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**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549**

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**FORM 10-K**

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| **ý**                                                                   | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------|
|                                                                         |                                                                                      |   |
| **For the fiscal year ended December  31, 2002**                             |
|                                                                         |                                                                                      |   |
| **Commission file number 333-63722**                                         |
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| **MICHAEL  FOODS, INC.**                                                     |
| (Exact name of registrant as specified in its charter)                       |
|                                                                         |                                                                                      |   |
| **Minnesota**                                                                |                                                                                      | **41-0498850** |
| (State or other jurisdiction of  incorporation or organization)              |                                                                                      | (IRS Employer  Identification No.) |
|                                                                         |                                                                                      |   |
| **401 Carlson Parkway  Suite 300  Minnetonka, Minnesota**                    |                                                                                      | **55305** |
| (Address of principal executive offices)                                     |                                                                                      | (Zip Code) |
|                                                                         |                                                                                      |   |
| Registrant’s telephone  number, including area code **(952) 258-4000**  |
|                                                                         |                                                                                      |   |
| Securities registered  pursuant to Section 12(b) of the Act:   **None** |
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| Securities registered  pursuant to Section 12(g) of the Act:   **None** |
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Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. ý Yes oNo 

 

Indicate by checkmarkwhether the Registrant is an accelerated filer (as defined in exchange Act Rule12b-2). o Yes  ý No 

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated by referencein Part III of this Form 10-K or any amendment to this Form 10-K. o  Not applicable 

 

The Registrant’s commonstock is not publicly traded. 

 

 

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PART I 

 

ITEM 1 – BUSINESS 

 

FORWARD-LOOKINGSTATEMENTS 

 

Certain items herein are“forward-looking statements.” Forward-looking statements include statementsconcerning our plans, objectives, goals, strategies, future events, futuresales or performance, capital expenditures, financing needs, plans orintentions relating to acquisitions, our competitive strengths and weaknesses,our business strategy and the trends we anticipate in the industries andeconomies in which we operate and other information that is not historicalinformation and, in particular, appear under the heading “Management’sDiscussion and Analysis of Financial Condition and Results of Operations.” Whenused herein, the words “estimates,” “expects,” “anticipates,” “projects,”“plans,” “intends,” “believes” and variations of such words or similarexpressions are intended to identify forward-looking statements. Allforward-looking statements, including, without limitation, our examination ofhistorical operating trends, are based upon our current expectations andvarious assumptions. Our expectations, beliefs and projections are expressed ingood faith, and we believe there is a reasonable basis for them, but there canbe no assurance that our expectations, beliefs and projections will berealized.

 

There are a number ofrisks and uncertainties that could cause our actual results to differ materiallyfrom the forward-looking statements contained in this report. Important factorsthat could cause our actual results to differ materially from theforward-looking statements we make in this Form 10-K include changes indomestic and international economic conditions. Additional risks anduncertainties include variances in the demand for our products due to consumerand industry developments, as well as variances in the costs to produce suchproducts, including normal volatility in egg, feed, and dairy products costs.If any of these risks or uncertainties materialize, or if any of our underlyingassumptions are incorrect, our actual results may differ significantly from theresults that we express in or imply by any of our forward-looking statements. Wedo not undertake any obligation to revise these forward-looking statements toreflect future events or circumstances. 

 

GENERAL 

 

Michael Foods, Inc. andits subsidiaries (the “Company”, “we”, “us”, “our”) is a diversified producerand distributor of food products in four areas - egg products, refrigerateddistribution, dairy products, and potato products. We believe, through our EggProducts Division, we are the largest producer of processed egg products inNorth America. The Refrigerated Distribution Division distributes a broad lineof refrigerated grocery products to retail grocery outlets, including cheese,shell eggs, bagels, butter, margarine, muffins, potato products, juice andethnic foods. The Dairy Products Division processes and distributes soft-servemix, ice cream mix, and extended shelf-life ultrapasteurized milk, creamers andother specialty dairy products to domestic quick service businesses and otherfoodservice outlets, ice cream manufacturers and others. The Potato ProductsDivision processes and distributes refrigerated potato products sold to thefoodservice and retail grocery markets in the United States. Please see Note Jto our consolidated financial statements for additional information about ourbusiness segments. 

 

Our strategy is to growvalue-added food product sales, primarily in the foodservice market, byfocusing on developing, marketing and distributing innovative, refrigeratedproducts. The key to this strategy is “value-added”, whether that is in theproduct, the distribution channel or in the service provided to customers. 

 

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In April 2001, we wereacquired by an investor group comprised of a management group led by ourChairman, President and Chief Executive Officer, affiliates of Jeffrey Michael,a director of the Company, and two private equity investment firms through themerger of Michael Foods Acquisition Corp. with and into Michael Foods, Inc.(the “Merger”). The “Predecessor” refers to Michael Foods, Inc. prior to theMerger. 

 

EGG PRODUCTS DIVISION 

 

The Egg ProductsDivision, comprised of M. G. Waldbaum Company (“Waldbaum”), Papetti’s HygradeEgg Products, Inc. (“Papetti’s”), and MFI Food Canada, Ltd., produces,processes and distributes numerous egg products and shell eggs. Collectively,the three subsidiaries are also known as the Michael Foods Egg ProductsCompany. We believe that the Egg Products Division is the largest egg productsproducer and the third largest egg producer in North America. Principalvalue-added egg products are ultrapasteurized, extended shelf-life liquid eggs(“Easy Eggs(R)”, “Table Ready(TM)”), and "Excell."egg white-based eggsubstitutes (“Better ‘n Eggs(TM)”, “Table Ready(TM)”, and “All Whites(TM)”),hardcooked and precooked egg products. Other egg products include frozen,liquid and dried egg whites, yolks and whole eggs. The Division is the largestsupplier of extended shelf-life liquid eggs, precooked egg patties and omelets,dried, and hardcooked eggs in the United States and is a leading supplier offrozen and liquid whole eggs, whites and yolks. 

 

The Division distributesits egg products to food processors and foodservice customers primarilythroughout the United States, with some international sales in the Far East,South America and Europe. The largest selling product line within the Division,extended shelf-life liquid eggs, and other egg products are marketed nationallyto a wide variety of foodservice and industrial customers. The Division also isa leading supplier of egg white-based egg substitutes sold in the U.S. retailand foodservice markets. Most of the Division’s annual shell egg sales are madeto our Refrigerated Distribution Division, which, in turn, distributes themthroughout its 30 state territory. 

 

In 2002, the Divisionderived approximately 97% of net sales from egg products, with 3% of net salescoming from shell eggs. Pricing for shell eggs and certain egg products in theUnited States reflects levels reported by Urner Barry Spot Egg MarketQuotations (“Urner Barry”), a recognized industry publication. Prices ofcertain valued-added products, such as extended shelf-life liquid eggs, eggsubstitutes, and hardcooked and pre-cooked egg products, typically are notsignificantly affected by Urner Barry quoted price levels. Such productsaccounted for approximately 60% of the Division’s 2002 sales. Prices for theDivision’s other products, including frozen, short shelf-life liquid, certaindried products and, particularly, shell eggs, are significantly affected byfrequently changing market levels as reported by Urner Barry.

 

In 2002, approximately30% of the Division’s egg needs were satisfied by production from Company-ownedhens, with the balance being purchased under grower contracts and in the spotmarket. The cost of eggs from Company-owned facilities is largely dependentupon the cost of feed. Additionally, for an increasing proportion of eggspurchased under grower contracts, the egg cost is determined by the cost offeed, as the contracts are priced using a formula based upon the underlyingfeed costs. For the larger proportion of eggs purchased under grower contracts,plus eggs purchased in the spot market, the egg cost is determined by normalmarket forces. Such costs are largely determined by reference to Urner Barryquotations. Historically, feed costs have generally been less volatile thanhave egg market prices and internally produced 

 

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eggs generally are lowerin cost than are externally sourced eggs. Key feed costs, such as corn andsoybean meal, are partially hedged through the use of futures and otherpurchase contracts. There is no market mechanism for hedging egg prices. 

 

The Division hasendeavored to moderate the effects of egg market commodity factors through anemphasis on value-added products and the internal production of eggs, where theegg cost is somewhat controllable. Further, the Division attempts to matchmarket-affected egg sourcing with the production of egg products whose sellingprices are also market-affected, and cost-affected egg sourcing, as best can bemanaged, with higher value-added products priced over longer terms, generally6-12 months. The former allows the Division to typically realize a modestprocessing margin on such sales, even though there are notable commodityinfluences on both the egg sourcing cost and the egg products pricing, witheach changing as frequently as daily. Shell eggs are essentially a commodityand are sold based upon reported egg prices. Egg prices are significantlyinfluenced by modest shifts in supply and demand. Pricing of shell eggs is alsotypically affected by seasonal demand related to increased consumption duringholiday periods. 

 

The Division’s principalegg processing plants are located in New Jersey, Minnesota, Nebraska,Pennsylvania, Iowa, Manitoba and Ontario. Certain of the Division’s facilitiesare fully integrated from the production and maintenance of laying flocksthrough the processing of egg products. Fully automated laying barns, housing approximately13,000,000 producing hens, are located in Nebraska, Minnesota and South Dakota,of which approximately 1,600,000 are housed in contract facilities. Majorlaying facilities also maintain their own grain and feed storage facilities.Further, the production of approximately 7,500,000 hens is under long-termsupply agreements, with an additional 21,000,000 hens under shorter-termagreements. The Division also maintains facilities with approximately 2,800,000pullets located in Nebraska and Minnesota. 

 

REFRIGERATED DISTRIBUTIONDIVISION 

 

The RefrigeratedDistribution Division, comprised of Crystal Farms Refrigerated DistributionCompany (“Crystal Farms”) and Wisco Farm Cooperative, distributes a wide rangeof refrigerated grocery products directly to retailers and to wholesalewarehouses. The Division believes that its strategy of offering quality brandedproducts at a good value relative to national brands has contributed to itsgrowth. These distributed refrigerated products, which consist principally ofcheese, eggs, bagels, butter, margarine, muffins, potato products, juice andethnic foods, are supplied by vendors, or other divisions of the Company, tothe Division’s specifications. Cheese accounts for approximately 61% ofdivisional annual sales. While we do not produce cheese, we operate a cheesepackaging facility in Lake Mills, Wisconsin, which processes and packagesvarious cheese products for our Crystal Farms brand cheese business and forprivate label customers. 

 

The Division has expandedits market area using both company-owned and leased resources and independentdistributors. The Division’s market area includes 30 states primarily in thecentral United States. Retail locations carrying the Division’s productsapproximate 4,500 stores, though a majority are served via customers’warehouses. In 2002, sales to the warehouse operations of SUPERVALU, Inc., andto its owned and franchised stores, represented approximately 41% of divisionalsales. The Division maintains a fleet of refrigerated tractor-trailers todeliver products daily to its retail customers from ten distribution centerslocated centrally in its key marketing areas. 

 

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DAIRY PRODUCTS DIVISION

 

The Dairy ProductsDivision, comprised of Kohler Mix Specialties, Inc. (“Kohler”), Kohler MixSpecialties of Connecticut, Inc., Midwest Mix, Inc., M-Foods Dairy, LLC, andM-Foods Dairy TXCT, LLC, processes and sells soft-serve mix, ice cream mix,frozen yogurt mix, creamers, milk and specialty dairy products, many of whichare ultra-high temperature (“UHT”) pasteurized products. The Division sells itsproducts throughout much of the United States from processing facilities inMinnesota, Texas and Connecticut. 

 

UHT processing isdesigned to produce bacteria-free products with delicate flavors, such as milk,ice cream mixes and specialty dairy products such as coffee creamers, whippingcream, half and half and cordials. Many of the Division’s products have anextended shelf-life of up to ninety days, which extends the trade territorythat can be effectively served by the Division to include most of the UnitedStates. 

 

Soft-serve, frozen yogurtand ice cream mixes are made to customers’ specifications. Currently, theDivision produces approximately 100 different formulations. We believe thecustomization of high quality products and high customer service levels arecritical to the Division's business. 

 

The Division hasapproximately 500 customers, including branded ice cream manufacturers, quickservice restaurants, other foodservice outlets and independent ice creamretailers. The Division’s top five customers represented approximately 60% of2002 divisional sales volume. Most of the Division’s sales are to customers whopurchase products on a cost-plus basis. This includes sales to most of thelarge quick service restaurant chains operating in its market areas. Sales ofsoft-serve, milk shake, and ice cream mixes are more seasonal than theCompany’s other products, with higher sales volume occurring between April andOctober. The addition of other specialty dairy products in recent years, suchas non-refrigerated dairy creamers and cartoned items, has somewhat offset theimpact on the Division’s sales and earnings from this seasonality. 

 

POTATO PRODUCTS DIVISION 

 

Refrigerated potatoproducts are produced and sold by Northern Star Co. (“Northern Star”) and FarmFresh Foods, Inc. (“Farm Fresh”) to both the foodservice and retail markets.Products consist of shredded hash browns and diced, sliced, mashed, and otherspecialty potato products. In 2002, approximately 61% of the Potato ProductsDivision’s net sales were to the foodservice market, with the balance to theretail market. 

 

The Division maintainsits main processing facility in Minnesota, with a smaller facility located inNevada. The Division typically purchases approximately 90%-95% of its annualpotato requirements from contract producers. The balance of potato requirementsare purchased on the spot market. The Division maintains a high percentage ofits contracted supply from irrigated fields and also has geographicaldiversification of its potato sources. However, weather remains an importantfactor in determining raw potato prices and quality. Variations in the purchaseprice and/or quality of potatoes can affect the Potato Products Division’soperating results. 

 

SALES, MARKETING ANDCUSTOMER SERVICE 

 

Each of our fourdivisions has developed a marketing strategy, which emphasizes high qualityproducts and customer service. Michael Foods Sales, an internal sales group,coordinates the foodservice and retail sales of the Egg Products, DairyProducts and Potato Products divisions, primarily for national and regionalaccounts,

 

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and is supported by acentralized order entry and customer service staff. The consolidations of thehistorically distinct egg products sales groups, and related customer servicegroups, were completed in 2001. A group of foodservice brokers is used byMichael Foods Sales to supplement its internal sales efforts. Further, the EggProducts Division utilizes a separate broker group for the retail market andmaintains a small sales group which handles certain industrial egg productsales. We have a marketing staff which executes marketing plans in thefoodservice market and a smaller marketing staff which handles retail marketingplans, with additional resources available from outside agencies andconsultants as needed. 

 

The RefrigeratedDistribution Division’s internal and external sales personnel obtain ordersfrom retail stores which are usually placed no more than one day ahead of therequested delivery date. The Division’s marketing efforts are primarily focusedon in-store and co-op advertising programs, which are executed with grocers ona market-by-market basis. During 2002, Crystal Farms increased its consumersupport programs, with largely favorable sales volume results. The Egg ProductsDivision also has consumer support programs to support its egg products sold inthe retail market. 

 

ACQUISITIONS 

 

We have made manyacquisitions and anticipate that we will continue to make acquisitions as partof our strategic plan. We made one acquisition in 2002.  We bought the egg products assets ofCanadian Inovatech Inc. This acquisition, along with the effect of aconsolidation of a previous joint venture, is expected to add approximately $60million to our net sales in 2003.  Therewere no acquisitions in 2001. 

 

CUSTOMERS 

 

Our foodservice sales areprimarily made under long-standing preferred supplier relationships with amajority of our customers. Our customers include each of the major broad-linefoodservice distributors and most national restaurant chains that servebreakfast. The major customers in each of the market channels include leadingfoodservice distributors, such as Sysco and U.S. Foodservice (each more than10% of our consolidated  net sales),national restaurant chains, such as Burger King and International House of Pancakes, and major industrialingredient customers, such as General Mills/Pillsbury and Unilever Bestfoods. 

 

COMPETITION 

 

All aspects of ourbusinesses are extremely competitive. In general, food products are pricesensitive and affected by many factors beyond our control, including changes inconsumer tastes, fluctuating commodity prices, changes in supply due toweather, production variances and feed costs. 

 

Our Egg Products Divisionis considered the largest egg products processor and the third largest eggproducer in North America. The Egg Products Division competes with manysuppliers of egg products and eggs. While the shell egg industry is highlyfragmented, the egg products sector is less fragmented, as there has been atrend toward consolidation in recent years and further consolidation in theindustry is expected. Other major egg producers include Cal-Maine Foods, Inc.and Rose Acre Farms, Inc. We believe our Egg Products Division is among thelowest cost egg producers in the United States. We believe that Easy Eggs’ (R)and Table Ready’s (TM) salmonella-negative aspects, extendedshelf-lives and ease of use are significant competitive advantages in thefoodservice and industrial food markets for eggs. We believe our largestcompetitor in egg products is the Sunny Fresh Foods, Inc. subsidiary ofCargill, Inc. 

 

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Our RefrigeratedDistribution Division competes with the refrigerated products of othersuppliers such as Beatrice Companies, Inc. (a subsidiary of ConAgra Foods,Inc.), Kraft Foods, Inc., Land O’ Lakes, Inc., and Sargento Cheese Company,Incorporated. The Division believes that its emphasis on a high level ofservice and lower-priced branded products has enabled it to compete effectivelyin its market area with larger national brand companies. 

 

We believe the DairyProducts Division provides a significant amount of the soft-serve mix, and asignificant percentage of ice cream mix, sold in Minnesota and Wisconsin.Kohler also has a large percentage of the UHT soft-serve mix and UHT fluid milkbusiness with quick service restaurant chains in the central and eastern UnitedStates. Competitors mainly include local dairies utilizing conventionalpasteurization and regional dairies with UHT products.  In certain lines, we compete with Dean FoodsCo., a national dairy products producer. 

 

The Potato ProductsDivision has a leading market share in refrigerated potato products sold in theUnited States foodservice and retail markets, where competitors are generallysmaller, local or regional companies. One refrigerated potato productscompetitor, Reser’s Fine Foods, Inc., has a national presence. Certaincompanies in the frozen potato products business, such as Ore-Ida Foods, Inc.(a subsidiary of H. J. Heinz Co.) and Lamb-Weston, Inc. (a subsidiary ofConAgra, Inc.), also sell frozen versions of potato products which are sold bythe Division in refrigerated form. 

 

PROPRIETARY TECHNOLOGIESAND TRADEMARKS 

 

We use a combination ofpatents, trademarks and trade secrets to protect the intellectual property forour products. We own proprietary patents, and we have exclusive licenseagreements for several patents and technologies. In 1988, we entered into anexclusive license agreement to use patented processes developed and owned byNorth Carolina State University involving the ultra-pasteurization of liquideggs. The patents licensed to us under this agreement expire between 2006 and2010. Our license to use these patents will continue until the expiration ofthe patents. This patented process produces liquid eggs that are salmonella andlisteria-negative, as defined by federal law, and extend the shelf-life ofliquid eggs from less than two weeks to over ten weeks. 

 

We also own an exclusivelicense to use a patented process, owned and developed by the University ofMissouri, to eliminate salmonella from shell eggs. This patent expires in 2016.Our license to use this patent will continue until the expiration of thepatent. We currently use this technology for processing in-shell pasteurized eggssold through our refrigerated distribution division. We also have acquiredlicenses to other patents and technology from other third parties, includingthe University of Nebraska. 

 

We believe that certainof our competitors infringe upon some of our patents and the patents licensedto us. Along with North Carolina State University, we have initiated litigationagainst several processors of competing liquid egg products claiminginfringement of the original and subsequent related process and product patentslicensed to us by North Carolina State University with respect toultra-pasteurized liquid egg production. In 1992, a jury in the United StatesDistrict Court for the Middle District of Florida found the original patent tobe valid and that a processor, Bartow Food Co., willfully and deliberatelyinfringed one of the patents. In another action, the United States DistrictCourt for the District of New Jersey found in 1992 and 1993 that Papetti’s hadinfringed certain of the patents and that the licensed patents are valid andenforceable. In 1994, the United States Court of Appeals for the FederalCircuit upheld this judgment. In 1993, Nulaid Foods, Inc. sought a declaratoryjudgment that the licensed patents are invalid. This action was subsequentlysettled and, in 2000, Nulaid Foods conceded the validity and enforceability ofthe patents, as well

 

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as their pastinfringement of the patents. Nulaid Foods is currently using the patentedprocess by operating under a sublicense agreement. In 1996, reissue andreexamination proceedings were initiated by us and our competitors with theU.S. Patent and Trademark Office, or PTO, seeking to determine the scope andvalidity of some of the patents that we license from North Carolina StateUniversity. The PTO ruled that the claims in the licensed patents are valid andin full force and effect. In 2000, Sunny Fresh Foods, Inc., a division ofCargill, Inc., filed an action seeking declaratory judgment that Sunny Fresh Foodsdoes not infringe upon the licensed patents and that the licensed patents areinvalid. We have filed a counter claim alleging that Sunny Fresh Foods hasinfringed the patents. For more information, see Item 3—Legal Proceedings. 

 

Although we actively pursuepatent infringement litigation, we do not believe that the expiration of thesepatents will have a material adverse affect on our business or market sharewithin these product segments because of our strong market position, combinedwith the fact that we believe our largest competitor is currently infringing onthese patents. 

 

The Egg Products Divisionmaintains numerous trademarks and/or trade names for its products, including“Logan Valley,” “Wakefield,” “Sunny Side Up,” “Michael Foods,” “Deep Chill,”“MGW,” “Simply Eggs Brand,” “Better `n Eggs,” “All Whites,” “Chef’s OmeletBrand,” “Express Eggs,” “Quaker State Farms,” “Broke N’ Ready,” “CanadianInovatech,” “Centromay” (trademark pending), “Centrova,” “Emulsa,” and“Inovatech.” Ultra-pasteurized liquid eggs are marketed using the “Easy Eggs,”“Table Ready,” and “Excelle” trade names. 

 

Within the PotatoProducts Division, Northern Star Co. markets its refrigerated potato productsto foodservice customers under a variety of brands, including “Northern Star,”“Farm Fresh” and “Quality Farms.” The “Simply Potatoes” and “Diner’s Choice”brands are used for retail refrigerated products. 

 

Refrigerated DistributionDivision products are marketed principally under the “Crystal Farms” tradename.  The Dairy Products Division doesnot have significant trade names. 

 

GOVERNMENT REGULATION 

 

All of our divisions aresubject to federal, state and local government regulations relating to grading,quality control, product branding and labeling, waste disposal and otheraspects of their operations. Our divisions are also subject to USDA and FDAregulation regarding grading, quality, labeling and sanitary control. Theprocessing plants of our Egg Products Division that break eggs, and some of ourother egg processing operations, are subject to continuous on-site USDAinspection. All of our other processing plants are subject to periodicinspections by the USDA, FDA and state regulatory authorities. 

 

Crystal Farms’ cheese andbutter products and the Dairy Products Division’s various dairy products areaffected by milk price supports established by the USDA. The support priceserves as an artificial minimum price for these products, which may not beindicative of market conditions that would prevail if such supports wereabolished. 

 

A substantial portion ofthe egg production operations of our Egg Products Division are located in theState of Nebraska. With certain exceptions, a provision of the Nebraskaconstitution generally prohibits corporations from engaging in farming orranching in Nebraska. Although the constitutional provision contains anexemption for agricultural land operated by a corporation for the purpose ofraising poultry, the Nebraska Attorney General has, in written opinions, takenthe position that facilities devoted primarily to the production of eggs do notfall within such exemption and therefore are subject to the restrictionscontained in the constitutional provision. We believe that our egg 

 

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production facilities inNebraska are part of integrated facilities for the production, processing anddistribution of egg products, and therefore, that any agricultural landpresently owned by us in Nebraska is being used for non-farming andnon-ranching purposes. 

 

The constitution empowersthe Nebraska Attorney General, or if the Attorney General fails to act, aNebraska citizen, to obtain a court order to, among other things, force adivestiture of land held in violation of this constitutional provision. If landsubject to such a court order is not divested within a two-year period, theconstitutional provision directs the court to declare the land escheated, orforfeited, to the State of Nebraska. We are not aware of any proceedings underthis approximately 75 year-old constitutional provision pending or threatenedagainst us or any other companies engaging in farming or ranching activities inNebraska. We believe that we have adequate contingency arrangements in place inthe event a determination is made that we engage in farming and/or ranchingactivities proscribed by the Nebraska constitution. Until the scope of suchprovision has been clarified by further judicial, legislative, or executiveaction, there can be no assurance as to the effect, if any, that it may have onour Egg Products Division. 

 

ENVIRONMENTAL REGULATION 

 

We are subject tofederal, state and local environmental regulations and requirements, includingthose governing discharges to air and water, the management of hazardoussubstances, the disposal of solid and hazardous wastes and the remediation ofcontamination. 

 

We use an environmentalconsulting firm to help us comply with environmental requirements. In addition,a review was conducted by independent environmental consultants in connectionwith the Merger, and, as a result, we believe we are currently in materialcompliance with all environmental regulations and requirements. Nonetheless, asis the case with any business, if we do not fully comply with environmentalregulations, or if a release of hazardous substances occurs at or from one ofour facilities, we may be subject to penalties and/or held liable for the costof remedying the condition. 

 

Many of our facilitiesdischarge wastewater pursuant to wastewater discharge permits. We dispose ofour waste from our internal egg production primarily by providing it to farmersfor use as fertilizer. We dispose of our solid waste from potato processing byselling the waste to a processor who converts it to animal feed. 

 

We have made, and willcontinue to make, expenditures to maintain our compliance with environmentalrequirements. We have upgraded the wastewater treatment system at ourKlingerstown, Pennsylvania facility and agreed to pay the city of Lenox, Iowathe cost to construct and operate a wastewater treatment plant used by ourfacility located there. We believe that these expenditures will reduce the riskof wastewater violations at these facilities. In addition, we updated ourwastewater treatment system at our egg production facility in Bloomfield,Nebraska in 2002. Assessments of our wastewater treatment systems at the EggProducts Division’s facility in Gaylord, Minnesota and the Dairy ProductsDivision’s facility in White Bear Lake, Minnesota are also underway. We may electto upgrade the wastewater controls at these facilities or we may be required toupgrade such

 

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controls at these orother facilities in the future. However, we do not anticipate making anymaterial capital expenditures for environmental controls for the foreseeablefuture. 

 

EMPLOYEES 

 

At December 31, 2002, wehad approximately 4,371 employees. Of this total, the Egg Products Divisionemployed approximately 2,975 full-time and 252 part-time employees, with 17 ofthese employees represented by the Teamsters Union. The Potato ProductsDivision employed approximately 262 persons, approximately 180 of which wererepresented by the Bakery, Laundry, Allied Sales Drivers and WarehousemenUnion, which is affiliated with the Teamsters. The Dairy Products Divisionemployed approximately 292 people, approximately 92 of which were representedby the Milk Drivers and Dairy Employees Union. The Refrigerated DistributionDivision employed approximately 450 employees, none of whom are represented bya union. The Michael Foods corporate, sales, distribution and customer serviceand information systems groups collectively employed approximately 140 peopleat December 31, 2002. 

 

EXECUTIVE OFFICERS OF THEREGISTRANT 

 

See Item 10 — Directorsand Executive Officers of the Registrant. 

 

ITEM 2 – PROPERTIES 

 

FACILITIES 

 

CORPORATE. We maintainleased space for our corporate headquarters in suburban Minneapolis, Minnesota.Leased space within the same building houses the headquarters, financial andadministrative services staffs of the Egg Products, Potato Products and DairyProducts divisions, as well as our customer service, distribution, sales,marketing and information services groups. We relocated all such staffs to ourpresent location in mid-2002 in order to enhance work flow and communicationsamong our foodservice businesses. 

 

EGG PRODUCTS DIVISION.The following table summarizes information relating to the primary facilitiesof our Egg Products Division: 

 
| **LOCATION**                  |   | **PRINCIPAL  USE**           |   | **SIZE  (SQUARE FEET)** |   | **OWNED/  LEASED** |
|-------------------------------|--------|------------------------------|--------|-------------------------|--------|--------------------|
| Elizabeth, New Jersey         |   | Processing                   |   | 75,000                  |   | Leased             |
| Elizabeth, New Jersey         |   | Processing                   |   | 125,000                 |   | Leased             |
| Bloomfield, Nebraska          |   | Processing                   |   | 80,000                  |   | Owned              |
| LeSueur, Minnesota            |   | Processing                   |   | 29,000                  |   | Owned              |
| Wakefield, Nebraska           |   | Processing                   |   | 380,000                 |   | Owned              |
| Klingerstown,  Pennsylvania   |   | Processing and  Distribution |   | 139,000                 |   | Leased             |
| Klingerstown,  Pennsylvania   |   | Processing and  Distribution |   | 19,000                  |   | Leased             |
| Lenox, Iowa                   |   | Processing and  Distribution |   | 143,000                 |   | Owned              |
| Gaylord, Minnesota            |   | Processing and  Distribution |   | 230,000                 |   | Owned              |
| Elizabeth, New Jersey         |   | Sales and Distribution       |   | 80,000                  |   | Leased             |
| Bloomfield, Nebraska          |   | Egg Production               |   | 619,000                 |   | Owned              |
| Wakefield, Nebraska           |   | Egg Production               |   | 658,000                 |   | Owned              |
| LeSueur, Minnesota            |   | Egg Production               |   | 345,000                 |   | Owned              |
| Gaylord, Minnesota            |   | Egg Production               |   | 349,000                 |   | Owned              |
| Gaylord, Minnesota            |   | Pullet Houses                |   | 130,000                 |   | Owned              |
| Wakefield, Nebraska           |   | Pullet Houses                |   | 432,000                 |   | Owned              |
| Plainview, Nebraska           |   | Pullet Houses                |   | 112,000                 |   | Owned              |
| Winnipeg, Manitoba            |   | Processing                   |   | 102,000                 |   | Leased             |
| St. Mary’s, Ontario      |   | Processing                   |   | 42,000                  |   | Leased             |
| Mississauga, Ontario          |   | Distribution                 |   | 8,000                   |   | Leased             |
| Abbotsford, British  Columbia |   | Sales Office                 |   | 5,000                   |   | Leased             |

 

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The Egg Products Divisionalso owns or leases, primarily for egg production operations, approximately1,600 acres of land in Nebraska and Minnesota. 

 

POTATO PRODUCTS DIVISION.The Potato Products Division owns a processing plant and land located inMinneapolis, Minnesota, consisting of approximately 175,000 square feet ofproduction area. The division leases a building in North Las Vegas, Nevadaconsisting of approximately 31,000 square feet. 

 

DAIRY PRODUCTS DIVISION.The Dairy Products Division’s facilities in White Bear Lake, Minnesota, consistof three owned buildings, with the main plant containing approximately 95,000square feet. It also leases a dairy plant in Sulphur Springs, Texas, which isapproximately 40,000 square feet, and a dairy plant in Newington, Connecticut,which is approximately 70,000 square feet. 

 

REFRIGERATED DISTRIBUTIONDIVISION. The Refrigerated Distribution Division leases administrative andsales offices in suburban Minneapolis and several small warehouses across theUnited States. It owns a distribution center located near LeSueur, Minnesota,which is approximately 33,000 square feet. The refrigerated distributiondivision also owns and operates a 48,200 square foot refrigerated warehouse anda 19,000 square foot cheese packaging facility on a 19 acre site in Lake Mills,Wisconsin. 

 

The total annual baserent of the facilities described above is approximately $7 million. The leasesfor these facilities have varying length terms ranging from month-to-month to2017. We believe that our owned and leased facilities, together with budgetedcapital projects in each of our four operating divisions, are adequate to meetanticipated requirements for our current lines of business for the foreseeablefuture.  All of our owned propertyserves as collateral under the terms of our credit agreement. 

 

ITEM 3 – LEGALPROCEEDINGS 

 

Four patents forultrapasteurizing liquid eggs licensed to us by North Carolina State Universitywere involved in proceedings before the PTO. In 1996, an examiner rejectedcertain claims under these patents as a result of challenges from competitors.We and North Carolina State University appealed this rejection to the PTO’sBoard of Patent Appeals and Interferences. In September 1999, the PTO Boardreversed the examiner’s rejection of the claims made under the patents. As aresult of these proceedings, process claims of all four patents continue to bevalid and in full force and effect. Also, the fourth patent was reissued in2001 to include product claims. 

 

In September 2000, SunnyFresh Foods, Inc., a division of Cargill Inc., filed a declaratory judgmentaction in the United States District Court for the District of Minnesotarequesting the adjudication of the unenforceability and invalidity of thosepatents exclusively licensed to us by North Carolina State University. We havefiled a counter-claim against Sunny Fresh Foods, claiming willful 

 

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infringement by SunnyFresh Foods of these patents. This litigation is on-going and is expected to goto trial in June 2003. 

 

Macartney Farms, aCanadian company that formerly distributed our egg products to the Canadianmarket, has filed a complaint against us seeking damages and asserting wrongfultermination of its alleged exclusive marketing and distribution rights of EasyEggs, intentional interference with economic relations, breach of fiduciaryduty and recoupment of monies invested for the benefit of Michael Foods.Macartney also seeks an injunction against Michael Foods from soliciting Macartney’scustomers. The litigation, which is pending in the Ontario Superior Court inOttawa, is on-going and is expected to reach trial this fall. 

 

In addition, we are fromtime to time party to other litigation, administrative proceedings and uniongrievances that arise in the ordinary course of our business. We do not havepending any litigation that, separately or in the aggregate, would, in ouropinion, have a material adverse effect on our results of operations,liquidity, or financial condition. 

 

ITEM 4 – SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS 

 

None. 

 

PART II 

 

ITEM 5 – MARKET FORREGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 

 

None. As a result of theMerger, our stock ceased to be publicly traded. 

 

ITEM 6 – SELECTED FINANCIALDATA 

 

The following table setsforth selected consolidated historical financial data with respect to theCompany and the Predecessor. The data presented below has been derived from theCompany’s Consolidated Financial Statements. Due to the Merger, which wasaccounted for as a purchase, different bases of accounting have been used toprepare the Company and Predecessor Consolidated Financial Statements. TheMerger resulted in additional interest expense for new debt incurred and higherdepreciation and amortization of fixed assets and other intangible assetsrecorded. The accompanying Predecessor Balance Sheet and Statements ofOperations data as of and for the three months ended March 31, 2001, and forthe years ended December 31, 2000, 1999 and 1998 were prepared from thehistorical books and records of the Predecessor. Such data should be read inconjunction with the Company’s Consolidated Financial Statements and Notesthereto included elsewhere herein and Item 7 – Management’s Discussion andAnalysis of Financial Condition and Results of Operations. 

 

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|                                            |   | **COMPANY**                            |      | **PREDECESSOR**                             |   |
|-------------------------------------------------|--------|----------------------------------------|-----------|---------------------------------------------|--------|
|                                            |   | **YEAR ENDED  DECEMBER 31,**

**2002** |      | **NINE  MONTHS  ENDED  DECEMBER 31,  2001** |   | **THREE  MONTHS  ENDED  MARCH 31,  2001** |   | **YEARS  ENDED DECEMBER 31,** |   |
|                                            |   | **2000**                               |      | **1999**                                    |   | **1998** |   |
|                                            |   | **(thousands)**                        |      |
| STATEMENT OF  OPERATIONS DATA                   |   |                                   |      |                                        |   |   |   |   |   |   |   |   |   |
| Net sales                                       |   | $                                      | 1,168,160 |                                        | $      | 885,642 |   | $ | 275,627 |   | $ | 1,080,601 |   | $ | 1,053,272 |   | $ | 1,020,484 |   |
| Cost of sales                                   |   | 953,333                                |      | 734,008                                     |   | 227,707 |   | 889,138 |   | 860,256 |   | 847,383 |   |
| Gross profit                                    |   | 214,827                                |      | 151,634                                     |   | 47,920 |   | 191,463 |   | 193,016 |   | 173,101 |   |
| Selling, general  and administrative expenses   |   | 116,444                                |      | 87,484                                      |   | 27,376 |   | 104,657 |   | 106,686 |   | 93,548 |   |
| Transaction  expenses                           |   | —                                 |      | —                                      |   | 11,050 |   | — |   | — |   | — |   |
| Operating profit                                |   | 98,383                                 |      | 64,150                                      |   | 9,494 |   | 86,806 |   | 86,330 |   | 79,553 |   |
| Interest expense                                |   | 50,179                                 |      | 42,335                                      |   | 3,293 |   | 13,206 |   | 11,664 |   | 10,136 |   |
| Earnings before  other expense and income taxes |   | 48,204                                 |      | 21,815                                      |   | 6,201 |   | 73,600 |   | 74,666 |   | 69,417 |   |
| Other expense                                   |   | —                                 |      | —                                      |   | 15,513 |   | — |   | — |   | — |   |
| Earnings (loss)  before income taxes            |   | 48,204                                 |      | 21,815                                      |   | (9,312 | ) | 73,600 |   | 74,666 |   | 69,417 |   |
| Income tax  expense                             |   | 18,543                                 |      | 12,000                                      |   | (3,659 | ) | 28,890 |   | 30,610 |   | 29,160 |   |
| Net earnings  (loss)                            |   | $                                      | 29,661    |                                        | $      | 9,815 |   | $ | (5,653 | ) | $ | 44,710 |   | $ | 44,056 |   | $ | 40,257 |   |
|                                            |   |                                   |      |                                        |   |   |   |   |   |   |   |   |   |
| AT PERIOD END  BALANCE SHEET DATA               |   |                                   |      |                                        |   |   |   |   |   |   |   |   |   |
| Working capital                                 |   | $                                      | 59,145    |                                        | $      | 65,477 |   | $ | 73,459 |   | $ | 78,628 |   | $ | 51,764 |   | $ | 61,297 |   |
| Total assets                                    |   | 893,022                                |      | 897,133                                     |   | 619,721 |   | 612,904 |   | 597,917 |   | 551,516 |   |
| Long-term debt,  including current maturities   |   | 511,389                                |      | 553,094                                     |   | 192,200 |   | 198,809 |   | 178,534 |   | 166,107 |   |
| Shareholder’s  equity                      |   | 179,326                                |      | 152,990                                     |   | 257,151 |   | 258,733 |   | 264,599 |   | 244,149 |   |

 

 

ITEM 7 – MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 

 

THE FOLLOWING DISCUSSIONSHOULD BE READ IN CONJUNCTION WITH THE COMPANY’S CONSOLIDATED FINANCIALSTATEMENTS AND THE NOTES TO THOSE STATEMENTS APPEARING ELSEWHERE IN THIS FORM10-K. THIS DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKSAND UNCERTAINTIES. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE INDICATED INFORWARD-LOOKING STATEMENTS. SEE ITEM 1—BUSINESS – FORWARD–LOOKING STATEMENTS. 

 

GENERAL 

 

We are a diversifiedproducer and distributor of specialty egg, potato and dairy products to thefoodservice, retail and industrial ingredient markets. We also distributerefrigerated grocery items, primarily cheese and other dairy products, to theretail grocery market in the central United States. The following sets forthselected historical financial data with respect to the Company and itssubsidiaries, and the Predecessor. The data has been derived from the Company’sand the Predecessor’s audited Consolidated Financial Statements includedelsewhere in this document. It is suggested that readers combine 2001 threemonth (Predecessor) and 2001 nine month (Company) periods in order to comparefull-year 2002 to full-year 2001.

