**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**Form 10-K**

 

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**ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**Forthe fiscal year ended December 31, 2002**

 

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**CommissionFile No. 000-24337**

 

| **Horizon  Organic Holding Corporation**                               |
|------------------------------------------------------------------------|
| (a Delaware  Corporation)                                              |
|                                                                   |
| I.R.S. Employer  Identification Number  **84-1405007**       |
| **6311  Horizon Lane  Longmont, Colorado  80503  (303) 530-2711** |
|                                                                   |
| Securities  registered pursuant to Section 12(b) of the Act:           |
| **Not  Applicable**                                                    |
|                                                                   |
| Securities  registered pursuant to Section 12(g) of the Act:           |
| **Common  Stock, $.001 Par Value Per Share**                           |

 

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 requirement for the past90 days.  Yes ý.  No  o.

 

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 byreference in Part III of this Form 10-K or any amendment to this Form10-K.  o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theAct).  Yes  ý.  No  o.

 

The approximate aggregatemarket value of the Common Stock held by non-affiliates of the registrant basedupon the last sales price of the Common Stock reported on the NationalAssociation of Securities Dealers Automated Quotation National Market Systemwas $105,706,010 as of June 30, 2002.

 

As of March 3, 2003, theregistrant had outstanding 10,305,101 shares of its common stock, $.001 parvalue per share.

 

**DOCUMENTS INCORPORATED BY REFERENCE:**

 

Information required byPart III (Items 10, 11, 12 and 13) is incorporated by reference to portions ofthe registrant’s definitive proxy statement for the 2003 Annual Meeting ofStockholders which will be filed with the Securities and Exchange Commissionwithin 120 days after the close of the 2002 year.

 

 

 

HORIZON ORGANICHOLDING CORPORATION

 

Annual Report onForm 10-K

December 31, 2002

 

Table of Contents

 
|    | **PART I**                                                                                  |
|---------|---------------------------------------------------------------------------------------------|
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| Item 1  | Business                                                                                    |
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| Item 2  | Properties                                                                                  |
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| Item 3  | Legal Proceedings                                                                           |
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| Item 4  | Submission of Matters to a Vote of Security  Holders                                        |
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|    | **PART  II**                                                                                |
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| Item 5  | Market for Registrant’s Common Equity and  Related Stockholder Matters                 |
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| Item 6  | Selected Consolidated Financial Data                                                        |
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| Item 7  | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |
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| Item 7A | Quantitative and Qualitative Disclosures about  Market Risks                                |
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| Item 8  | Consolidated Financial Statements and  Supplementary Data                                   |
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| Item 9  | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure       |
|    |                                                                                        |
|    | **PART  III**                                                                               |
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| Item 10 | Directors and Executive Officers of the  Registrant                                         |
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| Item 11 | Executive Compensation                                                                      |
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| Item 12 | Security Ownership of Certain Beneficial Owners  and Management                             |
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| Item 13 | Certain Relationships and Related Transactions                                              |
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| Item 14 | Controls and Procedures                                                                     |
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|    | **PART  IV**                                                                                |
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| Item 15 | Exhibits, Consolidated Financial Statement  Schedules and Reports on Form 8-K               |

 

 

**PART I**

 

Except for the historical information contained herein, the followingdiscussion contains forward-looking statements that involve risks anduncertainties.  Our actual results coulddiffer materially from those discussed herein. Factors that could cause or contribute to such differences include, butare not limited to, those discussed in this section under the heading “RiskFactors”.

 

**ITEM 1****.**                             **BUSINESS**

 

**Overview**

 

We produce and market the leading brands oforganic milk and a full line of branded, refrigerated, organic dairy products,juices and desserts. We market our products under the Horizon Organic and TheOrganic Cow of Vermont brand names in the U.S. and the Rachel’s Organic brandname in the U.K. Horizon Organic is the largest brand of organic foods in theU.S. We also license our Horizon Organic brand for use on organic dairyproducts in Japan and organic eggs in the U.S. According to *Information Resources, Inc.*, a marketresearch firm, our organic fluid milk had an approximately 70% market share ofall organic fluid milk sold in conventional supermarket chains in the U.Sduring the twelve weeks ended December 31, 2002.

 

Due in part to perceived health risks withconventional foods and production processes, consumers are increasingly seekingcertified organic foods as a safe alternative to conventional foods. Certifiedorganic foods are manufactured under strict regulations that mandate all rawingredients not contain, and production processes not use, any pesticides,antibiotics, hormones or genetically modified organisms. We believe that ourreputation and commitment to product quality enable us to position HorizonOrganic as the leading organic alternative to conventional food products.

 

We have experienced rapid growth since introducingour first product, organic non-fat yogurt, in 1992. We became the first companyto offer branded organic milk nationwide in the U.S., and we continue toleverage our strong position as the leading organic food brand in the U.S. tocapitalize on the growing demand for organic products. We have introduced acomplete line of branded organic products including yogurts, pasteurized andultra–pasteurized milk, cheese, butter, sour cream, cottage cheese, creamcheese, whipping cream, pudding, fruit jels, half and half and juices, in avariety of flavors, sizes and packaging. We currently sell 118 differentbranded and private label stock keeping units, or SKUs, in the U.S.  We believe that our organic brands appeal toa broad range of consumers, which will allow us to extend our brands byintroducing additional dairy and non-dairy organic products.

 

We sell our products through leading natural andorganic retailers, national and regional conventional supermarket chains, massmerchant retailers, other specialty food retailers and food manufacturers whouse our products as ingredients. Our products are available in many well-knownretail companies in the U.S., including A&P, Albertson’s, Bruno’s, FoodLion, Giant Foods, HEB, Kroger, Meijer, Safeway, Starbucks, Stop & Shop,Target, Wal-Mart, Whole Foods Market, Wild Oats and Winn-Dixie. We estimatethat we sell our products at over 20,000 retail locations in the U.S. and ourproducts are available, as of December 31, 2002, in retail locations that sell60% of all commodity volume, or ACV, of the total grocery products sold in theU.S.

In the U.K., we historically marketed highermargin branded dairy products under the Rachel’s Organic brand and privatelabel organic fluid milk. Based on an independent consumer research study wecommissioned, we found that the Rachel’s Organic brand has strong consumerappeal, is perceived by consumers as sophisticated, upscale and high qualityand has credibility as a leading organic brand. As a result, we are developingour business in the U.K. to focus on expanding the Rachel’s Organic brand, muchas we have done with the Horizon Organic brand in the U.S. In December 2001,we entered into a processing and distribution agreement with Dairy CrestLimited, the largest dairy foods company in the U.K. Under this agreement,Rachel’s Organic branded fluid milk has replaced all of Dairy Crest’s brandedorganic fluid milk and Dairy Crest is our primary processor and distributor fororganic fluid milk products throughout the U.K. Currently, our products areavailable in Tesco, Safeway, Sainsbury’s, Somerfield, Waitrose, and Morrisonschains which together represent approximately 64% of all grocery sales in theU.K. In addition, Dairy Crest is distributing our Rachel’s Organic brandedfluid milk through its home delivery system. We believe our distribution andprocessing agreement with Dairy Crest will increase recognition of the Rachel’sOrganic brand and allow us to further expand this brand into additional organiccategories in the U.K. 

 

Our total net sales have grown from$29.6 million in 1997 to $187.5 million in 2002, representing a compoundannual growth rate of 44.7%, driven primarily by internal growth andsupplemented with select strategic acquisitions. Diluted earnings per sharefrom continuing operations increased from $0.08 per share in 1997 to $0.34 pershare in 2002, representing a compound annual growth rate of 33.0%.

 

**Industry Overview**

 

According to Datamonitor’s U.S Organics 2002,organic food sales in the U.S. increased to an estimated $9.5 billion in 2001from $3.6 billion in 1996, representing a compound annual growth rate of21.5%, yet the segment represents less than 2.0% of overall U.S. food sales.

 

Organic food products are now available in leadingnatural and organic products retailers, conventional supermarket chains,mass-merchant retailers and other specialty food retailers across the U.S.  Datamonitor estimates that conventionalsupermarket chains represented 45.8% of organic food sales while natural andorganic retailers represented 54.2% in 2001. We believe that an increase in product availability and an increase inconsumer perception that organic foods represent a safer and healthier choicewill continue to support the industry’s future growth.

 

Organically grown foods are subject to strictfarming and handling practices that naturally optimize the health andproductivity of soil life, plants and animals. Prior to October 2002, variousorganizations, such as Quality Assurance International, Oregon Tilth CertifiedOrganic, Organic Growers and Buyers Association and The Organic CropImprovement Association, used differing standards to certify products as organic.The U.S. government has adopted federal regulations, which were fullyimplemented in October 2002, to standardize organic certificationrequirements regarding pesticides, antibiotics, hormones, genetically modifiedorganisms and farming practices. Producers in compliance with the newregulations are allowed to use the “USDA Organic” seal in product labeling,packaging and branding for products made with 95.0% or more organicingredients.

 

According to Datamonitor’s*U.S. Organics 2002*, from 1996 to 2001 theU.S. organic dairy market grew at a compound annual growth rate ofapproximately 57.9% per year, yet represents less than 1.0% of the$43.9 billion total retail market for U.S. dairy products.

 

According to the Soil Association, an independentorganic certification organization, the U.K. organic retail market is growingat a rate of more than 15% per year, and yet represents just 1.0% of the total food and drink market in theU.K.

**Our Strategy**

 

Our goal is to continue growing our net sales andearnings by strengthening our position as the leading organic food brand in theU.S. and building a leading position in the U.K. The key elements of ourbusiness strategy are to:

 

•                                          **Increase Retail Availability ofOur Products.**  We believe there is substantial opportunityto increase retail availability of our products by expanding our distributionto include additional stores of our existing retail customers, adding newretailers and targeting new categories of retailers such as food service,convenience, drug and club store chains. We increase shelf space and the numberof SKUs we sell through existing retail customer locations generally by firstintroducing organic fluid milk, and then as we establish credibility with aretailer, introducing our other dairy and juice products. In addition, wemanage organic dairy sections for our retailers to further increase retailavailability.

 

•                                          **Introduce New Organic Products inExisting and New Product Categories.**  We believe our brands areextendable to new products in existing and new organic product categories. Ournew product development strategy is to create branded organic counterparts topopular conventional foods. We believe that identifying products for whichthere is already consumer demand increases the likelihood of a successfulintroduction. We introduce new products through internal development,acquisitions and strategic partnerships with other organic and conventionalfoods companies. We have a strong record of successful product categoryintroductions. In 1998, we introduced a line of organic juices. In 1999, weintroduced a line of ultra-pasteurized milk products with a 60-day extendedshelf life, enabling us to expand significantly our retail customer base. InJanuary 2002, we introduced our flavored, single-serve milk products inapproximately 2,500 Starbucks locations, and we are expanding distribution inour existing retail channels. In 2002, we entered the refrigerated dessertbusiness with the March introduction of a new line of organic pudding, and the Octoberintroduction of a new line of organic fruit jels.

 

•                                          **Enhance the Image and IncreaseConsumer Awareness of our Brands.**  Our consumer research indicates that boththe Horizon Organic and Rachel’s Organic brands stand for high quality organicfood products. We believe that our distinctive product packaging stands out incrowded refrigerated dairy cases and supports our brand positioning. In theU.S., we market our products principally under the Horizon Organic brand nameusing our distinctive “Happy Cow” logo, which we believe is easily identifiedby, and appeals to, a broad range of consumers.  During 2002 we launched major public relations and consumereducation programs around the new Organic Standards which became effectiveOctober 21, 2002. In the U.K., our Rachel’s Organic brand uses distinctiveblack packaging to create brand identity and differentiate our productofferings.

 

•                                          **Strengthen Partnerships with ourSuppliers, Processors and Retailers.**  We work closely with oursuppliers to increase our supplies of raw organic fluid milk. We share theexpertise we have gained from running our own organic dairy farms with oursuppliers enabling them to provide us more milk, cost effectively. We carefullyselect our processors to achieve the highest quality at the lowest cost withthe best customer service. We expand our relationships with existing retailcustomers by providing category management expertise to help customers optimizethe merchandising of our products to attract increased consumer attention. Aspart of this, we currently manage approximately 2,000 organic dairy sections,including many at Kroger retail locations.

