UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
-------------------------------------------------
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________________ to ____________________________
Commission File Number: 0-15638
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MICHAEL FOODS, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Minnesota 41-0498850
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
Suite 324, Park National Bank Building
5353 Wayzata Boulevard
Minneapolis, MN 55416
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip code)
(612) 546-1500
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [X] Yes [ ] No
The number of shares outstanding of the registrant's Common Stock,
$.01 par value, as of November 2, 1998 was 21,209,848 shares.
1
<PAGE>
PART I - FINANCIAL INFORMATION
MICHAEL FOODS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
<TABLE>
<CAPTION>
=======================================================================================================
September 30, December 31,
ASSETS 1998 1997
- ------ ------------- -------------
<S> <C> <C>
CURRENT ASSETS
Cash and equivalents $ 3,587,000 $ 4,038,000
Accounts receivable, less allowances 87,054,000 83,495,000
Inventories 81,987,000 68,929,000
Prepaid expenses and other 3,153,000 1,676,000
------------- -------------
Total current assets 175,781,000 158,138,000
PROPERTY, PLANT AND EQUIPMENT-AT COST
Land 4,336,000 4,336,000
Buildings and improvements 102,071,000 99,023,000
Machinery and equipment 318,543,000 274,980,000
------------- -------------
424,950,000 378,339,000
Less accumulated depreciation 182,363,000 160,800,000
------------- -------------
242,587,000 217,539,000
OTHER ASSETS
Goodwill, net 121,033,000 123,711,000
Other 4,171,000 4,267,000
------------- -------------
125,204,000 127,978,000
------------- -------------
$ 543,572,000 $ 503,655,000
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES
Current maturities of long-term debt $ 9,521,000 $ 8,509,000
Accounts payable 49,136,000 46,910,000
Accrued compensation 10,117,000 10,064,000
Accrued insurance 6,704,000 4,782,000
Discounts and allowances 20,756,000 15,217,000
Other accrued expenses 19,818,000 17,868,000
------------- -------------
Total current liabilities 116,052,000 103,350,000
LONG-TERM DEBT, less current maturities 153,942,000 137,519,000
DEFERRED INCOME TAXES 35,873,000 33,540,000
CONTINGENCIES -- --
SHAREHOLDERS' EQUITY
Common stock, $.01 par value, 40,000,000 shares authorized,
shares issued 21,200,655 at September 30, 1998 and 21,816,098
at December 31, 1997 212,000 218,000
Additional paid-in capital 122,295,000 140,188,000
Retained earnings 115,198,000 88,840,000
------------- -------------
237,705,000 229,246,000
------------- -------------
$ 543,572,000 $ 503,655,000
============= =============
=======================================================================================================
</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
<PAGE>
MICHAEL FOODS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
Three Months Ended September 30, (Unaudited)
================================================================================
1998 1997
------------- -------------
Net sales $ 253,790,000 $ 245,868,000
Cost of sales 210,357,000 207,514,000
------------- -------------
Gross profit 43,433,000 38,354,000
Selling, general and administrative expenses 22,660,000 17,184,000
------------- -------------
Operating profit 20,773,000 21,170,000
Interest expense, net 2,637,000 2,673,000
------------- -------------
Earnings before income tax expense 18,136,000 18,497,000
Income tax expense 7,620,000 7,669,000
------------- -------------
NET EARNINGS $ 10,516,000 $ 10,828,000
============= =============
Earnings per share
Basic $ 0.49 $ 0.50
Diluted $ 0.48 $ 0.49
============= =============
Weighted average shares outstanding
Basic 21,627,000 21,583,000
Diluted 21,922,000 21,947,000
============= =============
================================================================================
See accompanying notes to condensed consolidated financial statements.
3
<PAGE>
MICHAEL FOODS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
Nine Months Ended September 30, (Unaudited)
================================================================================
1998 1997
------------- -------------
Net sales $ 743,064,000 $ 679,147,000
Cost of sales 615,021,000 577,603,000
------------- -------------
Gross profit 128,043,000 101,544,000
Selling, general and administrative expenses 68,175,000 54,029,000
------------- -------------
Operating profit 59,868,000 47,515,000
Interest expense, net 7,981,000 7,954,000
------------- -------------
Earnings before income tax expense 51,887,000 39,561,000
Income tax expense 21,800,000 16,419,000
------------- -------------
NET EARNINGS $ 30,087,000 $ 23,142,000
============= =============
Earnings per share
Basic $ 1.38 $ 1.10
Diluted $ 1.36 $ 1.09
============= =============
Weighted average shares outstanding
Basic 21,804,000 20,977,000
Diluted 22,156,000 21,201,000
============= =============
================================================================================
See accompanying notes to condensed consolidated financial statements.