 

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|                                          |   | **Company**           |   | **Predecessor**                           |   |
|-----------------------------------------------|--------|-----------------------|--------|-------------------------------------------|--------|
|                                          |   | **2002**              |   | **Nine Months  ended  December 31, 2001** |   | **Three  Months  ended  March 31, 2001** |   | **Year ended  December 31,  2000** |   |
|                                          |   | **$**                 |   | **%**                                     |   | **$** |   | **%** |   | **$** |   | **%** |   | **$** |   | **%** |   |
|                                          |   | **($ in  thousands)** |   |
| STATEMENT OF  OPERATIONS DATA:                |   |                  |   |                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                          |   |                  |   |                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |
| External net  sales:                          |   |                  |   |                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Egg products  division                        |   | 657,824               |   | 56.3                                      |   | 482,324 |   | 54.4 |   | 163,529 |   | 59.3 |   | 637,355 |   | 59.0 |   |
| Potato products  division                     |   | 72,170                |   | 6.2                                       |   | 51,268 |   | 5.8 |   | 15,585 |   | 5.7 |   | 60,731 |   | 5.6 |   |
| Dairy products  division                      |   | 190,578               |   | 16.3                                      |   | 150,554 |   | 17.0 |   | 35,328 |   | 12.8 |   | 141,401 |   | 13.1 |   |
| Refrigerated  distribution division           |   | 247,588               |   | 21.2                                      |   | 201,496 |   | 22.8 |   | 61,185 |   | 22.2 |   | 241,114 |   | 22.3 |   |
| Total net sales                               |   | 1,168,160             |   | 100.0                                     |   | 885,642 |   | 100.0 |   | 275,627 |   | 100.0 |   | 1,080,601 |   | 100.0 |   |
| Cost of sales                                 |   | 953,333               |   | 81.6                                      |   | 734,008 |   | 82.9 |   | 227,707 |   | 82.6 |   | 889,138 |   | 82.3 |   |
|                                          |   |                  |   |                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross profit                                  |   | 214,827               |   | 18.4                                      |   | 151,634 |   | 17.1 |   | 47,920 |   | 17.4 |   | 191,463 |   | 17.7 |   |
| Selling, general  and administrative expenses |   | 116,444               |   | 10.0                                      |   | 87,484 |   | 9.9 |   | 27,376 |   | 9.9 |   | 104,657 |   | 9.7 |   |
| Transaction  expenses                         |   | —                |   | —                                    |   | — |   | — |   | 11,050 |   | 4.0 |   | — |   | — |   |
|                                          |   |                  |   |                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating  profit:                            |   |                  |   |                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Egg products  division                        |   | 71,717                |   | 6.1                                       |   | 48,648 |   | 5.5 |   | 12,915 |   | 4.7 |   | 67,658 |   | 6.2 |   |
| Potato products  division                     |   | 10,832                |   | 0.9                                       |   | 6,639 |   | 0.7 |   | 1,688 |   | 0.6 |   | 7,650 |   | 0.7 |   |
| Dairy products  division                      |   | 9,918                 |   | 0.8                                       |   | 7,885 |   | 0.8 |   | 3,958 |   | 1.4 |   | 1,322 |   | 0.1 |   |
| Refrigerated  distribution division           |   | 13,744                |   | 1.2                                       |   | 4,947 |   | 0.6 |   | 3,639 |   | 1.3 |   | 16,001 |   | 1.5 |   |
| Corporate                                     |   | (7,828                | )      | (0.6                                      | )      | (3,969 | ) | (0.4 | ) | (12,706 | ) | (4.6 | ) | (5,825 | ) | (0.5 | ) |
| Total operating  profit                       |   | 98,383                |   | 8.4                                       |   | 64,150 |   | 7.2 |   | 9,494 |   | 3.4 |   | 86,806 |   | 8.0 |   |
| Interest  expense, net                        |   | 50,179                |   | 4.3                                       |   | 42,335 |   | 4.8 |   | 3,293 |   | 1.2 |   | 13,206 |   | 1.2 |   |
| Net earnings  (loss)                          |   | 29,661                |   | 2.5                                       |   | 9,815 |   | 1.1 |   | (5,653 | ) | (2.1 | ) | 44,710 |   | 4.1 |   |

 

RESULTS OF OPERATIONS 

 

RESULTS FOR THE YEARENDED DECEMBER 31, 2002 COMPARED TO THE COMBINED RESULTS FOR THE YEAR ENDEDDECEMBER 31, 2001 

 

NET SALES. Net sales forthe year ended December 31, 2002 increased $6.9 million, approximately 1%, to$1,168.2 million from $1,161.3 million for the Company and the Predecessor forthe year ended December 31, 2001. The strongest divisional sales growthoccurred in the Potato Products Division, which recorded an 8% external netsales increase. External net sales growth of 2% and 3% was recorded by the EggProducts and Dairy Products divisions, respectively, with the former benefitingfrom an acquisition in August 2002. Refrigerated Distribution external netsales declined by 6% due to lower commodity prices for butter, lower unitsales, and customer store closings. 

 

EGG PRODUCTS DIVISIONSALES. Egg Products Division external net sales for the year ended December 31,2002 increased $11.9 million, or 2%, to $657.8 million from $645.9 million forthe Company and the Predecessor for year ended December 31, 2001. Sales rosefor higher value-added products, in total, including pre-cooked items, eggsubstitutes and hardcooked eggs, and declined for the commodity-sensitivelines, such as frozen and dried products. As part of our strategy to sell morefurther-processed eggs, shell egg sales declined by 6% in 2002, while shell eggdozens sold decreased by over 12%. During 2002, shell egg prices increased byapproximately 3% as reported by Urner Barry, resulting in somewhat bettermargins for frozen and dried egg products. However, in some cases, we declinedto renew contracts for frozen products last year because of a lack of margincontribution. The Canadian egg products business acquired in August 2002, andthe related consolidation of a joint venture, added approximately 3% to 2002divisional net sales. Sales of higher value-added egg products representedapproximately 60% of the egg products division’s sales in both 2002 and 2001. 

 

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POTATO PRODUCTS DIVISIONSALES. Potato Products Division external net sales for the year ended December31, 2002 increased $5.3 million, or 8%, to $72.2 million from $66.9 million forthe Company and the Predecessor for the year ended December 31, 2001. Thisincrease was mainly due to strong unit sales growth for retail refrigeratedpotato products, which increased approximately 16% from 2001. Foodservice unitsales increased by approximately 4%. Sales to new customers, growth in sales toexisting customers, increased marketing and new product introductions allcontributed to the sales increase, with mashed products showing the greatestgrowth in both business segments. 

 

DAIRY PRODUCTS DIVISIONSALES. Dairy Products Division external net sales for the year ended December31, 2002 increased $4.7 million, or 3%, to $190.6 million from $185.9 millionfor the Company and the Predecessor for the year ended December 31, 2001. Thisincrease mainly was due to strong unit sales volumes for certain specialtycartoned items contract packed for other dairies and notable growth innon-refrigerated creamer sales. National dairy ingredient prices decreasedduring the year, resulting in a lower pricing environment of approximately 4%,on average,  for the products sold bythe Division. Hence, deflation was a factor in limiting divisional external netsales growth in 2002. 

 

REFRIGERATED DISTRIBUTIONDIVISION SALES. Refrigerated Distribution Division external net sales for theyear ended December 31, 2002 decreased $15.1 million, or 6%, to $247.6 millionfrom $262.7 million for the Company and the Predecessor for the year endedDecember 31, 2001. This decrease was due, in part, to lower unit sales forcheese, margarine and baked items. Customers’ store closings and a sluggishdomestic grocery sales environment contributed to this sales decline. Whiledollar net sales declined 6%, quantities of distributed products fell by lessthan 1%.  Further, shell egg dozens solddeclined by 6%, which was in line with our plans.  Deflation also contributed significantly to the divisional salesdecline, with lower market prices prevailing for butter (down 34% in 2002) andmargarine. 

 

GROSS PROFIT. Grossprofit for the year ended December 31, 2002 increased $15.2 million, orapproximately 7%, to $214.8 million from $199.6 million for the Company andPredecessor in the year ended December 31, 2001. Our gross profit margin was18.4% of net sales in 2002, whereas the combined gross profit margin was 17.2%in 2001. The increase in gross profit margin was due to increased gross profitsfrom many products, including egg substitutes, precooked egg products, cheeseand specialty dairy products.  Ingeneral, raw material costs were more favorable in 2002 than in 2001, and costsavings were realized from production efficiencies in several productcategories. 

 

SELLING, GENERAL ANDADMINISTRATIVE EXPENSES. Selling, general and administrative expenses for theyear ended December 31, 2002 increased $1.5 million, or 1%, to $116.4 millionfrom $114.9 million for the Company and the Predecessor for the year endedDecember 31, 2001. Selling, general and administrative expenses were nearlyconsistent at 10% of net sales in 2002 versus 9.9% for the Company andPredecessor in 2001. Whereas 2002 expenses no longer included goodwillamortization, there were increases in depreciation and incentives accruals in2002.  The former reflected a full yearof increased asset values (i.e., due to the purchase accounting at the time ofthe Merger) being depreciated as compared to a partial year in 2001.  Separate from selling, general andadministrative expenses in 2001, the Predecessor recorded non-recurringexpenses related to the Merger for financial, legal, advisory and regulatoryfiling fees. These expenses of approximately $11.1 million are reflected in thePredecessor’s Consolidated Statements of Earnings as transaction expenses. 

 

OPERATING PROFIT.Operating profit for the year ended December 31, 2002 increased $24.8 million,or approximately 34%, to $98.4 million from $73.6 million for the Company andthe Predecessor for the year ended December 31, 2001. This increase was duemainly to the increase in gross profit, as described above. Also, 2001 resultsincluded one-time transaction expenses for the Predecessor, also describedabove. 

 

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EGG PRODUCTS DIVISIONOPERATING PROFIT. Egg Products Division operating profit for the year endedDecember 31, 2002 increased $10.1 million, or 16%, to $71.7 million from $61.6million for the Company and the Predecessor for the year ended December 31,2001. Operating profit for higher value-added egg products increased by $9.3million, or 15%, from 2001, while operating profits from other egg products werenear break-even levels, collectively, as compared to modest profitability in2001. The increase in Divisional operating margin was due mainly to increasedgross profits from value-added items, resulting from favorable raw materialcosts and production efficiencies. The 2001 operating profit for the Divisionwas affected by an approximate $1.6 million loss from the Division’stermination of a European joint venture. 

 

POTATO PRODUCTS DIVISIONOPERATING PROFIT. Potato Products Division operating profit for the year endedDecember 31, 2002 increased $2.5 million, or 30%, to $10.8 million from $8.3million for the Company and the Predecessor for the year ended December 31,2001. This increase reflected gross profit improvement tied to volume growth,particularly from the more profitable retail segment, and continuingimprovements in plant operations. 

 

DAIRY PRODUCTS DIVISIONOPERATING PROFIT. Dairy Products Division operating profit for the year endedDecember 31, 2002 decreased $1.9 million, or 16%, to $9.9 million from $11.8million for the Company and the Predecessor for the year ended December 31,2001.  Divisional operating profit in2001 included a $3.2 million final insurance settlement payment related to a1999 recall.  Exclusive of thissettlement amount, the Division’s operating profit increased $1.3 million in2002.  This reflected more favorableingredient costs, which more than offset higher than expected production costsat one of our three dairy plants. 

 

REFRIGERATED DISTRIBUTIONDIVISION OPERATING PROFIT. Refrigerated Distribution Division operating profitfor the year ended December 31, 2002 increased $5.1 million, or 60%, to $13.7million from $8.6 million for the Company and the Predecessor for the yearended December 31, 2001. Profit margin for our key product line, cheese, rosein 2002 due to more normalized product costs prevailing through much of theyear.  However, profit results for thefirst several months of 2002 were depressed due to cheese hedging, whichresulted in cheese costs being in excess of market levels.  When cheese inventory costs returned to morenormal levels, due to a reduction in hedging, operating profits for theDivision increased significantly in the latter part of the year. 

 

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COMBINED RESULTS FOR THEYEAR ENDED DECEMBER 31, 2001 COMPARED TO THE PREDECESSOR’S RESULTS FOR THE YEARENDED DECEMBER 31, 2000 

 

NET SALES. Net sales forthe year ended December 31, 2001 increased $80.7 million, or 7%, to $1,161.3million from $1,080.6 million for the year ended December 31, 2000. Overone-half of this increase was the result of a 31% increase in net sales fromthe Dairy Products Division, with both volume growth and higher dairy marketpricing contributing to this growth. External net sales growth of 9% and 10%was recorded by the Refrigerated Distribution and Potato Products divisions.Refrigerated Distribution sales growth was roughly half from unit sales growthand half from price inflation, particularly in the important cheese category.Potato Products sales growth was primarily from increased unit sales, withparticularly strong growth seen in the retail category. Sales growth in the EggProducts Division was minimal due to fairly stable volume and pricing. 

 

EGG PRODUCTS DIVISIONSALES. Egg Products Division external net sales for the year ended December 31,2001 increased $8.5 million, or 1%, to $645.9 million from $637.4 million forthe year ended December 31, 2000. Sales growth for certain higher value-addedproducts, such as pre-cooked patties and omelets, egg substitutes andhardcooked eggs, offset lower sales from commodity-sensitive lines such asdried products. During 2001, shell egg prices declined by approximately 3% asreported by Urner Barry, resulting in narrow margins for frozen, short-shelflife liquid and dried egg products. As a result, we limited sales volumes forfrozen products, in particular, because of the adverse pricing and marginenvironment. Sales of higher value-added egg products represented approximately60% of the egg products division’s sales in both 2001 and 2000. 

 

POTATO PRODUCTS DIVISIONSALES. Potato Products Division external net sales for the year ended December31, 2001 increased $6.2 million, or 10%, to $66.9 million from $60.7 million forthe year ended December 31, 2000. This increase was mainly due to a strong unitsales growth for retail refrigerated potato products, which increasedapproximately 25% from 2000. Also, foodservice unit sales increased byapproximately 7%. Sales to new customers, growth in sales to existingcustomers, marketing spending and new product introductions all contributed tothe sales increase. 

 

DAIRY PRODUCTS DIVISIONSALES. Dairy Products Division external net sales for the year ended December31, 2001 increased by $44.5 million, or 31%, to $185.9 million from $141.4million for the year ended December 31, 2000. This increase was mainly due tostrong unit sales volumes for certain specialty cartoned items contract packedfor other dairies and notable growth in non-refrigerated creamer sales.National dairy ingredient price increases during the year resulted in a higherpricing environment for the products sold by the Division. Hence, inflation wasalso a significant factor in the higher divisional external net sales in 2001.Sales in 2000 were adversely impacted as a result of volume declines andoperating inefficiencies associated with the aftermath of a 1999 recall ofcartoned milk. 

 

REFRIGERATED DISTRIBUTIONDIVISION SALES. Refrigerated Distribution Division external net sales for theyear ended December 31, 2001 increased $21.6 million, or 9%, to $262.7 millionfrom $241.1 million for the year ended December 31, 2000. This increase wasmainly due to unit sales growth in cheese, margarine and bagels. Cheese salesgrowth was somewhat constrained, and butter sales declined, as a result of highretail price points during much of the year due to a high national butterfatmarket. Divisional volume growth in 2001 resulted from sales to new customers,particularly in new territories, promotional activity and increased consumeradvertising. Inflation also contributed to divisional sales growth due tohigher dairy prices. 

 

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GROSS PROFIT. Grossprofit for the year ended December 31, 2001 increased $8.1 million, orapproximately 4%, to $199.6 million from $191.5 million for the Predecessor inthe year ended December 31, 2000. The combined gross profit margin was 17.2% ofnet sales for 2001, as compared to 17.7% of net sales for the Predecessor in2000. The decrease in gross profit margin was mainly due to decreased grossprofit from frozen egg products, resulting from market price pressures, andreduced gross margins from cheese and butter sales due to the significant risein product costs in 2001, which outpaced our ability to adjust our sellingprices for much of the year. 

 

SELLING, GENERAL ANDADMINISTRATIVE EXPENSES. Selling, general and administrative expenses for theyear ended December 31, 2001 increased $10.2 million, or 10%, to $114.9 millionfrom $104.7 million for the Predecessor for the year ended December 31, 2000.Selling, general and administrative expenses increased as a percent of sales in2001, as compared to Predecessor results in 2000. Higher expenses were incurredin 2001 to support retail and foodservice marketing efforts and broadened salesefforts, and to establish a centralized purchasing department. Additionally,operating expenses reflected the impact of incremental amortization related tothe Merger, of approximately $3.0 million, which resulted in the slightlyhigher expense as a percentage of sales. Separate from selling, general andadministrative expenses in 2001, the Predecessor recorded non-recurringexpenses related to the Merger for financial, legal, advisory and regulatoryfiling fees. These expenses of approximately $11.1 million are reflected in thePredecessor’s Consolidated Statements of Earnings as transaction expenses. 

 

OPERATING PROFIT.Operating profit for the year ended December 31, 2001 decreased $13.2 million,or approximately 15%, to $73.6 million from $86.8 million for the Predecessorfor the year ended December 31, 2000. This decrease was mainly due to theMerger transaction expenses incurred by the Predecessor in the first threemonths of 2001, as discussed above. 

 

EGG PRODUCTS DIVISIONOPERATING PROFIT. Egg Products Division operating profit for the year endedDecember 31, 2001 decreased $6.1 million, or 9%, to $61.6 million from $67.7million for the year ended December 31, 2000. Operating profit for highervalue-added egg products decreased by $5.5 million, or 8%, from 2000, whileoperating profits from other egg products remained relatively flat. Thedecrease in operating margins was mainly due to an approximately $4.0 millionincrease in amortization of goodwill and increased depreciation ofapproximately $6.2 million as a result of asset appraisals related to theMerger. The 2001 operating profit for the Division was also affected by anapproximately $1.6 million loss from the Division’s termination of a Europeanjoint-venture. A break-even return was recorded from the same joint-venture in2000. 

 

POTATO PRODUCTS DIVISIONOPERATING PROFIT. Potato Products Division operating profit for the year endedDecember 31, 2001 increased $0.7 million, or 9%, to $8.3 million from $7.6million for the year ended December 31, 2000. This increase reflected benefitsfrom volume growth, particularly from the more profitable retail segment, andcontinuing improvements in plant operations. 

 

DAIRY PRODUCTS DIVISIONOPERATING PROFIT. Dairy Products Division operating profit for the year endedDecember 31, 2001 increased significantly, up $10.5 million to $11.8 millionfrom $1.3 million for the year ended December 31, 2000. Divisional operatingprofit increased substantially as a result of strong unit sales growth,particularly from specialty items such as non-refrigerated creamers, andimproved plant operating costs. Operating profits were also favorably impactedby a $3.2 million final insurance settlement payment related to a 1999 recalland reduced amortization expense of $1.2 million resulting from the appraisalof a non-compete agreement due

 

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to the Merger. Divisionaloperating profitability was depressed in 2000 due to the loss of a majorindustrial customer, increased bad debt expense resulting from a foodservicedistributor’s bankruptcy filing, higher overhead expenses and above-averageoperating expenses as a result of a 1999 product recall. 

 

REFRIGERATED DISTRIBUTIONDIVISION OPERATING PROFIT. Refrigerated Distribution Division operating profitfor the year ended December 31, 2001 decreased $7.4 million, or 46%, to $8.6million from $16.0 million for the year ended December 31, 2000. Profit marginsfor key lines, such as cheese and butter, were depressed due to a rapid andsustained increase in dairy market-based ingredient costs through much of theyear, without a comparable increase in retail selling prices. These marketconditions were in sharp contrast to those which prevailed in 2000. 

 

SEASONALITY AND INFLATION

 

Consolidated quarterlyoperating results are affected by the seasonality of our net sales andoperating profits. Specifically, shell egg prices typically rise seasonally inthe first and fourth quarters of the year due to increased demand duringholiday periods. Consequently, net sales in the Egg Products Division increasein the fourth quarter. Generally, the Refrigerated Distribution Division hashigher net sales and operating profits in the fourth quarter, coinciding withincremental consumer demand during the holiday season. Net sales and operatingprofits from the Dairy Products Division typically are significantly higher inthe second and third quarters due to increased consumption of ice creamproducts during the summer months. Operating profits from the Potato ProductsDivision are less seasonal, but tend to be higher in the second half of theyear coinciding with the potato harvest. In recent years, other than fluctuationsin raw material costs, largely related to short-term supply and demandvariances, inflation has not been a significant factor in our operations.Inflation is not expected to have a significant impact on the business,financial condition or results of operations since we can generally offset theimpact of inflation through a combination of productivity gains and priceincreases. 

 

LIQUIDITY AND CAPITALRESOURCES 

 

Historically, we havefinanced our liquidity requirements through internally generated funds, seniorbank borrowings, and the issuance of other indebtedness. We believe suchsources remain viable financing alternatives to meet our anticipated needs. Ourinvestments in acquisitions, joint ventures and capital expenditures have beena significant use of capital. We plan to continue to invest in state-of-the-artproduction facilities to enhance our competitive position. 

 

Cash flow provided byoperating activities was $83.0 million for the year ended December 31, 2002,compared to $114.8 million, combining Company and Predecessor results, for theyear ended December 31, 2001, and $69.1 million for the Predecessor’s yearended December 31, 2000. The decrease in cash flow provided by operatingactivities from 2001 to 2002 was due principally to an increase in operatingworking capital related to our Canadian acquisition. The increase in theCompany’s and Predecessor’s cash flow provided by operating activities from2000 to 2001 was due principally to significantly reduced operating workingcapital. 

 

Earnings before interest,taxes, depreciation and amortization (“EBITDA”) for the year ended December 31,2002 were $155,487,000, an increase of 7% compared to the Company’s andPredecessor’s combined $145,753,000 for the year ended December 31, 2001. EBITDAincreased because of the factors discussed in the above results of operationsdivisional reviews. We believe that EBITDA is a relevant measurement of ourfinancial results, as it is indicative of the relative strength of our cashflows and is a key measurement contained in the financial covenants of oursenior indebtedness. In addition, as a highly leveraged company, the holders ofour debt 

 

18

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have a significantinterest in our cash flows. We compute EBITDA as it is defined in our seniorcredit agreement (see Exhibit 10.1 of our Amendment No. 1 to Form S-4 filedwith the Securities and Exchange Commission on July 18, 2001). This definitionmay not be comparable to that used by other companies reporting similarfinancial information. 

 

We believe EBITDA is awidely accepted financial indicator used to analyze and compare companies onthe basis of operating performance. It should not be considered in isolation oras a substitute for measures of performance prepared in accordance withgenerally accepted accounting principles and is not indicative of operatingprofit or cash flow from operations as determined under generally acceptedaccounting principles. The following table reconciles our net earnings to EBITDAfor the past two years: 

 
|                                                                   |   | **For the  periods ended,** |        |
|------------------------------------------------------------------------|--------|-----------------------------|-------------|
|                                                                   |   | **December  31,  2002**     |        | **December  31,  2001** |   |
|                                                                   |   |                        |        |   |   |
| Net earnings                                                           |   | $                           | 29,661,000  |   | $ | 4,162,000 |   |
|                                                                   |   |                        |        |   |   |
| Total interest  expense, excluding amortization of debt issuance costs |   | 46,593,000                  |        | 43,722,000 |   |
|                                                                   |   |                        |        |   |   |
| Income taxes                                                           |   | 18,543,000                  |        | 8,341,000 |   |
|                                                                   |   |                        |        |   |   |
| Depreciation and  amortization                                         |   | 54,258,000                  |        | 59,480,000 |   |
|                                                                   |   |                        |        |   |   |
| Amortization of  debt issuance costs                                   |   | 4,218,000                   |        | 2,359,000 |   |
|                                                                   |   |                        |        |   |   |
| Transaction  expenses                                                  |   | —                      |        | 26,563,000 |   |
|                                                                   |   |                        |        |   |   |
| Other                                                                  |   | 2,214,000                   |        | 1,126,000 |   |
| EBITDA                                                                 |   | $                           | 155,487,000 |   | $ | 145,753,000 |   |

 

As a result of the Merger, we incurred approximately $580 million oflong-term debt, including $380 million of borrowings under our senior creditagreement and $200 million of indebtedness through the issuance of 11.75%senior subordinated notes due 2011. Our total annual interest expense relatedto the term loans under the credit agreement and the notes was in excess of $50million in 2002. In addition, the aggregate maturities of our long-term debt,our lease commitments and our long-term purchase commitments for the yearssubsequent to December 31, 2002, are as follows: 

 
|                 |   | **Long-term  Debt** |   | **Lease  Commitments** |   | **Long-term  Purchase Commitments(1)** |   | **Total(2)** |   |
|----------------------|--------|---------------------|--------|------------------------|--------|----------------------------------------|--------|--------------|--------|
| 2003                 |   |                | $      | 17,671,000             |   |                                   | $      | 6,901,000    |   | $ | 4,619,000 |   | $ | 29,191,000 |   |
| 2004                 |   | 14,699,000          |   | 7,006,000              |   | 4,363,000                              |   | 26,068,000   |   |
| 2005                 |   | 18,401,000          |   | 5,553,000              |   | —                                 |   | 23,954,000   |   |
| 2006                 |   | 23,356,000          |   | 5,014,000              |   | —                                 |   | 28,370,000   |   |
| 2007                 |   | 175,193,000         |   | 3,324,000              |   | —                                 |   | 178,517,000  |   |
| 2008 and  thereafter |   | 262,069,000         |   | 16,079,000             |   | —                                 |   | 278,148,000  |   |
|                 |   |                | $      | 511,389,000            |   |                                   | $      | 43,877,000   |   |  $ | 8,982,000 |   | $ | 564,248,000 |   |
|                      |        |                     |        |                        |        |                                        |        |              |        |  |  |  |  |  |  |  |  |  |

 

----

| (1)    |   | Contracted commitments to purchase potatoes.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| (2)    |   | We have egg volume contracts with many suppliers  which run from less than a year to multiple years, with our egg costs being  determined by either the price of grains fed to the flocks producing under  the agreements or by the periodic market price for eggs as reported by Urner  Barry.  Based upon the best estimates  available to us for grain and egg prices, we project that our purchases from  our top five long-term contracted egg suppliers will approximate $141 million  in 2003, $138 million in 2004, $82 million in 2005, $20 million in 2006, and  $16 million in 2007, and that the 2003 amount will account for approximately  60% of our total egg purchases this year. |

 

 

We have a credit agreement with various lenders, including commercialbanks, other financial institutions and investment groups, which expires in2007 and 2008 and provides credit facilities which originally provided $470million. Within these credit facilities there is a $100 million revolving lineof credit. As of December 31, 2002, approximately $300 million was outstanding

 

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under the credit agreement, with approximately $7.5 million securedunder the revolving line of credit for letters of credit. The weighted averageinterest rate for our borrowings under the credit agreement, adjusted for theeffects of hedging activities, was 6.76% at December 31, 2002. Given ourbusiness trends and cash flow forecast, we do not anticipate a significant useof the revolving line of credit during 2003. However, it is possible that oneor more acquisitions could arise, which could result in much of the revolvingline of credit being utilized at some point. 

 

The credit agreement contains various restrictive covenants. Itprohibits us from prepaying other indebtedness, including the notes, and itrequires us to maintain specified financial ratios, such as a minimum ratio ofEBITDA to interest expense, a minimum fixed charge coverage ratio, a maximumratio of senior debt to EBITDA and a maximum ratio of total debt to EBITDA. Inaddition, the credit agreement prohibits us from declaring or paying anydividends and prohibits us from making any payments with respect to the notesif we fail to perform our obligations under, or fail to meet the conditions of,the credit agreement or if payment creates a default under the creditagreement. The indenture governing the subordinated notes, among other things:(i) restricts our ability and the ability of our subsidiaries to incuradditional indebtedness, issue shares of preferred stock, incur liens, paydividends or make certain other restricted payments and enter into certaintransactions with affiliates; (ii) prohibits certain restrictions on theability of certain of our subsidiaries to pay dividends or make certainpayments to us; and (iii) places restrictions on our ability and the ability ofour subsidiaries to merge or consolidate with any other person or sell, assign,transfer, lease, convey or otherwise dispose of all or substantially all of ourassets. The indenture related to the notes and the credit agreement alsocontain various covenants which will limit our discretion in the operation ofour businesses. We were in compliance with all of the covenants in theindenture and the credit agreement as of December 31, 2002. 

 

We may repurchase from time to time a portion of our subordinatednotes, subject to market conditions and other factors.  No assurance can be given as to whether orwhen, or at what prices, such repurchases will occur.  Any such repurchases would be limited by certain restrictionsfound in our credit agreement and in the indenture governing the subordinatednotes. 

 

Our ability to make payments on and to refinance our debt, includingthe subordinated notes, and to fund planned capital expenditures will depend onour ability to generate sufficient cash in the future. This, to some extent, issubject to general economic, financial, competitive and other factors that arebeyond our control. We believe that, based on current levels of operations, wewill be able to meet our debt service obligations when due. Significantassumptions underlie this belief, including, among other things, that we willcontinue to be successful in implementing our business strategy and that therewill be no material adverse developments in our business, liquidity or capitalrequirements. If our future cash flows from operations and other capitalresources are insufficient to pay our obligations as they mature or to fund ourliquidity needs, we may be forced to reduce or delay our business activitiesand capital expenditures, sell assets, obtain additional debt or equity capitalor restructure or refinance all or a portion of our debt, including the notes,on or before maturity. We can provide no assurances that we would be able toaccomplish any of these alternatives on a timely basis or on satisfactoryterms, if at all. In addition, the terms of our existing and futureindebtedness, including the notes and our new credit agreement, may limit ourability to pursue any of these alternatives. 

 

Our longer-term planning is focused on growing our sales, earnings andcash flows primarily by focusing on our existing business lines, throughexpanding product offerings, increasing production capacity for value-addedproducts and broadening customer bases. We believe our financial resources aresufficient to meet the working capital and capital spending necessary toexecute our 

 

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longer-term plans. In executing these plans, we expect to reduce debtover the coming years. However, possible significant acquisition activity couldresult in us seeking additional financing resources, which we would expectwould be available to us if they are sought. 

 

CAPITAL SPENDING 

 

We invested approximately $27 million in capital expenditures duringthe year ended December 31, 2002, and the Company and Predecessor made capitalinvestments of approximately $34 million in 2001 and approximately $37 millionin 2000. Capital expenditures each year mainly related to expanding capacityfor value-added products, especially in the egg and dairy products divisions,to expand warehouse space for all of our divisions, and the upgrading ofcomputer technology. Also, during 2002, we purchased substantially all of theegg-related assets of Canadian Inovatech Inc. for approximately $18 million.Capital expenditures in 2002, 2001 and 2000 were funded from cash flow fromoperations and borrowings under credit facilities. 

 

We plan to spend approximately $39.5 million in total capitalexpenditures for 2003, which will be used to maintain existing productionfacilities, expand refrigerated warehouse capacity, and to expand productioncapacity for value-added products, such as specialty potato and dairy products.This spending will be funded from operating cash flow, plus available capacityunder our revolving line of credit, if need be. 

 

DEBT GUARANTEES 

 

We have guaranteed the repayment of certain industrial revenue bondsused for the expansion of the wastewater treatment facilities of severalmunicipalities where we have food processing facilities. The repayment of thesebonds is funded through the wastewater treatment charges paid by the Company.However, should those charges not be sufficient to pay the bond payments asthey become due, we have agreed to pay any shortfall. The remaining principalbalance of these bonds at December 31, 2002 was approximately $6,700,000. 

 

INSURANCE 

 

In general, our insurance costs have increased over the past threeyears. The insurance industry trends toward significantly higher premiums wereaccelerated by global geo-political events in the fall of 2001. We anticipateour 2003 property and casualty insurance premiums will rise by approximately15% from 2002 levels, with further premium increases likely in 2004. We havealso experienced, and expect to continue to see, rising premiums for the Company’sportion of health and dental insurance benefits offered to our employees. 

 

CRITCIAL ACCOUNTING POLICIES AND ESTIMATES 

 

Our discussion and analysis of our financial condition and results ofoperations is based upon the consolidated financial statements, which have beenprepared in accordance with accounting principles generally accepted in theUnited States of America. The preparation of these financial statementsrequires us to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses, and related disclosure ofcontingent assets and liabilities. On an on-going basis, we evaluate estimates,including those related to the allowance for doubtful accounts, goodwill andintangible assets, accrued promotion costs, accruals for insurance, financialinstruments and income tax provision. We base these estimates on historical experience and on various otherassumptions that are believed to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valuesof assets and liabilities that are not readily apparent from other sources.Actual results may differ from these estimates under different assumptions orconditions. 

 

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We believe the following critical accounting policies reflect thesignificant judgments and estimates used in the preparation of our consolidatedfinancial statements. 

* *

Allowance for doubtfulaccounts

 

We make estimates of the uncollectibility of our accounts receivable.In determining the adequacy of the allowance, we analyze the value of ourcustomer’s financial statements, historical collection experience, aging ofreceivables and other economic and industry factors. It is possible that theaccuracy of the estimation process could be materially impacted by differentjudgments as to collectibility based on the information considered and furtherdeterioration of accounts. 

* *

Goodwill and Intangibles 

 

We assess the impairment of identifiable intangibles, long-lived assetsand related goodwill whenever events or changes in circumstances indicate thecarrying value may not be recoverable. Factors which could trigger animpairment review include significant under-performance relative to expectedhistorical or projected future operating results, significant changes in theuse of acquired assets or our strategy, and significant negative industry oreconomic trends.  For intangible assetsand long-lived assets, an assessment may occur if the carrying value of theasset exceeds the undiscounted cash flows from the asset. 

 

When we determine that the carrying value of intangibles, long-livedassets and related goodwill may not be recoverable based upon the existence ofan impairment, we measure any potential impairment based on a projecteddiscounted cash flow method using a discount rate determined by management tobe commensurate with the risk inherent in our current business model.  On January 1, 2002, we adopted Statement ofFinancial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,”and were required to assess our goodwill for impairment issues upon adoption,and are required to do so at least annually now. 

* *

Accrued promotion costs 

 

The amount and timing of expense recognition for customer promotionactivities involve management judgment related to estimated participation,performance levels, and historical promotion data and trends. The vast majorityof year-end liabilities associated with these activities are resolved withinthe following fiscal year and, therefore, do not require highly uncertainlong-term estimates. 

* *

Accruals for insurance

 

We are primarily self-insured for our medical and dental liabilitycosts.  We maintain “high deductible”insurance policies for our workers compensation and general and automobileliability costs. It is our policy to record our self-insurance liabilitiesbased on claims filed and an estimate of claims incurred but not yet reported.Any projection of losses concerning medical, dental, workers compensation andgeneral and automobile liability is subject to a considerable degree ofvariability. Among the causes of this variability are unpredictable externalfactors affecting future inflation rates, litigation trends, legalinterpretations, benefit level changes and claim settlement patterns. 

* *

Financial instruments

 

We use derivative financial instruments to manage our exposure tovarious market risks, including certain interest rates, grain and feed costs. 

 

Income tax provision 

 

Income tax expense involves management judgment as to the ultimateresolution of any tax issues. Historically, our assessments of the ultimateresolution of tax issues have been reasonably accurate. The current open issuesare not dissimilar from historical items. 

 

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RECENT ACCOUNTING PRONOUNCEMENTS

 

On January 1, 2002, we adopted Emerging Issues Task Force (EITF) IssueNo. 00-25, *VendorIncome Statement Characterization of Consideration to a Reseller on the VendorsProducts*, effective January 1, 2002.  The adoption of EITF Issue 00-25 did not have a material effecton our consolidated financial statements. In addition, we adopted EITF IssueNo. 01-09, *Accountingfor Consideration given by a Vendor to a Customer (including a Reseller of theVendor’s Products),* effective January 1, 2002.  The adoption of EITF Issue No. 01-09 did nothave a material effect on our consolidated financial statements. 

 

In July 2001, the Financial Accounting Standards Board (FASB) issuedStatement of Financial Accounting Standards (SFAS) No. 143, “Accounting forAsset Retirement Obligations” which provides accounting requirements forretirement obligations associated with tangible long-lived assets. SFAS No. 143is effective for fiscal years beginning after June 15, 2002. We believe theadoption of SFAS No. 143 will not have a material impact on our financialposition or results of operations. 

 

In April 2002, the FASB issued SFAS No. 145, “Rescission of FASBStatement 4, 44, and 64, Amendment of FASB Statement No. 13, and TechnicalCorrections”.  SFAS No. 145 rescindsSFAS No. 4, “Reporting Gains and Losses from Extinguishment of Debt” Under SFASNo. 4, all gains and losses from extinguishment of debt were required to beaggregated and, if material, classified as an extraordinary item, net ofrelated income tax effect.  SFAS No. 145requires that gains and losses from extinguishment of debt be classified as anextraordinary item only if they are part of the entities recurring operationsand not unusual or infrequent.  Theeffect of adopting this standard on our financial statements was to reclassifyour extraordinary loss in the three-month period ended March 31, 2001 to otherexpense in the statement of operations. 

 

In June 2002, the Financial Accounting Standards Board (FASB) issuedStatement of Financial Accounting Standards (SFAS) No. 146, “Accounting forCosts Associated with Exit or Disposal Activities.”  SFAS No. 146 requiresthat a liability for a cost associated with an exit or disposal activity berecognized and measured initially at fair value only when the liability isincurred.  Prior to the adoption of this Standard, a liability for an exitcost, as defined by Emerging Issues Task Force Issue No. 94-3, “LiabilityRecognition for Certain Employee Termination Benefits and Other Costs to Exitan Activity (including Certain Costs Incurred in a Restructuring)”, wasrecognized at the date of an entity’s commitment to an exit plan.  SFAS No. 146 was effective for the Companyfor exit plans or disposal activities initiated after December 31, 2002. Adoption is not expected to have a material impact on our financial position orresults of operations. 

 

In November 2002, the FASB issued Interpretation No. 45, “Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others." This interpretation elaborates onthe disclosure requirements in the financial statements concerning obligationsunder certain guarantees. It also clarifies the requirements related to therecognition of liabilities by a guarantor at the inception of certainguarantees. The disclosure requirements of this interpretation were effectivefor us on December 31, 2002, but did not require any additional disclosure. Therecognition provisions of the interpretation are applicable only to guaranteesissued or modified after December 31, 2002. We do not expect adoption of theserecognition provisions to have a material impact on our financial position orresults of operations. 

 

In January 2003, the FASB issued Interpretation No. 46, “Consolidationof Variable Interest Entities." This interpretation addresses therequirements for business enterprises to consolidate related entities in whichthey are the determined to be the primary beneficiary as a result of theirvariable economic interests. The interpretation is intended to provide guidancein judging multiple economic

 

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interests in an entity and in determining the primary beneficiary. Theinterpretation outlines disclosure requirements for variable interest entitiesin existence prior to January 31, 2003 and outlines consolidation requirementsfor variable interest entities created after January 31, 2003. Adoption is notexpected to have a material impact on our consolidated financial statements.

 

MARKET RISK 

 

COMMODITY HEDGING 

 

COMMODITY RISK MANAGEMENT. The principal market risks to which we areexposed that may adversely affect our results of operations and financial positioninclude changes in future commodity prices and interest rates. We seek tominimize or manage these market risks through normal operating and financingactivities and through the use of commodity contracts and interest rate swapagreements, where practicable. We believe that the use of these instruments tomanage risk is in our best interest. We do not trade or use instruments withthe objective of earning financial gains on the commodity price or interestrate fluctuations, nor do we use instruments where there are not underlyingexposures. 

 

The primary raw materials used in the production of eggs are corn andsoybean meal. We purchase these materials to feed our approximately 13 millionhens, which produce approximately 30% of our annual egg requirements. Shell andliquid eggs are purchased from third-party suppliers and in the spot market forthe remainder of the Egg Products Division’s needs. Eggs, corn and soybean mealare commodities that are subject to significant price fluctuations due to marketconditions which, in certain circumstances, can adversely affect the results ofoperations. 

 

In order to reduce the impact of changes in commodity prices on ouroperating results, a risk management strategy that includes the followingelements has been developed: 

 

•                                          We hedge asignificant percentage of our grain commodity requirements for both internalegg production and third-party egg procurement contracts that are priced basedon grain prices, which collectively account for approximately 65% of our eggrequirements. This activity protects against unexpected increases in grainprices and provides predictability with respect to a portion of future rawmaterials costs. Hedging can diminish the opportunity to benefit from theimproved margins that would result from an unanticipated decline in grainprices. The degree to which we are hedged varies based on our expectation offuture commodity prices.

 

•                                          We seek toalign our procurement and sales volumes by matching the percentage of variablepricing contracts with our customers and the percentage of raw materialsprocured on a variable basis. This matching of our variable priced procurementcontracts with that of variable priced sales contracts provides us with anatural hedge during times of grain and egg market volatility. As part of thiseffort, we are attempting to transition customers to variable pricing contractsthat are priced off the same index used to purchase shell and liquid eggs.These efforts have generally been successful over the past two years.

 

•                                          We havenegotiated agreements with certain of our fixed price customers which allow usto raise prices by giving 30 to 60 days notice in response to increasedcommodity prices. The majority of

 

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these contracts are with major broad-line foodservicedistributorcustomers who are generally less sensitive to price increasesbecause their customers purchase food products from them on a cost-plus basis.

 

•                                          We arecontinuing to transition customers from lower value-added egg products tohigher margin, higher value-added specialty products. These products are lesssensitive to fluctuations in underlying commodity prices because the rawmaterial component is a smaller percentage of total cost and we generally havethe ability to pass through certain cost increases related to our highervalue-added egg products to customers. This transition to higher value-addedspecialty products has taken place gradually over the last five to six years.These products represented approximately 60% of our egg products sales in 2002,up from approximately 52% in 1997.

 

The following table is a sensitivity analysis that estimates ourexposure to market risk associated with corn and soybean meal futurescontracts. The notional value of commodity positions represents the notionalvalue of the corn and soybean meal futures contracts for the year endedDecember 31, 2002. Market risk is estimated as the potential loss in fair valueresulting from a hypothetical 10% adverse change in commodity prices (amountsin thousands). 

 
|                             |             | **Notional  value** |   | **Market  risk** |   |
|----------------------------------|------------------|---------------------|--------|------------------|--------|
| Corn futures contracts:          |             |                |   |             |   |
|                             |             |                |   |             |   |   |   |   |
|                             | Highest position |                | $      | 40,255           |   | $ | 4,026 |   |
|                             | Lowest position  |                | 16,594 |             | 1,659  |   |
|                             | Average position |                | 23,918 |             | 2,392  |   |
|                             |             |                |   |             |   |
| Soybean meal  futures contracts: |             |                |   |             |   |
|                             |             |                |   |             |   |   |   |   |
|                             | Highest position |                | $      | 20,126           |   | $ | 2,013 |   |
|                             | Lowest position  |                | 13,696 |             | 1,370  |   |
|                             | Average position |                | 14,995 |             | 1,500  |   |

 

During 2001, we began using futures contracts to cover a portion of ourestimated cheese procurement needs. During 2002 we used such contracts to hedgea portion of our needs for a portion of the year.  At December 31, 2002, there were no such contracts. 