•                                          **Increase Supply Chain Efficiencyto Reduce Costs.**  We source the majority of our organic dairysupply requirements from independent organic dairy farms, most of our dairy andjuice products are processed by third party processors and we outsource all ofour warehousing and distribution to independent distributors or transportationproviders. We continue to improve the efficiency of our supply chain byoptimizing our network of geographically dispersed suppliers and processors,enabling us to reduce transportation costs. During late 2001 and throughout2002, we implemented new enterprise-wide information technology systems tobetter manage our supply chain. These new systems enabled us to improve ourorder tracking and inventory management, which has helped us improve ourmargins.

 

**Our Products and Product Development**

 

We offer a full line of branded, refrigerated,organic dairy products and juices under the Horizon Organic, The Organic Cow ofVermont and Rachel’s Organic brands. We offer a total of 177 SKUs in the U.S.and U.K. of which 98 are marketed under the Horizon Organic brand, 10 aremarketed under The Organic Cow of Vermont brand, 44 are marketed under theRachel’s Organic brand and 25 are marketed under private labels. We also offera number of our products in larger volume varieties for industrial sales. Ourproduct mix has shifted and will continue to shift over time as we continue tointroduce additional organic dairy and non-dairy products.

 

Our new product development strategy is to createbranded organic counterparts to popular conventional foods. In 2002 weimplemented a corporate development function to evaluate consumer interest,sales and profit potential, and required operations for the introduction of newproducts. Internally, it generally takes between three to nine months fromconcept stage to the launch of a new product at retail. We will also seek toadd new product lines and categories through acquisitions or strategicpartnerships using our rigorous internal evaluation process.

 

*Fluid Milk.*  Weintroduced organic fluid milk in 1993 and currently market 28 SKUs of fluidmilk under the Horizon Organic brand name and 10 SKUs under The Organic Cow ofVermont brand name in New England. During late 1999 and in 2000, wesignificantly expanded the production and sale of ultra-pasteurized milkproducts. Ultra-pasteurized milk has a significantly longer shelf life than traditionallypasteurized milk (60 days versus 17 days), and as a result, is a muchmore desirable introductory product for new retail customers. During 2002,ultra-pasteurized milk accounted for 54.6% of our fluid milk sales in the U.S.and has been our strongest product line for expanding into new grocerydistribution. In January 2002, we introduced a new line of single-serve,flavored organic milk marketed under the Horizon Organic brand.  This product is shelf-stable and has a shelflife of approximately 180 days. We initially introduced this product intoapproximately 2,500 Starbucks locations, and by the end of the year it hadachieved ACV distribution in conventional grocery stores of 15.2%. Net sales oforganic fluid milk in the U.S. increased 20.3% to $109.1 million in 2002from $90.7 million in 2001.

 

*Other Dairy.*  Inaddition to fluid milk, we market organic cheese, yogurt, butter, sour cream,cottage cheese, pudding, fruit jels, half and half, whipping cream and creamcheese. We introduced organic cheese in 1996 and currently market 14 SKUs oforganic cheese under the Horizon Organic brand name. We market a variety oforganic cheeses, including Cheddar, Monterey Jack, Colby, Mozzarella andParmesan. Net sales of organic cheese in the U.S. increased 25.5% to $5.9million in 2002 from $4.7 million in 2001. We introduced organic yogurt in 1992and currently market 21 SKUs under the Horizon Organic brand name. We market 19flavors of yogurt in a variety of package sizes. Net sales of organic yogurt inthe U.S. increased 12.4 % to $9.7 million in 2002 from $8.6 millionin 2001. We introduced organic butter in 1996 and currently market 7 SKUs oforganic butter under the Horizon Organic brand name. Net sales of organicbutter in the U.S. increased 29.5 % to $10.2 million in 2002 from $7.9million in 2001.

 

*Juice.*  Weintroduced organic juice in 1998 and currently market 15 SKUs of organic juiceunder the Horizon Organic brand using various sizing and packaging. We market11 different varieties of organic juices including orange, pulp-free, with pulpand with added calcium; grapefruit, and with added calcium; orange-carrot;pineapple-orange; strawberry-lemonade; raspberry-lime; and lemonade. Net salesof organic juice in the U.S. decreased 4.2 % to $7.9 million in 2002 from$8.2 million in 2001.

*International.*  In early2002 we introduced organic fluid milk under the Rachel’s Organic brand. Wecurrently market 7 SKUs of fluid milk under the Rachel’s Organic brand name inthe U.K. and 8 SKUs under various private label brands. We market 39 SKUs oforganic yogurt, of which 34 are marketed under the Rachel’s Organic brand nameand 5 are private label. In addition to fluid milk and yogurt, we market 1 SKUof butter and 2 SKUs of cream products under the Rachel’s Organic brand and 2SKUs of private label butter.

 

*Licensing.*  We havealso introduced certain new products by licensing our Horizon Organic brand toother organic food producers. For example, we currently license our HorizonOrganic brand to Glenwood Foods, LLC and NuCal Foods, Inc. for use inconnection with the sale of organic eggs in the U.S. In 1999, we entered intoour first international licensing agreement with Takanashi MilkProducts, Ltd., granting Takanashi the right to use the Horizon Organicbrand on its organic dairy products for the Japanese market. We consider otherlicensing and co-branding arrangements, including ones in which our organicdairy products can be used as ingredients in other organic products.

 

**Organic Dairy Standards and Our Quality Assurance**

 

In October 2002, the U.S. Department ofAgriculture, or USDA, implemented the Organic Regulations under the OrganicFoods Production Act. The Organic Regulations set forth the minimum federalstandards that all organic food companies must comply with in order for theirproducts to be certified organic. Once producers are certified organic, theyare able to display the “USDA Organic” seal in product labeling and packagingto assure consumers that products displaying the seal meet these standards. Allof our products bear (or will bear when packaging materials are updated) theUSDA Organic seal. The Organic Regulations have replaced the previous organicstandards that were applied independently by a variety of state agencies andprivate certification organizations.

 

To be certified organic under the OrganicRegulations by independent, government-approved, private certificationorganizations in the U.S., feed must be grown on land that has been free ofsynthetic fertilizers, pesticides and herbicides for at least three years. TheOrganic Regulations specify:

 

•                                          the feed ratio and time periods for distinctorganic dairy herds;

 

•                                          replacement animal management requirements;

 

•                                          access to pasture requirements for organicanimals;

 

•                                          a list of allowed and prohibited substances thatcan be introduced to organic animals;

 

•                                          a process for petitioning for the inclusion orremoval of allowed and prohibited substances;

 

•                                          a list of prohibited vaccines for organic animals;and

 

•                                          regulations as to whether a product can be labeledorganic.

 

Organic farm milk must be isolated from contactwith conventional milk residue throughout the production and distributionprocess, from milking through transportation, processing and packaging.

 

Organic certification under the OrganicRegulations includes periodic field inspections of farming operations, soil andwater conditions and processing and distribution facilities. In addition,regulators and certification organizations will review detailed record-keepingand the organic producer’s comprehensive organic plan, which must detail farmpractices, document product inputs, and discuss all procedures. These reviewprocedures are designed to ensure that all producers, processors andtransporters are complying with the Organic Regulations.

In April 2002, Kevin R. O’Rell, ourVice-President of Research & Development/Quality Assurance, wasappointed to the National Organic Standards Board (NOSB). The NOSB wasestablished pursuant to The Organic Foods Production Act and was instrumentalin the development of the Organic Regulations. The NOSB, through its 15-memberboard, develops policies and standards for substances used in organic foods,and advises the Secretary of Agriculture on aspects of implementing the OrganicRegulations. Mr. O’Rell is on the board as a representative of the organicproducers and processors. His appointment continues through 2007.

 

**Marketing**

 

Our marketing strategy is designed to buildawareness of the Horizon Organic, The Organic Cow of Vermont and Rachel’s Organicbrands and generate consumer loyalty. We have positioned our products as highquality, premium alternatives to conventional foods. Our independent consumerresearch has shown that consumers recognize our brands as standing for highquality organic foods. We differentiate and support our brands through premiumbrand positioning, consumer-directed advertising, retail promotions, publicrelations and distinctive packaging.

 

All Horizon Organic brand dairy and juice productpackaging carries the proprietary Horizon Organic “Happy Cow” and earth logo,as well as our distinctive bright red, yellow and blue colors. The Organic Cowof Vermont brand products are packaged in their distinctive brown cow andpastel coloring, while the Rachel’s Organic brand products are packagedprimarily in distinctive black packaging. We believe our distinctive productpackaging stands out in crowded refrigerated cases. In addition, we use ourproduct packaging to carry consumer educational information about the value oforganic products in general and Horizon Organic products in particular.

 

We believe thatthe implementation of the Organic Regulations has increased awareness oforganic food products generally.  Inconnection with the implementation of the Regulations we launched extensiveadvertising and public relations campaigns to focus that awareness on ourbrands. As the largest organic food brand in the U.S., we believe HorizonOrganic benefited significantly from that increased awareness. We will continueto emphasize our status as a USDA certified organic producer in our advertisingand packaging now that the Organic Regulations are fully implemented.

 

The focus of our marketing strategy is to workwith our retail customers to educate consumers about the benefits of organicfoods for the consumer and the environment. These education efforts utilizetargeted direct mail and other written literature often with attached couponsto encourage new purchases. In addition, we utilize point-of-sale signage inour customers’ stores and consumer demonstrations to further educate andencourage consumers to try our organic dairy products.

 

During 2002, we increased consumer awareness andreinforced the positive image of our brands and the value of organic productsthrough a significant increase in consumer-directed advertising.  We also engage in other consumer and trademarketing activities, including public relations activities, aconsumer-oriented web page located at www.horizonorganic.com, consumer coupons,product sampling and trade promotions.

 

In October 2000, we opened the HorizonOrganic Farm and Education Center on the site of the former United States NavalAcademy Dairy Farm near Annapolis, Maryland. Approximately eight millionconsumers live within one-and-one-half hours of the Center. The Center is opento the public as a tourist attraction, with an 865 acre working organic farm, a3,000 square foot Discovery Barn, and a 2,200 square foot store featuringorganic merchandise, Horizon Organic branded products and other environmentallyfriendly products.

In the U.K., our marketing efforts are verysimilar to our activities in the U.S., but on a smaller scale and without anysignificant consumer-directed advertising. We conduct consumer promotionsthrough various retailer programs such as store circulars and food retailerpublications. We also utilize Rachel Rowlands, the founder of the Rachel’sOrganic brand, as our U.K. spokesperson for various public relations activitieswhile highlighting her role as a pioneer of organic farming and organic foodproduction. In addition, our association with Dairy Crest should provide uswith additional marketing capabilities, including higher impact point of saledisplays in retail outlets.

 

**Sales and Distribution**

 

We have established a sales team consisting of corporate and field basedemployees focused on improving the availability of Horizon Organic products inall classes of trade.  The field salesteam is managed by a national sales manager, and consists of thefollowing:  a national grocery manager,who is responsible for managing designated national accounts within theconventional grocery class of trade; a national natural foods manager, who isresponsible for managing the two largest retail chains in the natural foodsclass of trade; five regional sales managers, who are responsible for managingall conventional grocery retailers and distributors, natural foods retailersand distributors, and mass merchandisers within specified geographic regions.

 

We also have an agreement with Acosta Sales & Marketing, Inc., thenation’s largest food broker with over 8,000 employees, which provides us withkey account management, category management, and retail support in both classesof trade.  Our national and regionalsales managers manage and utilize each broker division within their areas ofresponsibility to effect product distribution, product placement, productmerchandising and product promotion for all retail customers.  Through this agreement, we successfullyincreased the percent of stores selling our products to 60% ACV in 2002.  This represents a 10 percentage pointincrease vs. prior year.

 

As the largest certified organic brand and the market leader invirtually every category in which we compete, we have assumed the role ofcategory manager for the organic dairy category.  By analyzing syndicated data, consumer panel data, and marketspecific historical data, our field sales team and broker network are able toidentify specific areas of opportunity for retailers and distributorsalike.  We are also able to outlineindustry trends, category growth rates, and consumer trends to the retailer inorder to assist in the buying decision. In this role, we have introduced over 2,000 organic dairy sections inconventional retailer chains throughout the U.S.  Each section contains a minimum of 20 Horizon Organic products.

 

The mission of our sales team is to establish,maintain, and continually develop relationships in all classes of trade inwhich we compete.  By maintaining closecontact and follow up on a regular basis, our sales team is better equipped tomeet the ever-changing demands of the marketplace.  New product innovation, speed to shelf, and commitment to ourcompany’s mission remain the key ingredients to our sales team’s ability tostay ahead of the competition.

