and
fiscal 1996, respectively.
The Company continued to expand its manufacturing capacity and
direct-store-delivery distribution system through investments of $35,078,000 in
property, plant and equipment during fiscal 1998 compared with $38,470,000 and
$58,470,000 during fiscal 1997 and fiscal 1996, respectively. The Company plans
to spend approximately $17,000,000 during fiscal 1999 on property, plant and
equipment primarily for further expansion of its manufacturing capacity,
construction of distribution facilities and replacement of delivery vehicles. It
is anticipated that these additions will be largely financed through internally
generated funds and borrowings.
The Company's financing activities provided cash of $4,001,000 during fiscal
1998 compared with cash used of $662,000 during fiscal 1997 and cash provided of
$28,513,000 during fiscal 1996. During fiscal 1998, borrowings of $12,400,000 on
the Company's line of credit and cash flows from operations were used to both
make $8,641,000 of scheduled payments on the Company's other debt and to pay
$3,950,000 in cash dividends to common and preferred stockholders. During fiscal
1997, borrowings of $11,700,000 on the Company's line of credit and cash flows
from operations were used to both make $9,070,000 of scheduled payments on the
Company's other debt and $7,833,000 in cash dividends to common and preferred
stockholders. During fiscal 1996, $50,000,000 of proceeds from the issuance of
senior notes and the completion of a $26,000,000 lease transaction involving the
majority of its direct-store-delivery truck fleet provided cash used for both
investments in property, plant and equipment and to reduce borrowings on the
Company's long-term line of credit. (See Note 8 of Notes to consolidated
financial statements.)
Refer to the Consolidated statement of cash flows for the components of
increases and decreases in cash and cash equivalents for the three year period
ended December 26, 1998.
On October 3, 1997, the Company converted its redeemable convertible Series B
preferred stock to redeemable convertible Series A preferred stock. (See Note 10
of Notes to consolidated financial statements.)
On November 18, 1997, the Company issued shares of common stock to holders of
record on October 30, 1997 to effect a two-for
26
40
Management's discussion and analysis
one common stock split. (See Note 11 of Notes to consolidated financial
statements.)
Nestle has stock warrants to purchase 2,000,000 shares of common stock at $16
per share, exercisable at any time prior to their expiration on June 14, 1999.
During fiscal 1996, the Company acquired the remaining 50.3 percent of the
outstanding common stock of M-K-D for 320,000 newly issued shares of its common
stock* having a value of $10,800,000. (See Note 6 of Notes to consolidated
financial statements.)
As of December 26, 1998, the Company had deferred tax assets relating to net
operating losses (NOL) carryforwards, alternative minimum tax and research tax
credit carryforwards. The pre-tax federal NOL carryforwards $3,647,000 expire in
2018. The research tax credit carryforwards of $2,334,000 expire between 2012
and 2018. The alternative minimum tax carryforwards of $4,398,000 can be carried
forward indefinitely, as they do not expire. Utilization of these carryforwards
may be limited in the event of a change in ownership of the Company. No
valuation allowance for these assets has been recorded because the Company
believes that it is more likely than not that these carryforwards will be used
in future years to offset taxable income. (See Note 7 of Notes to consolidated
financial statements.)
The Company's inventory is maintained at the same general level relative to
sales throughout the year by adjusting production and purchasing schedules to
meet demand. The ratio of inventory to sales typically does not vary
significantly from year to year.
The Company reviewed its restructuring program and other actions with its
various banks and private lenders and secured modifications to its debt
agreements required as a result of the restructuring program. These
modifications will result in higher interest rates on certain debt securities
during fiscal 1999, which the Company believes will be more than offset by lower
borrowings.
The Company anticipates that the restructuring program and other actions will
enhance its cash flow, both through short-term tax benefits, which will more
than offset any pre-tax cash outflows, and through longer-term savings in its
cost structure. The Company also has completed a phase of capital investment
required to support geographical expansion, and will reduce its capital spending
in fiscal 1999.
The Company's Series A redeemable convertible preferred stock, par value
$100,752,000, is convertible at any time at the option of the holder into
5,800,000 newly issued shares of common stock of the Company. The holder may
instead redeem the issue for cash at par value on June 30, 2001. The Company
presently anticipates that it would fund such a redemption from operating cash
flows, borrowings or other financing sources.
As of fiscal year-end 1998, the Company had $1,171,000 in cash and cash
equivalents, and an unused credit line of $75,200,000. (See Note 8 of Notes to
consolidated financial statements.) The current credit line expires on December
31, 2000. The Company believes that its credit line, along with its liquid
resources, internally generated cash and financing capacity are adequate to meet
anticipated operating and capital requirements.
Year 2000 Compliance
The Company is in the process of addressing its Year 2000 compliance. Critical
centralized information systems (software and hardware) are either being
upgraded or enhanced for Year 2000 compliance. The Company expects to complete
the upgrades or enhancements to its centralized information systems by June
1999. Embedded chip technology used in the Company's manufacturing systems is
also being reviewed to determine if upgrades or enhancements are necessary. The
Company expects to complete the embedded chip review process by March 1999. The
Company is also surveying key customers and suppliers to determine the status of
their Year 2000 compliance programs. The survey process is scheduled for
completion by mid-year 1999.
The Company believes the Year 2000 issue does not pose a significant
operational or financial risk. The Company has only one customer comprising 10
percent of sales. The Company also has a broad base of suppliers with multiple
sourcing options for all purchases. Nevertheless, the Company is in the process
of developing appropriate contingency plans in an attempt to minimize the effect
of any issues that may arise from the failure of the Company, its suppliers or
its customers to complete Year 2000 compliance work. The Company believes that
it will complete the contingency plan by the third quarter of fiscal 1999.
The Company's assessment of the Year 2000 issue is based upon certain
assumptions that may later prove to be inaccurate. The greatest potential risks
relate to those situations beyond the Company's control, particularly the
inability of suppliers and customers to be Year 2000 compliant, which would
cause disruptions in the manufacturing and distribution operations.
Additionally, customers' inability to pay in a timely manner and the disruption
of electronic invoicing and payment systems could cause financial risk and
losses to the Company. The Company expects to be able to more fully enumerate
the operational and financial risks from the Year 2000 issue upon completion of
the reviews discussed above.
The total cost for the Company's Year 2000 initiatives is estimated to be
$6,000,000 of which $3,500,000 was incurred during fiscal 1998 and $2,500,000
will be incurred during fiscal 1999. The majority of these costs relate to the
accelerated replacement of capitalized hardware and software systems. The
Company's cost estimates do not include costs that may result from the failure
of third parties to be Year 2000 compliant or the costs to implement contingency
plans. The Company does not expect the cost of Year 2000 compliance to have a
material impact on the Company's financial position, results of operations or
cash flows.
* The share information is presented before the effect of the 1997 common stock
split. (See Note 11.)