 

Additionally, we hedge some of our natural gas requirements forproducing our products by fixing the price for a portion of our natural gasusage.  At December 31, 2002, the netfair value of such fixed price purchases was approximately $4.6 million.  These monthly purchases have been madethrough March 2003 and cover approximately 75% of our estimated usage requirementsduring that period.  The potential lossin fair value of these contacts resulting from a 10% adverse change in theunderlying commodity prices would be approximately $0.5 million. 

 

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Additionally, we partially mitigate the risk of variability of ourtransportation-related fuel costs through the use of home heating oil futurescontracts. At December 31, 2002, the net fair value of such contracts wasapproximately $0.5 million. These contracts expire at various times throughMarch 2003 and cover approximately 25% of our estimated usage and exposureduring that period. The potential loss in fair value of these contractsresulting from a 10% adverse change in the underlying commodity prices would beapproximately $0.05 million. 

 

INTEREST RATES 

 

Due to our Merger, we have fixed rate debt of $200 million, which webelieve has a fair value of approximately the same amount as of the end of2002. The market risk related to this fixed rate debt, which represents theimpact on the fair value from a hypothetical 100 basis point change in interestrates, is $2 million. Our credit agreement debt obligations of approximately$300****millioncarry a variable rate of interest. We believe the fair value of this debt approximates$300 million as of the end of 2002. The interest paid on those obligationsfloats with market changes in interest rates. As part of our risk managementstrategy, we have entered into interest swap arrangements that correspond withthe interest payment terms on $215 million borrowed under the variable portionof our credit agreement. As such, the market risk related to these interestrate swaps using the same assumption as above would be $2.15 million. 

 

ITEM 7A – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 

 

See Item 7—Management’s Discussion and Analysis of Financial Conditionand Results of Operations – Market Risk, above. 

 

ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 

 

The consolidated financial statements and related notes and schedulesrequired by this Item are set forth in Part IV, Item 15 herein. 

 
|         |   | **QUARTER** |    |
|--------------|--------|-------------|---------|
| **2002**     |   | **FIRST**   |    | **SECOND** |   | **THIRD** |   | **FOURTH** |   |
|         |   |        |    |   |   |   |   |   |   |
| Net sales    |   | $           | 278,429 |   | $ | 289,753 |   | $ | 293,954 |   | $ | 306,024 |   |
| Gross profit |   | 51,116      |    | 54,204 |   | 54,177 |   | 55,330 |   |
| Net earnings |   | 5,359       |    | 7,316 |   | 7,366 |   | 9,620 |   |
|              |        |             |         |  |  |  |  |  |  |  |  |  |  |

 
| **2001**             |   | **Predecessor** |    | **Company** |   |
|----------------------|--------|-----------------|---------|-------------|--------|
|                 |   |            |    |        |   |   |   |   |   |
| Net sales            |   | $               | 275,627 |        | $      | 295,109 |   | $ | 299,225 |   | $ | 291,308 |   |
| Gross profit         |   | 47,920          |    | 50,254      |   | 50,789 |   | 50,591 |   |
| Net earnings  (loss) |   | (5,653          | )       | 1,669       |   | 3,297 |   | 4,849 |   |
|                      |        |                 |         |             |        |  |  |  |  |  |  |  |  |

 

ITEM 9 – CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTINGAND FINANCIAL DISCLOSURE 

 

On August 23, 2002, we dismissed Grant Thornton LLP (“Grant Thornton”)as our independent auditor and appointed PricewaterhouseCoopers LLP(“PricewaterhouseCoopers”) as our new independent accountants for the fiscalyear ending December 31, 2002.  Thisdetermination followed a decision of our Audit Committee, upon recommendationof our equity sponsors, to seek proposals from other independent auditing firmsto audit our financial statements for fiscal 2002.  The decision not to renew the engagement of Grant Thornton and toretain PricewaterhouseCoopers as our independent auditor for fiscal 2002 wasapproved by our Board of Directors upon the recommendation of the AuditCommittee.  The decision not to retainGrant Thornton was not a reflection of Grant Thornton’s capabilities or qualityof service.  Grant Thornton providedquality service and demonstrated a high level of professionalism throughout itsrelationship with us. 

 

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Grant Thornton’s reports on our consolidated financial statements foreach of the fiscal years ended December 31, 2001 and 2000 did not contain anadverse opinion or disclaimer of opinion, nor were they qualified or modifiedas to uncertainty, audit scope or accounting principles. 

 

During the fiscal years ended December 31, 2001 and 2000, to the dateof dismissal of Grant Thornton, there were no disagreements with Grant Thorntonon any matter of accounting principle or practice, financial statementdisclosure, or auditing scope or procedure which, if not resolved to GrantThornton’s satisfaction, would have caused it to make a reference to thesubject matter in connection with its report for such years.  None of the reportable events describedunder Item 304(a)(1)(v) of Regulation S-K occurred within our two most recentfiscal years and the subsequent interim period.  Current Reports on Form 8-K and Form 8-K/A were filed with theCommission on August 23, 2002 and September 25, 2002 regarding this dismissal. 

 

PART III 

 

ITEM 10 – DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 

 

Michael Foods, Inc. is a wholly owned subsidiary of M-Foods Holdings,Inc., a corporation owned by M-Foods Investors, LLC, whose members includeaffiliates of Vestar Capital Partners and Goldner Hawn Johnson & Morrison,members of our senior management and affiliates of the Michael family. Eachmember of the management committee of M-Foods Investors is also a director ofMichael Foods and was elected pursuant to the terms of a securityholdersagreement. For more information, see Item 13— Certain Relationships and RelatedTransactions. 

 

The executive officers, directors and key employees of Michael Foods,and their ages and positions, are as follows: 

 
| **NAME**                        |   | **AGE** |   | **POSITION**                                                                                          |
|---------------------------------|--------|---------|--------|-------------------------------------------------------------------------------------------------------|
| Gregg A. Ostrander              |   | 50      |   | President, Chief Executive Officer and Chairman                                                       |
| John D. Reedy                   |   | 57      |   | Executive Vice President, Chief Financial Officer  and Treasurer                                      |
| Mark D. Witmer                  |   | 45      |   | Assistant Treasurer and Secretary                                                                     |
| James D. Clarkson               |   | 50      |   | President—Potato Products, Dairy Products and  Refrigerated Distribution Divisions               |
| Bill L. Goucher                 |   | 56      |   | President—Egg Products Division                                                                  |
| Bradley L. Cook                 |   | 47      |   | Executive Vice President of Corporate  Development—Egg Products Division                         |
| Max R. Hoffmann                 |   | 44      |   | Chief Financial Officer—Potato Products, Dairy  Products and Refrigerated Distribution Divisions |
| James Mohr                      |   | 51      |   | Vice President—Supply Chain Logistics                                                            |
| Harold D. Sprinkle              |   | 56      |   | Vice President/General Manager of Potato Products and  Dairy Products Divisions                       |
| J. Christopher Henderson (1)(3) |   | 35      |   | Director                                                                                              |
| Jerome J. Jenko (2)(3)(4)       |   | 65      |   | Director                                                                                              |
| James P. Kelley (2)(4)          |   | 48      |   | Director                                                                                              |
| Leonard Lieberman (1)(4)        |   | 74      |   | Director                                                                                              |
| Jeffrey J. Michael (1)          |   | 46      |   | Director                                                                                              |
| John L. Morrison (2)(3)         |   | 57      |   | Director                                                                                              |
| Kevin A. Mundt (2)              |   | 49      |   | Director                                                                                              |

 

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(1) Members of our Audit Committee

(2) Members of our Compensation Committee

(3) Members of our Risk Management Committee

(4) Members of our ad hoc Litigation Committee 

 

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GREGG A. OSTRANDER is our President and Chief Executive Officer and hasheld these positions since 1994. Mr. Ostrander has also been Chairman since2001. Mr. Ostrander had been a director of the Predecessor beginning in 1994.In 1993, Mr. Ostrander served as the Predecessor’s Chief Operating Officer. Mr.Ostrander is also a director of Arctic Cat Inc. and of Birds Eye Foods, Inc. 

 

JOHN D. REEDY is our Executive Vice President, Chief Financial Officerand Treasurer and has held these positions since 2000. From 1988 to 2000, Mr.Reedy was the Predecessor’s Vice President—Finance and Chief Financial Officer,and he has been Predecessor and Company Treasurer since 1990. 

 

MARK D. WITMER is our Assistant Treasurer and Secretary. He has heldthe former position, with the Predecessor and the Company, since 1995 and hasheld the latter position since 2001. Mr. Witmer joined the Predecessor as theDirector of Corporate Communications in 1989. 

 

JAMES D. CLARKSON is President of the Potato Products, Dairy Productsand Refrigerated Distribution divisions, positions he has held since 1995, 2000and 2002, respectively. Mr. Clarkson joined the Predecessor in 1994 as VicePresident and General Manager of Crystal Farms. 

 

BILL L. GOUCHER is the President of the Egg Products Division, aposition he has held since 2000. He has also been President of Waldbaum sincejoining the Predecessor in 1993. 

 

BRADLEY L. COOK is Executive Vice President of Corporate Development ofour Egg Products Division. He has held this position since 2002 and previouslywas Executive Vice President and Chief Financial Officer for the Division, andpreviously Waldbaum, beginning in 1992. 

 

MAX R. HOFFMANN is the Chief Financial Officer for our Potato Products,Dairy Products and Refrigerated Distribution divisions. He has held the PotatoProducts position since 1995, the Dairy Products position since 2000, and theRefrigerated Distribution position since early 2002. He previously served asController of the Refrigerated Distribution Division from 1993 to 1995. 

 

JAMES MOHR is our Vice President—Supply Chain Logistics, a position hehas held with the Predecessor and the Company since 1996. 

 

HAROLD D. (DEAN) SPRINKLE is our Vice President/General Manager of thePotato Products and Dairy Products Divisions, a position he has held since2002.  Previously Mr. Sprinkle wasExecutive Vice President—Sales for the Predecessor and the Company.  He joined the Predecessor in 1989 and hasheld various positions, including Vice President of Foodservice Sales, NationalAccounts and U.S. Business Development. 

 

J. CHRISTOPHER HENDERSON has been a director and a member of themanagement committee of M-Foods Investors since 2001. Mr. Henderson is aManaging Director of Vestar Capital Partners. Prior to joining Vestar CapitalPartners in 1993, Mr. Henderson was a member of the Mergers and Acquisitionsgroup at The First Boston Corporation. Mr. Henderson is also a director of St.John Knits International, Incorporated. 

 

JEROME J. JENKO has been a director and a member of the managementcommittee of M-Foods Investors since 2001. Mr. Jenko had been a director of thePredecessor beginning in 1998. He has been a Senior Advisor with Goldsmith,Agio, Helms and Company, an investment banking firm, since 1997. Mr. Jenko is adirector of Ocean Spray Cranberries, Inc.

 

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JAMES P. KELLEY has been a director and a member of the managementcommittee of M-Foods Investors since 2001. Mr. Kelley is President of VestarCapital Partners and was a founding partner of Vestar Capital Partners in 1988.Mr. Kelley is a director of Consolidated Container Company LLC, St. John KnitsInternational, Incorporated and SAB Wabco. 

 

LEONARD LIEBERMAN has been a director and a member of the managementcommittee of M-Foods Investors since 2001. Since 1988, Mr. Lieberman has servedas a consultant to Vestar Capital Partners and its affiliates. Currently, Mr.Lieberman is a director of Sonic Corporation, Consolidated Container CompanyLLC, Nice-Pak Products, Inc. and Enterprise NewsMedia, Inc. 

 

JEFFREY J. MICHAEL has been a director and a member of the managementcommittee of M-Foods Investors since 2001. Mr. Michael had been a director ofthe Predecessor beginning in 1990. Mr. Michael is President, Chief ExecutiveOfficer and director of Corstar Holdings, Inc., a holding company owningbusinesses engaged in providing medical cost containment, managed careservices, and voice and data connectivity products and services. Mr. Michaelhas held these positions since 1997. Mr. Michael is a director of CorVelCorporation. 

 

JOHN L. MORRISON has been director and a member of the managementcommittee of M-Foods Investors since 2001. Mr. Morrison is a Managing Directorof Goldner Hawn Johnson & Morrison, a private investment company, aposition he has held since 1989. Mr. Morrison is a director of Claire-Sprayway,Inc., Woodcraft Industries, Inc., Havco Wood Products, Inc., AmericanEngineered Components, Inc. and Andersen Windows Corporation. 

 

KEVIN A. MUNDT has been a director and a member of the managementcommittee of M-Foods Investors since 2001. Mr. Mundt is Vice President, amember of the Board of Directors and head of the Retail and Consumer andFinancial Services practices of Mercer Management Consulting. Mercer is aglobal management consulting firm which advises CEO’s on issues of strategy,operations and brand architecture. Since 1982, Mr. Mundt has served as aconsultant to multinational corporations, working for Corporate Decisions, Inc.until its merger into Mercer Management Consulting. Mr. Mundt is a director ofRemington Products Company, L.L.C. and Telephone and Data Systems. 

 

Note:  In February 2002 one ofour directors, Daniel O’Connell, of Vestar Capital Partners, resigned from theBoard of Directors due to other business time commitments. 

 

ITEM 11 – EXECUTIVE COMPENSATION 

 

The following table sets forth information concerning the compensationof our chief executive officer and each of our four most highly compensatedexecutive officers during each of the last three fiscal years.

 

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SUMMARY COMPENSATIONTABLE

 
|                                                                                 |   | **ANNUAL COMPENSATION** |    | **LONG-TERM COMPENSATION** |    |
|--------------------------------------------------------------------------------------|--------|-------------------------|---------|----------------------------|---------|
| **NAME AND  PRINCIPAL POSITION**                                                     |   | **FISCAL  YEAR**        |    | **SALARY**                 |    | **BONUS** |   | **SECURITIES  UNDERLYING  OPTIONS(1)** |   | **LTIP  PAYOUTS(2)** |   | **ALL OTHER  COMPENSATION(3)** |   |
|                                                                                 |   |                    |    |                       |    |   |   |   |   |   |   |   |   |
| Gregg A. Ostrander                                                                   |   | 2002                    |    | $                          | 650,000 |   | $ | 520,000 |   | — |   | $ | — |   | $ | 13,654 |   |
| Chairman,  President and Chief Executive Officer                                     |   | 2001                    |    | 618,269                    |    | 463,702 |   | — |   | 110,226 |   | 12,000 |   |
|                                                                                 | 2000   |                    | 584,731 |                       | 347,150 |   | 75,000 |   | — |   | 7,621 |   |
|                                                                                 |   |                    |    |                       |    |   |   |   |   |   |   |   |   |
| John D. Reedy                                                                        |   | 2002                    |    | 295,000                    |    | 218,300 |   | — |   | — |   | 14,557 |   |
| Executive Vice  President, Chief Financial Officer and Treasurer                     |   | 2001                    |    | 283,462                    |    | 184,250 |   | — |   | 53,157 |   | 12,909 |   |
|                                                                                 | 2000   |                    | 273,269 |                       | 167,593 |   | 23,000 |   | — |   | 7,780 |   |
|                                                                                 |   |                    |    |                       |    |   |   |   |   |   |   |   |   |
| Bill L. Goucher                                                                      |   | 2002                    |    | 295,000                    |    | 218,300 |   | — |   | — |   | 12,192 |   |
| President-Egg Products Division                                                      |   | 2001                    |    | 283,462                    |    | 184,250 |   | — |   | 49,153 |   | 10,706 |   |
|                                                                                 |   | 2000                    |    | 258,269                    |    | 145,240 |   | 30,000 |   | — |   | 7,090 |   |
|                                                                                 |   |                    |    |                       |    |   |   |   |   |   |   |   |   |
| James D. Clarkson                                                                    |   | 2002                    |    | 295,000                    |    | 218,300 |   | — |   | — |   | 10,580 |   |
| President -  Potato Products, Dairy Products and Refrigerated Distribution Divisions |   | 2001                    |    | 272,885                    |    | 177,375 |   | — |   | 43,133 |   | 8,999 |   |
|                                                                                 | 2000   |                    | 231,192 |                       | 132,737 |   | 40,000 |   | — |   | 7,087 |   |
|                                                                                 |   |                    |    |                       |    |   |   |   |   |   |   |   |   |
| Bradley L. Cook                                                                      |   | 2002                    |    | 208,846                    |    | 113,550 |   | — |   | — |   | 8,270 |   |
| Executive Vice  President-Egg Products Division                                      |   | 2001                    |    | 197,692                    |    | 92,718 |   | — |   | 25,194 |   | 6,956 |   |
|                                                                                 | 2000   |                    | 177,346 |                       | 74,008  |   | 5,000 |   | — |   | 6,928 |   |
|                                                                                      |        |                         |         |                            |         |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)                                  Therewere no Predecessor stock option awards made to named executives in 2001.  Pursuant to the Predecessor’s 1994 ExecutiveIncentive Plan, as amended, stock option awards were made to certain executiveofficers in February 2000 based upon 1999 performance. The number of shares ofcommon stock purchasable under such option awards made to named executiveofficers were: Mr. Ostrander – 4,500 shares; Mr. Reedy – 3,000 shares; Mr.Goucher –3,000  shares; Mr. Clarkson –3,000 shares. Incentive Plan option grants are reflected in year earned, ratherthan year of grant. In addition, the following stock option grants were madeunder the discretionary authority of the Predecessor’s compensation committeein 2000: Mr. Ostrander – 75,000; Mr. Reedy – 23,000; Mr. Goucher – 30,000; Mr.Clarkson – 40,000; Mr. Cook – 5,000. 

 

(2)                                  Reflectsthe cash value of shares awarded under the Predecessor’s 1994 ExecutiveIncentive Plan, as amended, which vested upon the Merger affecting a change incontrol. These Predecessor share awards had been provisionally earned inprevious years, but were not vested prior to the Merger. Upon the Merger, theshare awards were converted to cash based upon the Merger price of $30.10 pershare. 

 

(3)                                  Reflectsthe value of contributions made by Michael Foods under the retirement savingsplan and the value of life insurance premiums paid by us. 

 

Note:                 All the aboveamounts exclude stock options granted and any deferred compensationarrangements from M-Foods Holdings, Inc., our parent company. 

 

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DIRECTOR COMPENSATION 

 

All members of our board of directors are reimbursed for their usualand customary expenses incurred in connection with attending all board andother committee meetings. Members of the board of directors who are also ouremployees, employees of Vestar Capital Partners or Goldner Hawn Johnson &Morrison do not receive remuneration for serving as members of the board. Othernon-employee directors receive an annual retainer of $24,000 and are paid $3,000for each board meeting attended. Non-employee directors are paid $1,000 foreach committee meeting attended, with committee chairs paid $1,500 per meeting.Non-employee directors are paid $500 for each telephonic committee or specialboard meeting attended, with committee chairs paid $1,000. Directors’ fees andtravel expense reimbursements in 2002 totaled $145,052. 

 

EMPLOYMENT AGREEMENTS 

 

GENERAL PROVISIONS 

 

The employment agreement with Gregg Ostrander provides for a term oftwo years, subject to certain termination rights, and automatic one yearextensions beginning with the first anniversary of the closing of the Merger.The Ostrander employment agreement provides that Mr. Ostrander will receive anannual base salary of at least $595,000 and that he will participate in certainbonus arrangements, long-term incentive plans and employee benefit plans ofMichael Foods. Mr. Ostrander would be subject to a noncompetition covenant,with respect to the businesses of the production, distribution or sales of eggsor egg products, and a nonsolicitation provision through the second anniversaryof his termination. As of August 1, 2001, Mr. Ostrander’s annual base salarywas adjusted to $650,000. 

 

The employment agreement with John Reedy provides for a term of twoyears, subject to certain termination rights and automatic one year extensionsbeginning with the first anniversary of the closing of the Merger. The Reedyemployment agreement provides that Mr. Reedy will receive an annual base salaryof at least $275,000 and that he will participate in certain bonusarrangements, long-term incentive plans and employee benefit plans of MichaelFoods. Mr. Reedy would be subject to a noncompetition covenant with respect tothe businesses of the production, distribution or sales of eggs or eggproducts, and a nonsolicitation provision through the second anniversary of histermination. As of August 1, 2001, Mr. Reedy’s annual base salary was adjustedto $295,000. 

 

The employment agreement with Bill Goucher provides for a termbeginning with the closing of the Merger through the second anniversary of achange in control, as defined in the Goucher employment agreement, subject tocertain termination rights. Mr. Goucher’s annual base salary will be at least$275,000, and he will participate in certain bonus arrangements and employeebenefit plans of Michael Foods. Mr. Goucher would be subject to anoncompetition covenant with respect to the businesses of the production,distribution or sales of eggs or egg products, and a nonsolicitation provisionthrough the second anniversary of Mr. Goucher’s termination. As of August 1,2001, Mr. Goucher’s annual base salary was adjusted to $295,000. 

 

The employment agreement with James Clarkson provides for a termbeginning with the close of the Merger through the second anniversary of achange in control, as defined in the Clarkson employment agreement, subject tocertain termination rights. Mr. Clarkson’s annual base salary will be at least$250,000, and he will participate in certain bonus arrangements and employeebenefit plans of Michael Foods. Mr. Clarkson would be subject to anoncompetition covenant with respect to the businesses of the production,distribution or sales of refrigerated potato products or specialty dairyproducts and mixes, and a nonsolicitation provision 

 

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through the second anniversary of his termination. As of August 1,2001, Mr. Clarkson’s annual base salary was adjusted to $295,000. 

 

TERMINATION PROVISIONS 

The Ostrander employment agreement provides that if Mr. Ostrander’semployment is terminated by his death or disability, Mr. Ostrander, or hisestate or beneficiaries, will receive, within 30 days, a payment equal to anyannual base salary through the date of termination not yet paid, plus thetarget bonus for the year prorated for months of employment in that year, plusany eligible unpaid other benefits, plus three times the total of Mr.Ostrander’s current annual base salary and target bonus. 

 

If Mr. Ostrander’s employment is terminated for cause or he terminateswithout good reason, as described below, Mr. Ostrander will receive his annualbase salary through the date of termination and other benefits not yet paidunder any plan, program, policy, contract or agreement with or practice ofMichael Foods. “Good reason” includes, among other things, any diminution inposition, authority, duties and responsibilities or any requirement to relocateor travel extensively. If Mr. Ostrander terminates his employment for goodreason or if Michael Foods terminates his employment other than for cause,death or disability, Mr. Ostrander will receive a lump sum, within 30 days, inan amount equal to any annual base salary through the date of termination notyet paid, plus the target bonus for the year prorated for months of employmentin that year, plus any eligible unpaid other benefits, plus three times thetotal of Mr. Ostrander’s current annual base salary and target bonus. Inaddition, Mr. Ostrander will receive for three years following the terminationdate, or until such earlier time as Mr. Ostrander becomes eligible to receivecomparable benefits, certain medical, dental and life insurance benefits forhimself and his family. 

 

Solely as such may be applicable to any severance payments deemed madein the context of the change in ownership resulting from the acquisition, Mr.Ostrander may also be eligible to receive an additional payment of any excisetax imposed by Section 4999 of the Internal Revenue Code, as well as a gross-uppayment such that he will retain an amount equal to the excise taxes, after allincome taxes, interest and penalties associated with all such payments. 

 

The Reedy employment agreement provides that if Mr. Reedy’s employmentis terminated by his death or disability, Mr. Reedy, or his estate orbeneficiaries, will receive within 30 days a payment equal to any annual basesalary through the date of termination not yet paid, plus the target bonus forthe year prorated for months of employment in that year, plus any eligibleunpaid other benefits, plus two times the total of Mr. Reedy’s current annualbase salary and target bonus. 

 

If Mr. Reedy’s employment is terminated for cause or he terminateswithout good reason, such term having a meaning substantially similar to themeaning given such term in the Ostrander employment agreement, Mr. Reedy willreceive his annual base salary through the date of termination and otherbenefits not yet paid under any plan, program, policy, contract or agreement withor practice of Michael Foods. If Mr. Reedy terminates his employment for goodreason or if Michael Foods terminates his employment other than for cause,death or disability, Mr. Reedy will receive a lump sum within 30 days in anamount equal to any annual base salary through the date of termination not yetpaid, plus the target bonus for the year prorated for months of employment inthat year, plus any eligible unpaid benefits, plus two times the total of Mr.Reedy’s current annual base salary and target bonus. In addition, Mr. Reedywill receive for two years following the termination date, or until suchearlier time as Mr. Reedy becomes eligible to receive comparable benefits,certain medical, dental and life insurance benefits for himself and his family.

 

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Solely as such may be applicable to any severance payments deemed madein the context of the change in ownership resulting from the acquisition, Mr.Reedy may also be eligible to receive an additional payment of any excise taximposed by Section 4999 of the Internal Revenue Code, as well as a gross-uppayment such that he will retain an amount equal to the excise taxes, after allincome taxes, interest and penalties associated with all such payments. 

 

The Goucher employment agreement provides that if Mr. Goucher isterminated by his death or disability, Mr. Goucher, or his estate orbeneficiaries, will receive, within 30 days, a payment equal to any annual basesalary through the date of termination not yet paid, plus the target bonus forthe year prorated for months of employment in that year, plus any eligibleunpaid other benefits, plus an amount equal to Mr. Goucher’s current annualbase salary. 

 

If Mr. Goucher is terminated for cause or without good reason, asdefined in the Goucher employment agreement, Mr. Goucher will receive hisannual base salary through the date of termination and other benefits not yetpaid under any plan, program, policy, contract or agreement with or practice ofMichael Foods. If Mr. Goucher’s employment is terminated prior to a change incontrol, as described below, by Michael Foods other than for cause, death ordisability, Mr. Goucher will receive a lump sum within 30 days equal to anyannual base salary through the date of termination not yet paid, plus anyeligible unpaid other benefits, plus an amount equal to Mr. Goucher’s currentannual base salary. 

 

If Mr. Goucher is terminated by Michael Foods other than for cause, orif Mr. Goucher terminates his employment for good reason, in anticipation of orwithin two years following a change in control, Mr. Goucher will receive within30 days a payment equal to any annual base salary through the date oftermination not yet paid, plus the target bonus for the year prorated formonths of employment in that year, plus any eligible unpaid other benefits,plus two times Mr. Goucher’s current annual base salary. A change in controlrefers to a transaction where another party acquires voting control of MichaelFoods, another party acquires substantially all of the assets of Michael Foods,or, prior to an initial public offering of Michael Foods, Vestar and itsaffiliates cease to have the ability to elect a majority of the board ofdirectors of Michael Foods. 

 

The Clarkson employment agreement contains severance provisionssubstantially identical to the severance provisions contained in the Goucheremployment agreement. 

 

BENEFIT PLANS, SEVERANCE PLANS AND DEFERRED COMPENSATION ARRANGEMENTS 

 

The severance plan of the Predecessor remains effective until thesecond anniversary of the Merger and each of Messrs. Witmer, Cook, Sprinkle,Mohr and Hoffmann has rights under the severance plan pursuant to hisrespective severance and deferred compensation agreement. 

 

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Participants in the Predecessor’s severance plan are eligible forcertain severance arrangements should they be terminated without cause withintwenty-four months following the Merger. Under the plan, certain key employeesare entitled to receive a lump sum payment equal to one times their totalannual compensation, with some key employees being entitled to a payment of twotimes total annual compensation. Annual compensation is defined as theemployee’s highest annual rate of salary, excluding bonuses, benefits,allowances, etc., within the three calendar year periods prior to the date oftermination of employment. However, if an employee has been employed by MichaelFoods or a predecessor for less than three years, total annual compensationequals the highest annualized salary during the period of employment. 

 

M–FOODS HOLDINGS STOCK OPTION PLAN 

 

In order to provide additional financial incentives to our management,certain members of our management and other key employees may be granted stockoptions to, collectively, purchase up to five percent of the common stock ofM-Foods Holdings, our parent company. The exercise price of options grantedreflects the fair market value of the underlying shares, as determined by thecompensation committee in its best judgment. 

 

Fifty percent of the options reserved for issuance under this stockoption plan were issued to Messrs. Ostrander, Reedy, Goucher, Clarkson, Cook,Hoffmann, Sprinkle and Mohr in July 2001. The exercise price is payable (1) incash, (2) after an initial public offering of Michael Foods’ common stock,through simultaneous sales of underlying shares by brokers or (3) through theexchange of M-Foods Holdings securities held by the optionee for longer thansix months. 

 

Options vest ratably over a five-year period starting at the Mergerdate, for those grants made in 2001, or the date of grant for subsequentgrants. On termination of employment for any reason, all unvested options ofthe terminated employee are cancelled. Vested options not exercised within 90days after termination are cancelled, unless such employee is terminated forcause or leaves without good reason, in which case such vested options shall becancelled upon termination. If employment is terminated for any reason otherthan for cause or a termination without good reason, M-Foods Holdings willprovide a notice setting forth the fair market value of the common stock within90 days of such termination. In the event of a change in control of M-FoodsHoldings or M-Foods Investors, all options which have not become vested willautomatically become vested. The options are subject to other customaryrestrictions and repurchase rights. 

 

OPTION GRANTS IN LAST YEAR 

 

There were no stock option grants to the named executive officers in2002. 

 

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OPTION EXERCISES IN LAST YEAR AND YEAR-END OPTION VALUES 

 

There were no shares exercised under options in 2002 by the namedexecutive officers. The number of shares of common stock of M-Foods Holdingsrepresented by options held at December 31, 2002 by the named executiveofficers follows. 

 
| **NAME**           |   | **SHARES ACQ.  ON EXERCISE** |            | **VALUE  REALIZED** |              | **NUMBER OF UNEXERCISED  OPTIONS AT YEAR-END** |   | **VALUE OF UNEXERCISED  IN-THE-MONEY  OPTIONS AT YEAR-END(1)** |
|--------------------|--------|------------------------------|-----------------|---------------------|-------------------|------------------------------------------------|--------|----------------------------------------------------------------|
| **EXERCISABLE**    |   | **UNEXERCISABLE**            | **EXERCISABLE** |                | **UNEXERCISABLE** |
| Gregg A. Ostrander |   | —                       |            | —              |              | 1,050                                          |   | 4,200                                                          |   | — |   | — |
| John D. Reedy      |   | —                       |            | —              |              | 375                                            |   | 1,500                                                          |   | — |   | — |
| Bill L. Goucher    |   | —                       |            | —              |              | 375                                            |   | 1,500                                                          |   | — |   | — |
| James D. Clarkson  |   | —                       |            | —              |              | 300                                            |   | 1,200                                                          |   | — |   | — |
| Bradley L. Cook    |   | —                       |            | —              |              | 100                                            |   | 400                                                            |   | — |   | — |

 

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(1)                                  Thereis no public market for M-Foods Holdings’ common stock. Hence, the value ofoptions granted is not readily available. 

 

ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS ANDMANAGEMENT AND RELATED STOCKHOLDER MATTERS 

 

Michael Foods, Inc. is a wholly owned subsidiary of M-Foods Holdings,Inc., a corporation owned, in part, by M-Foods Investors, LLC, whose membersinclude affiliates of Vestar Capital Partners and Goldner Hawn Johnson & Morrison,certain members of our management and affiliates of the Michael family. Aftergiving effect to the exercise of all options reserved for issuance inconnection with M-Foods Holdings’ stock option plan, M-Foods Investors ownsapproximately 95% of M-Foods Holdings’ common stock. 

 

The following table sets forth certain information regarding beneficialownership of M-Foods Investors by: (i) each person or entity known to us to ownmore than 5% of any class of M-Foods Investors’ outstanding securities and (ii)each member of M-Foods Investors’ management committee (which functions as didthe Predecessor’s board of directors), each of our named executive officers andall members of the management committee and executive officers as a group.M-Foods Investors’ outstanding securities consist of approximately 2,134,997Class A Units, 99,078 Class B Units and 100,000 Class C Units. The Class AUnits, Class B Units and Class C Units generally have identical rights andpreferences, except the Class C Units are nonvoting as to certaindistributions.  The Amended and RestatedLimited Liability Company Agreement of M-Foods Investors was filed as Exhibit10.13 to our Registration Statement on Form S-4, filed July 18, 2001, and isincorporated by reference. To our knowledge, each of such securityholders hassole voting and investment power as to the units shown unless otherwise noted.Beneficial ownership of the securities listed in the table has been determinedin accordance with the applicable rules and regulations promulgated under theExchange Act. 

 

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|                                                                                   |   | **SECURITIES BENEFICIALLY OWNED** |   |
|----------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
| **NAME AND  ADDRESS**                                                                  |   | **NUMBER OF  CLASS A UNITS**      |   | **NUMBER OF  CLASS B UNITS** |   | **PERCENTAGE OF  CLASS A AND  B UNITS** |   | **NUMBER OF  CLASS C UNITS** |   | **PERCENTAGE OF  CLASS C UNITS** |   |
| PRINCIPAL SECURITYHOLDERS:                                                             |   |                              |   |   |   |   |   |   |   |   |   |   |
| Vestar Capital Partners IV, L.P. (1)                                              |   | 1,364,976                         | .81    |   | — |   | 61.1 |   | — |   | — |   |
| Vestar/Michael, LLC (1)                                                           |   | 35,023                            | .19    |   |   |   | 1.6 |   |   |   |   |   |
| Marathon Fund Limited Partnership IV (2)                                          |   | 350,000                           |   |   | — |   | 15.7 |   | — |   | — |   |
| 4J2R1C Limited Partnership (3)                                                    |   | 195,650                           |   |   | — |   | 8.8 |   | — |   | — |   |
| 3J2R Limited Partnership (3)                                                      |   | 188,125                           |   |   | — |   | 8.4 |   | — |   | — |   |
| MANAGEMENT COMMITTEE MEMBERS AND EXECUTIVE OFFICERS:                                   |   |                              |   |   |   |   |   |   |   |   |   |   |
| Jeffrey J. Michael (3)                                                            |   | 383,775                           |   |   | — |   | 17.2 |   | — |   | — |   |
| Gregg A. Ostrander (4)                                                            |   | —                            |   |   | 42,000 |   | 1.9 |   | 42,000 |   | 42.0 |   |
| John D. Reedy (4)                                                                 |   | —                            |   |   | 15,000 |   | * |   | 15,000 |   | 15.0 |   |
| Bill L. Goucher (4)                                                               |   | —                            |   |   | 15,000 |   | * |   | 15,000 |   | 15.0 |   |
| James D. Clarkson (4)                                                             |   | —                            |   |   | 12,000 |   | * |   | 12,000 |   | 12.0 |   |
| Bradley L. Cook (4)                                                               |   | —                            |   |   | 4,000 |   | * |   | 4,000 |   | 4.0 |   |
| Jerome J. Jenko (5)                                                               |   | 300                               |   |   | — |   | * |   | — |   | — |   |
| All management committee members and named executive  officers as a group (12 persons) |   | 384,075                           |   |   | 88,000 |   | 21.1 |   | 88,000 |   | 88.0 |   |

 

----

*              Less than 1%. 

 

(1)                                  Theaddress for the Vestar entities is c/o Vestar Capital Partners, 245 ParkAvenue, 41st Floor, New York, New York 10167. 

 

(2)                                  Theaddress for Marathon Fund Limited Partnership IV is c/o Goldner Hawn Johnson& Morrison, 5250 Wells Fargo Center, Minneapolis, Minnesota 55402. 

 

(3)                                  Both4J2R1C and 3J2R are Minnesota limited partnerships. The general partners of4J2R1C are James H. Michael, Jeffrey J. Michael and 2JM Enterprises, Inc., aMinnesota corporation. The directors of 2JM Enterprises are James H. Michaeland Jeffrey J. Michael, and the officers of 2JM Enterprises are Jeffrey J.Michael, President and Treasurer, and James H. Michael, Vice President andSecretary. The general partners of 3J2R are Jeffrey J. Michael, as managinggeneral partner, and 2JM Enterprises. As a general partner of 4J2R1C and 3J2R,Mr. Michael may be deemed to beneficially own the securities held by suchpartnerships. Mr. Michael disclaims beneficial ownership except to the extentof his  pecuniary interest as a partnerin the limited partnerships’ assets. The address for each of 4J2R1C Limited Partnership, 3J2R Limited Partnershipand Jeffrey J. Michael is 10851 Louisiana Avenue South, Bloomington, Minnesota55438. 

 

(4)                                  Theaddress for each of the named executive officers is c/o Michael Foods, Inc.,401 Carlson Parkway, Suite 300, Minnetonka, Minnesota 55305. 

 

(5)                                  Theaddress for Mr. Jenko is 44818 Oro Grande Circle, Indian Wells, California92210. 

 

ITEM 13 – CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 

 

Pursuant to a management agreement with Vestar Capital Partners andGoldner Hawn Johnson & Morrison, the Company pays them a combined annualfee of $1,000,000 or .75% of consolidated earnings before interest, taxes,depreciation and amortization, whichever is greater. The management fee for2002 was approximately $1,166,000 (see MANAGEMENT AGREEMENT). In addition,these affiliates were paid approximately $10,500,000 by us for servicesrendered and expenses incurred in connection with the Merger. 

 

36

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CERTAIN AGREEMENTS RELATING TO THE MERGER 

 

SECURITYHOLDERS AGREEMENT 

 

Pursuant to the securityholders agreement entered into in connectionwith the acquisition, units of M-Foods Investors (or common stock following achange in corporate form) beneficially owned by certain of our executives andany other employees of M-Foods Investors and its subsidiaries, which wecollectively refer to as the management investors, Marathon Fund LimitedPartnership IV, a limited partnership associated with Goldner Hawn Johnson& Morrison, and 4J2R1C Limited Partnership and 3J2R Limited Partnership,each of which are associated with the Michael family, are subject to certainrestrictions on transfer, other than certain exempt transfers as defined in thesecurityholders agreement, as well as the other provisions described below.When reference is made to “units” of M-Foods Investors in the discussion thatfollows, it includes common stock of M-Foods Investors following a change incorporate form, whether in preparation for an initial public offering orotherwise. 

 

The securityholders agreement provides that Vestar Capital Partners IV,L.P., Marathon Fund Limited Partnership IV, 4J2R1C Limited Partnership, 3J2RLimited Partnership, the management investors and all other parties to theagreement will vote all of their units to elect and continue in officemanagement committees or boards of directors of M-Foods Investors and each ofits subsidiaries, other than subsidiaries of Michael Foods, consisting of up tonine members or directors composed of: 

 

•                                          five(5) persons designated by Vestar Capital Partners IV, L.P.; 

 

•                                          one(1) person designated by Marathon Fund Limited Partnership IV; 

 

•                                          one(1) person designated by 4J2R1C Limited Partnership and 3J2R LimitedPartnership, which are associated with the Michael family; 

 

•                                          thechief executive officer of Michael Foods; and 

 

•                                          one(1) independent person designated by the chief executive officer of MichaelFoods. 

 

The securityholders agreement also provides: 

 

•                                          MarathonFund Limited Partnership IV, 4J2R1C Limited Partnership, 3J2R LimitedPartnership and the management investors with customary “tag-along” rights withrespect to transfers of M-Foods Investors units beneficially owned by VestarCapital Partners IV, L.P., its partners or their transferees; and 

 

•                                          VestarCapital Partners IV, L.P. with “drag-along” rights with respect to M-FoodsInvestors units owned by Marathon Fund Limited Partnership IV, 4J2R1C LimitedPartnership, 3J2R Limited Partnership and the management investors in a sale ofM-Foods Investors. In addition, Vestar Capital Partners IV, L.P., and, afterM-Foods Investors’ first public offering, Marathon Fund Limited Partnership IVand 4J2R1C Limited Partnership and 3J2R Limited Partnership, have certainrights to require M-Foods Investors to register units held by them under theSecurities Act, up to four, two and two times, respectively. 

 

In addition, Vestar Capital Partners IV, L.P., Marathon Fund LimitedPartnership IV, 4J2R1C Limited Partnership, 3J2R Limited Partnership and themanagement

 

37

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investors have certain rights to participate in publicly registeredofferings of common equity of M-Foods Investors initiated by it or other thirdparties. For example, each of Vestar Capital Partners IV, L.P., Marathon FundLimited Partnership IV, 4J2R1C Limited Partnership, 3J2R Limited Partnershipand the management investors may elect to participate in a demand registrationinitiated by another party to the securityholders agreement. If M-FoodsInvestors issues or sells any new units to Vestar Capital Partners IV, L.P.,subject to certain exceptions, each management investor and each of MarathonFund Limited Partnership IV, 4J2R1C Limited Partnership and 3J2R Limited Partnershipshall have the right to subscribe for a sufficient number of new M-FoodsInvestors units to maintain its respective ownership percentage in M-FoodsInvestors. 