 

In the U.K. we sell and distribute our branded andprivate label organic fluid milk through Dairy Crest Limited, the largestconventional dairy in the U.K. We have sales people in the U.K. who manage ourrelationships for our non-fluid milk products with our retail customers,principally the aforementioned chains that represent 64% of all grocery salesin the U.K.

 

In the U.S., we direct ship through third partytransportation providers or use independent distributors to deliver productsdirectly to retail stores. Our retail supermarket and mass merchant customerstypically take delivery of our products at the customers’ distributionwarehouse. In the U.K., our products are either shipped directly to largercustomers or sold through dairy distributors. In 2002, our four largestaccounts were United Natural Foods, a national distributor comprised ofnumerous regional distributors; Safeway, including its affiliated U.S. stores,Dominick’s, Randall’s/Tom Thumb, Genuardi’s and Vons; HP Hood, a dairyprocessor and distributor headquartered in Boston; and Sainsbury’s, one of thelargest supermarket chains in the U.K. During 2002, these four customersaccounted for 14.2%, 11.7%, 10.6% and 10.7%, respectively, of our total netsales.

**Production andProcessing**

 

*Organic Milk Supply.*  Ourbusiness depends on obtaining adequate supplies of raw fluid organic milk andjuices. As a pioneer in the industry, we historically faced the difficult taskof finding an adequate supply to meet our needs. Initially, we contracted forour supply of organic fluid milk products with a Wisconsin-based cooperative.At the time, there was a limited supply of organic fluid milk available forpurchase by dairies. In 1994, we made a strategic decision to begin developing ourown organic milk supply. We began by building a herd of organic cows at a dairyfarm in Idaho, which we subsequently acquired in 1997. Also in 1997, weacquired a dairy farm in Maryland in order to develop an internal organic milksupply for the eastern United States. In 1999, we entered into a herdmanagement agreement for a third party to manage an additional herd of organiccows in Colorado. We have established an extensive supply system, currentlysourcing organic milk from approximately 200 producers across the U.S.

 

In 2001, we made a strategic decision that therising interest in organic farming would allow us to secure a sufficient supplyof organic fluid milk from third parties and that it was no longer necessaryfor us to invest capital to expand our company-owned farms.  On May 1, 2002, we announced that we were innegotiations for the sale of the Idaho Dairy to an experienced dairyfarmer.  We expect to enter into a definitiveagreement and close the transaction in the spring of 2003.  In addition, we did not renew the managementagreement for our Colorado herd, which expired on September 30, 2002.  As part of the Idaho Dairy sale, we intendto enter into a long-term supply agreement with the buyer for organic fluidmilk at the expected fair market value. As a result, we will rely on a single supplier to provide us withapproximately 35% of our current organic raw milk supply.

 

We generally enter into supply agreements withorganic dairy farmers throughout the U.S. with a typical term of one to twoyears. The agreements obligate us to purchase certain minimum amounts oforganic fluid milk.

 

In the U.K., we source all of our organic fluidmilk supply from two organic milk cooperatives and three independent dairyfarmers for the production of all of our organic fluid milk and other organicdairy products pursuant to the following agreements:

 

•                                          In 2000, we entered into an agreement with OrganicMilk Suppliers Co-Operative Limited to supply us with the organic milknecessary to meet our obligations to provide organic milk to Sainsbury’sSupermarkets Limited.

 

•                                          In 2000, we entered into an agreement with CalonWen Organic Milk Co-Operative Ltd. to supply milk for our Rachel’s Dairy.This agreement expires in 2005.

 

•                                          In 2000, we entered into separate agreements withthree individual producers: Geoffrey William Persey, Roger Lucas Persey, and W.Persey & Son. Under the terms of each of these agreements, we purchaseall of the organic milk produced by each dairy at a fixed price. Theseagreements are due to expire in 2005, but are automatically renewed unlesseither party expressly gives notice of its desire not to renew the agreement.

 

Historically, our long-term contracts obligated usto purchase minimum supply amounts at fixed prices, which affected our marginswhen prices fell or when we overestimated demand. During 2002, the supply oforganic milk in the U.S. became very tight, and as a result, for 2003 we havecontracted for an amount slightly in excess of our anticipated sales volume inorder to be able to meet customer demand while positioning ourselves foropportunities for future growth.  On along-term basis, however, we do not intend to contract for all of ouranticipated needs, but instead will contract for 90-95% upon developing supplysources that will be available to us on an as needed basis. We believe thiswill give us additional flexibility and minimize the impact of price volatilityand fluctuating demand on our margins.

*Processing.*  In theU.S., we have a strategically located, nationwide network of processors tomanufacture and package organic fluid milk and other organic products fordistribution to our customers. This network includes 21 dairy processors, 8 ofwhich process fluid milk and 13 of which process non-fluid milk products, suchas yogurt, cheese and butter, as well as 2 organic juice processors. All of ourmilk processors have cold storage facilities that allow us to store fluid milkfor a specified duration. We continuously monitor our inventory and product mixagainst forecasted demand and schedule production processing accordingly. If wedetermine that the required supply of a particular product has been met, we areable to convert our remaining raw milk supply into several alternativeproducts, thus mitigating the risk of spoilage. Several of our processorsutilize ultra-pasteurization techniques, a process that greatly extends theshelf life of our fluid milk products. Ultra-pasteurized milk has a much longershelf life than traditional milk, 60 days versus 17 days, enabling us todeliver the product outside of our core markets. Furthermore, ultra-pasteurizedproducts are a much more desirable introductory product for our new retailcustomers where product turn may be slower and, to date, has been one of ourstrongest product lines for expanding milk distribution into new grocerychains.

 

In the U.K., we historically processed ourproducts primarily at our 2 company-owned plants located in Aberystwyth andHoniton. The balance of our products, which comprised less than 5.0% of totalU.K. net sales, were processed at four third-party plants. In July 2002 weclosed our Honiton milk processing plant pursuant to the December 2001agreement with Dairy Crest that provides for processing and distribution of ourprivate label and Rachel’s Organic branded milk.    Furthermore, during 2002 we produced approximately 26.0% of oursales at our Rachel’s Organic plant in Aberystwyth, which produces primarilyyogurt.

 

*Transportation.* Transportation costs represent a significant portion of our cost ofsales. We outsource all of the inbound and outbound transportation of organicfarm milk from our producers to processors, as well as the transportation offinished goods from processing plants to our customers or cold storagewarehouses. We have and will continue to reduce transportation costs bychoosing processors and producers who are strategically located near each otheras well as near significant distribution points.

 

**Competition**

 

We compete with branded and private labelconventional, natural and organic dairy and non-dairy products. There are manybrands of conventional and natural foods that hold significant market shares,individually or in the aggregate in the retail food market. Our principalcompetitors for organic dairy products vary by region and include OrganicValley, which is marketed by CROPP, a dairy cooperative located in Wisconsin;Stonyfield Farm, a national brand of organic yogurt located in New Hampshire,whose major investor is Groupe Danone, the maker of Dannon yogurt; StrausFamily Creamery, a regional organic dairy located in California; Echo Springs,a regional organic and conventional dairy located in Oregon; Brown CowWest, Inc., a regional organic and conventional dairy located in NorthernCalifornia and Stremicks Heritage Foods, a regional dairy located in SouthernCalifornia.

 

Our principal competitor in organic juices isOrganic Valley, which markets not-from-concentrate organic juices. We alsocompete with traditional juice manufacturers including PepsiCo (Tropicana),Coca-Cola (Minute Maid and Odwalla), and private label products.

 

There has recently been significant interest inthe organic foods segment by conventional foods manufacturers. Groupe Danonehas recently acquired a significant minority interest in Stonyfield Farm;General Mills Corporation has acquired Cascadian Farms, a leading organic foodproducts company; H.J. Heinz Company has a significant investment in HainCelestial Group, Inc., the largest organic food company in the U.S.; andDean Foods Company has acquired White Wave, the leading producer of organic soymilk in the U.S.  If traditional foodcompanies acquire or partner with existing organic brands, they could leveragetheir existing retail distribution to compete more effectively with us in the organicfoods segment.

In the U.K., the largest competitor to ourRachel’s Organic brand of yogurt is Yeo Valley Organic, which produces organicdairy products and has the leading market share of organic yogurt.Traditionally, in the U.K. the organic fluid milk business has been dominatedby private label products with few branded products.

 

**Intellectual Property Rights**

 

Our logos and product packaging are integral toour success, and we take action to protect against imitation of our logos andpackaging and to protect our trademarks and copyrights as necessary. Wecurrently have eight registered trademarks with the United States Patent andTrademark Office. Our U.S. trademark registrations can be renewed perpetually.In addition, we have twenty-two registered trademarks in other countries.

 

**Government Regulation**

 

In addition to the Organic Regulations, we aresubject to extensive government regulation.

 

*United States Dairy SupportProgram and Federal Milk Marketing Order Program.*  Thewholesale price of farm milk purchased from dairy producers by dairy processorsand manufacturers is based on a combination of factors including supply anddemand and federal and state regulations. The federal government regulatesminimum farm milk pricing through federal market orders and price supportprograms. State governments can regulate farm milk pricing by establishingtheir own market order programs or by forming compacts that establish minimumprices for milk. Organic farm milk, the primary raw ingredient for our organicdairy products, is presently considered to be the same as conventional farmmilk for federal and state minimum pricing purposes. As a practical matter,however, we pay organic dairy producers amounts significantly in excess of theminimum prices for conventional milk established by federal, state or regionalauthorities.

 

On a monthly basis federal and state market ordersdetermine the minimum price processors and manufacturers are required to payfor farm milk. The minimum prices vary according to how the milk is used.Class I milk is used for fluid milk processing. Class II milk is usedfor fluid cream products and soft manufactured products, such as yogurt and icecream. Class III milk is used for the production of cheeses. Class IVmilk is used for manufacturing butter and dry milk products. Class I milkreceives the highest price and varies by region. Class II, III and IVprices are the same throughout the U.S. In each order, total value of milk inall classes is “pooled” together to determine the minimum average or “blend”milk price that must be paid by processors and manufacturers for farm milk.Like the Class I price, the minimum producer price is adjusted by region.Dairy processors and manufacturers with a class value above the blend value payinto the pool while processors and manufacturers with a class value below theblend value draw from the pool. This process equalizes dairy producer paymentsand allows all of the milk farmers within the region to share in the higherprice paid for Class I use.

 

We contract with milk processors to process ourorganic fluid milk products and, in some cases, are responsible through thoseprocessors for pooling charges and administrative assessments, the costs ofwhich are passed through to us by the processors of the organic milk. Thesepooling and administrative assessment charges are assessed retroactively on amonthly basis, and are not known or predictable, with certainty, in advance.

 

The state of California has similar poolingcharges. However, we and another dairy are currently challenging theconstitutionality of these pooling charges. There can be no assurance of asuccessful outcome to this challenge.

*Concentrated Animal FeedOperations.*  The United States Environmental ProtectionAgency and various state environmental agencies regulate Concentrated AnimalFeed Operations to ensure compliance with animal waste management limitations.Concentrated Animal Feed Operations with more than 1,000 Animal Units, or thosewith more than 300 Animal Units discharging directly into U.S. waters, arerequired to obtain a National Pollution Discharge Elimination System permit.Concentrated Animal Feed Operations are required to limit discharge of animalwaste through lined wastewater retention structures such as lagoons and aresubject to site investigation for analysis of compliance. We believe that ourfarms subject to the Concentrated Animal Feed Operations regulations arepresently in compliance. These regulations have not had a material impact onour level of capital expenditures, earnings or competitive position, but,because of the evolving nature of such regulations, management is unable topredict the impact such regulations may have on our business in the foreseeablefuture.

 

*Other Environmental Regulations.*  We aresubject to certain additional federal, state and local environmental laws andregulations. These laws include the Comprehensive Environmental Response,Compensation, and Liability Act of 1980, as amended; the Resource Conservationand Recovery Act, as amended; the Federal Water Pollution Control Act; andtheir state and local counterparts and equivalents.

 

We maintain aboveground or underground petroleumstorage tanks at two of our facilities in the U.S. These tanks are periodicallyinspected to determine compliance with applicable regulations. We may berequired to make expenditures from time to time in order to remain incompliance with such regulations.