4
<PAGE>
MICHAEL FOODS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, (Unaudited)
<TABLE>
<CAPTION>
====================================================================================================
1998 1997
------------- -------------
<S> <C> <C>
Net cash provided by operating activities $ 53,837,000 $ 65,937,000
Cash flows from investing activities:
Capital expenditures (49,579,000) (24,841,000)
Business acquisitions, net of cash acquired, and other assets 96,000 (43,139,000)
------------- -------------
Net cash used in investing activities (49,483,000) (67,980,000)
Cash flows from financing activities:
Payments on notes payable and long-term debt (15,965,000) (227,973,000)
Proceeds from notes payable and long-term debt 33,400,000 223,656,000
Proceeds from issuance of common stock 2,844,000 10,613,000
Purchase of shares (21,355,000) --
Cash dividends (3,729,000) (3,096,000)
------------- -------------
Net cash (used in) provided by financing activities (4,805,000) 3,200,000
------------- -------------
Net increase (decrease) in cash and equivalents (451,000) 1,157,000
Cash and equivalents at beginning of year 4,038,000 2,585,000
------------- -------------
Cash and equivalents at end of period $ 3,587,000 $ 3,742,000
============= =============
NON-CASH INVESTING AND FINANCING TRANSACTIONS
Acquisition:
Cash paid, net of cash acquired $ 42,720,000
Stock issued 38,859,000
Fair value of assets acquired (82,405,000)
Liabilities assumed 73,874,000
-------------
Purchase price in excess of fair value of assets acquired $ 73,048,000
=============
In connection with the merger in 1997 with North Star Universal, Inc., Michael Foods, Inc. (the
"Company") assumed $21,250,000 of net indebtedness and effectively repurchased 1,783,036 shares of
its Common Stock (see Note D).
====================================================================================================
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE>
MICHAEL FOODS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
(Unaudited)
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with Regulation S-X pursuant to the rules and regulations
of the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations, although management believes that the
disclosures are adequate to make the information presented not misleading.
The Company utilizes a fiscal year consisting of either 52 or 53 weeks, ending
on the Saturday nearest to December 31 each year. The quarters ended September
30, 1998 and 1997 each included thirteen weeks of operations and the three
quarters ended September 30, 1998 and 1997 each included 39 weeks of operations.
For clarity of presentation, the Company has described all periods presented as
if the quarter ended on September 30.
In the opinion of management, the unaudited condensed consolidated financial
statements contain all adjustments (consisting of only normal recurring
adjustments) necessary to present fairly the financial position as of September
30, 1998 and the results of operations for the three and nine month periods
ended September 30, 1998 and 1997 and cash flows for the nine months ended
September 30, 1998 and 1997. The results of operations for the nine months ended
September 30, 1998 are not necessarily indicative of the results for the full
year.
The Company's basic net earnings per share is computed by dividing net earnings
by the weighted average number of outstanding common shares. The Company's
diluted net earnings per share is computed by dividing net earnings by the
weighted average number of outstanding common shares and common share
equivalents relating to stock options, when dilutive. Options to purchase 20,000
and 10,678 shares of Common Stock, with weighted average exercise prices of
$29.31 and $29.43, which were outstanding during the three and nine month
periods ended September 30, 1998, were excluded from the computation of common
share equivalents for those periods because they were anti-dilutive. There were
no anti-dilutive options outstanding during the three month period ended
September 30, 1997. Options to purchase 323,068 shares of Common Stock, with a
weighted average exercise price $14.08, which were outstanding during the nine
month period ended September 30, 1997, were excluded from the computation of
common share equivalents for that period because they were anti-dilutive.
NOTE B - NEW ACCOUNTING PRONOUNCEMENT
The Financial Accounting Standards Board has issued SFAS No. 131 "Disclosures
about Segments of an Enterprise and Related Information." This statement
requires companies to disclose financial and other information about their
business segments as part of their consolidated financial statements. The
Company will include the required business segment disclosures in its 1998
annual report.