 

MANAGEMENT AGREEMENT 

 

Pursuant to the management agreement entered into in connection withthe acquisition, Vestar Capital Partners and Goldner Hawn Johnson &Morrison Incorporated will render to each of M-Foods Investors, M-FoodsHoldings and Michael Foods, and each of their subsidiaries, certain advisoryand consulting services. In consideration of those services, M-Foods Investors,M-Foods Holdings and Michael Foods jointly and severally will pay to VestarCapital Partners and Goldner Hawn Johnson & Morrison Incorporated,semi-annually in advance, an aggregate per annum management fee equal to thegreater of: 

 

•                                          $1,000,000and 

 

•                                          anamount equal to 0.75% of the consolidated earnings before interest, taxes,depreciation and amortization of M-Foods Investors and its subsidiaries forsuch fiscal year, but before deduction of any such fee, determined as set forthin documents related to the proposed senior credit facility. 

 

M-Foods Investors, M-Foods Holdings and the Predecessor also jointlyand severally agreed to pay Vestar Capital Partners and Goldner Hawn Johnson& Morrison Incorporated at the closing of the acquisition an aggregatetransaction fee equal to 1.25% of total transaction value plus allout-of-pocket expenses incurred by Vestar Capital Partners and Goldner HawnJohnson & Morrison Incorporated prior to the closing of the acquisition forservices rendered by them in connection with the acquisition. 

 

M-Foods Investors, M-Foods Holdings and Michael Foods also jointly andseverally agreed to indemnify Vestar Capital Partners and Goldner Hawn Johnson& Morrison Incorporated and their respective affiliates from and againstall losses, claims, damages and liabilities arising out of the performance byVestar Capital Partners and Goldner Hawn Johnson & Morrison Incorporated oftheir services pursuant to the management agreement. The management agreementwill terminate at such time as Vestar Capital Partners IV, L.P. and MarathonFund Limited Partnership IV and their respective partners and the respectiveaffiliates thereof hold, directly or indirectly in the aggregate, less than 20%of the voting power of our outstanding voting stock. 

 

ITEM 14 - CONTROLS AND PROCEDURES. 

 

a.             Evaluationof Disclosure Controls and Procedures. 

 

Under the supervision, and with the participation ofour management, including our Chief Executive Officer and Chief FinancialOfficer, we evaluated the effectiveness of the design and operation of ourdisclosure controls and procedures (as defined in Rules 13a-14(c)/15d-14(c)under the Exchange Act) as of a date (the “Evaluation Date”) within 90 daysprior to the filing date of this report. Based upon that evaluation, the Chief Executive Officer and ChiefFinancial Officer concluded that, as of the 

 

38

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Evaluation Date, our disclosure controls andprocedures are effective in timely alerting them to the material informationrelating to us (or our consolidated subsidiaries) required to be included inour periodic SEC filings. 

 

b.             Changesin Internal Controls.

 

There were no significant changes made in our internalcontrols during the period covered by this report or, to our knowledge, inother factors that could significantly affect these controls subsequent to thedate of their evaluation. 

 

PART IV 

 

ITEM 15 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM8-K 

 

(a)                                  Thefollowing consolidated financial statements of the Company and the Predecessor,the financial statements of the Company’s non-wholly-owned guarantorsubsidiaries, and the related Reports of Independent Accountants, are includedin this report:

 

1.             Financial Statements 

 
| MICHAEL FOODS, INC.                                   |
|-------------------------------------------------------|
| Report of Independent Accountants                     |
| Consolidated Balance Sheets                           |
| Consolidated  Statements of Operations                |
| Consolidated  Statements of Shareholders’ Equity |
| Consolidated  Statements of Cash Flows                |
| Notes to  Consolidated Financial Statements           |
| Quarterly  Financial Data (Unaudited)                 |
|                                                  |
| M-FOODS DAIRY, LLC                                    |
| Report of Independent Accountants                     |
| Balance Sheets                                        |
| Statements of Earnings                                |
| Statements  of Unit Holder and Operating Unit Equity  |
| Statements of Cash Flows                              |
| Notes to Financial  Statements                        |
|                                                  |
| M-FOODS DAIRY, TXCT, LLC                              |
| Report of Independent Accountants                     |
| Balance Sheets                                        |
| Statements of Operations                              |
| Statements of Unit Holder and  Operating Unit Equity  |
| Statements  of Cash Flows                             |
| Notes to Financial Statements                         |

 

2.             Financial Statement Schedules

 

The following financial statement schedules areincluded in this report and should be read in conjunction with the financialstatements referred to above:

 

Report of Independent Accountants on FinancialStatement Schedules 

Michael Foods, Inc. and Subsidiaries – Valuation and QualifyingAccounts 

M-Foods Dairy, LLC – Valuation and Qualifying Accounts

 

All other schedules areomitted, as the required information is not applicable or the information ispresented in the financial statements or related notes.

 

39

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3.  Exhibits

 

Reference is made to Item 15 (c) footnote (2) forexhibits filed with this form. 

 

(b)                                 Reportson Form 8-K 

 

Reference is made to reports filed on Form 8-K datedFebruary 21, 2002, April 25, 2002, July 25, 2002, and November 8, 2002**,**regarding news releases to our debtholders pertaining to our interim financialresults.  Reference is also made toreports filed on Form 8-K or Form 8-K/A dated August 14, 2002, August 23, 2002,September 24, 2002, and September 25, 2002, regarding other corporatedevelopments. 

 

(c)                                  Exhibitsand Exhibit Index 

 
| **EXHIBIT  NO.** |   | **DESCRIPTION**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 2.1              |   | Agreement and Plan of  Merger, dated December 21, 2000, by and among Michael Foods Acquisition  Corp., Michael Foods, Inc. and M-Foods Holdings, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 2.2              |   | Amendment Number One to  Agreement and Plan of Merger, dated March 6, 2001, by and among Michael Foods  Acquisition Corp., Michael Foods, Inc. and M-Foods Holdings, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 3.1              |   | Amended and Restated  Articles of Incorporation of Michael Foods, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 3.2              |   | Bylaws of Michael  Foods, Inc.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 4.1              |   | Purchase Agreement,  dated March 16, 2001, between Michael Foods Acquisition Corp., Michael Foods,  Inc., and Banc of America Securities, LLC and Bear, Stearns & Co.(1)                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 4.2              |   | Indenture, dated March  27, 2001, between Michael Foods Acquisition Corp. and BNY Midwest Trust  Company, as trustee(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 4.3              |   | Supplemental Indenture,  dated as of April 10, 2001, by and among Michael Foods, Inc., M-Foods  Holdings, Inc., Michael Foods of Delaware, Inc., Northern Star Co., Minnesota  Products, Inc., Farm Fresh Foods, Inc., Crystal Farms Refrigerated  Distribution Company, WFC, Inc., Wisco Farm Cooperative, M. G. Waldbaum  Company, Papetti’s Hygrade Egg Products, Inc., Casa Trucking, Inc., Papetti  Electroheating Corporation, Kohler Mix Specialties, Inc., Midwest Mix, Inc.,  Kohler Mix Specialties of Connecticut, Inc. and Midwest Mix, Inc. and BNY  Midwest Trust Company(1) |
| 4.4              |   | Second Supplemental  Indenture, dated as of May 2, 2001, by and among M-Foods Dairy, LLC and  M-Foods Dairy TXCT, LLC, Michael Foods, Inc. and BNY Midwest Trust Company(1)                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 4.5              |   | Registration Rights  Agreement, dated March 27, 2001, by and among Michael Foods Acquisition  Corp., and Banc of America Securities, LLC and Bear, Stearns & Co.(1)                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 4.6              |   | Collateral Pledge and  Security Agreement, dated March 27, 2001, between Michael Foods Acquisition  Corp., and Banc of America Securities, LLC and Bear, Stearns & Co. and  BNY Midwest Trust Company as collateral agent and securities intermediary(1)                                                                                                                                                                                                                                                                                                                                    |
| 10.1             |   | Credit Agreement, dated  April 10, 2001, among Michael Foods, Inc., M-Foods Holdings, Inc., the  Guarantors, Bank of America, N.A., as Agent, Banc of America Securities, LLC,  as Sole Lead Arranger and Sole Book Running Manager, and Bear, Stearns &  Co., as Syndication Agent(1)                                                                                                                                                                                                                                                                                                      |
| 10.2             |   | Pledge Agreement, dated  April 10, 2001, between Michael Foods, Inc., Bank of America, N.A. and Banc  of America Securities, LLC(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| *10.3            |   | M-Foods Holdings, Inc.  2001 Stock Option Plan(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| *10.4            |   | Form of M-Foods  Holdings 2001 Stock Option Plan Stock Option Award Agreement(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| *10.5            |   | Employment Agreement,  dated April 10, 2001, by and among Michael Foods, Inc., M-Foods Holdings,  Inc. and Gregg A. Ostrander(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| *10.6            |   | Employment Agreement,  dated April 10, 2001, by and among Michael Foods, Inc., M-Foods Holdings,  Inc. and John D. Reedy(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| *10.7            |   | Employment Agreement,  dated April 10, 2001, by and among Michael Foods, Inc., M-Foods Holdings,  Inc. and James D. Clarkson(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |

 

40

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| *10.8  |   | Employment Agreement, dated  April 10, 2001, by and among Michael Foods, Inc., M-Foods Holdings, Inc. and  Bill L. Goucher(1)                                                                                                                                                                                                                                                        |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *10.9  |   | Severance and Deferred  Compensation Agreement, dated April 10, 2001, by and among Michael Foods,  Inc., M-Foods Holdings, Inc. and James Mohr(1)                                                                                                                                                                                                                                    |
| *10.10 |   | Severance and Deferred  Compensation Agreement, dated April 10, 2001, by and among Michael Foods,  Inc., M-Foods Holdings, Inc. and Harold D. Sprinkle(1)                                                                                                                                                                                                                            |
| *10.11 |   | Severance and Deferred  Compensation Agreement, dated April 10, 2001, by and among Michael Foods,  Inc., M-Foods Holdings, Inc. and Max Hoffmann(1)                                                                                                                                                                                                                                  |
| *10.12 |   | Severance and Deferred  Compensation Agreement, dated April 10, 2001, by and among Michael Foods,  Inc., M-Foods Holdings, Inc. and Bradley Cook(1)                                                                                                                                                                                                                                  |
| 10.13  |   | Amended and Restated  Limited Liability Company Agreement of M-Foods Investors, LLC(1)                                                                                                                                                                                                                                                                                               |
| *10.14 |   | Securityholders  Agreement, dated April 10, 2001, between M-Foods Dairy Holdings, LLC,  Marathon Dairy Investment Corp., Vestar Capital Partners IV, L.P., 4J2R1C  Limited Partnership, 3J2R Limited Partnership, Gregg A. Ostrander, John D.  Reedy, Bill L. Goucher, James D. Clarkson, James Mohr, Harold D. Sprinkle,  Bradley Cook, and Max Hoffmann(1)                         |
| *10.15 |   | Management Stock  Purchase and Unit Subscription Agreement, dated April 10, 2001, among M-Foods  Investors, LLC, M-Foods Holdings, Inc., and Gregg A. Ostrander(1)                                                                                                                                                                                                                   |
| *10.16 |   | Management Stock  Purchase and Unit Subscription Agreement, dated April 10, 2001, among M-Foods  Investors, LLC, M-Foods Holdings, Inc., and John D. Reedy(1)                                                                                                                                                                                                                        |
| *10.17 |   | Management Stock Purchase  and Unit Subscription Agreement, dated April 10, 2001, among M-Foods  Investors, LLC, M-Foods Holdings, Inc., and James D. Clarkson(1)                                                                                                                                                                                                                    |
| *10.18 |   | Management Stock  Purchase and Unit Subscription Agreement, dated April 10, 2001, among M-Foods  Investors, LLC, M-Foods Holdings, Inc., and Bill L. Goucher(1)                                                                                                                                                                                                                      |
| *10.19 |   | Management Stock  Purchase and Unit Subscription Agreement, dated April 10, 2001, among M-Foods  Investors, LLC, M-Foods Holdings, Inc., and Max Hoffmann(1)                                                                                                                                                                                                                         |
| *10.20 |   | Management Stock  Purchase and Unit Subscription Agreement, dated April 10, 2001, among M-Foods  Investors, LLC, M-Foods Holdings, Inc., and Harold D. Sprinkle(1)                                                                                                                                                                                                                   |
| *10.21 |   | Management Stock  Purchase and Unit Subscription Agreement, dated April 10, 2001, among M-Foods  Investors, LLC, M-Foods Holdings, Inc., and Bradley Cook(1)                                                                                                                                                                                                                         |
| *10.22 |   | Management Stock  Purchase and Unit Subscription Agreement, dated April 10, 2001, among M-Foods  Investors, LLC, M-Foods Holdings, Inc., and James Mohr(1)                                                                                                                                                                                                                           |
| *10.23 |   | Management Unit  Subscription Agreement, dated April 10, 2001, between M-Foods Dairy Holdings,  LLC, and Gregg A. Ostrander(1)                                                                                                                                                                                                                                                       |
| *10.24 |   | Management Unit  Subscription Agreement, dated April 10, 2001, between M-Foods Dairy Holdings,  LLC, and John D. Reedy(1)                                                                                                                                                                                                                                                            |
| *10.25 |   | Management Unit  Subscription Agreement, dated April 10, 2001, between M-Foods Dairy Holdings,  LLC, and James D. Clarkson(1)                                                                                                                                                                                                                                                        |
| *10.26 |   | Management Unit  Subscription Agreement, dated April 10, 2001, between M-Foods Dairy Holdings,  LLC, and Bill L. Goucher(1)                                                                                                                                                                                                                                                          |
| *10.27 |   | Management Unit  Subscription Agreement, dated April 10, 2001, between M-Foods Dairy Holdings,  LLC, and Max Hoffmann(1)                                                                                                                                                                                                                                                             |
| *10.28 |   | Management Unit  Subscription Agreement, dated April 10, 2001, between M-Foods Dairy Holdings,  LLC, and Harold D. Sprinkle(1)                                                                                                                                                                                                                                                       |
| *10.29 |   | Management Unit  Subscription Agreement, dated April 10, 2001, between M-Foods Dairy Holdings,  LLC, and Bradley Cook(1)                                                                                                                                                                                                                                                             |
| *10.30 |   | Management Unit  Subscription Agreement, dated April 10, 2001, between M-Foods Dairy Holdings,  LLC, and James Mohr(1)                                                                                                                                                                                                                                                               |
| *10.31 |   | Securityholders  Agreement, dated April 10, 2001, between M-Foods Investors, LLC, M-Foods  Holdings, Inc., Marathon Fund Limited Partnership IV, Vestar Capital Partners  IV, L.P., 4J2R1C Limited Partnership, 3J2R Limited Partnership, Gregg A.  Ostrander, John D. Reedy, Bill L. Goucher, James D. Clarkson, James Mohr,  Harold D. Sprinkle, Bradley Cook, and Max Hoffmann(1) |
| 12.1   |   | Computation of Ratio of  Earnings to Fixed Charges(2)                                                                                                                                                                                                                                                                                                                                |
| 21.1   |   | Subsidiaries of Michael  Foods, Inc.(2)                                                                                                                                                                                                                                                                                                                                              |

 

41

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----

*                      ManagementContract or Compensation Plan Arrangement

 

(1)               Incorporated byreference from the Company’s Registration Statement on Form S-4 filed July 18,2001.

(2)               Filed as an exhibitto this Form 10-K. 

 

42

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Report of IndependentAccountants onFinancial Statement Schedules

 

To the Board of Directorsof Michael Foods, Inc. 

 

Our audit of the 2002 consolidated****financial statements referred to in ourreport dated February 18, 2003 appearing in the 2002 Annual Report on Form 10-Kof Michael Foods, Inc. also included an audit of the 2002 financial statementschedules listed in Item 15(a)(2) of this Form 10-K.  In our opinion, these financial statement schedules presentfairly, in all material respects, the information set forth therein when readin conjunction with the related consolidated financial statements. 

 
| /s/ PricewaterhouseCoopers LLP |   |
|--------------------------------|--------|
| PricewaterhouseCoopers LLP     |
| Minneapolis, MN                |
| February 18, 2003              |

 

43

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| (d)    Schedules |   | SCHEDULE II |
|--------------------------------------|--------|-------------|

 

MICHAEL FOODS, INC. ANDSUBSIDIARIES

(A wholly ownedsubsidiary of M-Foods Holdings, Inc.)

 

VALUATION AND QUALIFYINGACCOUNTS

 
| **Col. A**                                   |   | **Col. B**                           |      | **Col. C**                               |   | **Col. D**                                      |   | **Col. E**                     |
|----------------------------------------------|--------|--------------------------------------|-----------|------------------------------------------|--------|-------------------------------------------------|--------|--------------------------------|
|                                         |   |                                 |      | **Additions**                            |   |                                            |   |                           |
| **Description**                              |   | **Balance at  Beginning of  Period** |      | **(1)  Charged to  Costs and  Expenses** |   | **(2)  Charges to  Other  Accounts-  Describe** |   | **Deductions  -Describe  (a)** |   | **Balance at  End of  Period** |
|                                         |   |                                 |      |                                     |   |                                            |   |                           |   |   |
| Allowance for Doubtful  Accounts             |   |                                 |      |                                     |   |                                            |   |                           |   |   |
|                                         |   |                                 |      |                                     |   |                                            |   |                           |   |   |
| PREDECESSOR                                  |   |                                 |      |                                     |   |                                            |   |                           |   |   |
| For the Year ended  December 31, 2000        |   | $                                    | 2,051,000 |                                     | $      | 2,360,000                                       |   | $                              | 0 |   | $ | 2,179,000 |   | $ | 2,232,000 |
|                                         |   |                                 |      |                                     |   |                                            |   |                           |   |   |
| For the Three Months  ended March 31, 2001   |   | $                                    | 2,232,000 |                                     | $      | 239,000                                         |   | $                              | 0 |   | $ | 0 |   | $ | 2,471,000 |
|                                         |   |                                 |      |                                     |   |                                            |   |                           |   |   |
| COMPANY                                      |   |                                 |      |                                     |   |                                            |   |                           |   |   |
| For the Nine Months  ended December 31, 2001 |   | $                                    | 2,471,000 |                                     | $      | 679,000                                         |   | $                              | 0 |   | $ | 500,000 |   | $ | 2,650,000 |
|                                         |   |                                 |      |                                     |   |                                            |   |                           |   |   |
| For the Year ended  December 31, 2002        |   | $                                    | 2,650,000 |                                     | $      | 636,000                                         |   | $                              | 0 |   | $ | 176,000 |   | $ | 3,110,000 |

 

----

(a)                                  Write-offsof accounts deemed uncollectible 

 

44

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SCHEDULE II

 

M-FOODS DAIRY, LLC

(A majority ownedsubsidiary of Michael Foods, Inc.)

 

VALUATION AND QUALIFYINGACCOUNTS

 
| **Col. A**                                  |   | **Col. B**                           |    | **Col. C**                               |   | **Col. D**                                      |   | **Col. E**                    |   |
|---------------------------------------------|--------|--------------------------------------|---------|------------------------------------------|--------|-------------------------------------------------|--------|-------------------------------|--------|
|                                        |   |                                 |    | **Additions**                            |   |                                            |   |                          |   |
| **Description**                             |   | **Balance at  Beginning of  Period** |    | **(1)  Charged to  Costs and  Expenses** |   | **(2)  Charges  to Other  Accounts-  Describe** |   | **Deductions  Describe  (a)** |   | **Balance at  End of  Period** |   |
|                                        |   |                                 |    |                                     |   |                                            |   |                          |   |   |   |
| Allowance for Doubtful Accounts             |   |                                 |    |                                     |   |                                            |   |                          |   |   |   |
|                                        |   |                                 |    |                                     |   |                                            |   |                          |   |   |   |
| PREDECESSOR                                 |   |                                 |    |                                     |   |                                            |   |                          |   |   |   |
| For the Year ended December 31, 2000        |   | $                                    | 138,000 |                                     | $      | 853,000                                         |   | $                             | 0      |   | $ | 838,000 |   | $ | 153,000 |   |
|                                        |   |                                 |    |                                     |   |                                            |   |                          |   |   |   |
| For the Three Months ended March 31, 2001   |   | $                                    | 153,000 |                                     | $      | 15,000                                          |   | $                             | 0      |   | $ | 0 |   | $ | 168,000 |   |
|                                        |   |                                 |    |                                     |   |                                            |   |                          |   |   |   |
| COMPANY                                     |   |                                 |    |                                     |   |                                            |   |                          |   |   |   |
| For the Nine Months ended December 31, 2001 |   | $                                    | 168,000 |                                     | $      | 46,000                                          |   | $                             | 0      |   | $ | 14,000 |   | $ | 200,000 |   |
|                                        |   |                                 |    |                                     |   |                                            |   |                          |   |   |   |
| For the Year ended December 31, 2002        |   | $                                    | 200,000 |                                     | $      | 57,000                                          |   | $                             | 0      |   | $ | 2,000 |   | $ | 255,000 |   |

 

----

(a)                                  Write-offsof accounts deemed uncollectible 

 

45

----

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized. 

 
| MICHAEL FOODS, INC.                     |   |                                                                                              |
|-----------------------------------------|--------|---------------------------------------------------------------------------------------------------|
|                                    |   |                                                                                              |
| Date:     March 20, 2003 | By:    | /s/ Gregg A. Ostrander                                                                            |
|                                    |   | Gregg A. Ostrander                                                                                |
|                                    |   | (Chairman, President and Chief Executive  Officer)                                                |
|                                    |   |                                                                                              |
|                                    |   |                                                                                              |
| Date:     March 20, 2003 | By:    | /s/ John D. Reedy                                                                                 |
|                                    |   | John D. Reedy                                                                                     |
|                                    |   | (Executive Vice President, Chief Financial  Officer, Treasurer and Principal  Accounting Officer) |

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of theregistrant and in the capacities and on the dates indicated: 

 
| /s/ J. Christopher Henderson        |   | March 20, 2003 |
|-------------------------------------|--------|----------------|
| J. Christopher Henderson (Director) |   |
|                                |   |
| /s/ Jerome J. Jenko                 |   | March 20, 2003 |
| Jerome J. Jenko (Director)          |   |
|                                |   |
| /s/ James P. Kelley                 |   | March 20, 2003 |
| James P. Kelley (Director)          |   |
|                                |   |
| /s/ Leonard Lieberman               |   | March 20, 2003 |
| Leonard Lieberman (Director)        |   |
|                                |   |
| /s/ Jeffrey J. Michael              |   | March 20, 2003 |
| Jeffrey J. Michael (Director)       |   |
|                                |   |
| /s/ John L. Morrison                |   | March 20, 2003 |
| John L. Morrison (Director)         |   |
|                                |   |
| /s/ Kevin A. Mundt                  |   | March 20, 2003 |
| Kevin A. Mundt (Director)           |   |
|                                     |        |                |  |  |

 

46

----

 

**CERTIFICATIONOF CHIEF EXECUTIVE OFFICER**

 

I, Gregg A. Ostrander, certify that: 

 

1.  I have reviewed this annualreport on Form 10-K of Michael Foods, Inc.;

 

2.  Based on my knowledge, thisannual report does not contain any untrue statement of a material fact or omitto state a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this annual report;

 

3.  Based on my knowledge, thefinancial statements, and other financial information included in this annualreport, fairly present in all material respects the financial condition,results of operations and cash flows of the registrant as of, and for, theperiods presented in this annual report;

 

4.  The registrant’s othercertifying officers and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and have:

 

a)  designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this annual report is being prepared;

 

b)  evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this annual report (the“Evaluation Date”); and

 

c)  presentedin this annual report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.  The registrant’s othercertifying officers and I have disclosed, based on our most recent evaluation,to the registrant’s auditors and the audit committee of registrant’s board ofdirectors (or persons performing the equivalent functions):

 

a)  allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)  any fraud,whether or not material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.  The registrant’s othercertifying officers and I have indicated in this annual report whether therewere significant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses. 

 

Date:  March 20, 2003 

 
|   | /s/ Gregg A. Ostrander                          |   |
|--------|-------------------------------------------------|--------|
|   | Chairman, President and Chief Executive Officer |

 

47

----

 

**CERTIFICATIONOF CHIEF FINANCIAL OFFICER**

 

I, John D. Reedy, certify that: 

 

1.  I have reviewed this annualreport on Form 10-K of Michael Foods, Inc.;

 

2.  Based on my knowledge, thisannual report does not contain any untrue statement of a material fact or omitto state a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this annual report;

 

3.  Based on my knowledge, thefinancial statements, and other financial information included in this annualreport, fairly present in all material respects the financial condition,results of operations and cash flows of the registrant as of, and for, theperiods presented in this annual report;

 

4.  The registrant’s othercertifying officers and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and have:

 

a)  designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this annual report is being prepared;

 

b)  evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this annual report (the“Evaluation Date”); and

 

c)  presentedin this annual report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.  The registrant’s othercertifying officers and I have disclosed, based on our most recent evaluation,to the registrant’s auditors and the audit committee of registrant’s board ofdirectors (or persons performing the equivalent functions):

 

a)  allsignificant deficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)  any fraud,whether or not material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.  The registrant’s othercertifying officers and I have indicated in this annual report whether therewere significant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses. 

 

Date:  March 20, 2003 

 
|   | /s/ John D. Reedy                                                |   |
|--------|------------------------------------------------------------------|--------|
|   | Executive Vice President, Treasurer and  Chief Financial Officer |

 

48

----

 

SUPPLEMENTAL INFORMATIONTO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE ACT BYREGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THEACT. 

 

No annual report or proxystatement has been sent to securityholders during the Registrant’s last fiscalyear. 

 

EXHIBIT INDEX 

 
| **Exhibit No.** |   |                                               |
|-----------------|--------|----------------------------------------------------|
|            |   |                                               |
| 12.1            |   | Computation of Ratio of  Earnings to Fixed Charges |
| 21.1            |   | Schedule of Michael  Foods, Inc. Subsidiaries      |

 

49

----

 

MICHAELFOODS, INC.

(A wholly owned subsidiary of M-Foods Holdings, Inc.)

 

Report of Independent Accountants

 

 

BOARD OF DIRECTORS

MICHAEL FOODS, INC.

 

In our opinion, the accompanying consolidated balance sheet and therelated consolidated statements of operations, of shareholder’s equity and ofcash flows present fairly, in all material respects, the financial position ofMichael Foods, Inc. and its subsidiaries (the Company), a wholly ownedsubsidiary of M-Foods Holdings, Inc., at December 31, 2002, and the results oftheir operations and their cash flows for the year then ended in conformitywith accounting principles generally accepted in the United States ofAmerica.  These financial statements arethe responsibility of the Company’s management; our responsibility is toexpress an opinion on these financial statements based on our audit.  We conducted our audit of these statementsin accordance with auditing standards generally accepted in the United Statesof America, which require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, and evaluating the overallfinancial statement presentation.  We believethat our audit provides a reasonable basis for our opinion.

 

The financial statements of the Company as of December 31, 2001 and forthe nine months then ended were audited by other independent certified publicaccountants whose report, dated February 8, 2002, expressed an unqualifiedopinion on those statements.

 

The financial statements of Michael Foods, Inc. and subsidiaries (thePredecessor) for the three months ended March 31, 2001 and for the year endedDecember 31, 2000 were audited by other independent certified publicaccountants whose report, dated May 15, 2001, expressed an unqualified opinionon those statements.

 

As discussed in Note C to the financial statements, the Company adoptedStatement of Financial Accounting Standards No. 142, “Goodwill and OtherIntangible Assets” and Statement of Financial Accounting Standards No. 145,“Rescission of FASB Statement 4, 44, and 64, Amendment of FASB Statement No.13, and Technical Corrections” on January 1, 2002.

 

 
| /s/PricewaterhouseCoopers LLP |   |
|-------------------------------|--------|
|                          |
| Minneapolis, Minnesota        |
| February 18, 2003             |

 

50

----

 

MICHAEL FOODS, INC.

(A wholly owned subsidiary of M-Foods Holdings, Inc.)

 

REPORT OF INDEPENDENTCERTIFIED PUBLIC ACCOUNTANTS

 

BOARD OF DIRECTORS

MICHAEL FOODS, INC.

 

We have audited the accompanying consolidated balancesheet of Michael Foods, Inc. and subsidiaries (a wholly-owned subsidiary ofM-Foods Holdings, Inc.) as of December 31, 2001 and the related consolidatedstatements of earnings, shareholder’s equity, and cash flows for the ninemonths then ended.  These financialstatements are the responsibility of the Company's management.  Our responsibility is to express an opinionon these financial statements based on our audit.

 

We conducted our audit in accordance with auditingstandards generally accepted in the United States of America. Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believe ouraudit provides a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of Michael Foods, Inc. and subsidiaries (a wholly-owned subsidiary ofM-Foods Holdings, Inc.) as of December 31, 2001, and the results of itsoperations and its cash flows for the nine months then ended in conformity withaccounting principles generally accepted in the United States of America.

 

We have also audited Schedule II for the nine monthsended December 31, 2001.  In ouropinion, this schedule, when considered in relation to the basic financialstatements taken as a whole, presents fairly, in all material respects, theinformation therein.

 

 
| /s/ GRANT THORNTON LLP |   |
|------------------------|--------|
|                   |
| Minneapolis, Minnesota |
| February 8, 2002       |
|                   |

 

51

----

 

MICHAEL FOODS, INC.

(A wholly owned subsidiary of M-Foods Holdings, Inc.)

 

REPORT OF INDEPENDENT CERTIFIEDPUBLIC ACCOUNTANTS

 

BOARD OF DIRECTORS

MICHAEL FOODS, INC.

 

We have audited the consolidated statements ofoperations, shareholder’s equity, and cash flows of Michael Foods, Inc. andsubsidiaries (the Predecessor") for the year ended December 31, 2000 andthe three months ended March 31, 2001. These financial statements are the responsibility of the Predecessor'smanagement. Our responsibility is to express an opinion on these financialstatements based on our audits.

 

We conducted our audits in accordance with auditingstandards generally accepted in the United States of America. Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believe ouraudits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the results ofoperations and cash flows of Michael Foods, Inc. and subsidiaries for the yearended December 31, 2000 and for the three months ended March 31, 2001, inconformity with accounting principles generally accepted in the United Statesof America.

 

We have also audited Schedule II for the year endedDecember 31, 2000 and for the three months ended March 31, 2001. In ouropinion, this schedule, when considered in relation to the basic financialstatement taken as a whole, presents fairly, in all material respects, theinformation therein.

 

 
| /s/ GRANT THORNTON LLP                                                                                                                                    |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                                      |
| Minneapolis, Minnesota                                                                                                                                    |
| May 15, 2001, (except for the third paragraph of  "Recent Accounting Pronouncements" within Note C, as to which the  date is February 18, 2003) |

 

52

----

 

MICHAEL FOODS, INC.

(A wholly owned subsidiary of M-Foods Holdings, Inc.)

 

**CONSOLIDATED BALANCE SHEETS**

 
|                                                                            |   | **December  31,** |        |
|---------------------------------------------------------------------------------|--------|-------------------|-------------|
|                                                                            |   | **2002**          |        | **2001** |   |
| ASSETS                                                                          |   |              |        |   |   |
| CURRENT ASSETS                                                                  |   |              |        |   |   |
| Cash and equivalents                                                            |   | $                 | 20,572,000  |   | $ | 27,660,000 |   |
| Accounts receivable, less allowances                                            |   | 101,579,000       |        | 102,317,000 |   |
| Inventories                                                                     |   | 95,807,000        |        | 78,941,000 |   |
| Prepaid expenses and other                                                      |   | 13,571,000        |        | 11,370,000 |   |
| Total current assets                                                            |   | 231,529,000       |        | 220,288,000 |   |
| PROPERTY, PLANT AND EQUIPMENT                                                   |   |              |        |   |   |
| Land                                                                            |   | 3,873,000         |        | 3,873,000 |   |
| Buildings and improvements                                                      |   | 110,702,000       |        | 99,561,000 |   |
| Machinery and equipment                                                         |   | 259,501,000       |        | 226,759,000 |   |
|                                                                            |   | 374,076,000       |        | 330,193,000 |   |
| Less accumulated depreciation                                                   |   | 91,723,000        |        | 39,039,000 |   |
|                                                                            |   | 282,353,000       |        | 291,154,000 |   |
| OTHER ASSETS                                                                    |   |              |        |   |   |
| Goodwill                                                                        |   | 341,028,000       |        | 341,021,000 |   |
| Joint ventures and other assets                                                 |   | 38,112,000        |        | 44,670,000 |   |
|                                                                            |   | 379,140,000       |        | 385,691,000 |   |
|                                                                            |   | $                 | 893,022,000 |   | $ | 897,133,000 |   |
| LIABILITIES AND SHAREHOLDER’S  EQUITY                                      |   |              |        |   |   |
| CURRENT LIABILITIES                                                             |   |              |        |   |   |
| Current maturities of long-term debt                                            |   | $                 | 17,671,000  |   | $ | 12,962,000 |   |
| Accounts payable                                                                |   | 65,990,000        |        | 64,492,000 |   |
| Accrued liabilities                                                             |   |              |        |   |   |
| Compensation                                                                    |   | 15,251,000        |        | 12,582,000 |   |
| Insurance                                                                       |   | 7,855,000         |        | 8,191,000 |   |
| Customer programs                                                               |   | 26,484,000        |        | 21,996,000 |   |
| Income taxes                                                                    |   | 7,403,000         |        | 9,853,000 |   |
| Interest                                                                        |   | 9,336,000         |        | 10,619,000 |   |
| Hedging derivative liability                                                    |   | 11,001,000        |        | 4,186,000 |   |
| Other                                                                           |   | 11,393,000        |        | 9,930,000 |   |
| Total current liabilities                                                       |   | 172,384,000       |        | 154,811,000 |   |
| LONG-TERM DEBT, less current maturities                                         |   | 493,718,000       |        | 540,132,000 |   |
| DEFERRED INCOME TAXES                                                           |   | 47,119,000        |        | 48,725,000 |   |
| COMMITMENTS AND CONTINGENCIES                                                   |   | —            |        | — |   |
| NON-CONTROLLING INTEREST                                                        |   | 475,000           |        | 475,000 |   |
| SHAREHOLDER’S EQUITY                                                       |   |              |        |   |   |
| Common stock, $0.01 par value, 1,000 shares authorized,  issued and outstanding |   | —            |        | — |   |
| Additional paid-in capital                                                      |   | 147,498,000       |        | 146,792,000 |   |
| Retained earnings                                                               |   | 39,476,000        |        | 9,815,000 |   |
| Accumulated other comprehensive loss                                            |   | (7,648,000        | )           | (3,617,000 | ) |
|                                                                            |   | 179,326,000       |        | 152,990,000 |   |
|                                                                            |   | $                 | 893,022,000 |   | $ | 897,133,000 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

53

----

 

MICHAEL FOODS, INC.

(A wholly owned subsidiary of M-Foods Holdings, Inc.)

 

**CONSOLIDATED STATEMENTS OF OPERATIONS**

 

 
|                                           |   | **Company**                        |          | **Predecessor**                           | * *   |
|------------------------------------------------|--------|------------------------------------|---------------|-------------------------------------------|------------|
|                                           |   | **Year  ended  December 31, 2002** |          | **Nine Months  ended  December 31, 2001** |       | **Three Months  ended  March 31, 2001** |   | **Year  ended  December 31, 2000** | * * |
|                                           |   |                               | ** **    |                                      | ** ** |   | ** ** |   | ** ** |
| Net sales                                      |   | $                                  | 1,168,160,000 |                                      | $          | 885,642,000 |   | $ | 275,627,000 |   | $ | 1,080,601,000 |   |
| Cost of sales                                  |   | 953,333,000                        |          | 734,008,000                               |       | 227,707,000 |   | 889,138,000 |   |
| Gross profit                                   |   | 214,827,000                        |          | 151,634,000                               |       | 47,920,000 |   | 191,463,000 |   |
| Selling, general and administrative expenses   |   | 116,444,000                        |          | 87,484,000                                |       | 27,376,000 |   | 104,657,000 |   |
| Transaction expenses                           |   | —                             |          | —                                    |       | 11,050,000 |   | — |   |
| Operating profit                               |   | 98,383,000                         |          | 64,150,000                                |       | 9,494,000 |   | 86,806,000 |   |
| Interest expense, net                          |   | 50,179,000                         |          | 42,335,000                                |       | 3,293,000 |   | 13,206,000 |   |
| Earnings before other expense and income taxes |   | 48,204,000                         |          | 21,815,000                                |       | 6,201,000 |   | 73,600,000 |   |
| Other expense-early extinguishment of debt     |   | —                             |          | —                                    |       | 15,513,000 |   | — |   |
| Earnings (loss) before income taxes            |   | 48,204,000                         |          | 21,815,000                                |       | (9,312,000 | ) | 73,600,000 |   |
| Income tax expense (benefit)                   |   | 18,543,000                         |          | 12,000,000                                |       | (3,659,000 | ) | 28,890,000 |   |
| NET EARNINGS (LOSS)                            |   | $                                  | 29,661,000    |                                      | $          | 9,815,000 |   | $ | (5,653,000 | ) | $ | 44,710,000 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

54

----

 

MICHAEL FOODS, INC.

(A wholly owned subsidiary of M-Foods Holdings, Inc.)

 

**CONSOLIDATED STATEMENTS OFSHAREHOLDER’S EQUITY**

** **
|                                                                                    |   | **COMMON STOCK** |       | **ADDITIONAL  PAID-IN  CAPITAL** |       | **RETAINED  EARNINGS** |       | **ACCUMULATED  OTHER  COMPREHENSIVE  INCOME (LOSS)** |       | **TOTAL  SHAREHOLDER’S  EQUITY** |        |
|-----------------------------------------------------------------------------------------|--------|------------------|------------|----------------------------------|------------|------------------------|------------|------------------------------------------------------|------------|---------------------------------------|-------------|
| **SHARES  ISSUED**                                                                      |   | **AMOUNT**       |
| **Predecessor**                                                                         |   |             | ** ** |                             | ** ** |                   | ** ** |                                                 | ** ** |                                  | ** **  |   | ** ** |
| Balance at January 1, 2000                                                              |   | 20,301,624       |       | $                                | 203,000    |                   | $          | 102,777,000                                          |       | $                                     | 162,577,000 |   | $ | (958,000 | ) | $ | 264,599,000 |   |
| Repurchase of common stock                                                              |   | (2,109,400       | )          | (21,000                          | )          | (46,104,000            | )          | —                                               |       | —                                |        | (46,125,000 | ) |
| Incentive plan stock  compensation                                                      |   | 40,890           |       | —                           |       | 876,000                |       | —                                               |       | —                                |        | 876,000 |   |
| Stock options exercised, net  of shares surrendered for exercise price and income taxes |   | 56,370           |       | 1,000                            |       | 650,000                |       | —                                               |       | —                                |        | 651,000 |   |
| Tax benefit from stock  options exercised                                               |   | —           |       | —                           |       | 307,000                |       | —                                               |       | —                                |        | 307,000 |   |
| Net earnings                                                                            |   | —           |       | —                           |       | —                 |       | 44,710,000                                           |       | —                                |        | 44,710,000 |   |
| Foreign currency translation  adjustment loss                                           |   | —           |       | —                           |       | —                 |       | —                                               |       | (359,000                              | )           | (359,000 | ) |
| Comprehensive income                                                                    |   | —           |       | —                           |       | —                 |       | —                                               |       | —                                |        | 44,351,000 |   |
| Dividends ($.31 per share)                                                              |   | —           |       | —                           |       | —                 |       | (5,926,000                                           | )          | —                                |        | (5,926,000 | ) |
| Balance at December 31, 2000                                                            |   | 18,289,484       |       | 183,000                          |       | 58,506,000             |       | 201,361,000                                          |       | (1,317,000                            | )           | 258,733,000 |   |
| Incentive plan stock  compensation                                                      |   | 39,703           |       | —                           |       | 1,169,000              |       | —                                               |       | —                                |        | 1,169,000 |   |
| Stock options exercised, net  of shares surrendered for exercise price and income taxes |   | 36,543           |       | 1,000                            |       | 545,000                |       | —                                               |       | —                                |        | 546,000 |   |
| Tax benefit from stock  options exercised                                               |   | —           |       | —                           |       | 4,055,000              |       | —                                               |       | —                                |        | 4,055,000 |   |
| Stock options extended                                                                  |   | —           |       | —                           |       | 310,000                |       | —                                               |       | —                                |        | 310,000 |   |
| Net loss                                                                                |   | —           |       | —                           |       | —                 |       | (5,653,000                                           | )          | —                                |        | (5,653,000 | ) |
| Foreign currency translation  adjustment income                                         |   | —           |       | —                           |       | —                 |       | —                                               |       | 1,088,000                             |        | 1,088,000 |   |
| Futures loss                                                                            |   | —           |       | —                           |       | —                 |       | —                                               |       | (1,632,000                            | )           | (1,632,000 | ) |
| Comprehensive income (loss)                                                             |   | —           |       | —                           |       | —                 |       | —                                               |       | —                                |        | (6,197,000 | ) |
| Dividends ($.08 per share)                                                              |   | —           |       | —                           |       | —                 |       | (1,465,000                                           | )          | —                                |        | (1,465,000 | ) |
| Balance at March 31, 2001                                                               |   | 18,365,730       |       | $                                | 184,000    |                   | $          | 64,585,000                                           |       | $                                     | 194,243,000 |   | $ | (1,861,000 | ) | $ | 257,151,000 |   |
| **Company**                                                                             |   |             | ** ** |                             | ** ** |                   | ** ** |                                                 | ** ** |                                  | ** **  |   | ** ** |
| Balance at March 31, 2001                                                               |   | 18,365,730       |       | $                                | 184,000    |                   | $          | 64,585,000                                           |       | $                                     | 194,243,000 |   | $ | (1,861,000 | ) | $ | 257,151,000 |   |
| Merger with M-Foods  Holdings, Inc.                                                     |   | (18,365,730      | )          | (184,000                         | )          | (64,585,000            | )          | (194,243,000                                         | )          | 1,861,000                             |        | (257,151,000 | ) |
| Proceeds from issuance of  common stock, $0.01 par                                      |   | 1,000            |       | —                           |       | 213,393,000            |       | —                                               |       | —                                |        | 213,393,000 |   |
| Deemed dividend to continuing  shareholders                                             |   | —           |       | —                           |       | (66,631,000            | )          | —                                               |       | —                                |        | (66,631,000 | ) |
| Allocation of deemed dividend  to accumulated other comprehensive loss                  |   | —           |       | —                           |       | —                 |       | —                                               |       | (577,000                              | )           | (577,000 | ) |
| Balance at April 1, 2001                                                                |   | 1,000            |       | —                           |       | 146,762,000            |       | —                                               |       | (577,000                              | )           | 146,185,000 |   |
| Additional capital invested  by parent                                                  |   | —           |       | —                           |       | 30,000                 |       | —                                               |       | —                                |        | 30,000 |   |
| Net earnings                                                                            |   | —           |       | —                           |       | —                 |       | 9,815,000                                            |       | —                                |        | 9,815,000 |   |
| Foreign currency translation  adjustment income                                         |   | —           |       | —                           |       | —                 |       | —                                               |       | 10,000                                |        | 10,000 |   |
| Interest rate swap                                                                      |   | —           |       | —                           |       | —                 |       | —                                               |       | (1,206,000                            | )           | (1,206,000 | ) |
| Futures loss                                                                            |   | —           |       | —                           |       | —                 |       | —                                               |       | (1,844,000                            | )           | (1,844,000 | ) |
| Comprehensive income                                                                    |   | —           |       | —                           |       | —                 |       | —                                               |       | —                                |        | 6,775,000 |   |
| Balance at December 31, 2001                                                            |   | 1,000            |       | —                           |       | 146,792,000            |       | 9,815,000                                            |       | (3,617,000                            | )           | 152,990,000 |   |
| Additional capital invested  by parent                                                  |   | —           |       | —                           |       | 706,000                |       | —                                               |       | —                                |        | 706,000 |   |
| Net earnings                                                                            |   | —           |       | —                           |       | —                 |       | 29,661,000                                           |       | —                                |        | 29,661,000 |   |
| Foreign currency translation  adjustment income                                         |   | —           |       | —                           |       | —                 |       | —                                               |       | 141,000                               |        | 141,000 |   |
| Interest rate swap                                                                      |   | —           |       | —                           |       | —                 |       | —                                               |       | (5,384,000                            | )           | (5,384,000 | ) |
| Futures gain                                                                            |   | —           |       | —                           |       | —                 |       | —                                               |       | 1,212,000                             |        | 1,212,000 |   |
| Comprehensive income                                                                    |   | —           |       | —                           |       | —                 |       | —                                               |       | —                                |        | 25,630,000 |   |
| Balance at December 31, 2002                                                            |   | 1,000            |       | $                                | —     |                   | $          | 147,498,000                                          |       | $                                     | 39,476,000  |   | $ | (7,648,000 | ) | $ | 179,326,000 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

55

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MICHAEL FOODS, INC.