 

*Public Health Regulations.*  We areregulated extensively under federal, state and local laws. Regulation at thefederal, state and local levels are subject to change. As a manufacturer anddistributor of food products, we are subject to the Federal Food, Drug andCosmetic Act and regulations promulgated thereunder by the Food and DrugAdministration. This comprehensive regulatory scheme governs manufacturing(including composition and ingredients), labeling, packaging and food safety.The FDA regulates manufacturing practices, including quality assuranceprograms, for foods through its current good manufacturing practices andregulations. In addition, the FDA specifies the standards of identity forcertain foods, including many of the products sold by us, prescribes the formatand content of certain nutrition information required to appear on food productlabels, and approves and regulates claims of health benefits of food products.

 

In addition, the Food and Drug Administrationenforces the Public Health Services Act and regulations issued thereunder,which authorize regulatory activity necessary to prevent the introduction,transmission or spread of communicable diseases. These regulations require, forexample, pasteurization of milk and milk products. We are also subject to stateand local regulation through such measures as the licensing of dairy manufacturingfacilities, enforcement by state and local health agencies of state standardsfor our products, inspection of our facilities and regulation of our tradepractices in connection with the sale of dairy products.

 

All of our processors maintain quality controllaboratories to test milk, other ingredients and finished products, includingour products. Product quality and freshness are essential to the successfulretail distribution of refrigerated milk and dairy products. To monitor productquality at these facilities, we maintain quality control programs to testproducts during various processing and packaging stages. Each dairymanufacturing facility has its own staff of technicians who monitor products tomaintain high quality formulations and to protect against contamination.

 

*Employee Safety Regulations.*  We aresubject to certain health and safety regulations, including regulations issuedpursuant to the Occupational Safety and Health Act of 1970, as amended. Theseregulations require us to comply with certain manufacturing, health and safetystandards.

 

Compliance with existing or new regulations mayrequire us to make significant capital expenditures and to incur higher costs.In addition, we may be subject to additional laws or regulations administeredby the USDA or other federal, state, foreign or local regulatory authorities,the repeal of laws or regulations, or more stringent interpretations of currentlaws or regulations, from time to time in the future. We cannot predict thenature of such future laws, regulations, interpretations or applications, norcan we predict what effect additional government regulations or administrativeorders, when and if promulgated, would have on our business in the future. Suchlaws could, however, require the reconfiguration of production, processing andtransportation methods of our products, including but not limited to moreonerous food safety, labeling, and packaging requirements; increased complianceregulations for waste management; increases in transportation costs; highercosts under the Federal Milk Marketing Order System or similar state orregional programs; and greater uncertainty in production and sourcingestimates.

**Employees**

 

As of December 31, 2002, we had 203 full-time and43 part-time employees in the U.S. and 84 full-time and 8 part-timeemployees in the U.K. We believe that our relations with our employees aregood.

 

##### **Available Information**

 

Our internetaddress is horizonorganic.com.  We makeavailable free of charge and through our internet website our annual report onForm 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K andamendments to those reports filed or furnished pursuant to Section 13(a) or15(d) of the Exchange Act as soon as reasonably practicable after we electronicallyfile such material with, or furnish it to, the SEC.

 

**RISK FACTORS**

 

*You should carefully considerthe following risks before purchasing shares of our common stock. The tradingprice of our common stock could decline due to any of these risks, and you couldlose all or part of your investment. You should also refer to the otherinformation contained or incorporated by reference in this report, includingthe financial statements and related notes. In addition, the risks describedbelow are not the only ones that we are facing. We have only described therisks that we are presently aware of and consider to be material. However,there may be additional risks that we view as not material or of which we arenot presently aware. If any of the events described below were to occur, ourbusiness, prospects, financial condition, results of operations, or cash flowcould be materially adversely affected.*

 

**If we fail to continue to developand maintain our brands, we could lose existing customers and may not be able togenerate growth.**

 

We believe that developing and maintaining ourHorizon Organic, Rachel’s Organic and The Organic Cow of Vermont brands iscritical to our success. Our success in promoting and enhancing our brands willdepend on our ability to provide customers with consistently high qualityproducts. We intend to increase our marketing efforts to create and maintainbrand loyalty and to increase the awareness of our brands as the premierechoice for certified organic products. However, there can be no assurance thatwe will increase our marketing efforts or that we will allocate our marketingresources as planned, which could adversely affect brand loyalty and brandawareness. We intend to increase our stock keeping units, or SKUs, in retaillocations, create new usage opportunities for our current products, such aschanges in portions, sizes or flavors, and introduce new product lines. If weare unable to develop and maintain brand loyalty, we will not be able toeffectively generate growth.

 

**If we fail to maintain ourproduct quality, our brand image would be negatively affected.**

 

We differentiate our products through brand,quality standards and organic certification. Should we experience qualitycontrol issues, such as our products containing microbiological material inquantities in excess of published health standards, or if we or any of oursuppliers and processors lose their organic certifications, or if we provideproducts, even in small amounts, that are found not to comply with the OrganicStandards, our brand image could be harmed. If the distributor or retail sellerimproperly stores our products or does not remove our products from the shelvesafter the expiration date, the quality of our products may be affected, whichcould damage our brand image. In addition, from time to time we enter intobrand licensing agreements. Customer dissatisfaction or performance issues withany of our licensees could have an adverse impact on our reputation and theperception of our brands.

**Adverse publicity couldnegatively impact our brand image and our financial condition.**

 

From time to time we have received consumercomplaints regarding illness allegedly caused by our products. While suchclaims have not resulted in any material liability to date, there can be noassurance that future claims will not be made or that any such claim will notresult in adverse publicity for us or the payment by us of monetary damages,either of which could materially and adversely affect our brand image,financial condition and results of operations. There can be no assurance thatour insurance coverage will be adequate to protect us against the adversefinancial impact of a product liability claim, or that such insurance willcontinue to be available to us on reasonable terms in the future. A productrecall or a product liability judgment against us, regardless of whether it iscovered by insurance, would have a material negative impact on our brand image.

 

**If we cannot sell our IdahoDairy, our financial results may be impacted.**

 

On May 1, 2002, we announced that we were innegotiations for the sale of our Idaho Dairy to an experienced dairy farmer.Initially, we expected to enter into a definitive agreement and close with thebuyer by June 30, 2002. We experienced unexpected delays from the buyer’sdue diligence and financing efforts. We currently expect to enter into adefinitive agreement when the buyer obtains a financing commitment and closethe transaction in the spring of 2003. In addition, we did not renew themanagement agreement for our Colorado herd, which expired on September 30,2002. Most of the animals that were part of the Colorado herd were transferredto the Idaho Dairy and will be included as part of the sale.   As a result of our decisions to sell theIdaho Dairy and not renew the management agreement for our Colorado herd, werevised our financial statements to classify these operations as discontinuedoperations.  Until we close the sale ofthe Idaho Dairy, we will continue operating the dairy.  There can be no assurance that we will enterinto a definitive agreement with this prospective buyer in the time frame weexpect, or that if we do, that the transaction will close in the time frame weexpect, if at all.  In the event thistransaction does not occur, we will continue to seek a buyer for the IdahoDairy.  If we are unable to complete thesale of the Idaho Dairy on the terms we expect, and we sell it for a pricebelow what we currently anticipate, whether to the prospective buyer or a newbuyer, we will record an incremental loss equal to the difference between thebook value and the ultimate sales price. If we choose not to sell the assets and decide to operate the IdahoDairy, we would need to reverse our discontinued operations accountingtreatment. If we do so, there can be no assurance that we will be able tooperate the Idaho Dairy at a profit. In addition, we will have less cash forworking capital. Any increased loss on disposal or reversal of our currentaccounting treatment could have a significant impact on our financial conditionand results of operations.

 

**If we complete the sale of theIdaho Dairy, we will rely on a single supplier for approximately 35% of ourcurrent organic raw milk.**

 

If we complete the sale of the Idaho Dairy andenter into the long-term supply agreement with the buyer, we will rely on asingle supplier to provide us with approximately 35% of our current organic rawmilk at the expected fair market value. We cannot guarantee that this supplierwill be able to continue meeting our needs or that this supplier will have theamounts or capacity available when we need it. In the event that this supplieris unable to meet our needs, we may be required to find other suppliers oforganic raw milk. If the supply of organic raw milk is less than the demand, wemay be required to pay premium prices for the organic raw milk we need. If weincur these higher costs, our margins will decrease and our profitability willsuffer.

 

**Third-party infringement on ourintellectual property rights could negatively impact our brand image.**

Our product packaging and merchandising designsare integral to our success, and we take action to protect against imitation ofour products and packages and to protect our trademarks and copyrights asnecessary. We currently have 8 trademarks registered in the U.S. and 22trademarks registered in other countries. There can be no assurance that thirdparties will not infringe on or misappropriate our trademarks, trade dress andother proprietary rights. In addition, our proprietary rights may not besimilarly protected under the laws of certain foreign countries as they areunder U.S. laws.

 

**If we fail to develop and expandour Rachel’s Organic brand, the growth and profitability of our U.K. operationscould be jeopardized.**

 

The development and expansion of the Rachel’sOrganic brand image and product line is important to the future success of ourcompany. Historically, we have offered only a limited selection of yogurt andother dairy products under the Rachel’s Organic brand. During 2002 we decidedto capitalize on the positive consumer perception of the Rachel’s Organic brandby expanding it to include a full product line, including products developedspecifically for the U.K. market.

 

In December 2001, we entered into an agreementwith Dairy Crest Limited, the largest dairy company in the U.K., to distributeour Rachel’s Organic fluid milk products to Dairy Crest’s home deliverycustomers. In addition, Dairy Crest has replaced all of the organic milk brandsit offers to retail customers with our Rachel’s Organic brand. Dairy Crestcurrently distributes Rachel’s Organic fluid milk products to selectedSainsbury’s, Tesco and Safeway stores. While U.K. consumers have acceptedcertain Rachel’s Organic branded dairy products, there is no assurance thatthey will accept our Rachel’s Organic brand on a larger scale. If we cannotsuccessfully develop and expand our Rachel’s Organic brand, our profitabilityand growth would be negatively affected.

 

**If we fail to manage our supplychain efficiently, we may increase our operating costs and reduce our operatingmargins.**

 

Our supply chain is complex. We rely on thirdparties for our raw materials and for the production, processing andtransportation of our products. The inability of any of these third parties todeliver or perform for us in a timely or cost-effective manner could cause ouroperating costs to rise and our margins to fall. Most of our products areperishable and require immediate processing and transportation to retail outlets.Our products can only be stored for a limited amount of time before they spoiland cannot be sold. We must continuously monitor our inventory and product mixagainst forecasted demand, or risk having inadequate supplies to meet consumerdemand as well as having too much inventory that may reach its expiration date.In addition, we cannot guarantee that our suppliers will be able to meet ourneeds or that amounts or capacity will be available when needed. Shipping andtransportation costs are a large portion of our operating expenses and suchcosts can fluctuate based on our ability to schedule full truckloads fordelivery and volatility in fuel and labor costs. If we are not able to manageour supply chain efficiently to insure that our products are available to meetconsumer demand, our operating costs could increase and our margins could fall.

 

**Volatility in the cost of organicfarm products could increase our cost of sales and reduce our gross margin.**

 

Organic feed represents a material portion of thecost of producing organic milk. Our cost to produce or purchase raw organicfarm products, including organic feed, from our suppliers can fluctuatedepending on many factors, including weather patterns, outbreaks of livestockepidemics, economic and political conditions and the pricing volatility of theconventional dairy product market. In addition, we must compete with entitiesinvolved in other aspects of organic food production having substantiallygreater resources than us for limited supplies of raw organic farm products,particularly organic feed. If the cost of organic raw farm products increasesdue to any of these factors, we may not be able to pass along the increasedcosts to our customers.

 

**We may not be able to continue,or to effectively manage, our rapid growth.**

We have grown at a rapid pace, both internally andthrough acquisitions. Our expansion has placed, and will continue to place,significant demands on our administrative, marketing, financial, operationaland management personnel and systems. We cannot assure you that we will be ableto enhance or maintain our brand image and recognition, expand our productlines and retail distribution, manage costs, adapt our infrastructure andmodify our systems to accommodate future growth. In the fall of 2001 and during2002, we implemented new enterprise-wide information systems to better manageour business; however, there is no assurance that our new systems will beadequate to meet our future needs. We may expand our product lines, in part,through acquisitions of complementary businesses or products and joint ventureswith strategic partners. We may be unable to successfully integrate acquiredcompanies or joint venture partnerships into our existing businesses. We mayencounter problems in connection with the integration of any new businesses,such as:

 

•                                          transitioning non-organic food companies to meetour organic standards;

 

•                                          transitioning or incorporating acquired brandswith our three core organic brands;

 

•                                          unanticipated quality and production issues withacquired products;

 

•                                          adverse effects on business relationships with oursuppliers and customers;

 

•                                          diversion of management attention;

 

•                                          loss of key employees; and

 

•                                          compatibility of financial control and informationsystems.