NOTE C - INVENTORIES
Inventories, other than flocks, are stated at the lower of cost (determined on a
first-in, first-out basis) or market. Flock inventory represents the cost of
purchasing and raising flocks to laying maturity, at which time their cost is
amortized to operations over their expected useful life of generally one to two
years, assuming no salvage value.
6
<PAGE>
MICHAEL FOODS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
================================================================================
(Unaudited)
NOTE C - INVENTORIES, cont.
Inventories consist of the following:
September 30, December 31,
1998 1997
----------- -----------
Raw materials and supplies $14,556,000 $16,047,000
Work in process and finished goods 41,040,000 30,374,000
Flocks 26,391,000 22,508,000
----------- -----------
$81,987,000 $68,929,000
=========== ===========
NOTE D - ACQUISITION OF PAPETTI'S, MERGER WITH NORTH STAR UNIVERSAL AND ISSUANCE
OF LONG-TERM DEBT
On February 26, 1997, the Company completed the acquisition of Papetti's Hygrade
Egg Products, Inc. and affiliated entities (collectively "Papetti's"). The
acquisition was accounted for as a purchase with the results of Papetti's
operations included with the Company's from the date of acquisition. Total
consideration included the issuance of 3,195,455 shares of newly issued Common
Stock valued at $38,859,000, $44,315,000 in cash and closing costs, and the
assumption of $22,825,000 of notes payable and long-term debt.
On February 28, 1997, the Company completed a merger with North Star Universal,
Inc. ("NSU"). The merger was accounted for as a reverse acquisition utilizing
the purchase method of accounting. As a result of the merger, NSU delivered
approximately $21,250,000 of net subordinated indebtedness together with
1,783,036 shares of Common Stock of approximately equal value, which the Company
effectively retired in the form of a treasury stock redemption.
In February 1997, the Company issued $125,000,000 of 7.58% senior indebtedness
to finance the cash portion of the Papetti's acquisition, to retire a portion of
the Company's existing debt and to refinance the debt assumed in the Papetti's
acquisition and NSU merger.
The following unaudited pro forma statement of earnings information has been
prepared assuming the Papetti's acquisition, the merger with NSU and the
issuance of the senior indebtedness had occurred on January 1, 1997:
For the Nine months ended September 30, 1997
- -----------------------------------------------------------------
Net sales $727,742,000
Net earnings 23,695,000
Earnings per share
Basic $ 1.11
Diluted $ 1.10
============
This unaudited pro forma information is not necessarily indicative of the
combined results of operations that would have occurred had the acquisition,
merger and issuance of debt occurred on January 1, 1997, nor are they indicative
of the results which may occur in the future.
7
<PAGE>
MICHAEL FOODS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
================================================================================
(Unaudited)
NOTE E - COMMITMENTS AND CONTINGENCIES
Use of Estimates
Preparation of the Company's consolidated financial statements requires
management to make estimates and assumptions that affect reported amounts of
assets and liabilities and related revenues and expenses. Actual results could
differ from the estimates used by management.
License Agreement
The Company has an exclusive license agreement for a patented process for the
production and sale of extended shelf-life egg products. Under the license
agreement, the Company has the right to defend and prosecute infringement of the
licensed patents. The U.S. Federal Court of Appeals has upheld the validity of
the patents subject to the license agreement, but, subsequently, a patent
examiner at the U.S. Patent and Trademark Office rejected the patents. The
Company is appealing the decision of the examiner and believes the validity of
the patents will ultimately be upheld. During the appeal process, the patents
remain valid and in full force and effect. These patents are scheduled to expire
in 2006.
Litigation
The Company is engaged in routine litigation incidental to its business, which
management believes will not have a material effect upon its consolidated
financial position, liquidity or results of operations.
NOTE F - SHAREHOLDERS' EQUITY
During the three months ended September 30, 1998 the Company repurchased 868,700
shares of Common Stock under a Board of Directors authorized share repurchase
program.
8
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
================================================================================
THREE MONTHS ENDED SEPTEMBER 30, 1998 VS THREE MONTHS ENDED SEPTEMBER 30, 1997,
CONT.