(A wholly owned subsidiary of M-Foods Holdings, Inc.)

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
|                                                                                        |   | **Company**                        |       | **Predecessor**                           |   |
|---------------------------------------------------------------------------------------------|--------|------------------------------------|------------|-------------------------------------------|--------|
|                                                                                        |   | **Year  ended  December 31, 2002** |       | **Nine months  ended  December 31, 2001** |   | **Three months  ended  March 31, 2001** |   | **Year  ended  December 31, 2000** |   |
|                                                                                        |   |                               |       |                                      |   |   |   |   |   |
| Cash flows from operating activities:                                                       |   |                               |       |                                      |   |   |   |   |   |
| Net earnings (loss)                                                                         |   | $                                  | 29,661,000 |                                      | $      | 9,815,000 |   | $ | (5,653,000 | ) | $ | 44,710,000 |   |
| Adjustments to reconcile net earnings (loss) to net  cash provided by operating activities: |   |                               |       |                                      |   |   |   |   |   |
| Depreciation                                                                                |   | 53,543,000                         |       | 39,689,000                                |   | 11,114,000 |   | 42,355,000 |   |
| Amortization of intangibles                                                                 |   | 716,000                            |       | 7,256,000                                 |   | 1,421,000 |   | 5,628,000 |   |
| Amortization of deferred financing costs                                                    |   | 4,218,000                          |       | 2,359,000                                 |   | — |   | — |   |
| Deferred income taxes                                                                       |   | (1,606,000                         | )          | (2,749,000                                | )      | (1,547,000 | ) | 2,707,000 |   |
| Tax benefit from stock options exercised                                                    |   | —                             |       | —                                    |   | 4,055,000 |   | 307,000 |   |
| Changes in operating assets and liabilities:                                                |   |                               |       |                                      |   |   |   |   |   |
| Accounts receivable                                                                         |   | 1,648,000                          |       | 18,569,000                                |   | (7,903,000 | ) | (20,274,000 | ) |
| Inventories                                                                                 |   | (10,630,000                        | )          | 3,400,000                                 |   | (4,944,000 | ) | (4,537,000 | ) |
| Prepaid expenses and other                                                                  |   | (1,902,000                         | )          | (3,784,000                                | )      | 293,000 |   | (199,000 | ) |
| Accounts payable                                                                            |   | 560,000                            |       | 4,837,000                                 |   | 5,443,000 |   | 7,203,000 |   |
| Accrued liabilities                                                                         |   | 6,797,000                          |       | 21,401,000                                |   | 11,737,000 |   | (8,815,000 | ) |
| Net cash provided by operating activities                                                   |   | 83,005,000                         |       | 100,793,000                               |   | 14,016,000 |   | 69,085,000 |   |
| Cash flows from investing activities:                                                       |   |                               |       |                                      |   |   |   |   |   |
| Capital expenditures                                                                        |   | (27,394,000                        | )          | (23,299,000                               | )      | (10,837,000 | ) | (37,373,000 | ) |
| Business acquisitions                                                                       |   | (17,883,000                        | )          | (626,925,000                              | )      | — |   | — |   |
| Joint ventures and other assets                                                             |   | 4,752,000                          |       | (4,953,000                                | )      | 3,888,000 |   | (1,127,000 | ) |
| Net cash used in investing activities                                                       |   | (40,525,000                        | )          | (655,177,000                              | )      | (6,949,000 | ) | (38,500,000 | ) |
| Cash flows from financing activities:                                                       |   |                               |       |                                      |   |   |   |   |   |
| Payments on revolving line of credit                                                        |   | (30,000,000                        | )          | (65,750,000                               | )      | (52,000,000 | ) | (168,400,000 | ) |
| Proceeds from revolving line of credit                                                      |   | 25,000,000                         |       | 53,800,000                                |   | 45,500,000 |   | 191,600,000 |   |
| Payments on long-term debt                                                                  |   | (45,274,000                        | )          | (155,106,000                              | )      | (109,000 | ) | (3,109,000 | ) |
| Proceeds from long-term debt                                                                |   | —                             |       | 570,000,000                               |   | — |   | 184,000 |   |
| Repurchase of common stock                                                                  |   | —                             |       | —                                    |   | — |   | (46,125,000 | ) |
| Proceeds from issuance of common stock                                                      |   | —                             |       | 174,800,000                               |   | 546,000 |   | 651,000 |   |
| Additional capital invested by parent                                                       |   | 706,000                            |       | 30,000                                    |   | — |   | — |   |
| Dividends                                                                                   |   | —                             |       | —                                    |   | (1,465,000 | ) | (5,926,000 | ) |
| Other                                                                                       |   | —                             |       | —                                    |   | 310,000 |   | — |   |
| Net cash provided by (used in) financing activities                                         |   | (49,568,000                        | )          | 577,774,000                               |   | (7,218,000 | ) | (31,125,000 | ) |
| Net increase (decrease) in cash and equivalents                                             |   | (7,088,000                         | )          | 23,390,000                                |   | (151,000 | ) | (540,000 | ) |
| Cash and equivalents at beginning of period                                                 |   | 27,660,000                         |       | 4,270,000                                 |   | 4,421,000 |   | 4,961,000 |   |
| Cash and equivalents at end of period                                                       |   | $                                  | 20,572,000 |                                      | $      | 27,660,000 |   | $ | 4,270,000 |   | $ | 4,421,000 |   |
|                                                                                        |   |                               |       |                                      |   |   |   |   |   |
| Supplemental disclosures of cash flow information:                                          |   |                               |       |                                      |   |   |   |   |   |
| Cash paid during the year for:                                                              |   |                               |       |                                      |   |   |   |   |   |
| Interest                                                                                    |   | $                                  | 46,959,000 |                                      | $      | 28,866,000 |   | $ | 5,945,000 |   | $ | 13,484,000 |   |
| Income taxes                                                                                |   | 15,098,000                         |       | 7,467,000                                 |   | 1,025,000 |   | 27,225,000 |   |

 

The accompanying notes are anintegral part of these financial statements.

 

56

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MICHAEL FOODS, INC.

(A wholly owned subsidiary of M-Foods Holdings, Inc.)

 

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS

 

**NOTE A—MERGERAGREEMENT**

** **

On April 10, 2001, Michael Foods, Inc. and its subsidiaries (“MichaelFoods”, “Company”, “we”, “us”, “our”) was acquired in a transaction (the“Merger”) led by an investor group comprised of a management group led byMichael Foods’ Chairman, President and Chief Executive Officer, GreggOstrander, affiliates of Jeffrey Michael, a member of the Predecessor’s Boardof Directors, and affiliates of two private equity investment firms, VestarCapital Partners and Goldner Hawn Johnson & Morrison Incorporated,(collectively, “M-Foods Investors, LLC”). Michael Foods, Inc. is a wholly-ownedsubsidiary of M-Foods Holdings, Inc.; M-Foods Holdings, Inc. is a wholly-ownedsubsidiary of M-Foods Investors, LLC. Under the terms of the Merger agreement,all outstanding shares of Michael Foods common stock were converted into theright to receive $30.10 per share in cash, or value equal thereto, and alloutstanding stock options were converted into the right to receive, in cash,$30.10 per share reduced by the exercise price per share for all shares subjectto such stock options. The purchase of the outstanding shares was financedthrough new equity financing of approximately $175,000,000, a senior securedcredit facility of up to $470,000,000 at market-based variable interest rates,and $200,000,000 of senior subordinated notes at an 11.75% annual interestrate. As a result of the Merger, the stock of pre-merger Michael Foods(“Predecessor”) is no longer publicly traded and, therefore, earnings per sharecalculations are no longer included for financial statement presentation.

 

Immediately after the close of the Merger, we contributed the assets ofour Dairy Products Division into two limited liability corporations, M-FoodsDairy, LLC and M-Foods Dairy TXCT, LLC (collectively, the “Dairy LLCs”) and inexchange received voting preferred and voting common units from these entitiesequal to the fair value of the net assets contributed, which collectively wereapproximately $35,800,000. The preferred units issued to us have an annual 10%preferred return guarantee and represent 100% of the preferred units issued andoutstanding. In addition, we received 5% of the common units issued by theDairy LLCs, with the common units held by the Company representing 100% of thevoting common units issued and outstanding. These common units have a statedvalue of $25,000. The remaining 95% of the common units, which are non-voting,are owned by M-Foods Dairy Holdings, LLC, which is owned by the same owners oraffiliates of such owners, in the same proportion, as the unit holders ofM-Foods Investors, LLC. The common unit interests owned by M-Foods DairyHoldings, LLC were issued in exchange for $475,000 and are reflected asnon-controlling interest in the accompanying consolidated balance sheet.

 

The Merger was accounted for as a purchase in accordance withAccounting Principles Board Opinion 16, *Business Combinations* and EITF 88-16, *Basis inLeveraged Buyout Transactions*. Accordingly, the acquired assets andliabilities have been recorded at fair value for the interests acquired by newinvestors and at the carryover basis for continuing investors. As a result, theassets and liabilities were assigned new values, which are part Predecessorcost and part fair value in the same proportions as the carryover basis of theresidual interests retained by the continuing management investors and continuingaffiliate investors of the Michael family, and the new interests acquired bythe new investors. The amount of carryover basis was reflected as a deemeddividend of $66,631,000.

 

For ease of presentation, the Merger was accounted for as if it hadoccurred on April 1, 2001. Management determined that results of operationswere not significant and no material transactions occurred during the periodfrom April 1 through April 9, 2001. Our consolidated financial statements havebeen presented on a comparative basis with the Predecessor’s historicalconsolidated financial statements prior to the date of Merger. Different basesof accounting have been used to prepare the Company and Predecessorconsolidated financial statements.

 

57

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** **

The primary differences relate to additional interest expense for newdebt and depreciation and amortization of fixed assets and other intangibleassets recorded at fair value at the date of Merger.

 

For accounting purposes, the Merger was considered a leveraged buy-out.The total purchase price of approximately $562,881,000 was allocated to theacquired assets and assumed liabilities based on their fair values at April 1,2001, net of the deemed dividend of $66,631,000. These allocations were basedon a valuation by a third party appraisal firm. The allocation of the purchaseprice was as follows:

 
| Working capital                 |   | $           | 88,663,000 |   |
|---------------------------------|--------|-------------|------------|--------|
| Property, plant & equipment |   | 307,544,000 |       |
| Other assets                    |   | 42,816,000  |       |
| Goodwill                        |   | 347,537,000 |       |
| Long-term debt                  |   | 588,426,000 |       |
| Other liabilities               |   | 51,474,000  |       |

 

In connection with the Merger, the Predecessor incurred transactionexpenses of approximately $26,600,000 associated with the Merger andchange-in-control provisions of various compensation, debt and otheragreements, which have been reflected in the Predecessor financial statements.These transaction expenses include the expense related to the earlyextinguishment of debt resulting from the change-in-control. In addition, weincurred other merger related and debt issuance costs of approximately$40,000,000, which have been capitalized as direct costs of the Merger anddeferred financing costs in our consolidated balance sheet.

 

The following unaudited pro forma net sales and earnings before otherexpense and income taxes for the year ended December 31, 2001 are derived fromthe application of pro forma adjustments to the Predecessor’s historicalstatement of earnings, and assume the Merger had occurred on January 1, 2001.  The pro forma earnings for the year endedDecember 31, 2001 are also adjusted for goodwill amortization determined inaccordance with the provisions of SFAS 142 (see Note C, Goodwill andIntangibles).  The net sales andearnings before other expense and income taxes for the year ended December 31,2002 represent actual results for the period.

 
|                                           |   | **Year ended  December 31, 2002** |          | **Year ended  December 31, 2001** |   |
|------------------------------------------------|--------|-----------------------------------|---------------|-----------------------------------|--------|
|                                           |   |                              |          |                              |   |
| Net sales                                      |   | $                                 | 1,168,160,000 |                              | $      | 1,161,269,000 |   |
| Earnings before other expense and income taxes |   | 48,204,000                        |          | 19,446,000                        |   |
|                                                |        |                                   |               |                                   |        |  |  |

 

The most significant of the pro forma adjustments reflected in theabove amounts were to reverse the impact of the one-time transaction-relatedcharges recorded during the three months ended March 31, 2001, to record theincremental interest on the additional debt incurred in connection with theMerger and to record additional depreciation and amortization charges resultingfrom the fair value adjustments made to fixed assets and the recording ofadditional intangible assets. The pro forma financial information should beread in conjunction with the related historical information and is notnecessarily indicative of the results that would have been obtained had thetransaction actually taken place at the beginning of the periods presented.

 

58

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**NOTE B –ASSET PURCHASE**

 

On August 26, 2002, we acquired the egg products assets of CanadianInovatech Inc. for approximately $18,000,000. The total purchase price was allocated to the acquired assets andliabilities based on their fair values at the acquisition date as determined bya third party appraisal firm.  Theallocation of the purchase price resulted in goodwill of $4,807,000.  We also entered into long-term leases fortwo plants operated by the seller.  Thisentity’s results of operations have been included in our operating resultssince the date of the asset purchase. Also, as a result of this asset purchase, we now own 67%, rather than33%, of a Canadian egg products joint venture — Trilogy Egg Products, Inc.  Hence, Trilogy became a consolidated entityunder our financial reporting as of the date of the asset purchase.

 

The following unaudited pro forma statement of earnings information hasbeen prepared assuming the asset purchase and the merger transaction describedin Note A had occurred on January 1, 2001:

 
|                                           |   | **Year ended   December 31, 2002** |          | **Year ended  December 31, 2001** |   |
|------------------------------------------------|--------|------------------------------------|---------------|-----------------------------------|--------|
| Net sales                                      |   | $                                  | 1,202,515,000 |                              | $      | 1,197,509,000 |   |
| Earnings before other expense and income taxes |   | 50,434,000                         |          | 22,447,000                        |   |
|                                                |        |                                    |               |                                   |        |  |  |

 

This unaudited pro forma information is not necessarily indicative ofthe combined results of operations that would have occurred had thetransactions occurred on the noted dates, nor is it indicative of the resultswhich may occur in the future.

** **

**NOTE C—SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

 

**The Company**

TheCompany is a diversified producer and distributor of food products in fourareas—egg products, refrigerated distribution, dairy products, and potatoproducts. The Company believes it is the largest producer of processed eggproducts in the United States, and is a leading producer and distributor ofspecialty potato and dairy products to the foodservice, retail and industrialmarkets. The Company also distributes refrigerated grocery items, primarilycheese and other dairy items, to the retail grocery market in the centralUnited States. 

 

The Company adopted the accounting policies of the Predecessor. 

 

**Principles ofConsolidation and Fiscal Year**

Theconsolidated financial statements include the accounts of MichaelFoods, Inc. and all majority owned subsidiaries in which it has control.All significant inter-company accounts and transactions have beeneliminated. The Company's investments in non-controlled entities in which ithas the ability to exercise significant influence over operating and financialpolicies are accounted for by the equity method. The Company utilizes afifty-two, fifty-three week fiscal year ending on the Saturday nearest toDecember 31, but for clarity of presentation, describes all periods as ifthe year end is December 31. The years ended December 31, 2002, 2001and 2000 each consisted of fifty-two weeks. 

 

**Basis ofPresentation**

Theaccompanying consolidated financial statements as of December 31, 2000 andfor the year then ended and for the three months ended March 31, 2001 havebeen taken from the historical books and records of the Predecessor. 

 

59

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**Use of Estimates**

Preparationof the Company's consolidated financial statements in conformity withaccounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect reportedamounts of assets and liabilities, related revenues and expenses and disclosureabout contingent assets and liabilities at the date of the financialstatements. Actual results could differ from the estimates used by management. 

** **

**Cash andEquivalents**

TheCompany considers all highly liquid temporary investments with originalmaturities of three months or less to be cash equivalents.  Substantially all of the Company’s cash andequivalents is with one bank.

 

###### **AccountsReceivable**

The Company grants creditto customers in the normal course of business, but generally does not requirecollateral or any other security to support amounts due.  Management performs on-going creditevaluations of customers.  The Companymaintains an allowance for potential credit losses which, when realized, havebeen within management’s expectations. The allowance was $3,110,000 and $2,650,000 at December 31, 2002 and2001.

** **

**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 purchasingand raising flocks to laying maturity, at which time their cost is amortized tooperations over their expected useful lives of generally one to two years.

 

Inventories consisted of thefollowing at December 31:

 
|                               |   | **2002**   |       | **2001**   |       |
|------------------------------------|--------|------------|------------|------------|------------|
|                               |   |       | ** ** |       | ** ** |
| Raw materials and supplies         |   | $          | 18,552,000 |       | $          | 15,347,000 |   |
| Work in process and finished goods |   | 54,574,000 |       | 43,027,000 |       |
| Flocks                             |   | 22,681,000 |       | 20,567,000 |       |
|                               |   | $          | 95,807,000 |       | $          | 78,941,000 |   |

 

**Accountingfor Hedge Activities**

Effective January 1,2001, the Company adopted Statement of Financial Accounting Standard (“SFAS”)No. 133, *Accountingfor Derivative Instruments and Hedging Activities*, as amended. Thisstandard establishes accounting and reporting standards for derivativefinancial instruments and hedge activities. Certain of the Company’s operatingsegments hold derivative instruments, such as corn, soybean meal, cheese andfuel futures that the Company believes provide an economic hedge of futuretransactions and are designated as cash flow hedges.  As the commodities being hedged are either grain ingredients fedto the Company’s flocks, raw materials or production inputs, the changes in themarket value of such contracts have historically been, and are expected tocontinue to be, highly effective at offsetting changes in price movements ofthese items.  In addition, the Companyhas also entered into interest rate swap agreements, which correspond with theinterest payment terms of a portion of the Company’s variable rate seniorsecured credit facility.  As thesignificant components of the swap agreements and the credit facility arehighly correlative, the Company expects the swaps to be highly effective overthe terms of the agreements.  The amountof hedge ineffectiveness was immaterial for the years ended December 31, 2002and 2001.  

 

60

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The Company activelymonitors its exposure to commodity price risks and uses derivative commodityinstruments to manage the impact of certain of these risks. The Company usesderivatives, primarily futures contracts, only for the purpose of managingrisks associated with underlying exposures. The Company’s futures contracts arecash flow hedges of firm purchase commitments and anticipated productionrequirements, as they reduce the Company’s exposure to changes in the cashprice of the respective items and generally extend for less than one year.  

 

The Company does nottrade or use instruments with the objective of earning financial gains on thecommodity price, nor does it use instruments where there are not underlyingexposures. Gains and losses on futures contracts are deferred as a component ofAccumulated Other Comprehensive Loss ("AOCL") in the Company’s equitysection of the balance sheet and a corresponding amount is recorded in othercurrent assets or liabilities, as appropriate. The amounts deferred are subsequently recognized in cost of sales whenthe associated products are sold.  Thecost or benefit of contracts closed prior to the execution of the underlyingpurchase is deferred until the anticipated purchase occurs. As a result of thevolatility of the markets, deferred gains and losses in AOCL may fluctuateuntil the related contract is closed.

 

Initially, upon adoptionof the new derivative accounting standard, and prospectively as required by thestandard on the date new derivatives are entered into, the Company formallydocuments all relationships between hedging instruments and hedged items, aswell as the Company’s risk management objectives and strategy for undertakingthe hedge. This process includes specific identification of the hedginginstrument and the hedge transaction, the nature of the risk being hedged andhow the hedging instrument’s effectiveness will be assessed. Both at theinception of the hedge and on an ongoing basis, the Company assesses whetherthe derivatives that are used in hedging transactions are highly effective inoffsetting changes in cash flows of hedged items. If it is determined that aderivative ceases to be a highly effective hedge or the forecasted transactionbeing hedged will no longer occur, the Company will discontinue hedgeaccounting, and any gains or losses on the derivative instrument will berecognized in earnings during the period in which it no longer qualifies as ahedge. No such instances occurred in the years ended December 31, 2002 or 2001.

 

**Property, Plantand Equipment**

Depreciationis provided in amounts sufficient to relate the cost of depreciable assets tooperations over their estimated service lives, principally on the straight-linebasis. Estimated service lives range from 10-40 years for buildings andimprovements and 3-10 years for machinery and equipment. Accelerated andstraight-line methods are used for income tax purposes. The Company andPredecessor capitalized interest costs relating to the construction andinstallation of property, plant and equipment of $196,000 and $224,000 for thenine months ended December 31, 2001 and the year ended December 31, 2000,respectively. No interest was capitalized by the predecessor during the threemonths ended March 31, 2001 or by the Company for the year ended December31, 2002. 

 

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**Goodwill andIntangible Assets**

In June 2001, theFinancial Accounting Standards Board (“FASB”) issued Statement of Financial AccountingStandards (“SFAS”) No. 141, “Business Combinations,” and SAFS No. 142,“Goodwill and Other Intangible Assets.” SFAS 141 eliminates the pooling-of-interests method of accounting forbusiness combinations, requiring that all business combinations initiated afterJune 30, 2001 be accounted for using the purchase method.  SFAS 142 provides that goodwill is no longeramortized, but rather is reviewed for impairment at least annually and morefrequently in certain circumstances using a two-step process.

** **

In October 2001, the FASB issued SFAS No. 144, “Accounting for theImpairment of Disposal of Long-Lived Assets.” This statement addresses financial accounting and reporting for theimpairment of long-lived assets and for long-lived assets to be disposed of andsupercedes SFAS 121.  SFAS 144 does,however, retain the fundamental provisions of SFAS 121 for the recognition andmeasurement of the impairment of long-lived assets to be held and used and themeasurement of long-lived assets to be disposed of by sale.

 

As of January 1, 2002, we adopted SFAS 141, 142 and 144.  The effect of adopting SFAS 142 was toreduce amortization expense by approximately $8,824,000 for the year endedDecember 31, 2002.  As a result ofadopting these standards, our accounting policies for goodwill and intangibleassets changed effective January 1, 2002, as described below:

 

Goodwill and Intangible Assets with Indefinite Lives

We recognize the excess cost of an acquired entity over the net amountassigned to assets acquired, including intangible assets with indefinite lives,and liabilities assumed, as goodwill. Goodwill and intangible assets with indefinite lives will be tested forimpairment on an annual basis and between annual tests whenever there is animpairment indicated.  Impairment losseswill be recognized whenever the implied fair value is less than the carryingvalue of the related asset.  Prior toJanuary 1, 2002, goodwill and intangible assets with indefinite lives wereamortized over 40 years.  BeginningJanuary 1, 2002, goodwill and intangible assets with indefinite lives are nolonger amortized.

 

Other Intangibles

We recognize an acquired intangible asset apart from goodwill wheneverthe asset arises from contractual or other legal rights, or whenever it iscapable of being separated or divided from the acquired entity and sold,transferred, licensed, rented, or exchanged, either individually or incombination with a related contract, asset, or liability.  An intangible asset other than goodwill isamortized over its estimated useful life unless that life is determined to beindefinite.  Impairment losses arerecognized if the carrying amount of an intangible asset subject toamortization is not recoverable from expected future cash flows and itscarrying amount exceeds its fair value.

 

The adoption of SFAS 141 and 144 did not affect our financial positionor results of operations.  During thesecond quarter of 2002 pursuant to SFAS 142, we completed the transitionalimpairment test of goodwill with no impairment indicated at January 1,2002.  During the fourth quarter of2002, pursuant to SFAS 142, we completed the annual impairment test of goodwillwith no impairment indicated.

 

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The change in the carrying amount of goodwill for the year endedDecember 31, 2002 is as follows:

 
| Balance at  December 31, 2001                                                                     |   | $          | 341,021,000 |   |
|---------------------------------------------------------------------------------------------------|--------|------------|-------------|--------|
| Goodwill related  to the Inovatech acquisition (see Note B)                                       |   | 4,807,000  |        |
| Reduction  related to resolution of certain tax contingencies recorded at the date of  the Merger |   | (4,800,000 | )           |
| Balance at  December 31, 2002                                                                     |   | $          | 341,028,000 |   |

 

Each segment's share of this goodwill was as follows:

 
|                       |   | **2002**   |        | **2001**   |   |
|----------------------------|--------|------------|-------------|------------|--------|
| Egg Products               |   | $          | 254,189,000 |       | $      | 254,182,000 |   |
| Refrigerated  Distribution |   | 35,560,000 |        | 35,560,000 |   |
| Potato Products            |   | 49,516,000 |        | 49,516,000 |   |
| Dairy Products             |   | 1,763,000  |        | 1,763,000  |   |
|                            |        |            |             |            |        |  |  |

 

The following table presents a reconciliation of net earnings (loss),as reported in the financial statements, to those amounts adjusted for goodwilland intangible amortization determined in accordance with the provisions ofSFAS 142.

 
|                                  |   | **Year  ended  December 31,  2002** |       | **Nine  months ended  December 31,  2001** |   | **Three  months ended  March 31,  2001** |   |
|---------------------------------------|--------|------------------------------------------|------------|--------------------------------------------|--------|------------------------------------------|--------|
|                                  |   | **(Company)**                            |       | **(Predecessor)**                          |   |
| Reported net  earnings (loss)         |   | $                                        | 29,661,000 |                                       | $      | 9,815,000                                |   | $ | (5,653,000 | ) |
| Add back:  goodwill amortization |   | —                                   |       | 6,516,000                                  |   | 885,000                                  |   |
| Adjusted net  earnings (loss)         |   | $                                        | 29,661,000 |                                       | $      | 16,331,000                               |   | $ | (4,768,000 | ) |

 

The carrying amount for other indefinite-lived intangible assets(trademarks) as of December 31, 2002 and 2001 was $13,406,000.  The Predecessor had no indefinite-livedintangible assets.

 

Our acquired intangible assets that have been determined to have adefinite life and continue to be amortized as of December 31, 2002 are asfollows:

 
|                      |   | **Gross Carrying  Amount** |      | **Accumulated  Amortization** |   |
|---------------------------|--------|----------------------------|-----------|-------------------------------|--------|
| Licenses and  non-compete |   | $                          | 2,526,000 |                          | $      | (1,353,000 | ) |
|                           |        |                            |           |                               |        |  |  |

 

The aggregate amortization expense for the year ended December 31, 2002was approximately $716,000 and $637,000 for the nine months ended December 31,2001.  The Predecessor had amortizationexpense of approximately $500,000 during the three months ended March 31,2001.  The estimated amortizationexpense for the years ended December 31, 2003 through December 31, 2006 is asfollows:

 
| 2003 |   | $       | 715,000 |   |
|------|--------|---------|---------|--------|
| 2004 |   | 186,000 |    |
| 2005 |   | 186,000 |    |
| 2006 |   | 86,000  |    |

 

63

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**DeferredFinancing Costs**

Inconnection with the Merger financing, deferred financing costs of $21,035,000were capitalized.  These costsare included in other assets and are being amortized using the interest methodover the lives of the respective debt agreements.  Accumulated amortization was $6,473,000 and $2,359,000 atDecember 31, 2002 and 2001 respectively.

** **

**Foreign JointVentures and Currency Translation**

TheCompany has invested in foreign joint ventures in Europe and Canada related toits Egg Products Division. The European joint venture investment isaccounted for using the equity method of accounting. The financial statementsfor this entity are measured in their local currency and then translated intoU.S. dollars. The balance sheet accounts are translated using the currentexchange rate at the balance sheet date and the operating results aretranslated using the average rates prevailing throughout the reporting period.Accumulated translation gains or losses are recorded in AOCL and are includedas a component of comprehensive income (loss). The Company now owns 67% of the Canadian joint venture and therefore itsfinancial statements are included in the consolidated financial statements ofthe Company.  The financial statementsof the Canadian joint venture are translated using the same methodology as usedfor the European joint venture with the accumulated translation gains or lossesbeing recorded in AOCL and are included as a component of comprehensive income(loss).

 

**RevenueRecognition**

Sales are recognized when goods are shipped tocustomers and are recorded net of estimated customer programs and returns.

** **

**Stock-BasedCompensation**

ThePredecessor utilized the intrinsic value method of accounting for its stock-basedemployee compensation plans. Pro forma information related to the fair valuemethod of accounting is provided in Note I.  The Company does not have any stock-based compensation plans.

 

**RecentAccounting Pronouncements**

On January 1, 2002, we adopted Emerging Issues Task Force (EITF) IssueNo. 00-25, *VendorIncome Statement Characterization of Consideration to a Reseller on the VendorsProducts*, effective January 1, 2002.  The adoption of EITF Issue 00-25 did not have a material effecton our consolidated financial statements. In addition, we adopted EITF IssueNo. 01-09, *Accountingfor Consideration given by a Vendor to a Customer (including a Reseller of theVendor's Products),* effective January 1, 2002.  The adoption of EITF Issue No. 01-09 did nothave a material effect on our consolidated financial statements.

 

In July 2001, the Financial Accounting Standards Board (FASB) issuedStatement of Financial Accounting Standards (SFAS) No. 143, "Accountingfor Asset Retirement Obligations" which provides accounting requirementsfor retirement obligations associated with tangible long-lived assets. SFAS No.143 is effective for fiscal years beginning after June 15, 2002. We believe theadoption of SFAS No. 143 will not have a material impact on our financialposition or results of operations.

 

64

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In April 2002, the FASB issued SFAS No. 145, “Rescission of FASBStatement 4, 44, and 64, Amendment of FASB Statement No. 13, and TechnicalCorrections”.  SFAS No. 145 rescindsSFAS No. 4, “Reporting Gains and Losses from Extinguishment of Debt” Under SFASNo. 4, all gains and losses from extinguishment of debt were required to beaggregated and, if material, classified as an extraordinary item, net ofrelated income tax effect.  SFAS No. 145requires that gains and losses from extinguishment of debt be classified as anextraordinary item only if they are part of the entities recurring operationsand not unusual or infrequent.  Theeffect of adopting this standard on our financial statements was to reclassifyour extraordinary loss in the three-month period ended March 31, 2001 to otherexpense in the statement of operations.

 

In June 2002, the Financial Accounting Standards Board(FASB) issued Statement of Financial Accounting Standards (SFAS) No. 146,“Accounting for Costs Associated with Exit or Disposal Activities”.  SFASNo. 146 requires that a liability for a cost associated with an exit ordisposal activity be recognized and measured initially at fair value only whenthe liability is incurred.  Prior to the adoption of this Standard, aliability for an exit cost, as defined by Emerging Issues Task Force Issue No.94-3, “Liability Recognition for Certain Employee Termination Benefits andOther Costs to Exit an Activity (including Certain Costs Incurred in aRestructuring)”, was recognized at the date of an entity’s commitment to anexit plan. SFAS No. 146 was effective for the Company for exit plans or disposalactivities initiated after December 31, 2002.  Adoption is not expected tohave a material impact on our financial position or results of operations.

 

In November 2002, the FASB issued Interpretation No. 45, “ Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others”. This interpretation elaborates on thedisclosure requirements in the financial statements concerning obligationsunder certain guarantees. It also clarifies the requirements related to therecognition of liabilities by a guarantor at the inception of certainguarantees. The disclosure requirements of this interpretation were effectivefor us on December 31, 2002 but did not require any additional disclosure. Therecognition provisions of the interpretation are applicable only to guaranteesissued or modified after December 31, 2002. We do not expect adoption of theserecognition provisions to have a material impact on our financial position orresults of operations.

 

In January 2003, the FASB issued Interpretation No. 46, “Consolidationof Variable Interest Entities”. This interpretation addresses the requirementsfor business enterprises to consolidate related entities in which they are thedetermined to be the primary beneficiary as a result of their variable economicinterests. The interpretation is intended to provide guidance in judgingmultiple economic interests in an entity and in determining the primarybeneficiary. The interpretation outlines disclosure requirements for variableinterest entities in existence prior to January 31, 2003 and outlinesconsolidation requirements for variable interest entities created after January31, 2003. Adoption is not expected to have a material impact on ourconsolidated financial statements.

 

**Advertising**

Advertisingcosts are expensed as incurred. Advertising expense was $8,973,000 for the yearended December 31, 2002 and $3,779,000 during the nine months ended December31, 2001.  The Predecessor incurredadvertising expense of $3,011,000 during the three months ended March 31,2001 and $9,132,000 for the year ended December 31, 2000.

 

65

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** **

**NOTE D—LONG-TERMDEBT**

** **

Long-term debt consisted of thefollowing on December 31: 

 
|                       |   | **2002**    |        | **2001**    |   |
|----------------------------|--------|-------------|-------------|-------------|--------|
|                       |   |        |        |        |   |
| Revolving lines of credit  |   | $           | —      |        | $      | 5,000,000 |   |
| Senior notes payable       |   | 300,305,000 |        | 342,650,000 |   |
| Subordinated notes payable |   | 200,000,000 |        | 200,000,000 |   |
| Other                      |   | 11,084,000  |        | 5,444,000   |   |
|                       |   | 511,389,000 |        | 553,094,000 |   |
| Less current maturities    |   | 17,671,000  |        | 12,962,000  |   |
|                       |   | $           | 493,718,000 |        | $      | 540,132,000 |   |

 

Concurrent withthe Merger, the Company entered into a new senior credit agreement, whichconsists of a $100,000,000 revolving credit facility, a $100,000,000 seniorterm loan A, both of which are due April 2007, and a $270,000,000 seniorterm loan B due April 2008. The Company's senior credit facility bearsinterest at a floating base rate plus an applicable margin, as defined in theagreement (effective rate of 6.8% at December 31, 2002). In addition, theCompany also issued $200,000,000 of 11.75% senior subordinated notes dueApril 2011, which are subordinated to the senior credit agreement. 

 

The revolvingcredit and senior term loans are collateralized by substantially all of theassets of the Company. The revolving credit loan, the A and B term loans andsenior subordinated notes contain restrictive covenants, including restrictionson dividends and distributions to shareholders and unit holders, a minimumfixed charge coverage ratio, a maximum leverage ratio, and a minimum interestcoverage ratio, in addition to limitations on additional indebtedness andliens. Covenants related to operating performance are primarily based onearnings before income tax, interest expense and depreciation and amortizationexpense. In addition, the revolving credit, A and B term loans and seniorsubordinated note agreements also include guarantees by substantially all ofthe Company's domestic subsidiaries. The fair value of the Company's long-termdebt at December 31, 2002 approximated the carrying value. 

                

Aggregate maturities of the Company's long-term debt are as follows: 

 
| **Years Ending  December 31,** |   |        |        |
|--------------------------------|--------|-------------|-------------|
| 2003                           |   | $           | 17,671,000  |   |
| 2004                           |   | 14,699,000  |        |
| 2005                           |   | 18,401,000  |        |
| 2006                           |   | 23,356,000  |        |
| 2007                           |   | 175,193,000 |        |
| Thereafter                     |   | 262,069,000 |        |
|                           |   | $           | 511,389,000 |   |

 

66

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** **

**NOTE E—INCOMETAXES**

 

The Merger was accomplished through a cash-for-stocktransaction. As a result, the basis of the Company's assets and liabilities didnot change for income tax reporting purposes. Goodwill arising through the Merger is not deductible.  A portion of Predecessor goodwill, which wasdeductible for tax purposes prior to the Merger, will continue to bedeductible.

 

Thetaxable income or loss of the Dairy LLCs will be distributed primarily to theCompany until it has received payment for its preferred units and a 10%cumulative return on the preferred units, and all senior and subordinated debthas been retired. 

** **

Income tax expense (benefit) consists of the following: 

 
|      |   | **Company**                        |       | **Predecessor**                           |   |
|-----------|--------|------------------------------------|------------|-------------------------------------------|--------|
|      |   | **Year ended  December 31,  2002** |       | **Nine months ended  December 31,  2001** |   | **Three months  ended March 31,  2001** |   | **Year ended  December 31,  2000** |   |
| Current:  |   |                               |       |                                      |   |   |   |   |   |
| Federal   |   | $                                  | 17,579,000 |                                      | $      | 10,998,000 |   | $ | 3,100,000 |   | $ | 23,447,000 |   |
| Foreign   |   | 266,000                            |       | —                                    |   | — |   | — |   |
| State     |   | 2,304,000                          |       | 1,792,000                                 |   | 877,000 |   | 2,736,000 |   |
|      |   | 20,149,000                         |       | 12,790,000                                |   | 3,977,000 |   | 26,183,000 |   |
| Deferred: |   |                               |       |                                      |   |   |   |   |   |
| Federal   |   | (1,456,000                         | )          | (720,000                                  | )      | (1,406,000 | ) | 2,461,000 |   |
| State     |   | (150,000                           | )          | (70,000                                   | )      | (141,000 | ) | 246,000 |   |
|      |   | (1,606,000                         | )          | (790,000                                  | )      | (1,547,000 | ) | 2,707,000 |   |
|      |   | $                                  | 18,543,000 |                                      | $      | 12,000,000 |   | $ | 2,430,000 |   | $ | 28,890,000 |   |

 

Thenet deferred tax liability associated with the cumulative temporary differencesbetween the tax bases of assets and liabilities and their carrying amounts forfinancial reporting purposes are as follows: 

 
|                  |   | **December 31,** |       |
|-----------------------|--------|------------------|------------|
|                  |   | **2002**         |       | **2001** |   |
|                  |   |             |       |   |   |
| Depreciation          |   | $                | 41,301,000 |   | $ | 43,120,000 |   |
| Flock inventories     |   | 6,008,000        |       | 5,730,000 |   |
| Goodwill              |   | 3,830,000        |       | 3,150,000 |   |
| Trademarks            |   | 4,970,000        |       | 4,980,000 |   |
| Non-compete agreement |   | (3,404,000       | )          | (3,390,000 | ) |
| Other                 |   | (5,586,000       | )          | (4,865,000 | ) |
|                  |   | $                | 47,119,000 |   | $ | 48,725,000 |   |

 

67

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Thefollowing is a reconciliation of the federal statutory income tax rate to theconsolidated effective tax rate: 

 
|                   |   | **Company**                         |   | **Predecessor**                            |   |
|------------------------|--------|-------------------------------------|--------|--------------------------------------------|--------|
|                   |   | **Year  ended  December 31,  2002** |   | **Nine Months  ended  December 31,  2001** |   | **Three Months  ended  March 31,  2001** |   | **Year  ended  December 31,  2000** |   |
|                   |   |                                |   |                                       |   |   |   |   |   |
| Federal statutory rate |   | 35.0                                | %      | 35.0                                       | %      | 35.0 | % | 35.0 | % |
| State taxes            |   | 2.9                                 |   | 5.1                                        |   | 1.9 |   | 2.6 |   |
| Goodwill               |   | —                              |   | 10.2                                       |   | 3.4 |   | 1.2 |   |
| Other                  |   | 0.6                                 |   | 4.7                                        |   | (1.0 | ) | 0.5 |   |
|                   |   | 38.5                                | %      | 55.0                                       | %      | 39.3 | % | 39.3 | % |

** **

**NOTE F—EMPLOYEERETIREMENT PLAN**

** **

Full-timeemployees who meet certain service requirements are eligible to participate ina defined contribution retirement plan. The Company matches up to 4% of eachparticipant's eligible compensation. Company contributions for the year endedDecember 31, 2002 were $2,699,000 and for the nine months ended December 31,2001 were $1,964,000.  Predecessorcontributions totaled $1,194,000 for the three months ended March 31, 2001and $2,692,000 in the year ended December 31, 2000. 