 

If we are not able to continue our rapid growth,or if we are not able to manage our growth effectively, our business, financialcondition and results of operations could be adversely affected.

 

**Competition may result indecreased retail distribution and consumer demand for, and price reductions of,our products.**

 

We compete with conventional, natural and organicdairy products for consumer dollars and retail shelf space. We have manycompetitors in the organic dairy products market, most of which compete on aregional basis. There also has been significant interest in the organic foodssegment by conventional food manufacturers such as Group Danone, the maker ofDannon yogurt, the General Mills Corporation and the Heinz Corporation. Iftraditional food companies acquire organic brands, they could compete moreeffectively than us in the organic foods segment or make it uneconomical for usto introduce new products. Our juice products also compete with conventional,natural and organic juice products, including brands manufactured by largecompanies such as Coca-Cola and PepsiCo having significantly greater financial,marketing and advertising resources and distribution systems. In the U.K., ourfirst new product introduction under the Rachel’s Organic brand name was organicfluid milk. Our organic fluid milk is one of the few branded products in amarket previously dominated by private label products. We cannot guarantee thatwe will be able to compete successfully or that such competition in any of ourproduct markets will not result in price reductions or in decreased retaildistribution or consumer demand for our products.

 

**If consumer preferences fororganic foods decline or if we fail to anticipate consumer preferences, ourbusiness could be negatively affected.**

Our success depends, in part, on our ability tooffer products that anticipate the tastes and dietary habits of consumers andappeal to their preferences on a timely and affordable basis. We believe thatour growth to date has been due, in large part, to increased awareness of foodsafety issues and a growing consumer preference for a healthy lifestyle. Ourbrand image is built on the basis that our organic products are environmentallyresponsible, safe and of the highest quality. However, the market for organicfood products, including our products, is subject to changing consumer trends,demands and preferences. Our failure to anticipate, identify or react to thesechanges could lead to, among other things, reduced demand and price reductions,which could have a material adverse effect on our business. We intend tointroduce additional products; however, there is no assurance that consumerswill adopt our new products.

 

**Increases in charges under theUnited States Dairy Support Program and Federal Milk Marketing Order Programcould adversely affect our cost of sales and gross margin.**

 

Farm milk pricing is regulated by the federalgovernment through federal market orders and price support programs, and stategovernments can regulate farm milk pricing by establishing their own marketorder programs or by forming compacts that establish minimum prices for milk.As a result of these regulations, we must pay “pooling” and other charges underthe support programs and administrative assessments for government mandated marketingprograms. These pooling and administrative charges are assessed retroactivelyon a monthly basis and are not known or predictable, with certainty, inadvance. If these charges increase to levels higher than we anticipate, ourcost of sales and gross margin would be negatively affected.

 

**Changes in federal, state andlocal regulations may cause us to incur additional compliance costs.**

 

In order to claim that our products are certifiedorganic, we must be able to demonstrate that all of the feed, farm operations,fluid milk and processing steps involved in the production of the finishedgoods meet certain standards. In December 2000, the U.S. federalgovernment adopted final national organic regulations that became effective inOctober 2002. These regulations set forth the minimum standards producersmust meet in order to have their products labeled as “certified organic.” Whilewe believe our products and our supply chain are in compliance with theseregulations, there is no assurance that the regulations will not be modified inthe future, causing us, or our suppliers, to incur additional costs to remainin compliance. Any or all such actions could negatively affect our business.

 

**The loss of key management or ourinability to attract and retain management talent could adversely affect ourbusiness.**

 

Our future prospects depend to a significantextent upon the continued service of our key executives. The loss of any of thekey executives could have a material adverse effect on our business, financial conditionor results of operations. Furthermore, our continued growth depends on ourability to identify, recruit and retain key management personnel. Thecompetition for such employees is intense, and there can be no assurance thatwe will be successful in such efforts. We are also dependent on our ability tocontinue attracting, retaining and motivating our sourcing, production,distribution, sales, marketing and other personnel, of which there can be noassurance of success.

 

**Our quarterly financial resultsfluctuate and are difficult to predict. If our future results are below theexpectations of the public market analysts and investors, the price of ourcommon stock may decline.**

 

Our quarterly revenue and results of operationsare difficult to predict. We have experienced, and expect to continue toexperience, fluctuations in revenue and operating results from quarter toquarter. As a result, we believe that quarter-to-quarter comparisons of ourrevenue and operating results are not necessarily meaningful, and that suchcomparisons may not be accurate indicators of future performance. The reasonsfor these fluctuations include, but are not limited to:

 

•                                          the amount and timing of operating costs relatingto expansion of our business, operations and infrastructure;

•                                          changes in supply and demand and retaildistribution and the impact of these changes on our sales and gross margin; and

 

•                                          milk pooling charges assessed monthly in arrears,which vary from month to month.

 

Supply of organic raw farm products hashistorically been less than demand. As a result, we have entered intofixed-rice contracts for organic raw farm products under which we pay premiumprices to ensure our supplies. If supply grows faster than demand as it hasrecently in the U.K. organic market while these pricing arrangements are ineffect, we will be contractually obligated to pay premium prices for ourorganic raw farm products while market prices decline. In addition, if thesupply of organic raw milk is greater than the demand and we are unable toconvert our excess supply into other dairy products, we may be forced to sellthese excess supplies into the conventional market for prices lower than weoriginally paid. If we incur higher costs as part of our production process orsell our excess supplies for prices lower than we originally paid, our marginswill decrease and our profitability will suffer.

 

We plan to increase our operating expenses toexpand our marketing efforts in order to increase brand awareness. Ouroperating expenses are based on our expectations of future revenues and arerelatively fixed in the short term. If revenue falls below our expectations ina quarter and we are not able to quickly reduce our spending in response, ouroperating results for that quarter could be adversely affected. It is possiblethat in some future quarter, our operating results may be below theexpectations of public market analysts and investors and, as a result, theprice of our common stock could fall.

 

Although we are a publicly traded company, thevolume of trading activity in our stock is still relatively limited, allowingsmall amounts of trading activity to cause fluctuations in our stock price.

 

**Preemptive rights held by one ofour stockholders could make the sale of our company difficult.**

 

One of our stockholders, Dean Foods Company, haspreemptive rights, rights of first negotiation to acquire us, rights of firstrefusal on certain transfers and registration rights pursuant to stockholderagreements with us and with certain of our principal stockholders. Theserights, if exercised, could force delays in negotiating and completingtransactions that may be favorable to us and to our stockholders and negativelyaffect our stockholders’ ability to receive payment for their shares equal to thepayment premium they would receive if such rights did not exist. In addition,these rights, even if not exercised, may cause potential buyers to decide notto submit offers for our company or to submit offers based on substantiallylower valuations of our company.

 

**Fluctuations in exchange ratescould adversely affect our results of operations and financial condition.**

 

We may, from time to time, need to exchangecurrency between our U.S. and U.K. operations. In addition, we translate ourU.K. financial statements from British pounds sterling to U.S. dollars. Foreignexchange rates are volatile and can change in an unknown and unpredictablefashion. Because we do not engage in hedging activities, we are subject to anyvolatility that occurs. Should the foreign exchange rates change to levelsdifferent than we anticipated, our business, financial condition and results ofoperations may be materially adversely affected.

 

**ITEM 2****.**                             **PROPERTIES**

 

We own or lease the following properties.

 

•                                          We own two farms, the Idaho Dairy and the MarylandDairy. The Idaho Dairy consists of over 3,800 acres, including 22,755 squarefeet of production and office space. The Maryland Dairy consists of over 450acres, including 109,059 square feet of production and office space (includingbarns).

•                                          In March 2000, we purchased an additionalfarm consisting of 607 acres in Wilton, California. We do not operate this farmand it is held for sale.

 

•                                          We lease approximately 370 acres of agriculturalland including pasture in Idaho near the Idaho Dairy for our replacement heiferraising facility.  The lease expires onDecember 1, 2006.

 

•                                          We lease a 31,306 square foot facility inLongmont, Colorado for our corporate headquarters.  The lease expires on August 31, 2007.

 

•                                          We lease the U.S. Naval Academy Dairy nearAnnapolis, Maryland where we have built and maintain the Horizon Organic Farmand Education Center.  The lease expireson September 30, 2009 and has 2 five-year extension options.

 

•                                          We lease approximately 1,000 square feet of officespace and 19,645 square feet of milk processing space in the U.K. We closed ourU.K. milk processing facility in July 2002. The lease expires on June 1,2015.

 

•                                          We own approximately 14,840 square feet of officeand production space in Wales, U.K., that houses our Rachel’s Dairy operations.

 

**ITEM 3****.**                             **LEGAL PROCEEDINGS**

 

We are subject to various routine legalproceedings and claims arising in the ordinary course of business. We do notexpect that the results in any of these legal proceedings will have a materialadverse effect on our business, financial condition, results of operations, orcash flows.

 

**ITEM 4****.**                             **SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

None.

 

###### **PART II**

 

**ITEM 5****.**                             **MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATEDSTOCKHOLDER MATTERS**

 

PRICE RANGE OF COMMON STOCK

 

Our common stock is quoted on the Nasdaq NationalMarket under the symbol “HCOW.”  Thefollowing table identifies the high and low sales price per share of our commonstock as reported by the Nasdaq National Market for the years ending December31, 2002 and 2001.

 
|                             |   | **High** |   | **Low** |   |
|----------------------------------|--------|----------|--------|---------|--------|
| **Year Ended December 31, 2002** |   |     |   |    |   |
| First Quarter                    |   | $        | 17.40  |    | $      | 12.72 |   |
| Second Quarter                   |   | $        | 19.26  |    | $      | 14.87 |   |
| Third Quarter                    |   | $        | 18.24  |    | $      | 11.65 |   |
| Fourth Quarter                   |   | $        | 17.24  |    | $      | 14.42 |   |
|                             |   |     |   |    |   |
| **Year Ended December 31, 2001** |   |     |   |    |   |
| First Quarter                    |   | $        | 6.625  |    | $      | 4.125 |   |
| Second Quarter                   |   | $        | 9.71   |    | $      | 4.45 |   |
| Third Quarter                    |   | $        | 11.98  |    | $      | 8.00 |   |
| Fourth Quarter                   |   | $        | 17.21  |    | $      | 9.95 |   |

 

###### **On March 3, 2003, the last reportedsales price of our common stock on the Nasdaq National Market was $13.65 pershare and there were 252 shareholders of record of our common stock.**

 

Since January 1,2002, we have not sold or issued any unregistered securities.

 

###### **DIVIDEND POLICY**

 

We have never declared or paid a cash dividend on ourcommon stock and do not anticipate paying cash dividends in the foreseeablefuture.  We expect to retain futureearnings, if any, to finance the growth and development of our business.  The payment of any future dividends will beat the discretion of our board of directors and will depend upon, among otherthings, future earnings, operations, capital requirements, and our financialcondition.  In addition, our line ofcredit and term loan with US Bank prohibit us from paying cash dividends.