RESULTS OF OPERATIONS
The following table sets forth the percentage of net sales accounted for by each
of the Company's operating divisions for the periods indicated:
Three Months Ended Sept. 30,
----------------------------
1998 1997
---- ----
Egg Products 60% 65%
Refrigerated Distribution 21 21
Dairy Products 16 12
Potato Products 5 5
Intercompany Sales (2) (3)
---- ----
TOTAL 100% 100%
==== ====
The following table sets forth the percentage of divisional operating earnings
(before corporate, interest and income tax expenses) accounted for by each of
the Company's operating divisions for the periods indicated:
Three Months Ended Sept. 30,
----------------------------
1998 1997
---- ----
Egg Products 77% 75%
Refrigerated Distribution 9 10
Dairy Products 10 13
Potato Products 4 2
---- ----
TOTAL 100% 100%
==== ====
The Egg Products Division had lower dollar sales and higher dollar earnings in
the period ended September 30, 1998, as compared to the results of the same
period in 1997. Unit sales gains in most product lines were more than offset by
lower per unit selling prices for certain egg products. Earnings reflected, in
part, favorable spot market egg costs and lower feed costs. Sales were
particularly strong for precooked frozen omelets, patties and curds. Egg prices
decreased approximately 5% compared to third quarter 1997 levels, as reported by
Urner Barry Publications - a widely quoted industry pricing service, although
pricing for egg products, particularly value-added egg products, is not
necessarily directly affected by changes in shell egg pricing. Approximately
two-thirds of the Division's annual egg needs are purchased under contracts, or
in the spot market, where such egg cost is determined largely by market pricing
as reported by Urner Barry. Approximately one-third of annual egg needs are
sourced from internal flocks, where feed costs typically represent roughly
two-thirds of the cost of producing such eggs. Feed costs were lower in the 1998
period than in the 1997 period, due to lower prices for both corn and soybean
meal.
The Refrigerated Distribution Division had higher dollar sales and lower dollar
earnings in the period ended September 30, 1998, as compared to the results of
the same period in 1997. Unit sales were flat for core refrigerated grocery
items, reflecting the loss of two grocery chain accounts - one to a low priced
competitor, the other due to a customer's restructuring - earlier in the year,
and the impact of historically high cheese and butter retail price points on
consumer demand. A sharp rise in butter fat market prices during the 1998 period
also had an impact on profitability, as product sourcing costs rose more rapidly
than did retail selling prices for products such as cheese and butter.
9
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
================================================================================
THREE MONTHS ENDED SEPTEMBER 30, 1998 VS THREE MONTHS ENDED SEPTEMBER 30, 1997,
CONT.
RESULTS OF OPERATIONS, CONT.
The Dairy Products Division had higher dollar sales and lower dollar earnings in
the period ended September 30, 1998, as compared to the results of the same
period in 1997. Unit sales increased sharply and were helped by a stronger dairy
products focus by certain customers, particularly in the quick service
restaurant segment, and by a growing coffee creamer business. Dollar sales also
were affected by a sharp rise in the dairy ingredients market, which, under the
Division's cost-plus pricing arrangement with most customers, raised per unit
selling prices significantly. Raw material costs rose substantially during the
1998 period due to increases in the pricing of certain ingredients tied to the
national butter fat market, which caused margins to decline. The Division also
experienced higher than normal operating costs due to strong volume growth.
The Potato Products Division had higher dollar sales and higher dollar earnings
in the period ended September 30, 1998, as compared to the results of the same
period in 1997. The discontinuation of the sale of frozen potato products in
mid-1997 has allowed for an increased focus on the remaining refrigerated potato
products lines. The increased attention focused on plant operations and sales
volumes had a favorable impact on the Division's financial results in the 1998
period. Sales volumes increased in the 1998 period as compared to the 1997
period and operating efficiencies in the main plant were much improved
year-over-year, resulting in the improved financial results.
The increase in gross profit margin of the Company for the period ended
September 30, 1998, as compared to the results of the same period in 1997,
reflected the factors discussed above, particularly the strength of the Egg
Products Division operations and higher profitability in the Potato Products
Division. It is management's strategy to increase value-added product sales as a
percent of total sales over time, while decreasing commodity-sensitive products'
contribution to consolidated sales. These efforts historically have been
beneficial to gross profit margins in most periods. Selling, general and
administrative expenses increased as a percent of sales in the period ended
September 30, 1998, as compared to the results of the same period in 1997.