 

TheCompany also contributes funds to two union retirement plans which totaled$139,000 for the year ended 2002 and $101,000 for the nine months endedDecember 31, 2001.  Predecessorcontributions to the two union plans totaled $34,000 for the three months endedMarch 31, 2001 and $163,000 for the year ended December 31, 2000.

 

**NOTE G—RELATEDPARTY TRANSACTIONS**

** **

Pursuantto management agreements with Vestar and Goldner Hawn Johnson and Morrison, theCompany pays them a combined annual fee of $1,000,000 or .75% of consolidatedearnings before interest, taxes, depreciation and amortization, whichever isgreater.  The management fee for theyear ended December 31, 2002 was $1,166,000 and for the nine month period endedDecember 31, 2001 was approximately $800,000.

 

InFebruary 1997, the Predecessor acquired Papetti's Hygrade EggProducts, Inc. and affiliated companies (collectively,"Papetti's"). In connection with this acquisition, the Predecessorentered into various operating leases with the previous owners of Papetti's forthe majority of Papetti's operating facilities. The future annual minimumrental commitments under these leases are approximately $2,100,000 throughFebruary 2007, with the exception of one lease that expires in February2017. In addition, the Company and Predecessor purchase eggs under an annual eggsupply agreement with a partnership in which various Papetti family members owna 50% interest. Annual purchases in 2001 from this partnership wereapproximately $10,000,000.  Followingthe Merger, the previous owners of Papetti's are no longer considered to berelated parties, as these individuals no longer own Company stock. The Companycontinues to be obligated under the operating lease obligations and egg supplycontracts described above. 

 

68

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**NOTE H—COMMITMENTSAND CONTINGENCIES**

 

**LeaseCommitments**

TheCompany’s corporate offices and several of its manufacturing facilities areleased under operating leases expiring at various times through February2017.  The leases provide that realestate taxes, insurance, and mainte­nance expenses are obligations of theCompany.  In addition, the Companyleases some of its transportation and manufacturing equipment under operatingleases.  

 

Rentexpense, including real estate taxes and main­tenance expenses, was approximately$11,258,000 for the year ended December 31, 2002 and $8,795,000 for the ninemonths ended December 31, 2001. Predecessor rent expense was $2,002,000 for the three months ended March31, 2001 and $8,639,000 for the year ended Decem­ber 31, 2000.  The following is a schedule of minimumrental commitments for base rent for the years ending December 31:

 

| 2003       |   | $          | 6,901,000 |   |
|------------|--------|------------|-----------|--------|
| 2004       |   | 7,006,000  |      |
| 2005       |   | 5,553,000  |      |
| 2006       |   | 5,014,000  |      |
| 2007       |   | 3,324,000  |      |
| Thereafter |   | 16,079,000 |      |

** **

**Debt Guarantees**

The Company has guaranteed the repayment of certain industrial revenuebonds used for the expansion of the wastewater treatment facilities of severalmunicipalities where the Company has manufacturing facilities.  The repayment of these bonds is fundedthrough the wastewater treatment charges paid by the Company.  However, should those charges not besufficient to pay the bond payments as they become due the Company has agreedto pay any shortfall.  The remainingprincipal balance of these bonds at December 31, 2002 was approximately$6,700,000.

** **

**PotatoProcurement Contract**

The Company has a contract to purchasepotatoes which expires in 2004 and which will supply approximately 45% and 40%of the Potato Products Division's raw material needs in 2003 and 2004,respectively.

** **

# ***Egg ProcurementContracts***

The Company maintains egg procurement contracts with numerouscooperatives and egg producers throughout the Midwestern and Eastern UnitedStates and Canada, which supply approximately 50% of the Company’s eggrequirements.  Most of these contractsvary in length from 18 to 72 months with prices primarily indexed to grain orUrner Barry market indices.  No singleegg supplier provides more than 10% of the Company’s egg requirements.  Based upon the best estimates available tous for grain and egg prices, we project our purchases from our top fivelong-term contracted egg suppliers will approximate $141 million in 2003, $138million in 2004, $82 million in 2005, and $16 million in 2007, and that the2003 amount will account for approximately 60% of our total egg purchases thisyear.

 

**Patent Litigation**

TheCompany has an exclusive license agreement for a patented process for theproduction and sale of extended shelf-life liquid egg products. Under thelicense agreement, the Company has the right to defend and prosecuteinfringement of the underlying patents. The Company may offset 50% of its costs of defending the patents againstroyalty payments due to the patent holders-North Carolina State University. 

 

TheU.S. Federal Court of Appeals has upheld the validity of the patents on twoseparate occasions.  InSeptember 2000, the U.S. Patent and Trademark Office allowed productclaims beyond the process claims previously allowed for the extended shelf-lifeegg product. These patents are scheduled to expire beginning in 2006. 

 

69

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In2000, the Predecessor settled litigation with one party related to theinfringement of these patents and issued a sub-license to the infringing partygranting them the right to manufacture and distribute extended shelf-lifeliquid whole egg product subject to a royalty payable to the Company and thepatent holder on all future product sold. In connection with this settlement,the patent holder received a lump sum payment for the past production and saleof the product and other matters related to the infringement. The Company iscontinuing to pursue litigation related to other parties who are infringing theproduct and process patents, including Sunny Fresh Foods, Inc., a subsidiary ofCargill, Inc.

 

**Other Litigation**

TheCompany is engaged in routine litigation incidental to its business. Managementbelieves the ultimate outcome of this litigation will not have a materialeffect on the Company's consolidated financial position, liquidity or resultsof operations. 

 

**NOTEI—SHAREHOLDER’S EQUITY**

** **

**Company -***Common Stock*

TheCompany has authorized, issued and outstanding common stock of 1,000 shareswith a $.01 par value. All common shares were issued to M-Foods Holdings, Inc.,a wholly owned subsidiary of M-Foods Investors, LLC, in connection with theMerger. 

                

**Predecessor -***Capital Stock*

ThePredecessor had authorized capital stock of 50,000,000 shares consisting of40,000,000 shares of $.01 par value common stock and 10,000,000 shares ofundesignated stock. The Board of Directors had the authority to determinevoting, conversion and other rights of the undesignated stock.

 

*Incentive Plan*

ThePredecessor had an incentive compensation plan for certain key employees. ThePredecessor utilized unissued common stock for a portion of the incentivecompensation in this plan. The Predecessor accrued for all incentivecompensation as earned. In connection with the Merger, this Plan was terminatedand all shares of common stock previously awarded under the plan were retiredthrough the Merger. 

 

*Stock OptionPlans*

ThePredecessor maintained non-qualified stock option plans.  The stock options granted under these plansgenerally had a ten year term, vested ratably over five years, and had anexercise price equal to the fair market value of the stock on the date ofgrant.  In connection with the Merger,all options for common stock previously awarded became fully vested inaccordance with the terms of the respective plans and the option holders,except for certain options held by senior members of management, were paid thedifference between the $30.10 per share consideration and the exercise price oftheir respective options (See Note A). 

 

70

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Optiontransactions under these plans for the year ended December 31, 2000 and thethree months ended March 31, 2001, are summarized as follows: 

 
|                             |   | **NUMBER  OF SHARES** |       | **WEIGHTED  AVERAGE  EXERCISE PRICE** |       |
|----------------------------------|--------|-----------------------|------------|---------------------------------------|------------|
|                             |   |                  | ** ** |                                  | ** ** |
| Outstanding at January 1, 2000   |   | 1,638,541             |       | 18.53                                 |       |
| Granted                          |   | 306,500               |       | 21.51                                 |       |
| Exercised                        |   | (65,070               | )          | 13.09                                 |       |
| Canceled                         |   | (60,056               | )          | 22.01                                 |       |
| Outstanding at December 31, 2000 |   | 1,819,915             |       | 19.11                                 |       |
| Exercised                        |   | (36,581               | )          | 14.94                                 |       |
| Canceled                         |   | (2,889                | )          | 23.69                                 |       |
| Outstanding at March 31, 2001    |   | 1,780,445             |       | 19.20                                 |       |

 

Thefollowing tables summarize information concerning outstanding and exercisablestock options at March 31, 2001: 

 

**OPTIONS OUTSTANDING**

 

| **EXERCISE PRICES**        |   |                  |   |                  |    |
|----------------------------|--------|-----------------------|--------|-----------------------|---------|
| **RANGE**                  |   | **WEIGHTED  AVERAGE** |   | **NUMBER OF  SHARES** |    | **WEIGHTED AVERAGE  REMAINING  CONTRACTUAL LIFE** |   |
|                       |   |                  |   |                  |    |   |   |
| $ 7.63 - $11.13            |   | $                     | 10.04  |                  | 368,800 |   | 3.9 years |   |
|  11.50 -   15.13 |   | 12.53                 |   | 233,019               |    | 3.8 years |   |
|  17.83 -   24.56 |   | 21.90                 |   | 605,526               |    | 7.9 years |   |
|  24.69 -   29.75 |   | 25.04                 |   | 573,100               |    | 7.2 years |   |
|                       |   |                  |   | 1,780,445             |    |   |   |
|                            |        |                       |        |                       |         |  |  |  |

 

**OPTIONSEXERCISABLE**

 

| **EXERCISE PRICES**        |   |                  |   |
|----------------------------|--------|-----------------------|--------|
| **RANGE**                  |   | **WEIGHTED  AVERAGE** |   | **NUMBER  OF SHARES** |   |
|                       |   |                  |   |   |   |
| $ 7.63 - $11.13            |   | $                     | 10.00  |   | 350,100 |   |
|  11.50 -   15.13 |   | 12.53                 |   | 229,019 |   |
|  17.83 -   24.56 |   | 21.86                 |   | 238,606 |   |
|  24.69 -   29.75 |   | 25.19                 |   | 310,000 |   |
|                       |   |                  |   | 1,127,725 |   |
|                            |        |                       |        |  |  |  |

 

71

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Proforma net earnings would have been $43,037,000 had the fair value method beenused for valuing options granted in the year ended 2000. 

 

Theweighted average fair value of options granted in the year ended 2000 were$9.49 per share, computed by applying the following weighted averageassumptions to the Black Scholes options pricing model: dividend yield of 1%;risk-free rate of return of 5.1%; volatility of 40%, and an average term of7 years. There were no options granted during the three months endedMarch 31, 2001. 

 

**NOTE J—BUSINESSSEGMENTS**

** **

TheCompany operates in four reportable segments: 

 

EggProducts processes and distributes numerous egg products and shell eggsprimarily through its facilities in the Midwest and Eastern United States andCanada. Sales of egg products are made through an internal sales force andindependent brokers to the foodservice, industrial and retail markets primarilythroughout North America. 

 

RefrigeratedDistribution distributes a wide range of refrigerated grocery products,including various cheese products packaged at its Wisconsin cheese packagingfacility. Sales of refrigerated grocery products are made through an internalsales force to retail and wholesale markets primarily throughout the centralUnited States. 

 

DairyProducts processes and distributes soft serve ice cream mix, frozen yogurt mix,milk and specialty dairy products, many of which are ultra-high temperaturepasteurized, from its facilities in Connecticut, Minnesota and Texas. Sales ofdairy products are made through an internal sales force to domestic quickservice restaurants, other foodservice outlets and independent retailersthroughout the United States. 

 

PotatoProducts processes and distributes refrigerated potato products from itsmanufacturing facilities in Minnesota and Nevada. Sales of potato products aremade through an internal sales force to foodservice and retail marketsthroughout the United States. 

 

TheCompany identifies its segments based on its organizational structure, which isprimarily by principal products. Operating profit represents earnings beforeinterest expense, interest income, income taxes, and allocations of corporatecosts to the respective divisions. Intersegment sales are made at marketprices. The Company's corporate office maintains a majority of the Company'scash under its cash management policy. 

 

Salesto two customers, primarily by the Egg Products segment, accounted forapproximately 17% and 15% of consolidated net sales for the year ended December31, 2002 and 18% and 15% of consolidated net sales for the nine months endedDecember 31, 2001.  Accounts receivablefor one customer was 14% of consolidated accounts receivable at December 31,2002.  The Predecessor had sales to onecustomer, which accounted for approximately 12% of consolidated net sales forthe three months ended March 31, 2001 and 15% of consolidated net salesfor the year ended December 31, 2000. 

 

72

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Certain financial information for the Company's operating segments is asfollows (in thousands): 

 
|                                      |   | **EGG  PRODUCTS** |       | **REFRIGERATED  DISTRIBUTION** |       | **DAIRY****PRODUCTS** |       | **POTATO  PRODUCTS** |       | **CORPORATE** |       | **TOTAL** |       |
|-------------------------------------------|--------|-------------------|------------|--------------------------------|------------|-----------------------|------------|----------------------|------------|---------------|------------|-----------|------------|
|                                      |   |              | ** ** |                           | ** ** |                  | ** ** |                 | ** ** |          | ** ** |      | ** ** |
| **Company**                               |   |              |       |                           |       |                  |       |                 |       |          |       |      |       |
| Year ended December 31, 2002:        |   |              |       |                           |       |                  |       |                 |       |          |       |      |       |
| External net sales                        |   | $                 | 657,824    |                           | $          | 247,588               |       | $                    | 190,578    |          | $          | 72,170    |       | $ | — |   | $ | 1,168,160 |   |
| Intersegment sales                        |   | 12,375            |       | —                         |       | 81                    |       | 3,376                |       | —        |       | 15,832    |       |
| Operating profit (loss)                   |   | 71,717            |       | 13,744                         |       | 9,918                 |       | 10,832               |       | (7,828        | )          | 98,383    |       |
| Total assets                              |   | 644,395           |       | 83,224                         |       | 52,248                |       | 78,526               |       | 34,629        |       | 893,022   |       |
| Depreciation and amortization             |   | 42,833            |       | 2,108                          |       | 4,626                 |       | 4,658                |       | 34            |       | 54,259    |       |
| Capital expenditures                      |   | 18,198            |       | 1,167                          |       | 6,399                 |       | 1,630                |       | —        |       | 27,394    |       |
|                                      |   |              |       |                           |       |                  |       |                 |       |          |       |      |       |
| Nine months ended December 31, 2001: |   |              |       |                           |       |                  |       |                 |       |          |       |      |       |
| External net sales                        |   | $                 | 482,324    |                           | $          | 201,496               |       | $                    | 150,554    |          | $          | 51,268    |       | $ | — |   | $ | 885,642 |   |
| Intersegment sales                        |   | 9,137             |       | —                         |       | —                |       | 2,552                |       | —        |       | 11,689    |       |
| Operating profit (loss)                   |   | 48,648            |       | 4,947                          |       | 7,885                 |       | 6,639                |       | (3,969        | )          | 64,150    |       |
| Total assets                              |   | 623,502           |       | 90,844                         |       | 49,691                |       | 80,303               |       | 52,793        |       | 897,133   |       |
| Depreciation and amortization             |   | 37,020            |       | 1,990                          |       | 3,120                 |       | 4,787                |       | 28            |       | 46,945    |       |
| Capital expenditures                      |   | 13,604            |       | 2,327                          |       | 5,810                 |       | 1,549                |       | 9             |       | 23,299    |       |
|                                      |   |              |       |                           |       |                  |       |                 |       |          |       |      |       |
| **Predecessor**                           |   |              |       |                           |       |                  |       |                 |       |          |       |      |       |
| Three months ended March 31, 2001:   |   |              |       |                           |       |                  |       |                 |       |          |       |      |       |
| External net sales                        |   | $                 | 163,529    |                           | $          | 61,185                |       | $                    | 35,328     |          | $          | 15,585    |       | $ | — |   | $ | 275,627 |   |
| Intersegment sales                        |   | 4,246             |       | —                         |       | —                |       | 1,003                |       | —        |       | 5,249     |       |
| Operating profit (loss)                   |   | 12,915            |       | 3,639                          |       | 3,958                 |       | 1,688                |       | (12,706       | )          | 9,494     |       |
| Depreciation and amortization             |   | 9,611             |       | 339                            |       | 1,274                 |       | 1,278                |       | 33            |       | 12,535    |       |
| Capital expenditures                      |   | 3,990             |       | 248                            |       | 5,916                 |       | 683                  |       | —        |       | 10,837    |       |
|                                      |   |              |       |                           |       |                  |       |                 |       |          |       |      |       |
| Year ended December 31, 2000:        |   |              |       |                           |       |                  |       |                 |       |          |       |      |       |
| External net sales                        |   | $                 | 637,355    |                           | $          | 241,114               |       | $                    | 141,401    |          | $          | 60,731    |       | $ | — |   | $ | 1,080,601 |   |
| Intersegment sales                        |   | 13,357            |       | 80                             |       | 516                   |       | 2,477                |       | —        |       | 16,430    |       |
| Operating profit (loss)                   |   | 67,658            |       | 16,001                         |       | 1,322                 |       | 7,650                |       | (5,825        | )          | 86,806    |       |
| Total assets                              |   | 461,298           |       | 45,716                         |       | 53,505                |       | 44,122               |       | 8,263         |       | 612,904   |       |
| Depreciation and amortization             |   | 36,435            |       | 1,316                          |       | 4,724                 |       | 5,372                |       | 136           |       | 47,983    |       |
| Capital expenditures                      |   | 25,376            |       | 1,042                          |       | 9,565                 |       | 1,390                |       | —        |       | 37,373    |       |

 

73

----

 

**NOTEK—SUPPLEMENTAL GUARANTOR FINANCIAL INFORMATION**

** **

The Company's revolving credit facility, A and B term loans and seniorsubordinated notes have been guaranteed, on a joint and several basis, by theCompany and its domestic subsidiaries. The revolving credit facility and A andB term loans are also guaranteed by the Company's parent, M-FoodsHoldings, Inc. 

 

The following condensed consolidating financial information presents theconsolidated balance sheet and statements of earnings and cash flows of theCompany as of December 31, 2002 and the nine months December 31, 2001, and thePredecessor's consolidated balance sheet as of December 31, 2000 and theconsolidated statements of earnings and cash flows for the three months endedMarch 31, 2001 and for the year ended December 31, 2000. Thesefinancial statements reflect Michael Foods, Inc. (the parent), the whollyowned guarantor subsidiaries (on a combined basis), the non-wholly ownedguarantor subsidiaries, and elimination entries necessary to combine suchentities on a consolidated basis. Included elsewhere in this annual report onForm 10-K is the audited financial statements of the non-wholly ownedguarantor subsidiaries. 

** **

**Condensed Consolidating Balance Sheets**

**December 31, 2002**

**(in thousands)**

** **
|                                             |   | **Parent**                    |    | **Wholly  owned  Guarantor  Subsidiaries** |   | **Non-wholly  owned  Guarantor Subsidiaries** |   | **Eliminations** |   | **Consolidated** |   |
|--------------------------------------------------|--------|-------------------------------|---------|--------------------------------------------|--------|-----------------------------------------------|--------|------------------|--------|------------------|--------|
| **M-Foods  Dairy,  LLC**                         |   | **M-Foods  Dairy  TXCT, LLC** |
| Assets                                           |   |                          |    |                                       |   |                                          |   |             |   |             |   |   |   |
| Current Assets                                   |   |                          |    |                                       |   |                                          |   |             |   |             |   |   |   |
| Cash and  equivalents                            |   | $                             | 19,665  |                                       | $      | 907                                           |   | $                | — |             | $      | — |   | $ | — |   | $ | 20,572 |   |
| Accounts  receivable, less allowances            |   | 314                           |    | 90,108                                     |   | 7,836                                         |   | 4,399            |   | (1,078           | )      | 101,579 |   |
| Inventories                                      |   | —                        |    | 88,376                                     |   | 3,412                                         |   | 4,019            |   | —           |   | 95,807 |   |
| Prepaid expenses  and other                      |   | 202                           |    | 12,704                                     |   | 600                                           |   | 65               |   | —           |   | 13,571 |   |
| Total current  assets                            |   | 20,181                        |    | 192,095                                    |   | 11,848                                        |   | 8,483            |   | (1,078           | )      | 231,529 |   |
| Property, Plant  and Equipment – net        |   | 44                            |    | 252,825                                    |   | 18,104                                        |   | 11,380           |   | —           |   | 282,353 |   |
| Other assets:                                    |   |                          |    |                                       |   |                                          |   |             |   |             |   |   |   |
| Goodwill                                         |   | —                        |    | 339,265                                    |   | 1,763                                         |   | —           |   | —           |   | 341,028 |   |
| Joint ventures  and other assets                 |   | 15,362                        |    | 22,082                                     |   | 139                                           |   | 529              |   | —           |   | 38,112 |   |
| Preferred return  receivable for subs            |   | —                        |    | 17,170                                     |   | —                                        |   | —           |   | (17,170          | )      | — |   |
| Investment in  subsidiaries                      |   | 639,819                       |    | —                                     |   | —                                        |   | —           |   | (639,819         | )      | — |   |
|                                             |   | 655,181                       |    | 8,517                                      |   | 1,902                                         |   | 529              |   | (6,989           | )      | 379,140 |   |
| Total assets                                     |   | $                             | 675,406 |                                       | $      | 3,437                                         |   | $                | 31,854 |             | $      | 20,392 |   | $ | (8,067 | ) | $ | 893,022 |   |
|                                             |   |                          |    |                                       |   |                                          |   |             |   |             |   |   |   |
| Liabilities and Shareholder’s Equity        |   |                          |    |                                       |   |                                          |   |             |   |             |   |   |   |
| Current  Liabilities                             |   |                          |    |                                       |   |                                          |   |             |   |             |   |   |   |
| Current  maturities of long-term debt            |   | $                             | 14,714  |                                       | $      | 557                                           |   | $                | — |             | $      | 2,400 |   | $ | — |   | $ | 17,671 |   |
| Accounts payable                                 |   | 426                           |    | 60,933                                     |   | 2,836                                         |   | 2,873            |   | (1,078           | )      | 65,990 |   |
| Accrued  liabilities                             |   | 35,372                        |    | 49,953                                     |   | 2,352                                         |   | 1,046            |   | —           |   | 88,723 |   |
| Total current  liabilities                       |   | 50,512                        |    | 111,443                                    |   | 5,188                                         |   | 6,319            |   | (1,078           | )      | 172,384 |   |
| Long-term debt,  less current maturities         |   | 448,734                       |    | 44,984                                     |   | —                                        |   | —           |   | —           |   | 493,718 |   |
| Deferred income  taxes                           |   | (3,641                        | )       | 50,760                                     |   | —                                        |   | —           |   | —           |   | 47,119 |   |
| Total  liabilities                               |   | 495,605                       |    | 207,187                                    |   | 5,188                                         |   | 6,319            |   | (1,078           | )      | 713,221 |   |
| Non-controlling  interest                        |   | 475                           |    | —                                     |   | —                                        |   | —           |   | —           |   | 475 |   |
| Preferred unit  holder return payable            |   | —                        |    | —                                     |   | 12,442                                        |   | 4,728            |   | (17,170          | )      | — |   |
| Shareholder’s  equity                       |   | 179,326                       |    | 6,250                                      |   | 14,224                                        |   | 9,345            |   | (639,819         | )      | 179,326 |   |
| Total  liabilities and shareholder’s equity |   | $                             | 675,406 |                                       | $      | 3,437                                         |   | $                | 31,854 |             | $      | 20,392 |   | $ | (8,067 | ) | $ | 893,022 |   |

 

74

----

 

MICHAEL FOODS, INC.

(A wholly owned subsidiary of M-Foods Holdings, Inc.)

 

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS

 

**Company**

**Condensed Consolidating Balance Sheets**

**December 31, 2001**

**(in thousands)**

** **
|                                             |   | **Parent**                    |    | **Wholly  owned  Guarantor  Subsidiaries** |   | **Non-wholly  owned  Guarantor Subsidiaries** |   | **Eliminations** |   | **Consolidated** |   |
|--------------------------------------------------|--------|-------------------------------|---------|--------------------------------------------|--------|-----------------------------------------------|--------|------------------|--------|------------------|--------|
| **M-Foods  Dairy,  LLC**                         |   | **M-Foods  Dairy  TXCT, LLC** |
| Assets                                           |   |                          |    |                                       |   |                                          |   |             |   |             |   |   |   |
| Current Assets                                   |   |                          |    |                                       |   |                                          |   |             |   |             |   |   |   |
| Cash and  equivalents                            |   | $                             | 33,947  |                                       | $      | (6,287                                        | )      | $                | — |             | $      | — |   | $ | — |   | $ | 27,660 |   |
| Accounts  receivable, less allowances            |   | 223                           |    | 91,744                                     |   | 6,535                                         |   | 5,765            |   | (1,950           | )      | 102,317 |   |
| Inventories                                      |   | —                        |    | 72,034                                     |   | 3,592                                         |   | 3,315            |   | —           |   | 78,941 |   |
| Prepaid expenses  and other                      |   | 972                           |    | 9,850                                      |   | 496                                           |   | 52               |   | —           |   | 11,370 |   |
| Total current  assets                            |   | 35,142                        |    | 167,341                                    |   | 10,623                                        |   | 9,132            |   | (1,950           | )      | 220,288 |   |
| Property, Plant  and Equipment – net        |   | 78                            |    | 263,893                                    |   | 15,657                                        |   | 11,526           |   | —           |   | 291,154 |   |
| Other assets:                                    |   |                          |    |                                       |   |                                          |   |             |   |             |   |   |   |
| Goodwill, net                                    |   | —                        |    | 339,258                                    |   | 1,763                                         |   | —           |   | —           |   | 341,021 |   |
| Joint ventures  and other assets                 |   | 19,521                        |    | 24,091                                     |   | —                                        |   | 1,058            |   | —           |   | 44,670 |   |
| Preferred return  receivable for subs            |   | —                        |    | 8,188                                      |   | —                                        |   | —           |   | (8,188           | )      | — |   |
| Investment in  subsidiaries                      |   | 675,556                       |    | —                                     |   | —                                        |   | —           |   | (675,556         | )      | — |   |
|                                             |   | 695,077                       |    | 371,537                                    |   | 1,763                                         |   | 1,058            |   | (683,744         | )      | 385,691 |   |
| Total assets                                     |   | $                             | 730,297 |                                       | $      | 802,771                                       |   | $                | 28,043 |             | $      | 21,716 |   | $ | (685,694 | ) | $ | 897,133 |   |
| Liabilities and  Shareholder’s Equity       |   |                          |    |                                       |   |                                          |   |             |   |             |   |   |   |
|                                             |   |                          |    |                                       |   |                                          |   |             |   |             |   |   |   |
| Current  Liabilities                             |   |                          |    |                                       |   |                                          |   |             |   |             |   |   |   |
| Current  maturities of long-term debt            |   | $                             | 10,255  |                                       | $      | 307                                           |   | $                | — |             | $      | 2,400 |   | $ | — |   | $ | 12,962 |   |
| Accounts payable                                 |   | 265                           |    | 60,223                                     |   | 2,612                                         |   | 3,342            |   | (1,950           | )      | 64,492 |   |
| Accrued  liabilities                             |   | 30,210                        |    | 44,020                                     |   | 2,151                                         |   | 976              |   | —           |   | 77,357 |   |
| Total current  liabilities                       |   | 40,730                        |    | 104,550                                    |   | 4,763                                         |   | 6,718            |   | (1,950           | )      | 154,811 |   |
| Long-term debt,  less current maturities         |   | 537,395                       |    | 337                                        |   | —                                        |   | 2,400            |   | —           |   | 540,132 |   |
| Deferred income  taxes                           |   | (1,293                        | )       | 50,018                                     |   | —                                        |   | —           |   | —           |   | 48,725 |   |
| Total  liabilities                               |   | 576,832                       |    | 154,905                                    |   | 4,763                                         |   | 9,118            |   | (1,950           | )      | 743,668 |   |
| Non-controlling  interest                        |   | 475                           |    | —                                     |   | —                                        |   | —           |   | —           |   | 475 |   |
| Preferred unit  holder return payable            |   | —                        |    | —                                     |   | 7,500                                         |   | 688              |   | (8,188           | )      | — |   |
| Shareholder’s  equity                       |   | 152,990                       |    | 647,866                                    |   | 15,780                                        |   | 11,910           |   | (675,556         | )      | 152,990 |   |
| Total  liabilities and shareholder’s equity |   | $                             | 730,297 |                                       | $      | 802,771                                       |   | $                | 28,043 |             | $      | 21,716 |   | $ | (685,694 | ) | $ | 897,133 |   |

 

75

----

 

MICHAEL FOODS, INC.

(A wholly owned subsidiary of M-Foods Holdings, Inc.)

 

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS

 

**Company**

**Condensed Consolidating Earnings Statements**

**Year ended December 31, 2002**

**(in thousands)**

 
|                                                                                                           |   | **Parent**                    |   | **Wholly  owned  Guarantor  Subsidiaries** |   | **Non-wholly  owned  Guarantor Subsidiaries** |   | **Eliminations** |    | **Consolidated** |   |
|----------------------------------------------------------------------------------------------------------------|--------|-------------------------------|--------|--------------------------------------------|--------|-----------------------------------------------|--------|------------------|---------|------------------|--------|
| **M-Foods  Dairy,  LLC**                                                                                       |   | **M-Foods  Dairy  TXCT, LLC** |
|                                                                                                           |   |                          |   |                                       |   |                                          |   |             |    |             |   |   |   |
| Net sales                                                                                                      |   | $                             | — |                                       | $      | 993,333                                       |   | $                | 105,299 |             | $      | 85,360 |   | $ | (15,832 | ) | $ | 1,168,160 |   |
| Cost of sales                                                                                                  |   | —                        |   | 796,995                                    |   | 94,693                                        |   | 77,477           |    | (15,832          | )      | 953,333 |   |
| Gross profit                                                                                                   |   | —                        |   | 196,338                                    |   | 10,606                                        |   | 7,883            |    | —           |   | 214,827 |   |
| Selling, general  and administrative expenses                                                                  |   | 7,828                         |   | 104,019                                    |   | 5,563                                         |   | 3,830            |    | (4,796           | )      | 116,444 |   |
| Operating profit  (loss)                                                                                       |   | (7,828                        | )      | 92,319                                     |   | 5,043                                         |   | 4,053            |    | 4,796            |   | 98,383 |   |
|                                                                                                           |   |                          |   |                                       |   |                                          |   |             |    |             |   |   |   |
| Interest  expense, net                                                                                         |   | (46,800                       | )      | (3,264                                     | )      | (102                                          | )      | (13              | )       | —           |   | (50,179 | ) |
| Other income  (expense)                                                                                        |   | 4,796                         |   | —                                     |   | —                                        |   | —           |    | (4,796           | )      | — |   |
|                                                                                                           |   |                          |   |                                       |   |                                          |   |             |    |             |   |   |   |
| Earnings (loss)  before preferred stock dividends, equity in earnings (loss) of subsidiaries  and income taxes |   | (49,832                       | )      | 89,055                                     |   | 4,941                                         |   | 4,040            |    | —           |   | 48,204 |   |
| Preferred stock  dividends                                                                                     |   | —                        |   | 8,981                                      |   | (4,941                                        | )      | (4,040           | )       | —           |   | — |   |
| Equity in  earnings (loss) of subsidiaries                                                                     |   | 59,556                        |   | —                                     |   | —                                        |   | —           |    | (59,556          | )      | — |   |
|                                                                                                           |   |                          |   |                                       |   |                                          |   |             |    |             |   |   |   |
| Earnings (loss)  before income taxes                                                                           |   | 9,724                         |   | 98,036                                     |   | —                                        |   | —           |    | (59,556          | )      | 48,204 |   |
|                                                                                                           |   |                          |   |                                       |   |                                          |   |             |    |             |   |   |   |
| Income tax  expense (benefit)                                                                                  |   | (19,937                       | )      | 38,480                                     |   | —                                        |   | —           |    | —           |   | 18,543 |   |
|                                                                                                           |   |                          |   |                                       |   |                                          |   |             |    |             |   |   |   |
| NET EARNINGS  (LOSS)                                                                                           |   | $                             | 29,661 |                                       | $      | 59,556                                        |   | $                | —  |             | $      | — |   | $ | (59,556 | ) | $ | 29,661 |   |

 

76

----

 

MICHAEL FOODS, INC.

(A wholly owned subsidiary of M-Foods Holdings, Inc.)

 

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS

 

**Company**

**Condensed Consolidating Earnings Statements**

**Nine months ended December 31, 2001**

**(in thousands)**

 
|                                                                                                           |   | **Parent**                    |   | **Wholly  owned  Guarantor  Subsidiaries** |   | **Non-wholly  owned  Guarantor Subsidiaries** |   | **Eliminations** |   | **Consolidated** |   |
|----------------------------------------------------------------------------------------------------------------|--------|-------------------------------|--------|--------------------------------------------|--------|-----------------------------------------------|--------|------------------|--------|------------------|--------|
| **M-Foods  Dairy,  LLC**                                                                                       |   | **M-Foods  Dairy  TXCT, LLC** |
|                                                                                                           |   |                          |   |                                       |   |                                          |   |             |   |             |   |   |   |
| Net sales                                                                                                      |   | $                             | — |                                       | $      | 746,777                                       |   | $                | 69,911 |             | $      | 80,643 |   | $ | (11,689 | ) | $ | 885,642 |   |
| Cost of sales                                                                                                  |   | —                        |   | 608,961                                    |   | 59,626                                        |   | 77,110           |   | (11,689          | )      | 734,008 |   |
| Gross profit                                                                                                   |   | —                        |   | 137,816                                    |   | 10,285                                        |   | 3,533            |   | —           |   | 151,634 |   |
| Selling, general  and administrative expenses                                                                  |   | 3,969                         |   | 80,043                                     |   | 3,194                                         |   | 3,367            |   | (3,089           | )      | 87,484 |   |
| Operating profit  (loss)                                                                                       |   | (3,969                        | )      | 57,773                                     |   | 7,091                                         |   | 166              |   | 3,089            |   | 64,150 |   |
|                                                                                                           |   |                          |   |                                       |   |                                          |   |             |   |             |   |   |   |
| Interest income  (expense), net                                                                                |   | (42,361                       | )      | (436                                       | )      | 409                                           |   | 53               |   | —           |   | (42,335 | ) |
| Other income                                                                                                   |   | 3,089                         |   | —                                     |   | —                                        |   | —           |   | (3,089           | )      | — |   |
|                                                                                                           |   |                          |   |                                       |   |                                          |   |             |   |             |   |   |   |
| Earnings (loss)  before preferred stock dividends, equity in earnings (loss) of subsidiaries  and income taxes |   | (43,241                       | )      | 57,337                                     |   | 7,500                                         |   | 219              |   | —           |   | 21,815 |   |
| Preferred stock  dividends                                                                                     |   | —                        |   | 8,188                                      |   | (7,500                                        | )      | (688             | )      | —           |   | — |   |
| Equity in  earnings (loss) of subsidiaries                                                                     |   | 29,269                        |   | (469                                       | )      | —                                        |   | 469              |   | (29,269          | )      | — |   |
|                                                                                                           |   |                          |   |                                       |   |                                          |   |             |   |             |   |   |   |
| Earnings (loss)  before income taxes                                                                           |   | (13,972                       | )      | 65,056                                     |   | —                                        |   | —           |   | (29,269          | )      | 21,815 |   |
|                                                                                                           |   |                          |   |                                       |   |                                          |   |             |   |             |   |   |   |
| Income tax  expense (benefit)                                                                                  |   | (23,787                       | )      | 35,787                                     |   | —                                        |   | —           |   | —           |   | 12,000 |   |
|                                                                                                           |   |                          |   |                                       |   |                                          |   |             |   |             |   |   |   |
| NET EARNINGS  (LOSS)                                                                                           |   | $                             | 9,815  |                                       | $      | 29,269                                        |   | $                | — |             | $      | — |   | $ | (29,269 | ) | $ | 9,815 |   |

 

77

----

 

MICHAEL FOODS, INC.

(A wholly owned subsidiary of M-Foods Holdings, Inc.)

 

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS

 

**Predecessor**

**Condensed Consolidating Earnings Statements**

**Three months ended March 31, 2001**

**(in thousands)**

 
|                                                                        |   | **Parent**                    |   | **Wholly  owned  Guarantor  Subsidiaries** |   | **Non-wholly  owned  Guarantor Subsidiaries** |   | **Eliminations** |   | **Consolidated** |   |
|-----------------------------------------------------------------------------|--------|-------------------------------|--------|--------------------------------------------|--------|-----------------------------------------------|--------|------------------|--------|------------------|--------|
| **M-Foods  Dairy,  LLC**                                                    |   | **M-Foods  Dairy  TXCT, LLC** |
|                                                                        |   |                          |   |                                       |   |                                          |   |             |   |             |   |   |   |
| Net sales                                                                   |   | $                             | — |                                       | $      | 245,548                                       |   | $                | 17,684 |             | $      | 17,644 |   | $ | (5,249 | ) | $ | 275,627 |   |
| Cost of sales                                                               |   | —                        |   | 200,854                                    |   | 14,994                                        |   | 17,108           |   | (5,249           | )      | 227,707 |   |
| Gross profit                                                                |   | —                        |   | 44,694                                     |   | 2,690                                         |   | 536              |   | —           |   | 47,920 |   |
| Selling, general  and administrative expenses                               |   | 1,656                         |   | 27,720                                     |   | 1,027                                         |   | 1,712            |   | (1,522           | )      | 30,593 |   |
| Recall insurance  settlement                                                |   | —                        |   | —                                     |   | (3,217                                        | )      | —           |   | —           |   | (3,217 | ) |
| Transaction  costs                                                          |   | 11,050                        |   | —                                     |   | —                                        |   | —           |   | —           |   | 11,050 |   |
| Operating profit  (loss)                                                    |   | (12,706                       | )      | 16,974                                     |   | 4,880                                         |   | (1,176           | )      | 1,522            |   | 9,494 |   |
|                                                                        |   |                          |   |                                       |   |                                          |   |             |   |             |   |   |   |
| Interest income  (expense), net                                             |   | (3,308                        | )      | 14                                         |   | 1                                             |   | —           |   | —           |   | (3,293 | ) |
| Other income  (expense)                                                     |   | (13,991                       | )      | —                                     |   | —                                        |   | —           |   | (1,522           | )      | (15,513 | ) |
|                                                                        |   |                          |   |                                       |   |                                          |   |             |   |             |   |   |   |
| Earnings (loss)  before equity in earnings of subsidiaries and income taxes |   | (30,005                       | )      | 16,988                                     |   | 4,881                                         |   | (1,176           | )      | —           |   | (9,312 | ) |
|                                                                        |   |                          |   |                                       |   |                                          |   |             |   |             |   |   |   |
| Equity in  earnings (loss) of subsidiaries                                  |   | 12,573                        |   | —                                     |   | —                                        |   | —           |   | (12,573          | )      | — |   |
|                                                                        |   |                          |   |                                       |   |                                          |   |             |   |             |   |   |   |
| Earnings (loss)  before income taxes                                        |   | (17,432                       | )      | 16,988                                     |   | 4,881                                         |   | (1,176           | )      | (12,573          | )      | (9,312 | ) |
|                                                                        |   |                          |   |                                       |   |                                          |   |             |   |             |   |   |   |
| Income tax  expense (benefit)                                               |   | (11,779                       | )      | 6,649                                      |   | 1,918                                         |   | (447             | )      | —           |   | (3,659 | ) |
|                                                                        |   |                          |   |                                       |   |                                          |   |             |   |             |   |   |   |
| NET EARNINGS  (LOSS)                                                        |   | $                             | (5,653 | )                                          | $      | 10,339                                        |   | $                | 2,963  |             | $      | (729 | ) | $ | (12,573 | ) | $ | (5,653 | ) |

 

78

----

 

MICHAEL FOODS, INC.