 

**ITEM 6****.**                             **SELECTED CONSOLIDATED FINANCIAL DATA**

 

                The selectedfinancial data below presents our consolidated financial information. Theselected consolidated financial data should be read in conjunction with “Item7. Management’s Discussion and Analysis of Financial Condition and Results ofOperations” and our Consolidated Financial Statements and related notes,included elsewhere herein.  Thefinancial data pertaining to 2002, 2001 and 2000 is derived from ourconsolidated financial statements included in this report.  The financial data pertaining to 1999 and1998 is derived from our audited financial statements not included in thisreport.

 
|                                                                          |   | **Fiscal  Year Ended**                     |       |
|-------------------------------------------------------------------------------|--------|--------------------------------------------|------------|
|                                                                          |   | **Dec. 31,  2002**                         |       | **Dec. 31,  2001** |   | **Dec. 31,  2000** |   | **Dec. 31,  1999** |   | **Dec. 31,  1998** |   |
|                                                                          |   | **(in  thousands, except per share data)** |       |
| **Consolidated Statements of  Operations Data:**                              |   |                                       | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Net sales                                                                     |   | $                                          | 187,537    |   | $ | 158,870 |   | $ | 127,206 |   | $ | 84,771 |   | $ | 49,271 |   |
| Cost of sales                                                                 |   | 127,681                                    |       | 111,847 |   | 89,406 |   | 59,217 |   | 33,029 |   |
| Gross profit                                                                  |   | 59,856                                     |       | 47,023 |   | 37,800 |   | 25,554 |   | 16,242 |   |
| Selling expenses                                                              |   | 41,390                                     |       | 31,341 |   | 25,387 |   | 18,399 |   | 11,007 |   |
| General and  administrative expenses                                          |   | 10,704                                     |       | 8,036 |   | 8,963 |   | 6,186 |   | 2,871 |   |
| Intangible  assets amortization                                               |   | 1,307                                      |       | 3,115 |   | 2,389 |   | 1,058 |   | 311 |   |
| Operating income  (loss)                                                      |   | 6,455                                      |       | 4,531 |   | 1,061 |   | (89 | ) | 2,053 |   |
| Other income  (expense), net                                                  |   | (545                                       | )          | (1,750 | ) | (548 | ) | 1,837 |   | 985 |   |
| Income from  continuing operations before income taxes and extraordinary item |   | 5,910                                      |       | 2,781 |   | 513 |   | 1,748 |   | 3,038 |   |
| Income tax  expense                                                           |   | (2,305                                     | )          | (1,119 | ) | (221 | ) | (743 | ) | (1,302 | ) |
| Income from  continuing operations                                            |   | 3,605                                      |       | 1,662 |   | 292 |   | 1,005 |   | 1,736 |   |
| Income (loss)  from operations of discontinued Idaho Dairy and Colorado herd  |   | (4,954                                     | )          | 131 |   | 399 |   | 691 |   | (1,463 | ) |
| Income tax  benefit (expense) from discontinued operations                    |   | 1,316                                      |       | (53 | ) | (172 | ) | (294 | ) | 627 |   |
| Extraordinary  item, net of income tax(1)                                     |   | —                                     |       | — |   | — |   | — |   | (414 | ) |
| Net income  (loss)                                                            |   | $                                          | (33        | ) | $ | 1,740 |   | $ | 519 |   | $ | 1,402 |   | $ | 486 |   |
| Income from  continuing operations per basic share(2)                         |   | $                                          | .35        |   | $ | .16 |   | $ | .03 |   | $ | .10 |   | $ | .24 |   |
| Income from  continuing operations per diluted share(2)                       |   | $                                          | .34        |   | $ | .16 |   | $ | .03 |   | $ | .10 |   | $ | .22 |   |
| Income (loss)  from discontinued operations per basic share(2)                |   | $                                          | (.35       | ) | $ | .01 |   | $ | .02 |   | $ | .05 |   | $ | (.17 | ) |
| Income (loss)  from discontinued operations per diluted share(2)              |   | $                                          | (.34       | ) | $ | .01 |   | $ | .02 |   | $ | .04 |   | $ | (.16 | ) |
| Net income  (loss) per basic share(2)                                         |   | $                                          | (.00       | ) | $ | .17 |   | $ | .05 |   | $ | .15 |   | $ | .07 |   |
| Net income  (loss) per diluted share(2)                                       |   | $                                          | (.00       | ) | $ | .17 |   | $ | .05 |   | $ | .14 |   | $ | .06 |   |
| Weighted average  shares outstanding:                                         |   |                                       |       |   |   |   |   |   |   |   |   |
| Basic                                                                         |   | 10,204                                     |       | 10,007 |   | 9,796 |   | 9,668 |   | 7,339 |   |
| Diluted                                                                       |   | 10,583                                     |       | 10,213 |   | 10,030 |   | 9,992 |   | 7,742 |   |
|                                                                          |   |                                       |       |   |   |   |   |   |   |   |   |
| **Consolidated  Balance Sheet Data:**                                         |   |                                       |       |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                                                    |   | $                                          | 1,382      |   | $ | 3,534 |   | $ | 2,438 |   | $ | 3,693 |   | $ | 14,384 |   |
| Working capital                                                               |   | 23,250                                     |       | 21,885 |   | 23,714 |   | 18,436 |   | 28,298 |   |
| Total assets                                                                  |   | 128,207                                    |       | 129,268 |   | 132,164 |   | 84,612 |   | 69,356 |   |
| Long-term debt,  less current portion                                         |   | 14,110                                     |       | 40,313 |   | 45,685 |   | 11,337 |   | 4,923 |   |
| Total  stockholders’ equity                                              |   | 65,653                                     |       | 60,754 |   | 58,644 |   | 57,888 |   | 55,970 |   |

----

(1)                                  Theextraordinary item relates to the early extinguishment of the seniorsubordinated promissory notes and is comprised of the write off of unaccreteddiscount of $667,000.  The write off wascharged to expense and is classified as an extraordinary item net of taxbenefit of $253,000 in our consolidated statements of operations for the yearended December 31, 1998.

 

(2)                                  Netincome (loss) per share is computed using the weighted average number of commonshares (basic) and common and common equivalent shares (diluted) outstandingduring the year. See note 2 to our Consolidated Financial Statements.

 

**ITEM 7****.**      **MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

*The following discussion andanalysis should be read in conjunction with Item 1 of this report and theconsolidated financial statements and accompanying notes attached to thisreport. This section contains forward-looking statements that involve risks anduncertainties, such as statements about our plans, objectives, expectations andintentions. We use words such as “anticipate,” “believe,” “expect,” “future”and “intend” and similar expressions to identify forward-looking statements formany reasons, including the factors described below and in the section titled“Risk Factors”.*

 

**Overview**

 

We produce and market the leading brands ofcertified organic fluid milk and a full line of branded, refrigerated organicdairy products, juices and desserts. We market our products under the HorizonOrganic and The Organic Cow of Vermont brand names in the U.S., and theRachel’s Organic brand name in the U.K. In addition, we license our HorizonOrganic brand for use on organic milk and dairy products in Japan and fororganic eggs in the U.S. According to *InformationResources, Inc*, a market research firm, our organic fluid milk hadan approximately 70.0% market share of all organic milk sold in conventionalsupermarket chains in the U.S. during the twelve weeks ended December 31,2002.

 

Our company was founded in Boulder, Colorado in1991. We introduced our first products, organic nonfat yogurts, in 1992, withorganic fluid milk following in 1993. Initially, we contracted for our supplyof organic milk products with a Wisconsin-based cooperative. At the time, therewas a limited supply of organic fluid milk available for purchase by dairies.In 1994, we made a strategic decision to begin developing our own organic milksupply. We began by building a herd of organic cows at a dairy farm in Idaho,which we subsequently acquired in 1997. Also in 1997, we acquired a dairy farmin Maryland in order to develop an internal organic fluid milk supply for theeastern United States. In 1999, we entered into a herd management agreementwith a third party to manage an additional herd of organic cows in Colorado.

 

In 1995, we began focusing on expanding andintegrating a nationwide production, processing and distribution system. Aspart of our efforts to increase our distribution, in April 1998, weacquired the largest brand of organic dairy products in the metropolitan NewYork region and rebranded it under our Horizon Organic label. InApril 1999, we acquired The Organic Cow of Vermont brand name. We continueto market products under this brand in the New England region.

 

In 1999, we began selling our products in Europeby acquiring Rachel’s Dairy Limited, a U.K. company that processes, markets anddistributes organic yogurts, butters and creams. In 2000, we furthered ourpresence in the U.K. by acquiring Meadow Farms Limited, the leading processorand supplier of organic fluid milk in the U.K. Meadow Farms sold primarilyprivate label products at the time of our acquisition. In 2002, we introducedorganic fluid milk products under the Rachel’s Organic brand as a result ofstrong U.K. consumer support for the Rachel’s Organic brand. InDecember 2001, we entered into a processing and distribution agreementwith Dairy Crest, the largest dairy foods company in the U.K., that providesfor them to distribute our Rachel’s Organic dairy products throughout the U.K.and to replace all of Dairy Crest’s branded organic fluid milk with Rachel’sOrganic branded milk.

In 2001, we made a strategic decision that therising interest in organic farming would allow us to secure a sufficient supplyof organic fluid milk from third parties and that it was no longer necessaryfor us to invest capital to expand our company-owned farms. On May 1,2002, we announced that we were in negotiations to sell our Idaho Dairy to anexperienced dairy farmer. Initially, we expected to enter into a definitiveagreement with the buyer and close by June 30, 2002. We experiencedunexpected delays from the buyer’s due diligence and financing efforts. Wecurrently expect to enter into a definitive agreement and close the transactionin the spring of 2003. In conjunction with the definitive agreement, we intendto enter into a long-term supply agreement with the buyer for organic fluidmilk at the expected fair market value. In addition, the management agreementlapsed for our Colorado herd, which expired on September 30, 2002. Most ofthose assets were transferred to the Idaho Dairy prior to, and will be includedas part of, the sale. As a result of our decisions to sell the Idaho Dairy andnot renew the management agreement for our Colorado herd, we revised ourfinancial statements to classify these operations as discontinued operations.Until we close the sale of the Idaho Dairy, we will continue operating thedairy. There can be no assurance that we will enter into a definitive agreementwith this prospective buyer in the time frame we expect, or that if we do, thatthe transaction will close in the time frame we expect, if at all. In the eventthis transaction does not occur, we will continue to seek a buyer for the IdahoDairy. We believe that the decision to sell these farm assets will allow us tofocus on developing additional products, marketing our brands and pursuingacquisitions.

 

We sell our products in the U.S. primarily throughAcosta, an external food broker and one of the largest national foodbrokers, and our internal sales force. Our agreement with Acosta provides uswith outsourced sales and category management support through its approximately8,000 sales representatives. Our customers are natural foods supermarkets,supermarket chains, mass merchant retailers, specialty food retailers and foodmanufacturers who use our organic products as ingredients. Domestic salesaccounted for approximately 82.3%, 79.9% and 82.5% of total net sales in 2002, 2001and 2000, respectively. International sales accounted for approximately 17.7%,20.1% and 17.5% of our total net sales in 2002, 2001 and 2000, respectively. Wehave distribution arrangements with United Natural Foods, Inc., a nationaldistributor headquartered in Dayville, Connecticut, and H.P. Hood, Inc., adairy processor and distributor headquartered in Boston, Massachusetts. Each ofthese arrangements accounted for 14.2% and 10.6%, respectively, of our totalsales in 2002. In addition, sales to Safeway and its affiliates in the U.S.represented 11.7% of our total sales in 2002. In the U.K., we sell our productsthrough the sales force of Dairy Crest, pursuant to our agreement, as well asour internal sales force. In addition to increased retail distribution, ouragreement with Dairy Crest includes distributing our Rachel’s Organic brandedfluid milk through Dairy Crest’s home delivery system. In addition, sales toSainsbury’s, one of the leading supermarket chains in the U.K., represented10.7% of our total sales in 2002.

 

We derive revenue primarily through product sales.Net sales include product sales, less product returns, if any, and allowances.Product sales are comprised primarily of sales of organic fluid milk, organicyogurts, organic butters, organic cheeses and organic juices. Revenue isrecognized upon transfer of title at the time of shipment to or pickup by acustomer.

 

Cost of sales includes the cost of raw materials,including milk purchased from our Idaho Dairy and Colorado herd which areincluded in discontinued operations, processing fees, inbound freight costs,milk pooling charges and operating income or loss from Maryland farmoperations. The costs of our farm operations include all costs associated withthe milk production from our Maryland organic dairy herd which is included incontinuing operations. Such cost factors primarily include organic feed, cattledepreciation, cull losses, payroll, general operating expenses and fixed assetdepreciation. We depreciate our Maryland farm assets using the straight-linemethod over the estimated useful lives, which range from 3 to 27 years.Cattle are depreciated using a straight-line method over five years commencingwith their first milking and have a capitalized cost based on purchase price pluspre-production costs.

 

We purchase most of our fluid milk supply fromvarious organic farmers and cooperatives throughout the U.S. and the U.K. Inthe U.S., we generally have contracts with our suppliers with terms of one totwo years. In the U.K., terms generally range anywhere from three months tofive years. Prices are set based on butterfat content and quality testingcriteria and most contracts require that we purchase minimum quantities oforganic farm milk. If we cannot use the minimum amounts of milk we are requiredto purchase under these contracts, either as organic milk or in other organicdairy products, we sell the organic milk as conventional milk, which has alower selling price.  We record the differencebetween our purchase price for organic milk and the conventional milk pricereceived by us in cost of sales.