Expenses increased largely due to higher marketing support for foodservice
selling efforts and spending to support the Company's information systems
upgrade project. Also, the 1997 period included a non-recurring gain of
approximately $1.3 million pretax resulting from the disposition of french fry
production assets.
NINE MONTHS ENDED SEPTEMBER 30, 1998 VS NINE MONTHS ENDED SEPTEMBER 30, 1997
RESULTS OF OPERATIONS
The following table sets forth the percentage of net sales accounted for by each
of the Company's operating divisions for the periods indicated:
Nine Months Ended Sept. 30,
---------------------------
1998 1997
---- ----
Egg Products 62% 62%
Refrigerated Distribution 21 23
Dairy Products 14 11
Potato Products 5 7
Intercompany Sales (2) (3)
---- ----
TOTAL 100% 100%
==== ====
10
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
================================================================================
NINE MONTHS ENDED SEPTEMBER 30, 1998 VS NINE MONTHS ENDED SEPTEMBER 30, 1997,
CONT.
RESULTS OF OPERATIONS, CONT.
The following table sets forth the percentage of divisional operating earnings
(before corporate, interest and income tax expenses) accounted for by each of
the Company's operating divisions for the periods indicated:
Nine Months Ended Sept. 30,
---------------------------
1998 1997
---- ----
Egg Products 79% 79%
Refrigerated Distribution 9 11
Dairy Products 8 11
Potato Products 4 (1)
---- ----
TOTAL 100% 100%
==== ====
The Egg Products Division had higher dollar sales and higher dollar earnings in
the period ended September 30, 1998, as compared to the results of the same
period in 1997, due to strong unit sales, favorable spot market egg costs, lower
feed costs and contributions from Papetti's. Owning Papetti's for nine months,
versus seven months in the 1997 period, explained a portion of the increases.
Additionally, sales were strong for certain value-added egg products, notably
extended shelf-life liquid eggs and precooked frozen omelets, patties and curds.
Egg prices decreased approximately 7% in the 1998 period as compared to first
nine months of 1997, as reported by Urner Barry Publications, although pricing
for egg products, particularly value-added egg products, is not necessarily
directly affected by changes in shell egg pricing. Approximately two-thirds of
the Division's annual egg needs are purchased under contracts, or in the spot
market, where such egg cost is determined largely by market pricing as reported
by Urner Barry. Approximately one-third of annual egg needs are sourced from
internal flocks, where feed costs typically represent roughly two-thirds of the
cost of producing such eggs. Feed costs were lower in the 1998 period than in
the 1997 period, due to lower prices for both corn and soybean meal.
The Refrigerated Distribution Division had flat dollar sales and flat dollar
earnings in the period ended September 30, 1998, as compared to the results of
the same period in 1997. Unit sales were fairly flat for core refrigerated
grocery items, reflecting, in part, some lost business and the impact of
historically high cheese and butter retail price points on consumer demand. A
sharp rise in butter fat market prices during the 1998 period also had an impact
on profitability, as product sourcing costs rose more rapidly than did retail
selling prices for products such as cheese and butter.
The Dairy Products Division had higher dollar sales and flat dollar earnings in
the period ended September 30, 1998, as compared to the results of the same
period in 1997. Unit sales increased sharply and were helped by a stronger dairy
products focus by certain customers, particularly in the quick service
restaurant segment, and by a growing coffee creamer business. Dollar sales also
were affected by a sharp rise in the dairy ingredients market, which, under the
Division's cost-plus pricing arrangement with most customers, raised per unit
selling prices significantly. Raw material costs rose substantially during the
1998 period due to increases in the pricing of certain ingredients tied to the
national butter fat market, which caused margins to decline. The Division also
experienced higher than normal operating costs due to strong volume growth.
The Potato Products Division had lower dollar sales and operated at a profit in
the period ended September 30, 1998, as compared to a loss in the same period in
1997. 1997 results included frozen french fry sales. The frozen french fry
business was discontinued in mid-1997. Losses from the
11
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
================================================================================
NINE MONTHS ENDED SEPTEMBER 30, 1998 VS NINE MONTHS ENDED SEPTEMBER 30, 1997,
CONT.