(A wholly owned subsidiary of M-Foods Holdings, Inc.)

 

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS

 

**Predecessor**

**Condensed Consolidating Earnings Statements**

**Year ended December 31, 2000**

**(in thousands)**

 
|                                                                        |   | **Parent**                    |   | **Wholly  owned  Guarantor  Subsidiaries** |   | **Non-wholly  owned  Guarantor Subsidiaries** |   | **Eliminations** |   | **Consolidated** |   |
|-----------------------------------------------------------------------------|--------|-------------------------------|--------|--------------------------------------------|--------|-----------------------------------------------|--------|------------------|--------|------------------|--------|
| **M-Foods  Dairy,  LLC**                                                    |   | **M-Foods  Dairy  TXCT, LLC** |
|                                                                        |   |                          |   |                                       |   |                                          |   |             |   |             |   |   |   |
| Net sales                                                                   |   | $                             | — |                                       | $      | 955,115                                       |   | $                | 68,102 |             | $      | 73,814 |   | $ | (16,430 | ) | $ | 1,080,601 |   |
| Cost of sales                                                               |   | —                        |   | 775,173                                    |   | 59,948                                        |   | 70,447           |   | (16,430          | )      | 889,138 |   |
| Gross profit                                                                |   | —                        |   | 179,942                                    |   | 8,154                                         |   | 3,367            |   | —           |   | 191,463 |   |
| Selling, general  and administrative expenses                               |   | 5,825                         |   | 93,294                                     |   | 3,668                                         |   | 7,412            |   | (5,542           | )      | 104,657 |   |
|                                                                        |   |                          |   |                                       |   |                                          |   |             |   |             |   |   |   |
| Operating profit  (loss)                                                    |   | (5,825                        | )      | 86,648                                     |   | 4,486                                         |   | (4,045           | )      | 5,542            |   | 86,806 |   |
|                                                                        |   |                          |   |                                       |   |                                          |   |             |   |             |   |   |   |
| Interest income  (expense), net                                             |   | (13,276                       | )      | 64                                         |   | 6                                             |   | —           |   | —           |   | (13,206 | ) |
| Other income                                                                |   | 5,542                         |   | —                                     |   | —                                        |   | —           |   | (5,542           | )      | — |   |
|                                                                        |   |                          |   |                                       |   |                                          |   |             |   |             |   |   |   |
| Earnings (loss)  before equity in earnings of subsidiaries and income taxes |   | (13,559                       | )      | 86,712                                     |   | 4,492                                         |   | (4,045           | )      | —           |   | 73,600 |   |
| Equity in  earnings (loss) of subsidiaries                                  |   | 53,279                        |   | —                                     |   | —                                        |   | —           |   | (53,279          | )      | — |   |
|                                                                        |   |                          |   |                                       |   |                                          |   |             |   |             |   |   |   |
| Earnings (loss)  before income taxes                                        |   | 39,720                        |   | 86,712                                     |   | 4,492                                         |   | (4,045           | )      | (53,279          | )      | 73,600 |   |
|                                                                        |   |                          |   |                                       |   |                                          |   |             |   |             |   |   |   |
| Income tax  expense (benefit)                                               |   | (4,990                        | )      | 33,651                                     |   | 1,766                                         |   | (1,537           | )      | —           |   | 28,890 |   |
|                                                                        |   |                          |   |                                       |   |                                          |   |             |   |             |   |   |   |
| NET EARNINGS (LOSS)                                                         |   | $                             | 44,710 |                                       | $      | 53,061                                        |   | $                | 2,726  |             | $      | (2,508 | ) | $ | (53,279 | ) | $ | 44,710 |   |

 

79

----

 

MICHAEL FOODS, INC.

(A wholly owned subsidiary of M-Foods Holdings, Inc.)

 

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS

 

**Predecessor**

**Condensed Consolidating Statements of Cash Flows**

**Year ended December 31, 2002**

**(in thousands)**

** **
|                                                      |   | **Parent**                    |   | **Wholly  Owned  Guarantor  Subsidiaries** |   | **Non-wholly  owned  Guarantor Subsidiaries** |   | **Consolidated** |   |
|-----------------------------------------------------------|--------|-------------------------------|--------|--------------------------------------------|--------|-----------------------------------------------|--------|------------------|--------|
| **M-Foods  Dairy,  LLC**                                  |   | **M-Foods  Dairy  TXCT, LLC** |
|                                                      |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Net cash  provided by operating activities                |   | $                             | 32,175 |                                       | $      | 37,773                                        |   | $                | 6,144  |   | $ | 6,913 |   | $ | 83,005 |   |
|                                                      |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Cash flows from  investing activities:                    |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Capital  expenditures                                     |   | —                        |   | (20,997                                    | )      | (4,449                                        | )      | (1,948           | )      | (27,394 | ) |
| Business acquisitions                                     |   | —                        |   | (17,883                                    | )      | —                                        |   | —           |   | (17,883 | ) |
| Investments in  joint ventures and other assets           |   | (133                          | )      | 5,024                                      |   | (139                                          | )      | —           |   | 4,752 |   |
|                                                      |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Net cash used in  investing activities                    |   | (133                          | )      | (33,856                                    | )      | (4,588                                        | )      | (1,948           | )      | (40,525 | ) |
|                                                      |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Cash flows from  financing activities:                    |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Payments on  notes payable and revolving line of credit   |   | (30,000                       | )      | —                                     |   | —                                        |   | —           |   | (30,000 | ) |
| Proceeds from  notes payable and revolving line of credit |   | 25,000                        |   | —                                     |   | —                                        |   | —           |   | 25,000 |   |
| Payments on  long-term debt                               |   | (42,345                       | )      | (529                                       | )      | —                                        |   | (2,400           | )      | (45,274 | ) |
| Proceeds from  issuance of stock                          |   | —                        |   | —                                     |   | —                                        |   | —           |   | — |   |
| Additional  capital invested by parent                    |   | 706                           |   | —                                     |   | —                                        |   | —           |   | 706 |   |
| Distribution to  preferred unit holders                   |   | —                        |   | 4,121                                      |   | (1,556                                        | )      | (2,565           | )      | — |   |
| Investment in  subsidiaries                               |   | 315                           |   | (315                                       | )      | —                                        |   | —           |   | — |   |
| Net cash  provided by (used in) financing activities      |   | (46,324                       | )      | 3,277                                      |   | (1,556                                        | )      | (4,965           | )      | (49,568 | ) |
| Net increase  (decrease) in cash and equivalents          |   | (14,282                       | )      | 7,194                                      |   | —                                        |   | —           |   | (7,088 | ) |
| Cash and  equivalents at beginning of year                |   | 33,947                        |   | (6,287                                     | )      | —                                        |   | —           |   | 27,660 |   |
| Cash and  equivalents at end of year                      |   | $                             | 19,665 |                                       | $      | 907                                           |   | $                | — |   | $ | — |   | $ | 20,572 |   |

 

80

----

 

MICHAEL FOODS, INC.

(A wholly owned subsidiary of M-Foods Holdings, Inc.)

 

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS

 

**Company**

**Condensed Consolidating Statements of Cash Flows**

**Nine months ended December 31, 2001**

**(in thousands)**

** **
|                                                      |   | **Parent**                    |   | **Wholly  Owned  Guarantor  Subsidiaries** |   | **Non-wholly  owned  Guarantor Subsidiaries** |   | **Consolidated** |   |
|-----------------------------------------------------------|--------|-------------------------------|--------|--------------------------------------------|--------|-----------------------------------------------|--------|------------------|--------|
| **M-Foods  Dairy,  LLC**                                  |   | **M-Foods  Dairy  TXCT, LLC** |
|                                                      |   |                          |   |                                       |   |                                          |   |             |   |   |   |
|                                                      |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Net cash  provided by operating activities                |   | $                             | 28,125 |                                       | $      | 52,276                                        |   | $                | 13,334 |   | $ | 7,058 |   | $ | 100,793 |   |
|                                                      |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Cash flows from  investing activities:                    |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Capital  expenditures                                     |   | (9                            | )      | (17,480                                    | )      | (1,770                                        | )      | (4,040           | )      | (23,299 | ) |
| Business  acquisitions                                    |   | (626,925                      | )      | —                                     |   | —                                        |   | —           |   | (626,925 | ) |
| Investments in  joint ventures and other assets           |   | (249                          | )      | (4,704                                     | )      | —                                        |   | —           |   | (4,953 | ) |
| Net cash used in  investing activities                    |   | (627,183                      | )      | (22,184                                    | )      | (1,770                                        | )      | (4,040           | )      | (655,177 | ) |
|                                                      |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Cash flows from  financing activities:                    |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Payments on  notes payable and revolving line of credit   |   | (65,750                       | )      | —                                     |   | —                                        |   | —           |   | (65,750 | ) |
| Proceeds from  notes payable and revolving line of credit |   | 53,800                        |   | —                                     |   | —                                        |   | —           |   | 53,800 |   |
| Payments on  long-term debt                               |   | (152,349                      | )      | (357                                       | )      | —                                        |   | (2,400           | )      | (155,106 | ) |
| Proceeds from  long-term debt                             |   | 570,000                       |   | —                                     |   | —                                        |   | —           |   | 570,000 |   |
| Proceeds from  issuance of stock                          |   | 174,800                       |   | —                                     |   | —                                        |   | —           |   | 174,800 |   |
| Additional  capital invested by parent                    |   | 30                            |   | —                                     |   | —                                        |   | —           |   | 30 |   |
| Distribution to  preferred unit holders                   |   | —                        |   | 12,189                                     |   | (11,571                                       | )      | (618             | )      | — |   |
| Investment in  subsidiaries                               |   | 48,147                        |   | (48,147                                    | )      | —                                        |   | —           |   | — |   |
| Net cash  provided by (used in) financing activities      |   | 628,678                       |   | (36,315                                    | )      | (11,571                                       | )      | (3,018           | )      | 577,774 |   |
| Net increase  (decrease) in cash and equivalents          |   | 29,620                        |   | (6,223                                     | )      | (7                                            | )      | —           |   | 23,390 |   |
| Cash and  equivalents at beginning of period              |   | 4,327                         |   | (64                                        | )      | 7                                             |   | —           |   | 4,270 |   |
| Cash and  equivalents at end of period                    |   | $                             | 33,947 |                                       | $      | (6,287                                        | )      | $                | — |   | $ | — |   | $ | 27,660 |   |

 

81

----

 

MICHAEL FOODS, INC.

(A wholly owned subsidiary of M-Foods Holdings, Inc.)

 

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS

 

**Predecessor**

**Condensed Consolidating Statements of Cash Flows**

**Three months ended March 31, 2001**

**(in thousands)**

 
|                                                      |   | **Parent**                    |   | **Wholly  Owned  Guarantor  Subsidiaries** |   | **Non-wholly  owned  Guarantor Subsidiaries** |   | **Consolidated** |   |
|-----------------------------------------------------------|--------|-------------------------------|--------|--------------------------------------------|--------|-----------------------------------------------|--------|------------------|--------|
| **M-Foods  Dairy,  LLC**                                  |   | **M-Foods  Dairy  TXCT, LLC** |
|                                                      |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Net cash  provided by (used in) operating activities      |   | $                             | 12,000 |                                       | $      | 4,487                                         |   | $                | (2,440 | ) | $ | (31 | ) | $ | 14,016 |   |
|                                                      |   |                          |   |                                       |   |                                          |   |             |   |   |   |   |   |   |   |   |
| Cash flows from  investing activities:                    |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Capital  expenditures                                     |   | —                        |   | (4,923                                     | )      | (3,664                                        | )      | (2,250           | )      | (10,837 | ) |
| Investments in  joint ventures and other assets           |   | 434                           |   | 3,454                                      |   | —                                        |   | —           |   | 3,888 |   |
| Net cash  provided by (used in) investing Activities      |   | 434                           |   | (1,469                                     | )      | (3,664                                        | )      | (2,250           | )      | (6,949 | ) |
|                                                      |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Cash flows from  financing activities:                    |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Payments on  notes payable and revolving line of credit   |   | (52,000                       | )      |                                       |   | —                                        |   | —           |   | (52,000 | ) |
| Proceeds from  notes payable and revolving line of credit |   | 45,500                        |   | —                                     |   | —                                        |   | —           |   | 45,500 |   |
| Payments on  long-term debt                               |   | —                        |   | (109                                       | )      | —                                        |   | —           |   | (109 | ) |
| Proceeds from  issuance of stock                          |   | 546                           |   | —                                     |   | —                                        |   | —           |   | 546 |   |
| Other                                                     |   | 310                           |   | —                                     |   | —                                        |   | —           |   | 310 |   |
| Dividends                                                 |   | (1,465                        | )      | —                                     |   | —                                        |   | —           |   | (1,465 | ) |
| Investment in  subsidiaries                               |   | (9,785                        | )      | 1,393                                      |   | 6,111                                         |   | 2,281            |   | — |   |
| Net cash  provided by (used in) financing activities      |   | (16,894                       | )      | 1,284                                      |   | 6,111                                         |   | 2,281            |   | (7,218 | ) |
| Net increase  (decrease) in cash and equivalents          |   | (4,460                        | )      | 4,302                                      |   | 7                                             |   | —           |   | (151 | ) |
| Cash and  equivalents at beginning of period              |   | 8,787                         |   | (4,366                                     | )      | —                                        |   | —           |   | 4,421 |   |
| Cash and  equivalents at end of period                    |   | $                             | 4,327  |                                       | $      | (64                                           | )      | $                | 7      |   | $ | — |   | $ | 4,270 |   |

 

82

----

 

MICHAEL FOODS, INC.

(A wholly owned subsidiary of M-Foods Holdings, Inc.)

 

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS

 

**Predecessor**

**Condensed Consolidating Statements of Cash Flows**

**Year ended December 31, 2000**

**(in thousands)**

 
|                                                      |   | **Parent**                    |   | **Wholly  Owned  Guarantor  Subsidiaries** |   | **Non-wholly  owned  Guarantor Subsidiaries** |   | **Consolidated** |   |
|-----------------------------------------------------------|--------|-------------------------------|--------|--------------------------------------------|--------|-----------------------------------------------|--------|------------------|--------|
| **M-Foods  Dairy,  LLC**                                  |   | **M-Foods  Dairy  TXCT, LLC** |
|                                                      |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Net cash  provided by (used in) operating activities      |   | $                             | 47,044 |                                       | $      | 18,514                                        |   | $                | 3,900  |   | $ | (373 | ) | $ | 69,085 |   |
|                                                      |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Cash flows from  investing activities:                    |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Capital  expenditures                                     |   | —                        |   | (27,808                                    | )      | (3,181                                        | )      | (6,384           | )      | (37,373 | ) |
| Investments in  joint ventures and other assets           |   | (112                          | )      | (1,015                                     | )      | —                                        |   | —           |   | (1,127 | ) |
|                                                      |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Net cash used in  investing activities                    |   | (112                          | )      | (28,823                                    | )      | (3,181                                        | )      | (6,384           | )      | (38,500 | ) |
|                                                      |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Cash flows from  financing activities:                    |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Payments on  notes payable and revolving line of credit   |   | (168,400                      | )      | —                                     |   | —                                        |   | —           |   | (168,400 | ) |
| Proceeds from  notes payable and revolving line of credit |   | 191,600                       |   | —                                     |   | —                                        |   | —           |   | 191,600 |   |
| Payments on  long-term debt                               |   | —                        |   | (709                                       | )      | —                                        |   | (2,400           | )      | (3,109 | ) |
| Proceeds from  long-term debt                             |   | —                        |   | 184                                        |   | —                                        |   | —           |   | 184 |   |
| Proceeds from  issuance of stock                          |   | 651                           |   | —                                     |   | —                                        |   | —           |   | 651 |   |
| Repurchase of  common stock                               |   | (46,125                       | )      | —                                     |   | —                                        |   | —           |   | (46,125 | ) |
| Dividends                                                 |   | (5,926                        | )      | —                                     |   | —                                        |   | —           |   | (5,926 | ) |
| Investment in  subsidiaries                               |   | (16,621                       | )      | 8,183                                      |   | (719                                          | )      | 9,157            |   | — |   |
| Net cash  provided by (used in) financing activities      |   | (44,821                       | )      | 7,658                                      |   | (719                                          | )      | 6,757            |   | (31,125 | ) |
| Net increase  (decrease) in cash and equivalents          |   | 2,111                         |   | (2,651                                     | )      | —                                        |   | —           |   | (540 | ) |
| Cash and  equivalents at beginning of year                |   | 6,676                         |   | (1,715                                     | )      | —                                        |   | —           |   | 4,961 |   |
| Cash and  equivalents at end of year                      |   | $                             | 8,787  |                                       | $      | (4,366                                        | )      | $                | — |   | $ | — |   | $ | 4,421 |   |

 

83

----

 

MICHAEL FOODS, INC.

(A wholly owned subsidiary of M-Foods Holdings, Inc.)

 

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS

** **

**NOTE L — QUARTERLY FINANCIAL DATA**

 

QUARTERLY FINANCIAL DATA (UNAUDITED) (Inthousands) 

 

As a result ofthe Merger, the stock of the Predecessor is no longer publicly traded and,therefore, earnings per share information is no longer included for financialstatement presentation.

 
|         |   | **QUARTER** |    |
|--------------|--------|-------------|---------|
|         |   | **FIRST**   |    | **SECOND** |   | **THIRD** |   | **FOURTH** |   |
|         |   |        |    |   |   |   |   |   |   |
| **2002**     |   |        |    |   |   |   |   |   |   |
| Net sales    |   | $           | 278,429 |   | $ | 289,753 |   | $ | 293,954 |   | $ | 306,024 |   |
| Gross profit |   | 51,116      |    | 54,204 |   | 54,177 |   | 55,330 |   |
| Net earnings |   | 5,359       |    | 7,316 |   | 7,366 |   | 9,620 |   |
|              |        |             |         |  |  |  |  |  |  |  |  |  |  |

 
|                |   | **Predecessor** |    | **Company** |   |
|---------------------|--------|-----------------|---------|-------------|--------|
|                |   | **QUARTER**     |    |
|                |   | **FIRST**       |    | **SECOND**  |   | **THIRD** |   | **FOURTH** |   |
|                |   |            |    |        |   |   |   |   |   |
| **2001**            |   |            |    |        |   |   |   |   |   |
| Net sales           |   | $               | 275,627 |        | $      | 295,109 |   | $ | 299,225 |   | $ | 291,308 |   |
| Gross profit        |   | 47,920          |    | 50,254      |   | 50,789 |   | 50,591 |   |
| Net earnings (loss) |   | (5,653          | )       | 1,669       |   | 3,297 |   | 4,849 |   |
|                     |        |                 |         |             |        |  |  |  |  |  |  |  |  |

 

84

----

 

**Report of Independent Accountants**

 

BOARD OF DIRECTORS

MICHAEL FOODS, INC.

 

In our opinion, the accompanying consolidated balance sheet and therelated consolidated statements of earnings, of unit holder and operating unitequity and of cash flows present fairly, in all material respects, thefinancial position of M-Foods Dairy, LLC (the Company), a majority-ownedsubsidiary of Michael Foods, Inc. at December 31, 2002, and the results of itsoperations and its cash flows for the year then ended in conformity withaccounting principles generally accepted in the United States of America.  These financial statements are theresponsibility of the Company’s management; our responsibility is to express anopinion on these financial statements based on our audit.  We conducted our audit of these statementsin accordance with auditing standards generally accepted in the United Statesof America, which require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, and evaluating the overallfinancial statement presentation.  Webelieve that our audit provides a reasonable basis for our opinion.

 

The financial statements of the Company as of December 31, 2001 and forthe nine months then ended were audited by other independent certified publicaccountants whose report, dated February 8, 2002, expressed an unqualifiedopinion on those statements.  

 

The financial statements of Kohler Mix-MN (the Predecessor) for thethree months ended March 31, 2001 and for the year ended December 31, 2000 wereaudited by other independent certified public accountants whose report, datedMay 15, 2001, expressed an unqualified opinion on these statements.

 

As discussed in Note B to the financial statements, the Company adoptedStatement of Accounting Standards No. 142, “Goodwill and Other IntangibleAssets” on January 1, 2002.

 

 
| /s/PricewaterhouseCoopers LLP |   |
|-------------------------------|--------|
|                          |
|                          |
| Minneapolis, Minnesota        |
| February 18, 2003             |

 

85

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**Reportof Independent Certified Public Accountants**

 

 

BOARD OF DIRECTORS

MICHAEL FOODS, INC.

 

We have audited the accompanying balance sheet of M-FoodsDairy, LLC (a majority owned subsidiary of Michael Foods, Inc.) as of December31, 2001 and the related statements of operations, unit holder and operatingunit equity, and cash flows for the nine months then ended.  These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audit.

 

We conducted our audit in accordance with auditingstandards generally accepted in the United States of America. Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believe ouraudit provides a reasonable basis for our opinion.

 

In our opinion, the financial statements referred toabove present fairly, in all material respects, the financial position ofM-Foods Dairy, LLC (a majority owned subsidiary of Michael Foods, Inc.) as ofDecember 31, 2001, and the results of its operations and its cash flows for thenine months then ended in conformity with accounting principles generallyaccepted in the United States of America.

 

 
| /s/ GRANT THORNTON LLP |   |
|------------------------|--------|
|                   |
|                   |
| Minneapolis, Minnesota |
| February 8, 2002       |

 

86

 

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**Reportof Independent Certified Public Accountants**

 

 

BOARDOF DIRECTORS

MICHAELFOODS, INC.

 

We have audited the statements of earnings, unit holder and operating unit equity, and cashflows of Kohler Mix MN (an operating unit of Michael Foods, Inc.) (the“Predecessor”) for the year ended December 31, 2000 and the three months endedMarch 31, 2001.  These financialstatements are the responsibility of the Predecessor’ management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

We conducted our audits in accordance with auditingstandards generally accepted in the United States of America. Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements arefree of material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financialstatement presentation. We believe our audits provide a reasonable basisfor our opinion.

 

In our opinion, the financial statements referred toabove present fairly, in all material respects, the results of operations andcash flows of Kohler Mix MN (an operatingunit of Michael Foods, Inc.) for theyear ended December 31, 2000 and the three months ended March 31, 2001, inconformity with accounting principles generally accepted in the UnitedStates of America.

 

 
| /s/ GRANT THORNTON LLP |   |
|------------------------|--------|

 

 

Minneapolis, Minnesota

May 15, 2001

 

87

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**M-FOODS DAIRY,LLC**

**(A MajorityOwned Subsidiary of Michael Foods, Inc.)**

**BALANCE SHEETS**

(in thousands)

 
|                                                      |   | **December 31,  2002** |   | **December 31,  2001** |   |
|-----------------------------------------------------------|--------|------------------------|--------|------------------------|--------|
| **ASSETS**                                                |   |                   |   |                   |   |
| CURRENT ASSETS                                            |   |                   |   |                   |   |
| Accounts receivable, less allowances                      |   | $                      | 7,836  |                   | $      | 6,535 |   |
| Inventories                                               |   | 3,412                  |   | 3,592                  |   |
| Prepaid expenses and other                                |   | 600                    |   | 496                    |   |
| Total current assets                                      |   | 11,848                 |   | 10,623                 |   |
| PROPERTY, PLANT AND EQUIPMENT                             |   |                   |   |                   |   |
| Land                                                      |   | 855                    |   | 855                    |   |
| Buildings and improvements                                |   | 4,648                  |   | 3,999                  |   |
| Machinery and equipment                                   |   | 15,852                 |   | 12,051                 |   |
|                                                      |   | 21,355                 |   | 16,905                 |   |
| Less accumulated depreciation                             |   | 3,251                  |   | 1,248                  |   |
|                                                      |   | 18,104                 |   | 15,657                 |   |
| OTHER ASSETS                                              |   |                   |   |                   |   |
| Goodwill                                                  |   | 1,763                  |   | 1,763                  |   |
| Other assets                                              |   | 139                    |   | —                 |   |
|                                                      |   | 1,902                  |   | 1,763                  |   |
|                                                      |   | $                      | 31,854 |                   | $      | 28,043 |   |
|                                                      |   |                   |   |                   |   |
| **LIABILITIES AND UNIT HOLDER AND OPERATING UNIT EQUITY** |   |                   |   |                   |   |
| CURRENT LIABILITIES                                       |   |                   |   |                   |   |
| Accounts payable                                          |   | $                      | 2,836  |                   | $      | 2,612 |   |
| Accrued liabilities:                                      |   |                   |   |                   |   |
| Compensation                                              |   | 841                    |   | 688                    |   |
| Insurance                                                 |   | 144                    |   | 124                    |   |
| Customer programs                                         |   | 884                    |   | 836                    |   |
| Other                                                     |   | 483                    |   | 503                    |   |
| Total current liabilities                                 |   | 5,188                  |   | 4,763                  |   |
|                                                      |   |                   |   |                   |   |
| COMMITMENTS AND CONTINGENCIES                             |   | —                 |   | —                 |   |
| PREFERRED UNIT HOLDER RETURN PAYABLE                      |   | 12,442                 |   | 7,500                  |   |
| UNIT HOLDER EQUITY                                        |   | 14,224                 |   | 15,780                 |   |
|                                                      |   | $                      | 31,854 |                   | $      | 28,043 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

88

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**M-FOODSDAIRY, LLC**

**(A MajorityOwned Subsidiary of Michael Foods, Inc.)**

**STATEMENTS OF EARNINGS**

(in thousands)

 
|                                             |   | **Company**                          |    | **Predecessor**                            |   |
|--------------------------------------------------|--------|--------------------------------------|---------|--------------------------------------------|--------|
|                                             |   | **Year ended  December 31,****2002** |    | **Nine Months  ended****December 31,2001** |   | **Three Months  ended****March 31,  2001** |   | **Year ended****December 31,2000** |   |
|                                             |   |                                 |    |                                       |   |   |   |   |   |
| Net sales                                        |   | $                                    | 105,299 |                                       | $      | 69,911 |   | $ | 17,684 |   | $ | 68,102 |   |
| Cost of sales                                    |   | 94,693                               |    | 59,626                                     |   | 14,994 |   | 59,948 |   |
| Gross profit                                     |   | 10,606                               |    | 10,285                                     |   | 2,690 |   | 8,154 |   |
|                                             |   |                                 |    |                                       |   |   |   |   |   |
| Selling, general and administrative expenses     |   | 5,563                                |    | 3,194                                      |   | 1,027 |   | 3,668 |   |
| Recall insurance settlement                      |   | —                               |    | —                                     |   | (3,217 | ) | — |   |
| Operating profit                                 |   | 5,043                                |    | 7,091                                      |   | 4,880 |   | 4,486 |   |
|                                             |   |                                 |    |                                       |   |   |   |   |   |
| Other income (expense)                           |   | (102                                 | )       | 409                                        |   | 1 |   | 6 |   |
| Earnings before income taxes                     |   | 4,941                                |    | 7,500                                      |   | 4,881 |   | 4,492 |   |
| Income tax expense                               |   | —                               |    | —                                     |   | 1,918 |   | 1,766 |   |
| NET EARNINGS                                     |   | 4,941                                |    | 7,500                                      |   | $ | 2,963 |   | $ | 2,726 |   |
|                                             |   |                                 |    |                                       |   |   |   |   |   |
| Preferred stock dividends                        |   | (4,941                               | )       | (7,500                                     | )      |   |   |   |   |
| Net earnings attributable to common unit holders |   | $                                    | —  |                                       | $      | — |   |   |   |   |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

89

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**M-Foods Dairy,LLC**

**(A MajorityOwned Subsidiary of Michael Foods, Inc.)**

**STATEMENTSOF UNIT HOLDER AND OPERATING UNIT EQUITY**

(in thousands)

 
| **Predecessor**                                                                         |   | **Operating  Unit  Equity** |       |
|-----------------------------------------------------------------------------------------|--------|-----------------------------|------------|
|                                                                                    |   |                        |       |
| Balance at January 1, 2000                                                              |   | $                           | 16,236     |   |
| Net dividends paid                                                                      |   | (719                        | )          |
| Net earnings                                                                            |   | 2,726                       |       |
|                                                                                    |   |                        |       |
| Balance at December 31, 2000                                                            |   | 18,243                      |       |
| Net additional capital invested                                                         |   | 6,111                       |       |
| Net earnings                                                                            |   | 2,963                       |       |
|                                                                                    |   |                        |       |
| Balance at March 31, 2001                                                          |   | $                           | 27,317     |   |
|                                                                                    |   |                        | ** ** |
| **Company**                                                                             |   | **Unit Holder  Equity**     |       |
|                                                                                    |   |                        |       |
| Balance at March 31, 2001                                                          |   | $                           | 27,317     |   |
| Merger with M-Food Investors, LLC                                                       |   | (27,317                     | )          |
| Issuance of:                                                                            |   |                        |       |
| Class A - voting  common units, 50 units issued and outstanding, net of deemed dividend |   | 18                          |       |
| Class B -  non-voting common units, 950 units issued and outstanding                    |   | 356                         |       |
| Preferred units,  29,981 units issued and outstanding, net of deemed dividend           |   | 26,977                      |       |
| Net earnings                                                                            |   | 7,500                       |       |
| Preferred unit  holder return payable                                                   |   | (7,500                      | )          |
| Distribution to  preferred unit holders                                                 |   | (11,571                     | )          |
| Balance at December 31, 2001                                                            |   | $                           | 15,780     |   |
| Net earnings                                                                            |   | 4,941                       |       |
| Preferred unit  holder return payable                                                   |   | (4,941                      | )          |
| Distribution to  preferred unit holders                                                 |   | (1,556                      | )          |
| Balance at December 31, 2002                                                            |   | $                           | 14,224     |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

90

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**M-FOODS DAIRY,LLC**

**(A MajorityOwned Subsidiary of Michael Foods, Inc.)**

**STATEMENTS OF CASH FLOWS**

(in thousands)

 
|                                                                                           |   | **Company**                        |   | **Predecessor**                            |   |
|------------------------------------------------------------------------------------------------|--------|------------------------------------|--------|--------------------------------------------|--------|
|                                                                                           |   | **Year ended  December 31,  2002** |   | **Nine months****EndedDecember 31,  2001** |   | **Three months****EndedMarch 31,  2001** |   | **Year ended  December 31,  2000** |   |
|                                                                                           |   |                               |   |                                       |   |   |   |   |   |
| Cash flows from operating activities:                                                          |   |                               |   |                                       |   |   |   |   |   |
| Net earnings                                                                                   |   | $                                  | 4,941  |                                       | $      | 7,500 |   | $ | 2,963 |   | $ | 2,726 |   |
| Adjustments to reconcile net earnings to net cash  provided by (used in) operating activities: |   |                               |   |                                       |   |   |   |   |   |
| Depreciation                                                                                   |   | 2,003                              |   | 1,248                                      |   | 329 |   | 1,336 |   |
| Amortization of intangibles                                                                    |   | —                             |   | 37                                         |   | 26 |   | 104 |   |
| Deferred income taxes                                                                          |   | —                             |   | —                                     |   | 38 |   | 150 |   |
| Changes in operating assets andliabilities:                                                    |   |                               |   |                                       |   |   |   |   |   |
| Accounts receivable                                                                            |   | (1,301                             | )      | 6,438                                      |   | (6,647 | ) | 590 |   |
| Inventories                                                                                    |   | 180                                |   | (777                                       | )      | (531 | ) | 476 |   |
| Prepaid expenses and other                                                                     |   | (104                               | )      | (424                                       | )      | 22 |   | 342 |   |
| Accounts payable                                                                               |   | 224                                |   | (453                                       | )      | 1,103 |   | (381 | ) |
| Accrued liabilities                                                                            |   | 201                                |   | (235                                       | )      | 257 |   | (1,443 | ) |
| Net cash provided by (used in) operating activities                                            |   | 6,144                              |   | 13,334                                     |   | (2,440 | ) | 3,900 |   |
| Cash flows from investing activities:                                                          |   |                               |   |                                       |   |   |   |   |   |
| Capital expenditures                                                                           |   | (4,449                             | )      | (1,770                                     | )      | (3,664 | ) | (3,181 | ) |
| Other assets                                                                                   |   | (139                               | )      | —                                     |   | — |   | — |   |
| Net cash used in investing activities                                                          |   | (4,588                             | )      | (1,770                                     | )      | (3,664 | ) | (3,181 | ) |
|                                                                                           |   |                               |   |                                       |   |   |   |   |   |
| Cash flows from financing activities:                                                          |   |                               |   |                                       |   |   |   |   |   |
| Additional capital invested                                                                    |   | —                             |   | —                                     |   | 6,111 |   | — |   |
| Dividends paid                                                                                 |   | (1,556                             | )      | (11,571                                    | )      | — |   | (719 | ) |
| Net cash provided by (used in) financing activities                                            |   | (1,556                             | )      | (11,571                                    | )      | 6,111 |   | (719 | ) |
| Net increase in cash and equivalents                                                           |   | —                             |   | (7                                         | )      | 7 |   | — |   |
| Cash at beginning of period                                                                    |   | —                             |   | 7                                          |   | — |   | — |   |
| Cash at end of period                                                                          |   | $                                  | — |                                       | $      | — |   | $ | 7 |   | $ | — |   |

 

Duringthe year ended December 31, 2002 and the nine months ended December 31, 2001,the Company recorded a non-cash guaranteed preferred unit holder return payableequal to the net earnings for the period, which reduced unit holder equity by alike amount.

 

Theaccompanying notes are an integral part of these financial statements.

 

91

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**M–FOODSDAIRY, LLC**

**(AMajority Owned Subsidiary of Michael Foods, Inc.)**

**NOTES TOFINANCIAL STATEMENTS**

 

**NOTE A – ORGANIZATION, BUSINESS ANDMERGER**

 

**Organization**

M-Foods Dairy, LLC (the “Company”) is a majority owned subsidiary ofMichael Foods, Inc., a wholly owned subsidiary of M-Foods Holdings, Inc.  Prior to the Merger described below, KohlerMix — MN (the “Predecessor,” “Operating Unit” or the “Unit”) was an operatingunit of Michael Foods, Inc.  The changein control of Michael Foods, Inc. and the reorganization of the operating unitinto M-Foods Dairy, LLC are more fully described below.

 

**Business**

The Company processes and distributes soft serve ice cream mix, frozenyogurt mix, milk and specialty dairy products, many of which are ultra-hightemperature pasteurized, from its facility in Minnesota.

 

**Merger**

On April 10, 2001, Michael Foods, Inc. and its subsidiaries (“MichaelFoods”) was acquired in a transaction (the “Merger”) led by an investor groupcomprised of a management group led by Michael Foods’ Chairman, President andChief Executive Officer, Gregg Ostrander, affiliates of Jeffrey Michael, amember of the Predecessor Board of Directors, and affiliates of two privateequity investment firms, Vestar Capital Partners and Goldner HawnJohnson & Morrison Incorporated, collectively, M-Foods Investors,LLC.  Under the terms of the Mergeragreement, all outstanding shares of Michael Foods com­mon stock were convertedinto the right to receive $30.10 per share in cash, or value equal thereto, andall outstanding stock options were converted into the right to receive, incash, $30.10 per share reduced by the exercise price per share for all sharessubject to such stock options.  Thepurchase of the outstand­ing shares was financed through new equity financingof approximately $175,000,000, a senior secured credit facility of up to$470,000,000 at market-based variable interest rates, and $200,000,000 ofsenior subordinated notes at an 11.75% annual inter­est rate.

 

Immediately after the close of the Merger, Michael Foods contributedthe assets of its Dairy Products Division into two limited liabilitycorporations, M-Foods Dairy, LLC and M-Foods Dairy TXCT, LLC (collectively, the“Dairy LLCs”) and in exchange received voting preferred and voting common unitsfrom these entities equal to the fair value of the net assets contributed,which collectively were approxi­mately $35,800,000 (the approximate fair valuecontributed to M-Foods Dairy, LLC was $26,850,000).  The preferred units issued to Michael Foods have an annual 10%preferred return guarantee and represent 100% of the preferred units issued andoutstanding.  In addition, Michael Foodsreceived 5% of the common units issued by each of the Dairy LLCs with thecommon units held by Michael Foods representing 100% of the voting common unitsissued and outstanding.  These commonunits have a stated value of $25,000. The remaining 95% of the common units, which are non-voting, are ownedby M-Foods Dairy Holdings, LLC, which is owned by the same owners, oraffiliates of such owners, in the same proportion, as the unit holders ofM-Foods Investors, LLC.  The Dairy LLCscommon unit interest owned by M-Foods Dairy Holdings, LLC was purchased for$475,000 as of April 1, 2001.

 

92

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Following the Merger, Michael Foods, Inc. became an indirectwholly-owned subsidiary of M-Foods Investors, LLC and M-Foods Dairy LLC becamea majority owned subsidiary of Michael Foods, Inc.

 

The Merger was accounted for as a purchase in accordance withAccounting Principles Board Opinion 16, Business Combinations and EITF 88-16,Basis in Leveraged Buyout Transac­tions. Accordingly, the acquired assets and liabilities were recorded at fairvalue for the interests acquired by new investors and at the carryover basisfor continuing investors.  As a result,the assets and liabilities were assigned new values, which are part Predecessorcost and part fair value, in the same proportions as the carryover basis of theresidual interests retained by the continuing management investors andcontinuing affiliate investors of the Michael family and the new interestsacquired by the new investors.  Thedeemed dividend related to the Michael Foods investment in the assets andliabilities of the Dairy LLCs was pushed down to these majority ownedsubsidiaries, as if they were wholly owned subsidiaries since Michael Foodsowns all of the voting stock and the Dairy LLCs are being operated by themanagement of Michael Foods.  The amountof the deemed dividend at Michael Foods was $66,631,000.

 

For ease of presentation, the Merger has been reflected in theaccompanying financial statements as if it had occurred on April 1, 2001.  Management determined that no materialtransactions occurred during the period from April 1 through April 9,2001.  The Company’s financialstatements have been presented on a comparative basis with the Predecessor’shistorical operating unit financial statements, prior to the date ofMerger.  Different bases of accountinghave been used to prepare the Company and Predecessor financialstatements.  The primary differencesrelate to the 10% yield on preferred units, depreciation and amortization offixed assets and other intangible assets recorded at fair value at the date ofacquisition, and income taxes which are payable by the Company’s unit holders.

 

The fair value contributed by Michael Foods to M-Foods Dairy, LLC was$26,850,000.  In addition, $356,250 wascontributed by new investors in exchange for Class B non-voting commonunits.  This combined amount wasallocated to the acquired assets and liabilities based on their fair values atApril 1, 2001, net of the deemed dividend. The fair values of long-term assets were obtained from a valuationreport issued by a third party appraisal firm. The allocations were as follows:

 
| Working capital                   |   | $      | 10,426 |   |
|-----------------------------------|--------|--------|--------|--------|
| Property, plant  & equipment  |   | 15,135 |   |
| Other assets,  including goodwill |   | 3,962  |   |

 

93

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The following unaudited pro forma net sales and net earnings for theyear ended December 31, 2001 include results for the three months ended March31, 2001, which were derived from the application of pro forma adjustments tothe Predecessor’s historical statement of earnings, and assumes the Merger hadoccurred on January 1, 2001.  The proforma net earnings for the year ended December 31, 2001 are also adjusted forgoodwill amortization determined in accordance with the provisions of SFAS 142(see Note B).  The net sales and netearnings for the year ended December 31, 2002 represent actual results for theperiod.

 
|                         |   | **Year ended****December 31, 2002** |    | **Year ended****December 31, 2001** |   |
|------------------------------|--------|-------------------------------------|---------|-------------------------------------|--------|
|                         |   | **(in thousands)**                  |    |
| Net sales                    |   | $                                   | 105,299 |                                | $      | 87,595 |   |
| Earnings before income taxes |   | 4,941                               |    | 12,435                              |   |
|                              |        |                                     |         |                                     |        |  |  |

 

The most significant of the pro forma adjustmentsreflected in the above amounts were to record additional amortization chargesresulting from increased intangible assets. The pro forma financial informationshould be read in conjunction with the related historical information and isnot necessarily indicative of the results that would have been obtained had thetransaction actually taken place at the beginning of the periods presented.

 

**NOTE B – SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

 

**Basis of Presentation**

The accompanying consolidated financial statements as ofDecember 31, 2000 and the year then ended and for the three months endedMarch 31, 2001 have been taken from the historical books and records ofthe Predecessor. The respective Statements of Earnings include an allocation ofgeneral and administrative costs incurred by Michael Foods and allocations fromthis Operating Unit to the other Dairy LLC operating unit, M-Foods Dairy TXCT,LLC.  Management believes itsallocations to, and between, these Operating Unit financial statements arereasonable.  Additionally, PredecessorOperating Unit equity includes the cumulative net advances between theOperating Unit and Michael Foods, which are considered additional capitalinvested from, or constructive dividends to, Michael Foods.  Accordingly, the accompanying financialstatements may not necessarily be indicative of the results that could havebeen obtained if the Operating Unit had been operated as a stand-alone entity.

 

The Company adopted the accounting policies of the Predecessor.

 

**Use of Estimates**

Preparation of the accompanying financial statements in conformity withaccount­ing principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect reportedamounts of assets and liabilities, related revenues and expenses and disclosureabout contingent assets and liabilities at the date of the financialstatements. Actual results could differ from the estimates used by management.