Processing fees include payments made to our dairyand juice processors to process and package raw ingredients into organic milk,dairy and juice products. Inbound freight costs include all raw materialinbound shipping costs to the processors. Milk pooling charges include chargesincurred by our processors as calculated by the Federal Milk Market OrderSystem. Because the pooling charge assessments are received from the Market Administratorsone month in arrears, we adjust the prior month’s estimates to actual amountscharged.

 

Gross profit includes net sales less cost ofsales.

 

Selling expenses consist of all expenses requiredto market and sell our products, including our direct selling, marketing anddistribution costs.

 

General and administrative costs are comprised ofall costs of operations and corporate support not specifically included in anyof the items above. Most of our depreciation expense is included in this lineitem.

 

Intangible assets amortization includes theamortization of goodwill resulting from the acquisitions of Meadow Farms andOrganic Matters in 2000 and Rachel’s Dairy in 1999. It also includesamortization of intangible assets acquired from the Juniper Valley brandpurchase in 1998 and The Organic Cow of Vermont brand purchase in 1999. As ofJanuary 1, 2002, we adopted the provisions of Financial AccountingStandards No. 142, *Goodwill and otherIntangible Assets, or SFAS 142,* which requires that all goodwilland certain identifiable intangible assets no longer be amortized, but insteadwill be reviewed for impairment at least annually in accordance with theprovisions of this statement.

 

Discontinued operations includes the net costs ofour milk production from our Idaho Dairy and Colorado herd which are assetsheld for sale. Such costs primarily include organic feed, cattle depreciation,cull losses, payroll, general operating expenses, fixed asset depreciationprior to triggering discontinued operations, goodwill amortization, interestexpense and expected loss on disposal which includes transaction costs. Weceased depreciating our assets held for sale upon their classification as suchand recognized on the measurement date of March 31, 2002 the expected losson disposal. Prior to the measurement date, we depreciated our Idaho Dairy andColorado herd assets using the straight-line method over the estimated usefullives, which ranged from 3 to 27 years. Cattle were depreciated using astraight-line method over five years commencing with their first milking andhad a capitalized cost based on purchase price plus pre-production costs. Wefollow generally accepted accounting principles for ceasing amortization ofgoodwill which took effect on January 1, 2002. Prior to January 1,2002, goodwill associated with the Idaho farm was amortized and that amount wasincluded in discontinued operations with approximately $0.2 millionamortized annually.

 

**Results of Operations**

 

The following table sets forth certain items fromour consolidated statements of operations as a percent of net sales.

 
|                                                  |   | **Years Ended December 31,** |       |
|-------------------------------------------------------|--------|------------------------------|------------|
|                                                  |   | **2002**                     | ** ** | **2001** | ** ** | **2000** | ** ** |
|                                                  |   |                         | ** ** |   | ** ** |   | ** ** |
| Net  sales                                            |   | 100.0                        | %          | 100.0 | % | 100.0 | % |
| Cost  of sales                                        |   | 68.1                         |       | 70.4 |   | 70.3 |   |
| Gross margin                                          |   | 31.9                         |       | 29.6 |   | 29.7 |   |
| Selling expense                                       |   | 22.1                         |       | 19.7 |   | 20.0 |   |
| General and administrative expense                    |   | 5.7                          |       | 5.1 |   | 7.0 |   |
| Intangible asset amortization                         |   | 0.7                          |       | 2.0 |   | 1.9 |   |
| Total operating expenses                              |   | 28.5                         |       | 26.7 |   | 28.9 |   |
| Operating income                                      |   | 3.4                          |       | 2.9 |   | 0.8 |   |
| Other income (expense), net                           |   | (0.3                         | )          | (1.1 | ) | (0.4 | ) |
| Income from continuing operations before income taxes |   | 3.2                          |       | 1.8 |   | 0.4 |   |
| Income tax expense                                    |   | (1.2                         | )          | (0.7 | ) | (0.2 | ) |
| Income from continuing operations                     |   | 1.9                          |       | 1.0 |   | 0.2 |   |
| Income (loss) from discontinued operations, net       |   | (1.9                         | )          | — |   | 0.2 |   |
| Net income (loss)                                     |   | (0.0                         | )%         | 1.1 | % | 0.4 | % |

 

**Year ended December 31, 2002 compared to year endedDecember 31, 2001**

 

*Net Sales.*  Net salesincreased by 18.0%, or $28.6 million, to $187.5 million in 2002 from$158.9 million in 2001. Net sales from U.S. operations increased 21.6%, or$27.4 million, to $154.4 million from $127.0 million resultingprimarily from increased sales of existing products to existing accounts andcontinued expansion of conventional grocery distribution channels. Changes inour U.S. product category sales were as follows:

 

Fluid Milk

 

•                                          Total fluid milk sales increased 20.3%, or$18.4 million, to $109.1 million in 2002 from $90.7 million in2001.

 

•                                          Sales of UP fluid milk increased 46.5%, or$18.9 million, to $59.6 million in 2002, from $40.7 million in2001. This increase was primarily due to increased sales volume as we continuedour expansion of UP milk to new customers throughout the year.

 

•                                          Sales of traditional pasteurized fluid milkdecreased 0.9%, or $0.5 million, to $49.5 million in 2002 from$50.0 million in 2001. This decrease was primarily the result of decreasedsales volume as some customers substituted UP fluid milk for traditionalpasteurized milk. As a result of these shifts, our fluid milk product line mixshifted to 45.4% traditional pasteurized fluid milk in 2002 from 55.1% in 2001.

 

OtherDairy

 

•                                          Total net sales of our other dairy productsincreased 29.3%, or $9.0 million, to $39.5 million in 2002 from$30.5 million in 2001, driven primarily by increased sales of our butter, cheeseand increased industrial sales.

 

•                                          Net sales of yogurt increased 12.4%, or$1.1 million, to $9.7 million in 2002 from $8.6 million in2001.  This increase was due toincreased sales volume.

•                                          Net sales of butter increased 29.5%, or$2.3 million, to $10.2 million in 2002 from $7.9 million in2001.  This increase was primarily dueto increased sales volume.

 

•                                          Net sales of cheese increased 25.5%, or$1.2 million, to $5.9 million in 2002 from $4.7 million in2001.  This increase was primarily dueto increased sales volume.

 

•                                          Net sales of industrial products, such as powderand cheeses sold for further processing into finished goods, and of foodserviceproducts, such as single serve milk sold to restaurants and other serviceproviders, increased 46.2%, or $1.9 million, to $5.9 million in 2002from $4.0 million in 2001. This increase was primarily the result ofincreased sales volume from our introduction of yogurt and single-serve milkproducts into food service outlets.

 

Juice

 

•                                          Net sales of our juice products decreased 4.2%, or$0.3 million, to $7.9 million in 2002 from $8.2 million in2001.  This decrease was the result of adecrease in sales volume. We believe that this decrease was primarily theresult of aggressive pricing on conventional juice, which widened the price gapbetween conventional and organic juice.

 

International

 

•                                          Net sales from international operations increased3.9%, or $1.2 million, to $33.1 million in 2002 from$31.9 million in 2001.  Expressedin British pounds, sales decreased 0.4%; however, shifts in the exchange ratein the two periods produced the dollar-denominated increase.  There were no material fluctuations inaverage sales price or sales volume during 2002 from 2001, despite the loss oftwo private-label customers and the replacement of that business with newRachel’s Organic branded sales.

 

•                                          Net sales of Rachel’s Organic branded products,which in 2002 included fluid milk in addition to what it consisted primarily ofin 2001 of yogurt, double cream, crème fraiche and butter increased 164.8%, or$9.1 million to $14.6 million in 2002 from $5.5 million in2001.  Expressed in British pounds,sales increased 153.5%; however, shifts in the exchange rate in the two periodsproduced the balance of the dollar-denominated increase.

 

•                                          We anticipate that the net sales of Rachel’sOrganic branded products will continue to increase as we continue ourintroduction of branded fluid milk under the Rachel’s Organic brand.  Previously, our fluid milk sales were eitherprivate label or branded under the Horizon Organic label.  In early 2002, we replaced Horizon Organicbranded milk with Rachel’s Organic branded milk to leverage the existingstrength of the Rachel’s Organic brand. As part of our December 2001 agreement with Dairy Crest Limited, inFebruary 2002 Dairy Crest replaced its brands of organic fluid milk withRachel’s Organic branded fluid milk in its direct home delivery system and ingrocery stores throughout the U.K.

 

*Cost of Sales and Gross Profit.*  Cost ofsales increased 14.2%, or $15.9 million, to $127.7 million in 2002from $111.8 million in 2001. The increase in cost of sales was primarilythe result of our increased sales volume. Gross profit increased 27.3%, or$12.9 million, to $59.9 million in 2002 from $47.0 million in2001. As a percentage of net sales, gross profit increased to 31.9% in 2002from 29.6% in 2001. Our gross profit in the U.S. increased to 33.7% in 2002from 31.4% in 2001 primarily due to better matching of supply and demand in ourU.S. milk supply during 2002, which resulted in fewer sales of organic milk asconventional milk at lower conventional prices, versus 2001 and partially dueto increased efficiencies and economies of scale gained with our U.S.processors during 2002. Our gross profit in the U.K. increased to 23.7% in 2002from 22.2% in 2001. This was primarily the result of the increased Rachel’sOrganic branded sales during 2002 versus 2001 and improved processing andpackaging efficiencies from the Dairy Crest agreement. Branded product sales generallyyield a higher gross profit than sales of private label products.

*Selling Expenses.*  Sellingexpenses increased 32.1%, or $10.1 million, to $41.4 million in 2002from $31.3 million in 2001.  Thisincrease was a result of increased U.S. sales support in the form of increasedtrade promotion, consumer promotion, billboard and national magazineadvertising, and a national public relations campaign in conjunction with theOctober 2002 implementation of the new USDA organic regulations.  As a result, selling expenses as apercentage of net sales increased to 22.1% in 2002 from 19.7% in 2001.

 

*General and AdministrativeExpenses.*  General and administrative expensesincreased 33.2%, or 2.7 million, to $10.7 million in 2002 from$8.0 million in 2001. This increase was primarily due to increased generaloverhead, including primarily salaries and benefits and consulting fees, andpartially due to increased depreciation and administrative costs related to theinformation system installed in October 2001. As a result, our general andadministrative expenses as a percentage of net sales increased to 5.7% in 2002from 5.1% in 2001.

 

*Intangible Asset Amortization.* Intangible asset amortization expenses decreased 58.0%, or$1.8 million, to $1.3 million in 2002 from $3.1 million in 2001.This decrease was a result of our January 1, 2002, adoption of Statement ofFinancial Accounting Standards No. 142, *Goodwilland Other Intangible Assets*, or SFAS 142, which requires that wecease to amortize goodwill and requires review for impairment at least annuallyin accordance with the provisions of this statement.

 

*Other Income (Expense), Net.*  Otherincome (expense), net decreased 68.8%, or $1.3 million, to$0.5 million expense in 2002 from $1.8 million expense in 2001. The decreasewas primarily attributable to a decrease in the average interest rate on ourdebt facilities and partially attributable to a decrease in our outstandingdebt balances.  Our average interestrate on our LIBOR-based debt facilities decreased to 4.4% for 2002 from 7.0% in2001.

 

*Income Tax Expense.*  Incometax expense increased 105.9%, or $1.2 million, to $2.3 million in2002 from $1.1 million in 2001. Our effective income tax rate decreased to39.0% in 2002 from 40.3% in 2001 resulting from ceasing to amortize goodwill,pursuant to the adoption of SFAS 142, that otherwise was not deductible for taxpurposes.

 

*Income From ContinuingOperations.*  Income from continuing operations increased116.9%, or $1.9 million, to $3.6 million in 2002 from$1.7 million in 2001.

 

•                                          Income from continuing operations for U.S.operations increased 25.3%, or $0.7 million, to $3.4 million in 2002from $2.7 million in 2001.

 

•                                          Income (loss) from continuing operations forinternational operations increased 115.9%, or $1.3 million, to income of$0.2 million in 2002 from a loss of $1.1 million in 2001.