RESULTS OF OPERATIONS, CONT.
french fry business in the 1997 period totaled approximately $0.05 per share.
Efforts begun in 1997 in the areas of improving both plant operations and sales
volumes for the remaining refrigerated product lines were beneficial to the
Division's financial results in the 1998 period. Refrigerated products sales
volumes increased in the 1998 period as compared to the 1997 period and
operating efficiencies in the main plant were much improved year-over-year,
resulting in the improved financial results.
The increase in gross profit margin of the Company for the period ended
September 30, 1998, as compared to the results of the same period in 1997,
reflected the factors discussed above, particularly the strength of the Egg
Products Division operations and the return to profitability in the Potato
Products Division. It is management's strategy to increase value-added product
sales as a percent of total sales over time, while decreasing
commodity-sensitive products' contribution to consolidated sales. These efforts
historically have been beneficial to gross profit margins in most periods.
Selling, general and administrative expenses increased as a percent of sales in
the period ended September 30, 1998, as compared to the results of the same
period in 1997, due primarily to increased foodservice marketing activities and
spending to support the Company's information systems upgrade project. The 1997
period included non-recurring severance expenses, and other costs, including a
reorganization of the Company's sales group, of approximately $2.4 million
pretax and a non-recurring gain of approximately $1.3 million pretax resulting
from the disposition of french fry production assets.
GENERAL
Certain of the Company's products are sensitive to changes in commodity prices.
The Company's Egg Products Division derived approximately 6% of the Division's
first nine months of 1998 net sales from shell eggs, which are sensitive to
commodity price swings. Value-added extended shelf-life liquid egg product lines
accounted for approximately 36% of the Egg Products Division's net sales. The
remainder of Egg Products Division sales are derived from the sale of other egg
products, which vary from being commodity-sensitive to value-added. Gross profit
from shell eggs is primarily dependent upon the relationship between shell egg
prices and the cost of feed, both of which can fluctuate significantly. Shell
egg pricing in the 1998 period was approximately 7% below 1997 levels as
measured by a widely quoted pricing service. Gross profit margins for extended
shelf-life liquid eggs and precooked egg products are less sensitive to
commodity price fluctuations than are other egg products or shell eggs.
The Company's Refrigerated Distribution Division derives approximately 70% of
its net sales from refrigerated products produced by others, thereby reducing
the effect of commodity price swings. The balance of refrigerated distribution
sales are from shell eggs, some of which are produced by the Egg Products
Division and are sold on a distribution, or non-commodity, basis by the
Refrigerated Distribution Division.
The Dairy Products Division sells its products primarily on a cost-plus basis
and, therefore, the Division's earnings are not typically affected greatly by
raw ingredient price fluctuations, except over short time periods.
12
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
================================================================================
GENERAL, CONT.
The Potato Products Division typically purchases 70%-90% of its raw potatoes
from contract producers under annual contracts. The remainder is purchased at
market prices to satisfy short-term production requirements or to take advantage
of market prices when they are lower than contracted prices. Small variations in
the purchase price of raw materials or the selling price per pound of end
products can have a significant effect on Potato Products Division operating
results. The impact of raw material costs within the Potato Products Division is
lower now that the frozen french fry business has been discontinued, as
refrigerated potato products pricing is generally not subject to the volatility
seen in frozen french fry selling prices.
Inflation is not expected to have a significant impact on the Company's
business. The Company generally has been able to offset the impact of inflation
through a combination of productivity gains and price increases.
CAPITAL RESOURCES AND LIQUIDITY
Acquisitions and capital expenditures have been, and will likely continue to be,
a significant capital requirement. The Company plans to continue to invest in
state-of-the-art production facilities to enhance its competitive position.
Historically, the Company has financed its growth principally from internally
generated funds, bank borrowings, issuance of senior debt and the sale of Common
Stock. The Company believes that these financing alternatives will continue to
meet its anticipated needs.
The Company invested $49,580,000 in capital expenditures during the nine months
ended September 30, 1998. The Company plans to spend approximately $80,000,000
in total capital expenditures in 1998, the majority of which is to expand
production capacity.
The Company has an unsecured line of credit for $80,000,000 with its principal
banks. As of September 30, 1998, $22,000,000 was outstanding under this line of
credit.
On July 30, 1998 the Company's Board of Directors authorized the purchase of up
to two million shares of Common Stock on the open market. The line of credit may
be used to finance such purchases.