 

94

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**Accounts Receivable**

The company grants credit to customers in the normal course ofbusiness, but generally does not require collateral or any other security tosupport amounts due.  Managementperforms on-going credit evaluations of customers.  The company maintains an allowance for potential credit losseswhich, when realized, have been within management’s expectations.  The allowance was $255,000 and $200,000 atDecember 31, 2002 and 2001.

 

**Inventories**

Inventories are stated at the lower of cost (determined on a first-in,first-out basis) or market.  Inventoriesconsisted of the following at December 31 (in thousands):

 
|                               |   | **2002** |   | **2001** |   |
|------------------------------------|--------|----------|--------|----------|--------|
| Raw materials and supplies         |   | $        | 1,682  |     | $      | 1,625 |   |
| Work in process and finished goods |   | 1,730    |   | 1,967    |   |
|                               |   | $        | 3,412  |     | $      | 3,592 |   |

 

**Property, Plant and Equipment**

Depreciation is provided in amounts sufficient to relate the cost ofdepreciable assets to operations over their estimated service lives,principally on the straight-line basis. Estimated service lives range from10-40 years for buildings and improvements and 3-10 years formachinery and equipment. Accelerated and straight-line methods are used forincome tax purposes.

 

**Goodwill**

In June 2001, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards (“SFAS”) No. 141, “BusinessCombinations,” and SFAS No. 142, “Goodwill and Other Intangible Assets.”  SFAS 141 eliminates the pooling-of-interestsmethod of accounting for business combinations, requiring that all businesscombinations initiated after June 30, 2001 be accounted for using the purchasemethod.  SFAS 142 provides that goodwillis no longer amortized, but rather is reviewed for impairment at least annuallyand more frequently in certain circumstances using a two-step process.

 

In October 2001, the FASB issued SFAS No. 144,“Accounting for the Impairment of Disposal of Long-Lived Assets.”  This statement addresses financialaccounting and reporting for the impairment of long-lived assets and forlong-lived assets to be disposed of and supercedes SFAS 121.  SFAS 144 does, however, retain thefundamental provisions of SFAS 121 for the recognition and measurement of theimpairment of long-lived assets to be held and used and the measurement oflong-lived assets to be disposed of by sale.

 

95

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As of January 1, 2002, we adopted SFAS 142 and144.  The affect of adopting SFAS 142was to reduce amortization expense by approximately $50,000 for the year endedDecember 31, 2002.  As a result ofadopting these standards, our accounting policies for goodwill and intangibleassets changed effective January 1, 2002 as described below:

 

We recognize the excess cost of an acquired entityover the net amount assigned to assets acquired, including intangible assetswith indefinite lives, and liabilities assumed, as goodwill.  Goodwill and intangible assets withindefinite lives will be tested for impairment on an annual basis and betweenannual tests whenever there is an impairment indicated.  Impairment losses will be recognizedwhenever the implied fair value is less than the carrying value of the relatedasset.  Prior to January 1, 2002,goodwill and intangible assets with indefinite lives were amortized over 40years.  Beginning January 1, 2002,goodwill and intangible assets with indefinite lives are no longer amortized.

 

The adoption of SFAS 141 and 144 did not affectour financial position or result of operations.  During the second quarter of fiscal 2002 pursuant to SFAS 142, wecompleted the transitional impairment test of goodwill with no impairmentindicated at January 1, 2002.  Duringthe fourth quarter of 2002 pursuant to SFAS 142, we completed the annual impairmenttest of goodwill with no impairment indicated. Our carrying amount for goodwill as of December 31, 2002 and 2001 was$1,763,000.

 

The following table presents a reconciliation ofnet earnings (loss), as reported in the financial statements, to those amountsadjusted for goodwill and intangible amortization determined in accordance withthe provisions of SFAS 142.

 
|                                   |   | **Year  ended  December 31,  2002** |      | **Nine months  ended  December 31,  2001** |   | **Three months****endedMarch 31,  2001** |   |
|----------------------------------------|--------|-------------------------------------|-----------|--------------------------------------------|--------|------------------------------------------|--------|
|                                   |   | **(Company)**                       |      | **(Predecessor)**                          |   |
| Reported net earnings                  |   | $                                   | 4,941,000 |                                       | $      | 7,500,000                                |   | $ | 2,963,000 |   |
| Add back:  goodwill  amortization |   | —                              |      | 37,000                                     |   | 26,000                                   |   |
| Adjusted net earnings                  |   | $                                   | 4,941,000 |                                       | $      | 7,537,000                                |   | $ | 2,989,000 |   |

 

**Revenue Recognition**

Sales are recognized when goods are shipped to customers and arerecorded net of estimated customer programs and returns.

 

96

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**NOTE C – SETTLEMENT OF RECALLINSURANCE CLAIM**

 

During the three months ended March 31, 2001, the Unit settled itsinsurance claim related to a product recall, which occurred in early 1999.  The settlement reimbursed the Unit forrecall related costs incurred as well as a partial reimbursement for lostbusiness as a result of the recall.

 

**NOTE D – INCOME TAXES**

 

**Company**

For income tax purposes the Company is a pass-through entity and,therefore, income taxes have not been reflected in the Company’s financialstatements.

 

**Predecessor**

The activity of the Operating Unit has been included in the income taxreturn of Michael Foods, Inc. for financial reporting purposes.  The Unit has been allocated a provision forincome taxes in an amount generally equivalent to the provision that would haveresulted had the Unit filed a separate income tax return.

 

**NOTE E – EMPLOYEE RETIREMENT PLANS**

 

Full-time non-union employees who meet certain service requirements areeligible to participate in a defined contribution retirement plan of MichaelFoods, Inc.  Under the Plan, the Companymatches up to 4% of each participant’s eligible compensation.  The Company’s union employees are alsocovered by a defined benefit plan sponsored by the Company.  Company contributions under these plans forthe year ended December 31, 2002 were $173,000 and for the nine months endedDecember 31, 2001 were $105,000.  ThePredecessor’s contributions related to the Unit’s eligible employees totaled$190,000 for the year ended December 31, 2000 and $48,000 for the threemonths ended March 31, 2001.

 

**NOTE F – COMMITMENTS ANDCONTINGENCIES**

 

**Leases**

The Company leases certain equipment and property under operating leaseagreements expiring at various dates through 2004.  Rent expense for the Company totaled $669,000 for the year endedDecember 31, 2002 and $689,000 for the nine months ended December 31, 2001.  Rent expense for the Predecessor totaled$527,000 for the year ended December 31, 2000 and $146,000 for the threemonths ended March 31, 2001.

 

Minimumfuture lease obligations under these operating leases are as follows for theyears ending December 31 (in thousands):

 

| 2003 |   | $   | 313 |
|------|--------|-----|-----|
| 2004 |   | 287 |

 

97

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**Litigation**

The Company is engaged in routine litigation incidental to itsbusiness.  Management believes theultimate outcome of this litigation will not have a material effect on theCompany’s financial position, liquidity or results of operations.

 

**NOTE G – UNITHOLDER RETURN PREFERENCES**

 

The income or loss resulting from the Company’s operations will beallocated as follows:

 

•                  Losses willfirst be allocated to the common unit holders to the extent of their capitalaccounts.  The maximum loss allocationis, therefore, limited to $375,000 which would be allocated $18,750 to MichaelFoods, Inc. and $356,250 to the non-voting common unit holders; thereafter, alllosses are allocated to Michael Foods, Inc.;

 

•                  The Company’sincome will be allocated to Michael Foods, Inc. until all preferred units andreturn on preferred units of both Dairy LLCs have been recovered.  The Dairy LLC’s combined preferred unitshave a value of approxi­mately $26,850,000 and earn the greater of a 10% cumulativereturn on the capital contribution or the Company’s net earnings through thesecond anniversary of the agreement and a 10% cumulative returnthereafter.  The preferred unit holderreturn payable as of December 31, 2002 and December 31, 2001, respectively, was$12,442,000 and $7,500,000, which represents the cumulative net earnings forthe periods;

 

•                  Income in excessof the preferred unit amount and preferred unit return is distributed, subjectto various limitations, to the common unit holders.  Michael Foods, Inc. will receive 5% of this income, for theirportion of the common units outstanding and the other common unit holders willreceive 95%.  The other common unitholders are permitted to keep an amount of this distribution equal to the taxdue on the income they receive.  Anyaddi­tional distribution, in excess of the taxes due, must be contributed inexchange for capital stock of M-Foods Holdings, Inc. until such time as all ofthe revolving credit facility, term loans A and B, and senior subordinatednotes have been repaid;

 

•                  In the event theCompany is sold while Michael Foods, Inc.’s revolving credit facility, seniorterm loans A and B or subordinated debt is outstanding, the gain or loss on thesale will follow the allocation methods described above and gains must becontributed in exchange for capital stock of M-Foods Holdings, Inc. until allof the revolving credit facility, term loans A and B, and senior subordinatednotes have been retired.  The totalamount of Michael Foods, Inc. outstanding debt subject to this distributionrestriction was approximately $500,000,000 and $548,000,000 at December 31,2002 and 2001, respectively.

 

98

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**NOTE H – STOCK OPTION PLANS**

 

Certain officers and employees of the Predecessor participated invarious stock option plans sponsored by the Michael Foods Predecessor.  The Michael Foods Predecessor followedAccounting Principal Board No. 25 (“APB 25”) in accounting for stock optionsissued under its plans.  Under APB 25,no compensation expense was recognized by the Michael Foods Predecessor relatedto the Unit’s officers or employees for any of the periods presented.  At the time of the Merger, all stock optionsissued and outstanding under these plans vested and were retired.  For information related to the Michael FoodsPredecessor’s stock option plans, refer to Note I of its financial statementscontained elsewhere in this document.

 

**NOTE I – SIGNIFICANT CUSTOMERS**

 

Sales to one customer accounted for approximately 10% of net sales forthe year ended December 31, 2002.  Salesto two customers accounted for approximately 12% and 12% of net sales for theyear ended December 31, 2001.  Sales toone customer accounted for approximately 15% of net sales for the year endedDecember 31, 2000.

 

99

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Report of Independent Accountants

 

BOARD OF DIRECTORS

MICHAEL FOODS, INC.

 

In our opinion, the accompanying consolidated balance sheet and therelated consolidated statements of operations, of unit holder and operatingunit equity and of cash flows present fairly, in all material respects, thefinancial position of M-Foods Dairy TXCT, LLC (the Company), a majority-ownedsubsidiary of Michael Foods, Inc. at December 31, 2002, and the results of itsoperations and its cash flows for the year then ended in conformity withaccounting principles generally accepted in the United States of America.  These financial statements are theresponsibility of the Company’s management; our responsibility is to express anopinion on these financial statements based on our audit.  We conducted our audit of these statementsin accordance with auditing standards generally accepted in the United Statesof America, which require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, and evaluating the overallfinancial statement presentation.  Webelieve that our audit provides a reasonable basis for our opinion.

 

The financial statements of the Company as of December 31, 2001 and forthe nine months then ended were audited by other independent certified publicaccountants whose report, dated February 8, 2002, expressed an unqualifiedopinion on those statements.

 

The financial statements of Kohler Mix-TXCT (the Predecessor) for thethree months ended March 31, 2001 and for the year ended December 31, 2000 wereaudited by other independent certified public accountants whose report, datedMay 15, 2001, expressed an unqualified opinion on those statements.

 

 
| /s/ PricewaterhouseCoopers LLP |   |
|--------------------------------|--------|

 

 

Minneapolis, Minnesota

February 18, 2003

 

100

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**Reportof Independent Certified Public Accountants**

 

BOARDOF DIRECTORS

MICHAELFOODS, INC.

 

We have audited the accompanying balance sheet of M-Foods Dairy TXCT, LLC (amajority owned subsidiary of Michael Foods, Inc.) as of December 31,2001 and the related statements of operations,unit holder and operating unit equity, and cash flows for the nine months thenended.  These financial statementsare the responsibility of the Company’s management. Our responsibility is toexpress an opinion on these financial statements based on our audit.

 

We conducted our audit in accordance with auditingstandards generally accepted in the United States of America. Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements arefree of material mis­statement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financialstatement presentation. We believe our audit provides a reasonable basisfor our opinion.

 

In our opinion, the financial statements referred toabove present fairly, in all material respects, the financial position of M-Foods Dairy TXCT, LLC (a majority ownedsubsidiary of Michael Foods, Inc.) as of December 31, 2001, and theresults of its operations and its cash flows for the nine months then ended inconformity with accounting principles generally accepted in the United Statesof America.

 

 
| /s/ GRANT THORNTON LLP |   |
|------------------------|--------|

 

Minneapolis, Minnesota

February 8, 2002

 

101

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**Reportof Independent Certified Public Accountants**

 

BOARDOF DIRECTORS

MICHAELFOODS, INC.

 

We have audited the statements ofoperations, unit holder and operating unit equity, and cash flows of Kohler Mix– TXCT (an operating unit of Michael Foods, Inc.) (the “Predecessor”) for theyear ended December 31, 2000 and the three months ended March 31,2001.  These financial statements arethe responsibility of the Predecessor’s management.  Our responsibility is to express an opinion on these financialstatements based on our audits.

 

We conducted our audits inaccordance with auditing standards generally accepted in the United States ofAmerica.  Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation.  We believe our audits provide a reasonablebasis for our opinion.

 

In our opinion, the financialstatements referred to above present fairly, in all material respects, theresults of operations and cash flows of Kohler Mix **–** TXCT(an operating unit of Michael Foods, Inc.) for the year ended December 31,2000 and for the three months ended March 31, 2001, in conformity withaccounting principles generally accepted in the United States of America.

 

 
| /s/ GRANT THORNTON LLP |   |
|------------------------|--------|

 

 

Minneapolis,Minnesota

May15, 2001

 

102

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**M-FOODS DAIRYTXCT, LLC**

**(A MajorityOwned Subsidiary of Michael Foods, Inc.)**

**BALANCE SHEETS**

(in thousands)

 
|                                                         |   | **December 31,  2002** |   | **December 31,  2001** |   |
|--------------------------------------------------------------|--------|------------------------|--------|------------------------|--------|
| **ASSETS**                                                   |   |                   |   |                   |   |
| CURRENT ASSETS                                               |   |                   |   |                   |   |
| Accounts receivable                                          |   | $                      | 4,399  |                   | $      | 5,765 |   |
| Inventories                                                  |   | 4,019                  |   | 3,315                  |   |
| Prepaid expenses and other                                   |   | 65                     |   | 52                     |   |
| Total current assets                                         |   | 8,483                  |   | 9,132                  |   |
| PROPERTY, PLANT AND EQUIPMENT                                |   |                   |   |                   |   |
| Leasehold improvements                                       |   | 3,176                  |   | 3,023                  |   |
| Machinery and equipment                                      |   | 11,792                 |   | 9,997                  |   |
|                                                         |   | 14,968                 |   | 13,020                 |   |
| Less accumulated depreciation                                |   | 3,588                  |   | 1,494                  |   |
|                                                         |   | 11,380                 |   | 11,526                 |   |
| OTHER ASSETS                                                 |   |                   |   |                   |   |
| Non-compete agreement, net                                   |   | 529                    |   | 1,058                  |   |
|                                                         |   | $                      | 20,392 |                   | $      | 21,716 |   |
|                                                         |   |                   |   |                   |   |
| **LIABILITIES AND UNIT HOLDER AND****OPERATING UNIT EQUITY** |   |                   |   |                   |   |
| CURRENT LIABILITIES                                          |   |                   |   |                   |   |
| Current maturities of non-compete commitment                 |   | $                      | 2,400  |                   | $      | 2,400 |   |
| Accounts payable                                             |   | 2,873                  |   | 3,342                  |   |
| Accrued liabilities:                                         |   |                   |   |                   |   |
| Compensation                                                 |   | 250                    |   | 292                    |   |
| Insurance                                                    |   | 1                      |   | 37                     |   |
| Customer programs                                            |   | 240                    |   | 200                    |   |
| Other                                                        |   | 555                    |   | 447                    |   |
| Total current liabilities                                    |   | 6,319                  |   | 6,718                  |   |
| NON-COMPETE COMMITMENT, less current maturities              |   | —                 |   | 2,400                  |   |
| COMMITMENTS AND CONTINGENCIES                                |   | —                 |   | —                 |   |
| PREFERRED UNIT HOLDER RETURN PAYABLE                         |   | 4,728                  |   | 688                    |   |
| UNIT HOLDER AND OPERATING UNIT EQUITY                        |   | 9,345                  |   | 11,910                 |   |
|                                                         |   | $                      | 20,392 |                   | $      | 21,716 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

103

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**M-FOODS DAIRYTXCT, LLC**

**(A MajorityOwned Subsidiary of Michael Foods, Inc.)**

**STATEMENTS OF OPERATIONS**

(in thousands)

 
|                                                    |   | **Company**                         |   | **Predecessor**                            |   |
|---------------------------------------------------------|--------|-------------------------------------|--------|--------------------------------------------|--------|
|                                                    |   | **Year  ended****December 31,2002** |   | **Nine Months  ended****December 31,2001** |   | **Three Months  ended****March 31,2001** |   | **Year  Ended****December 31,2000** |   |
|                                                    |   |                                |   |                                       |   |   |   |   |   |
| Net sales                                               |   | $                                   | 85,360 |                                       | $      | 80,643 |   | $ | 17,644 |   | $ | 73,814 |   |
| Cost of sales                                           |   | 77,477                              |   | 77,110                                     |   | 17,108 |   | 70,447 |   |
| Gross profit                                            |   | 7,883                               |   | 3,533                                      |   | 536 |   | 3,367 |   |
|                                                    |   |                                |   |                                       |   |   |   |   |   |
| Selling, general and administrative expenses            |   | 3,830                               |   | 3,367                                      |   | 1,712 |   | 7,412 |   |
| Operating profit (loss)                                 |   | 4,053                               |   | 166                                        |   | (1,176 | ) | (4,045 | ) |
|                                                    |   |                                |   |                                       |   |   |   |   |   |
| Other income (expense)                                  |   | (13                                 | )      | 53                                         |   | — |   | — |   |
| Earnings (loss) before incometaxes                      |   | 4,040                               |   | 219                                        |   | (1,176 | ) | (4,045 | ) |
| Income tax expense (benefit)                            |   | —                              |   | —                                     |   | (447 | ) | (1,537 | ) |
|                                                    |   |                                |   |                                       |   |   |   |   |   |
| NET EARNINGS (LOSS)                                     |   | 4,040                               |   | 219                                        |   | $ | (729 | ) | $ | (2,508 | ) |
| Preferred stock dividends                               |   | (4,040                              | )      | (688                                       | )      |   |   |   |   |
|                                                    |   |                                |   |                                       |   |   |   |   |   |
| Net earnings (loss) attributable to common unit holders |   | $                                   | — |                                       | $      | (469 | ) |   |   |   |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

104

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**M-Foods DairyTXCT, LLC**

**(A MajorityOwned Subsidiary of Michael Foods, Inc.)**

**STATEMENTS OF UNIT HOLDER ANDOPERATING UNIT EQUITY**

(in thousands)

 
|                                                                                                                   |   | **Operating Unit Equity** |       |
|------------------------------------------------------------------------------------------------------------------------|--------|---------------------------|------------|
| **Predecessor**                                                                                                        |   |                      |       |
|                                                                                                                   |   |                      |       |
| Balance at January 1, 2000                                                                                             |   | $                         | 13,422     |   |
| Net additional capital invested                                                                                        |   | 9,157                     |       |
| Net loss                                                                                                               |   | (2,508                    | )          |
| Balance at December 31, 2000                                                                                           |   | 20,071                    |       |
| Net additional capital invested                                                                                        |   | 2,281                     |       |
| Net loss                                                                                                               |   | (729                      | )          |
| Balance at March 31, 2001                                                                                         |   | $                         | 21,623     |   |
|                                                                                                                   |   |                      | ** ** |
|                                                                                                                   |   | **Unit Holder Equity**    |       |
| **Company**                                                                                                            |   |                      |       |
| Balance at March 31, 2001                                                                                         |   | $                         | 21,623     |   |
| Merger with M-Food Investors, LLC                                                                                      |   | (21,623                   | )          |
| Issuance of:                                                                                                           |   |                      |       |
| Class A – voting common units, 50 units issued and  outstanding, plus additional carryover basis adjustment of $2 |   | 8                         |       |
| Class B – non-voting common units, 950 units issued and  outstanding                                              |   | 119                       |       |
| Preferred units, 14,304 units  issued and outstanding, plus additional carryover basis adjustment of $3,926            |   | 12,870                    |       |
| Net earnings                                                                                                           |   | 219                       |       |
| Preferred unit holder return  payable                                                                                  |   | (688                      | )          |
| Distribution to preferred unit holders                                                                                 |   | (618                      | )          |
| Balance at December 31, 2001                                                                                           |   | $                         | 11,910     |   |
| Net earnings                                                                                                           |   | 4,040                     |       |
| Preferred unit holder return  payable                                                                                  |   | (4,040                    | )          |
| Distribution to preferred unit holders                                                                                 |   | (2,565                    | )          |
| Balance at December 31, 2002                                                                                           |   | $                         | 9,345      |   |

 

The accompanying notes are an integral part of these financialstatements.

 

105

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**M-Foods Dairy TXCT, LLC**

**(A MajorityOwned Subsidiary of Michael Foods, Inc.)**

**STATEMENTS OF CASH FLOWS**

(in thousands)

 
|                                                                                       |   | **Company**                                     |   | **Predecessor**                                        |   |
|--------------------------------------------------------------------------------------------|--------|-------------------------------------------------|--------|--------------------------------------------------------|--------|
|                                                                                       |   | **Year********ended  December 31,********2002** |   | **Nine Months********ended  December 31,********2001** |   | **Three Months  ended  March 31,********2001** |   | **Year********ended  December 31,********2000** |   |
| Cash flows from operating activities:                                                      |   |                                            |   |                                                   |   |   |   |   |   |
| Net earnings (loss)                                                                        |   | $                                               | 4,040  |                                                   | $      | 219 |   | $ | (729 | ) | $ | (2,508 | ) |
| Adjustments to reconcile net loss to net cash provided  by (used in) operating activities: |   |                                            |   |                                                   |   |   |   |   |   |
| Depreciation                                                                               |   | 2,094                                           |   | 1,494                                                  |   | 417 |   | 1,284 |   |
| Amortization                                                                               |   | 529                                             |   | 340                                                    |   | 500 |   | 2,000 |   |
| Deferred income taxes                                                                      |   | —                                          |   | —                                                 |   | (17 | ) | (68 | ) |
| Changes in operating assets andliabilities:                                                |   |                                            |   |                                                   |   |   |   |   |   |
| Accounts receivable                                                                        |   | 1,366                                           |   | 5,515                                                  |   | (244 | ) | (1,220 | ) |
| Inventories                                                                                |   | (704                                            | )      | 195                                                    |   | (1,090 | ) | 27 |   |
| Prepaid expenses and other                                                                 |   | (13                                             | )      | 1                                                      |   | 3 |   | (3 | ) |
| Accounts payable                                                                           |   | (469                                            | )      | (796                                                   | )      | 1,005 |   | (69 | ) |
| Accrued liabilities                                                                        |   | 70                                              |   | 90                                                     |   | 124 |   | 184 |   |
| Net cash provided by (used in) operating activities                                        |   | 6,913                                           |   | 7,058                                                  |   | (31 | ) | (373 | ) |
| Cash flows from investing activities:                                                      |   |                                            |   |                                                   |   |   |   |   |   |
| Capital expenditures                                                                       |   | (1,948                                          | )      | (4,040                                                 | )      | (2,250 | ) | (6,384 | ) |
| Net cash used in investing activities                                                      |   | (1,948                                          | )      | (4,040                                                 | )      | (2,250 | ) | (6,384 | ) |
| Cash flows from financing activities:                                                      |   |                                            |   |                                                   |   |   |   |   |   |
| Payments on non-compete  commitment                                                        |   | (2,400                                          | )      | (2,400                                                 | )      | — |   | (2,400 | ) |
| Additional capital invested                                                                |   | —                                          |   | —                                                 |   | 2,281 |   | 9,157 |   |
| Dividends paid                                                                             |   | (2,565                                          | )      | (618                                                   | )      | — |   | — |   |
| Net cash provided by (used in) financing activities                                        |   | (4,965                                          | )      | (3,018                                                 | )      | 2,281 |   | 6,757 |   |
| Net decrease in cash                                                                       |   | —                                          |   | —                                                 |   | — |   | — |   |
| Cash at beginning of period                                                                |   | —                                          |   | —                                                 |   | — |   | — |   |
| Cash at end of period                                                                      |   | $                                               | — |                                                   | $      | — |   | $ | — |   | $ | — |   |

 

Duringthe year ended December 31, 2002 and the nine months ended December 31, 2001,the Company recorded a non-cash guaranteed preferred unit holder return payableof $4,040 and $688 representing the net earnings and 10% guaranteed preferredunit holder return, respectively, which reduced unit holder equity by a likeamount.

 

Inconjunction with the purchase of the Connecticut facility during 1999, thecompany recorded a non-compete agreement of $12,000 and a related non-competecommitment for $12,000 of which $2,400 was paid in 2002, 2001 and 2000.  (See Note D).

 

Theaccompanying notes are an integral part of these financial statements.

 

106

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**M-FOODSDAIRY TXCT, LLC**

**(AMajority Owned Subsidiary of Michael Foods, Inc.)**

**NOTES TOFINANCIAL****STATEMENTS**

 

**NOTE A – ORGANIZATION, BUSINESS ANDMERGER**

 

**Organization**

M-Foods Dairy TXCT, LLC (the “Company”) is a majority owned subsidiaryof Michael Foods, Inc., a wholly owned subsidiary of M-Foods Holdings,Inc.  Prior to the Merger describedbelow, Kohler Mix – TXCT (the “Predecessor,” “Operating Unit” or the “Unit”)was an operating unit of Michael Foods, Inc. The change in control of Michael Foods, Inc. and the reorganization ofthe operating unit into M-Foods Dairy TXCT, LLC are more fully described below.

 

**Business**

The Company processes and distributes soft serve ice cream mix, frozenyogurt mix, milk and specialty dairy products, many of which are ultra-hightemperature pasteurized, from its facilities in Texas and Connecticut.

 

**Merger**

On April 10, 2001, Michael Foods, Inc. and its subsidiaries (“MichaelFoods”) was acquired in a transaction (the “Merger”) led by an investor groupcomprised of a management group led by Michael Foods’ Chairman, President andChief Executive Officer, Gregg Ostrander, affiliates of Jeffrey Michael, amember of the Predecessor Board of Directors, and affiliates of two privateequity investment firms, Vestar Capital Partners and Goldner HawnJohnson & Morrison Incorporated, collectively, M-Foods Investors,LLC.  Under the terms of the Mergeragreement, all outstanding shares of Michael Foods com­mon stock were convertedinto the right to receive $30.10 per share in cash, or value equal thereto, andall outstanding stock options were converted into the right to receive, incash, $30.10 per share reduced by the exercise price per share for all sharessubject to such stock options.  Thepurchase of the outstand­ing shares was financed through new equity financingof approximately $175,000,000, a senior secured credit facility of up to$470,000,000 at market-based variable interest rates, and $200,000,000 ofsenior subordinated notes at an 11.75% annual inter­est rate.

 

Immediately after the close of the Merger, Michael Foods contributedthe assets of its Dairy division into two limited liability corporations,M-Foods Dairy, LLC and M-Foods Dairy TXCT, LLC (collectively, the “Dairy LLCs”)and in exchange received voting preferred and voting common units from theseentities equal to the fair value of the net assets contributed, whichcollectively were approxi­mately $35,800,000 (the approximate fair valuecontributed to M-Foods Dairy TXCT, LLC was $8,950,000).  The preferred units issued to Michael Foodshave an annual 10% preferred return guarantee and represent 100% of thepreferred units issued and outstanding. In addition, Michael Foods received 5% of the common units issued byeach of the Dairy LLCs with the common units held by Michael Foods representing100% of the voting common units issued and outstanding.  These common units have a stated value of$25,000.  The remaining 95% of thecommon units, which are non-voting, are owned by M-Foods Dairy Holdings, LLC,which is owned by the same owners, or affiliates of such owners, in the sameproportion, as the unit holders of M-Foods Investors, LLC.  The Dairy LLCs common unit interest owned byM-Foods Dairy Holdings, LLC was purchased for $475,000 as of April 1, 2001.

 

107

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Following the Merger, Michael Foods, Inc. became an indirectwholly-owned subsidiary of M-Foods Investors, LLC and M-Foods Dairy TXCT, LLCbecame a majority owned subsidiary of Michael Foods, Inc.

 

The Merger was accounted for as a purchase in accordance withAccounting Principles Board Opinion 16, Business Combinations and EITF 88-16,Basis in Leveraged Buyout Transac­tions. Accordingly, the acquired assets and liabilities were recorded at fairvalue for the interests acquired by new investors and at the carryover basisfor continuing investors.

 

As a result, the assets and liabilities were assigned new values, whichare part Predecessor cost and part fair value, in the same proportions as thecarryover basis of the residual interests retained by the continuing managementinvestors and continuing affiliate investors of the Michael family and the newinterests acquired by the new investors. The deemed dividend related to the Michael Foods investment in theassets and liabilities of the Dairy LLCs was pushed down to these majorityowned subsidiaries, as if they were wholly owned subsidiaries since MichaelFoods owns all of the voting stock and the Dairy LLCs are being operated by themanagement of Michael Foods.  The amountof the deemed dividend at Michael Foods was $66,631,000.  However, the historical cost basis equity ofthe continuing investors of the Company was $21,623,000, which exceeded theCompany’s fair market value by $12,673,000. This resulted in an allocation of carryover basis in excess of the fairmarket value of the Company in the amount of $3,928,000.

 

For ease of presentation, the Merger has been reflected in theaccompanying financial statements as if it had occurred on April 1,2001.  Management determined that nomaterial transactions occurred during the period from April 1 through April 9,2001. The Company’s financial statements have been presented on a comparativebasis with the Predecessor’s historical operating unit financial statements,prior to the date of Merger.  Differentbases of accounting have been used to prepare the Company and Predecessorfinancial statements.  The primarydifferences relate to the 10% yield on preferred units, depreciation andamortization of fixed assets and other intangible assets recorded at fair valueat the date of acquisition, and income taxes which are payable by the Company’sunit holders.

 

The fair value contributed by Michael Foods to M-Foods Dairy TXCT, LLCwas $8,950,000 and this amount, plus an additional carryover basis of$3,928,000, was allocated to the acquired assets and liabilities based on theirfair values at April 1, 2001.  Inaddition, $118,750 was contributed by new investors in exchange for Class B -non voting common units.  The fairvalues of long-term assets were obtained from a valuation report issued by athird party appraisal firm.  Theallocations were as follows:

 
| Working capital                  |   | $     | 7,420  |   |
|----------------------------------|--------|-------|--------|--------|
| Property, plant & equipment  |   | 8,980 |   |
| Other assets                     |   | 1,397 |   |
| Long-term non-compete commitment |   | 4,800 |   |

 

108

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Theunaudited pro forma revenue and pre-tax net earnings for the year endedDecember 31, 2001, which assumes the Merger had occurred on January 1, 2001,are derived by combining the application of the pro forma adjustments to thePredecessor’s historical statement of earnings for the three months ended March31, 2001, with the Company’s actual results for the nine months ended December31, 2001.  The net sales and netearnings for the year ended December 31, 2002 represent actual results for theperiod.

 
|                                |   | **Year ended****December 31, 2002** |   | **Year ended****December 31, 2001** |   |
|-------------------------------------|--------|-------------------------------------|--------|-------------------------------------|--------|
|                                |   | **(in thousands)**                  |   |
| Revenue                             |   | $                                   | 85,360 |                                | $      | 98,287 |   |
| Earnings (loss) before income taxes |   | 4,040                               |   | (351                                | )      |
|                                     |        |                                     |        |                                     |        |  |  |

 

The most significant of the pro forma adjustments reflected in the aboveamounts were to record a reduction in depreciation and amortization chargesresulting from write-down of long-term assets. The pro forma financial information should be read in conjunction withthe related historical information and is not necessarily indicative of theresults that would have been obtained had the transaction actually taken placeat the beginning of the periods presented.

 

**NOTE B – SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

 

**Basis of Presentation**

The accompanying consolidated financial statements as ofDecember 31, 2000 and for the year then ended and for the three monthsended March 31, 2001 have been taken from the historical books and recordsof the Predecessor. The respective Statements of Operations include an allocationof general and administrative costs incurred by Michael Foods and allocationsto this Operating Unit from the other Dairy LLC operating unit, M-Foods Dairy,LLC.  Management believes itsallocations to, and between, these Operating Unit financial statements are reasonable.  Additionally, Predecessor Operating Unitequity includes the cumulative net advances between the Operating Unit andMichael Foods, which are considered additional capital invested from, orconstructive dividends to, Michael Foods. Accordingly, the accompanying financial statements may not necessarilybe indicative of the results that could have been obtained if the OperatingUnit had been operated as a stand-alone entity.

 

The Company adopted the accounting policies of the Predecessor.

 

**Use of Estimates**

Preparation of the accompanying financial statements in conformity withaccount­ing principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect reportedamounts of assets and liabilities, related revenues and expenses and disclosureabout contingent assets and liabilities at the date of the financialstatements. Actual results could differ from the estimates used by management.

 

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**Accounts Receivable**

The company grants credit to customers in the normal course ofbusiness, but generally does not require collateral or any other security tosupport amounts due.  Managementperforms on-going credit evaluations of customers.  The company considers accounts receivable to be fullycollectible; accordingly, no allowance for doubtful accounts is provided.  If amounts become uncollectible, they willbe charged to operations when that determination is made.

 

**Inventories**

Inventoriesare stated at the lower of cost (determined on a first-in, first-out basis) ormarket. Inventories consisted of the following at December 31 (in thousands):

 
|                               |   | **2002** |   | **2001** |   |
|------------------------------------|--------|----------|--------|----------|--------|
| Raw materials and supplies         |   | $        | 3,014  |     | $      | 1,880 |   |
| Work in process and finished goods |   | 1,005    |   | 1,435    |   |
|                               |   | $        | 4,019  |     | $      | 3,315 |   |

 

**Property, Plant and Equipment**

Depreciation is provided in amounts sufficient to relate the cost ofdepreciable assets to operations over their estimated service lives,principally on the straight-line basis. Estimated service lives range from3-10 years for machinery and equipment. Leasehold improvements are amortized over the shorter of the lease termor the useful life of the improvement. Accelerated and straight-line methods areused for income tax purposes.

 

**Revenue Recognition**

Sales are recognized when goods are shipped to customers and arerecorded net of estimated customer programs and returns.

 

**NOTE C – INCOME TAXES**

 

**Company**

For income tax purposes the Company is a pass through entity,therefore, income taxes have not been reflected on the Company’s financialstatements.

 

**Predecessor**

The activity of the Operating Unit has been included in the income taxreturn of Michael Foods, Inc. for financial reporting purposes.  The Unit has been allocated a provision forincome taxes in an amount generally equivalent to the provision that would haveresulted had the Unit filed a separate income tax return.

 

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**NOTE D – NON-COMPETE AGREEMENT ANDCOMMITMENT**

 

During 1999, as part of the consideration for its Connecticut dairyasset purchase, the Operating Unit entered into a $12,000,000 non-competeagreement.  Under the agreement, theOperating Unit agreed to make five annual $2,400,000 payments beginning in1999.  The total remaining commitment atDecember 31, 2002 and 2001 was $2,400,000 and $4,800,000, respectively.

 

Our acquired intangible non-compete asset that hasbeen determined to have a definite life and continues to be amortized as ofDecember 31, 2002 is as follows:

 
|        |   | **Gross Carrying  Amount** |      | **Accumulated  Amortization** |   |
|-------------|--------|----------------------------|-----------|-------------------------------|--------|
| Non-compete |   | $                          | 1,398,000 |                          | $      | (869,000 | ) |
|             |        |                            |           |                               |        |  |  |

 

The aggregate amortization expense for the yearended December 31, 2002 was approximately $529,000 and $340,000 for the ninemonths ended December 31, 2001.  ThePredecessor had amortization expense of approximately $500,000 during the threemonths ended March 31, 2001.  Theremaining amortization expense of $529,000 will be recorded in 2003.  The non-compete will be fully amortized byDecember 31, 2003.

 

**NOTE E – EMPLOYEE RETIREMENT PLAN**

 

Full-time employees who meet certain service requirements are eligibleto participate in a defined contribution retirement plan of Michael Foods,Inc.  Under the Plan, the Companymatches up to 4% of each participant’s eligible compensation.  Company contributions under the plan for theyear ended December 31, 2002 were $107,000 and for the nine months endedDecember 31, 2001 were $82,000.  ThePredecessor’s contributions related to the Unit’s eligible employees totaled$104,000 for the year ended December 31, 2000 and $33,000 for the threemonths ended March 31, 2001.

 

**NOTE F – COMMITMENTS ANDCONTINGENCIES**

 

**Leases**

The Company leases certain equipment and property under operating leaseagreements expiring at various dates through 2009.  Rent expense, including real estate taxes and maintenanceexpenses, was approximately $2,621,000 for the year ended December 31, 2002 and$1,754,000 for the nine months ended December 31, 2001.  Predecessor rent expense was $527,000 forthe three months ended March 31, 2001 and $2,593,000 for the year endedDecember 31, 2000.

 

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Minimumfuture lease obligations under these operating leases are as follows for theyears ending December 31 (in thousands):

 

| 2003       |   | $     | 2,196  |   |
|------------|--------|-------|--------|--------|
| 2004       |   | 2,196 |   |
| 2005       |   | 1,410 |   |
| 2006       |   | 1,177 |   |
| 2007       |   | 914   |   |
| Thereafter |   | 982   |   |

 

**Litigation**

The Company is engaged in routine litigation incidental to itsbusiness.  Management believes theultimate outcome of this litigation will not have a material effect on theCompany’s financial position, liquidity or results of operations.

 

**NOTE G – UNIT HOLDER RETURNPREFERENCES**

 

The income or loss resulting from the Company’s operations will beallocated as follows:

 

•                  Losses willfirst be allocated to the common unit holders to the extent of their capitalaccounts.  The maximum loss allocationis, therefore, limited to $125,000 which would be allocated $6,250 to MichaelFoods, Inc. and $118,750 to the non-voting common unit holders; thereafter, alllosses are allocated to Michael Foods, Inc.;

 

•                  The Company’sincome will be allocated to Michael Foods, Inc. until all preferred units andreturn on preferred units of both Dairy LLCs have been recovered.  The Dairy LLC’s combined preferred unitshave a value of approxi­mately $26,850,000 and earn the greater of a 10%cumulative return on the capital contribution or the Company’s net earningsthrough the second anniversary of the agreement and a 10% cumulative returnthereafter.  The preferred unit holderreturn payable as of December 31, 2002 and December 31, 2001, respectively, was$4,040,000 and $688,000, which represented the net earnings for 2002 and the10% cumulative return for 2001;

 

•                  Income in excessof the preferred unit amount and preferred unit return is distributed, subjectto various limitations, to the common unit holders.  Michael Foods, Inc. will receive 5% of this income, for theirportion of the common units outstanding and the other common unit holders willreceive 95%.  The other common unit holdersare permitted to keep an amount of this distribution equal to the tax due onthe income they receive.  Any addi­tionaldistribution, in excess of the taxes due, must be contributed in exchange forcapital stock of M-Foods Holdings, Inc. until such time as all of the revolvingcredit facility, term loans A and B, and senior subordinated notes have beenrepaid;

 

•                  In the event theCompany is sold while Michael Foods, Inc.’s revolving credit facility, seniorterm loans A and B or subordinated debt is outstanding, the gain or loss on thesale will follow the allocation methods described above and gains must becontributed in exchange for capital stock of M-Foods Holdings, Inc. until allof the revolving credit facility, term loans A and B, and senior subordinatednotes have been retired.  The total 

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amount of Michael Foods, Inc. outstanding debt subjectto this distribution restriction is approximately $500,000,000 and $548,000,000at December 31, 2002 and 2001, respectively.

 

**NOTE H – STOCK OPTION PLANS**

 

Certain officers and employees of the Predecessor participated invarious stock option plans sponsored by the Michael Foods Predecessor.  The Michael Foods Predecessor followedAccounting Principal Board No. 25 (“APB 25”) in accounting for stock optionsissued under its plans.  Under APB 25,no compensation expense was recognized by the Michael Foods Predecessor relatedto the Unit’s officers or employees for any of the periods presented.  At the time of the Merger, all stock optionsissued and outstanding under these plans vested and were retired.  For information related to the Michael FoodsPredecessor’s stock option plans, refer to Note I of its financial statementscontained elsewhere in this document.

 

**NOTE I – SIGNIFICANT CUSTOMERS**

 

Sales to three customers accounted for approximately 28%, 18% and 18%of net sales for the year ended December 31, 2002 and 33%, 25% and 14% for theyear ended December 31, 2001.  Sales totwo customers accounted for approximately 27% and 18% of net sales for the yearended December 31, 2000.

 

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