SEASONALITY
Consolidated quarterly operating results are affected by the seasonality of the
Company's net sales and operating profits. Specifically, shell egg prices
typically rise seasonally in the first and fourth quarters of the year due to
increased demand during holiday periods. Generally, refrigerated distribution
operations experience higher net sales and operating profits in the fourth
quarter. Net sales and operating profits from dairy operations typically are
significantly higher in the second and third quarters due to increased
consumption of ice milk and ice cream products during the summer months.
Operating profits from potato products are less seasonal, but tend to be higher
in the second half of the year coinciding with the potato harvest.
YEAR 2000
The Company has broken its "Year 2000" initiative into several projects. These
projects include legacy systems, personal computer components, wide area network
components, local area network components, and non - computer components. The
approach used for each of these projects includes the following phases:
13
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
================================================================================
YEAR 2000, CONT.
- - an inventory of possible Year 2000 components;
- - an assessment of Year 2000 compliance of each component;
- - any corrective action for items that fail the assessment phase.
The status for each of the projects follows:
Michael Foods undertook the implementation of the SAP Enterprise Resource
Planning system in 1995 as a means to present a single interface with customers
and to have better information available to management to make more effective
decisions. This project addresses a majority of the Company's legacy systems and
is scheduled for completion before the end of 1999. This project includes
processes that begin with Order Entry and end with Accounts Receivable and Cash
Application, plus Transportation and Warehouse Management, the Purchasing
Life-Cycle, Financial Management, Product Costing, and Production Planning. The
SAP system has been certified Year 2000 compliant by an outside party.
The Company will complete corrective actions for all personal computer hardware
by November 1998 and all personal computer software by December 1998. The
remaining information technology systems for wide area networking, local area
networking, and communications are currently being assessed for Year 2000
compliance, with corrective action to be completed by June 1999. Overall
business risk is judged to be not significant from these systems.
The Company's non-computer systems are now being assessed for Year 2000
compliance. The assessment of these systems will be completed by March 1999. Any
corrective actions are expected to be completed by September 1999.
The Year 2000 projects include an evaluation of critical vendors, suppliers and
customers relative to their Year 2000 readiness. Electronic data communications
with customers will be tested. Information is being solicited from these
important business partners and will be evaluated as it is received.
Based upon the assessment completed at this time, the Company does not
anticipate any significant Year 2000 issues. All Year 2000 projects are
proceeding according to management's expectations. However, if there are
significant delays in their completion, or if major suppliers or customers
experience Year 2000 issues with their systems, Year 2000 issues may have a
material adverse affect on the operations of the Company.
After assessing the information received from customers and suppliers and
evaluating the successful completion of the Year 2000 projects, the Company will
develop an appropriate contingency plan, as required. It is anticipated that
this plan will be developed by June 1999.
14
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
================================================================================
FORWARD-LOOKING STATEMENTS
Certain items in this Form 10-Q are forward-looking statements, which are made
in reliance upon the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. Such forward-looking statements are subject to numerous
risks and uncertainties, including the possibility that capital projects and the
Year 2000 initiative may not be completed as rapidly as management expects.
Additional risks and uncertainties include variances in the demand for the
Company's products due to consumer developments and industry developments, as
well as variances in the costs to produce such products, including normal
volatility in egg costs and feed costs. The Company's actual financial results
could differ materially from the results estimated by, forecasted by, or implied
by the Company in such forward-looking statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
For the period ended September 30, 1998 this disclosure is not applicable to the
registrant.
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit
27.1 Financial Data Schedule
(b) There were no reports on Form 8-K filed during the quarter ended September
30, 1998.
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
MICHAEL FOODS, INC.
----------------------------------------------
(Registrant)
Date: November 13, 1998 By: /s/ Gregg A. Ostrander
---------------------------------------
Gregg A. Ostrander
(President and Chief Executive Officer)
Date: November 13, 1998 By: /s/ John D. Reedy
---------------------------------------
John D. Reedy
(Vice President - Finance, Treasurer,
Chief Financial Officer and Principal
Accounting Officer)
15
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<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED BALANCE SHEETS AND CONDENSED CONSOLIDATED STATEMENTS OF
EARNINGS INCLUDED HEREIN AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
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<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
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