 

*Income (loss) from DiscontinuedOperations, Net.*  Income (loss) from discontinued operations,net decreased $3.7 million to a loss of $3.6 million in 2002 fromincome of $0.1 million in 2001. The decrease was primarily due to theanticipated loss including all transaction costs on disposal of the IdahoDairy, including the transferred Colorado herd, of $3.4 million after incometaxes, and partially due to increased costs of production, which consists offeed and cattle costs of the Idaho Dairy and Colorado herd operations.

If we had determined that the pending sale of our Idaho Dairy assets,including the transferred Colorado herd, had not met the definition of adisposal group under Statement of Financial Accounting Standards No. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets*, the results ofthe Idaho Dairy and Colorado herd would have been recorded in continuingoperations. Had we not determined to sell our Idaho Dairy, including thetransferred Colorado herd, the results of the Idaho Dairy’s operations wouldnot have included loss on disposal charges of $1.9 million net of income taxesbecause we would not have incurred these anticipated losses associated with thedisposal of the Idaho Dairy. These disposal losses consist of transaction costsand write downs to expected net realizable value, including charges equal tonormal depreciation through the expected transaction close date. Accordingly,for 2002, an operating loss before interest and income taxes of $1.1 millionfrom the Idaho Dairy and Colorado herd would have been included in cost ofsales, thereby increasing our cost of sales which in turn would have decreasedour gross profit to $58.8 million for 2002. For 2001, operating income beforeinterest, amortization and income taxes of $2.0 million from the Idaho Dairyand Colorado herd would have been included in cost of sales, thereby decreasingour cost of sales which in turn would have increased our gross profit to $49.0million for 2001. Additionally, if we had included the Idaho Dairy’s operationsand the Colorado herd operations with continuing operations and had notincurred an anticipated loss on disposal of $1.9 million net of income taxesduring 2002, we would have reported net income of $1.9 million, or $.18 perdiluted share, for 2002, and our reported net income would have remained $1.7million, or $.17 per diluted share, for 2001.

 

*Net Income (Loss).*  Netincome (loss) decreased to a loss of $33,000 in 2002 from income of$1.7 million in 2001.

 

•                                          Income (loss) for U.S. operations decreased$3.0 million to a loss of $0.2 million in 2002 from income of$2.8 million in 2001.   Thedecrease was primarily due to the anticipated loss on disposal of the IdahoDairy, including the transferred Colorado herd, and partially due to increasedfeed and cattle costs of the Idaho Dairy and Colorado herd discontinuedoperations.

 

•                                          Income (loss) for international operationsincreased $1.3 million to income of $0.2 million in 2002 from a lossof $1.1 million in 2001.  Theincrease in income was primarily due to the decrease in intangible assetamortization and partially due to decreased interest expense.

 

*Comprehensive Income.* Comprehensive income increased 278.7%, or $2.4 million, to$3.2 million in 2002 from $0.8 million in 2001. This increase was dueto the increase in unrealized gain on translation adjustment from the Britishpound to the U.S. dollar. We translate our investment in our U.K. subsidiariesfrom pounds sterling to U.S. dollars at the rate in effect at the end of aperiod. At December 31, 2002 and December 31, 2001, we translated theBritish pound at an exchange rate of approximately U.S. $1.604 and U.S. $1.452,respectively.

 

**Year ended December 31, 2001 compared to year endedDecember 31, 2000**

 

*Net Sales.*  Net salesincreased by 24.9%, or $31.7 million, to $158.9 million in 2001 from$127.2 million in 2000. Net sales from U.S. operations increased 21.0%, or$22.0 million, to $127.0 million from $105.0 million resultingprimarily from increased sales of existing products to existing accounts andcontinued expansion of conventional grocery distribution channels. Changes inour U.S. product category sales were as follows:

 

Fluid Milk

 

•                                          Total fluid milk sales increased 21.4%, or$16.0 million, to $90.7 million in 2001 from $74.7 million in2000.

 

•                                          Sales of UP fluid milk increased 96.4%, or$20.0 million, to $40.7 million in 2001, from $20.7 million in2000. This increase was primarily due to expansion of UP milk to new customersthroughout the year.

•                                          Sales of traditional pasteurized fluid milkdecreased 7.4%, or $4.0 million, to $50.0 million in 2001 from$54.0 million in 2000. The decrease was primarily the result of somecustomers substituting UP fluid milk distribution for traditional pasteurizedmilk distribution. As a result of these shifts, our fluid milk product line mixshifted to 55.1% traditional pasteurized fluid milk in 2001 from 72.3% in 2000.

 

Other Dairy

 

•                                          Total net sales of our other dairy productsincreased 19.6%, or $5.0 million, to $30.5 million in 2001 from$25.5 million in 2000, driven primarily by increased sales of our cheeseproducts and increased industrial sales.

 

•                                          Net sales of yogurt increased 12.0%, or$0.9 million, to $8.6 million in 2001 from $7.7 million in 2000.

 

•                                          Net sales of butter increased 4.8%, or$0.4 million, to $7.9 million in 2001 from $7.5 million in 2000.

 

•                                          Net sales of cheese increased 62.6%, or$1.8 million, to $4.7 million in 2001 from $2.9 million in 2000.This resulted from the introduction of new cheese varieties and expansion ofdistribution of existing items.

 

•                                          Net sales of industrial products, such as powderand cheeses sold for further processing into finished goods, increased 36.2%,or $1.1 million, to $4.0 million in 2001 from $2.9 million in2000. This increase also included the expansion of single-serve branded cupyogurt into food service outlets.

 

Juice

 

•                                          Net sales of our juice products increased 20.4%,or $1.4 million, to $8.2 million in 2001 from $6.8 million in2000 principally as the result of increased distribution of our expanded flavorvarieties and expanded distribution of our single–serve juice products.

 

International

 

•                                          Net sales from international operations increased43.3%, or $9.7 million, to $31.9 million in 2001 from$22.2 million in 2000, primarily as a result of a full year of operationsfrom our fluid milk acquisitions compared to seven months in 2000.

 

•                                          Net sales of Rachel’s Organic dairy products,which in 2001 and 2000 consisted primarily of yogurt, double cream, crèmefraiche and butter increased 18.0%, or $0.8 million to $5.4 millionin 2001 from $4.6 million in 2000.

 

*Cost of Sales and Gross Profit.*  Cost ofsales increased 25.1%, or $22.4 million, to $111.8 million in 2001from $89.4 million in 2000. The increase in cost of sales was primarilythe result of our increased sales. Gross profit increased 24.4%, or$9.2 million, to $47.0 million in 2001 from $37.8 million in2000. As a percentage of net sales, gross profit decreased to 29.6% in 2001from 29.7% in 2000 primarily due to an increase in lower margin internationalprivate label sales. Our gross profit in the U.S. increased to 31.4% in 2001from 30.8% in 2000. Our gross profit in the U.K. decreased to 22.2% in 2001 from24.6% in 2000. This was primarily the result of a full year of private labelorganic fluid milk sales, as opposed to seven months in 2000. Private labelfluid milk sales are generally made at a lower gross profit than sales of ourbranded products.

*Selling Expenses.*  Sellingexpenses increased 23.5%, or $5.9 million, to $31.3 million in 2001from $25.4 million in 2000 driven primarily by increased trade andconsumer promotion to support higher sales in the U.S. As a percentage of netsales, selling expenses decreased to 19.7% in 2001 from 20.0% in 2000 primarilythe result of a full year of primarily private label organic fluid milk in theU.K. as a result of the Meadow Farms acquisition, as compared to seven monthsin 2000. We generally incur lower selling expenses with private label products.

 

*General and AdministrativeExpenses.*  General and administrative expensesdecreased 10.3%, or 1.0 million, to $8.0 million in 2001 from$9.0 million in 2000. This decrease was primarily due to theDecember 2000 U.K. management restructuring. As a percentage of net salesour general and administrative expenses decreased to 5.1% in 2001 from 7.0% in2000 primarily due to improved productivity.

 

*Intangible Asset Amortization.* Intangible asset amortization expenses increased 30.4%, or$0.7 million, to $3.1 million in 2001 from $2.4 million in 2000.The increase was a result of a full year of amortization associated with theJune 2000 acquisitions of Meadow Farms and Organic Matters in the U.K., asopposed to seven months in 2000.

 

*Other Income (Expense), Net.*  Otherincome (expense), net increased 219.4%, or $1.3 million, to$1.8 million expense in 2001 from $0.5 million expense in 2000. Theincrease was primarily attributable to a full year of interest expense in 2001 onthe term note used to finance the June 2000 acquisitions of Meadow Farmsand Organic Matters compared to seven months in 2000, and to a lesser extent,an increase in amounts outstanding under our line of credit, which more thanoffset a decrease in the average interest rate in our debt facilities. Ouraverage interest rate for the year on our LIBOR-based debt facilities decreasedto 7.0% for 2001 from 9.1% in 2000.

 

*Income Tax Expense.*  Incometax expense increased 406.0%, or $0.9 million, to $1.1 million in2001 from $0.2 million in 2000. Our effective income tax rate decreased to40.3% in 2001 from 43.1% in 2000 resulting from our ability to fully utilizeour U.K. losses in 2001 as opposed to 2000.

 

*Income From ContinuingOperations.*  Income from continuing operations increased$1.4 million to income from continuing operations of $1.7 million in2001 from income from continuing operations of $0.3 million in 2000.

 

•                                          Income from continuing operations for U.S.operations increased $1.2 million to $2.7 million income in 2001 from$1.5 million income in 2000.

 

•                                          Loss from continuing operations for internationaloperations decreased $0.2 million to a loss of $1.1 million in 2001from a loss of $1.3 million in 2000.

 

*Income from DiscontinuedOperations, Net.*  Income from discontinued operations, netdecreased $0.1 million to $0.1 million in 2001 from $0.2 millionin 2000. The decrease was primarily due to increased general operating costsand feed costs of the Idaho Dairy and Colorado herd.

 

*Net Income.*  Net incomeincreased 235.0%, or $1.2 million, to $1.7 million in 2001 from$0.5 million in 2000.

 

•                                          Net income for U.S. operations increased 58.9%, or$1.0 million, to $2.8 million in 2001 from $1.8 million in 2000.

•                                          Net loss for international operations decreased14.0%, or $0.2 million, to a net loss of $1.1 million in 2001 from anet loss of $1.3 million in 2000.

 

*Comprehensive Income.* Comprehensive income increased 218.6%, or $0.5 million, to$0.8 million in 2001 from $0.3 million in 2000. This increase was dueto the increase in net income primarily caused by the increased leverage ofsales volume, partially offset primarily by unrealized loss on translationadjustment from the British pound to the U.S. dollar. We translate ourinvestment in our U.K. subsidiaries from pounds sterling to U.S. dollars at therate in effect at the end of a period. At December 31, 2001 andDecember 31, 2000, we translated the British pound at an exchange rate ofapproximately U.S. $1.452 and U.S. $1.494, respectively.

 

**Supplemental Quarterly Information**

 

The following table sets forth quarterly unauditedfinancial data for the quarters of 2002 and 2001. We believe that thisunaudited financial information includes all adjustments, consisting only ofnormal recurring adjustments, necessary for a fair presentation of theinformation for each period.

 
|                                             |   | **Year Ended December 31, 2002** |       |
|--------------------------------------------------|--------|----------------------------------|------------|
|                                             |   | **1st Qtr**                      | ** ** | **2nd Qtr** | ** ** | **3rd Qtr** | ** ** | **4th Qtr** | ** ** |
|                                             |   | **(in thousands)**               | ** ** |
|                                             |   |                             | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Net  sales                                       |   | $                                | 42,218     |   | $ | 44,713 |   | $ | 47,631 |   | $ | 52,975 |   |
| Gross  profit                                    |   | 13,850                           |       | 14,067 |   | 14,950 |   | 16,989 |   |
| Operating  income                                |   | 1,574                            |       | 1,182 |   | 1,370 |   | 2,329 |   |
|                                             |   |                             |       |   |   |   |   |   |   |
| Income  from continuing operations               |   | 845                              |       | 647 |   | 723 |   | 1,390 |   |
| Loss  from discontinued operations, net          |   | (2,519                           | )          | (294 | ) | (399 | ) | (426 | ) |
| Net  income (loss)                               |   | $                                | (1,674     | ) | $ | 353 |   | $ | 324 |   | $ | 964 |   |
|                                             |   |                             |       |   |   |   |   |   |   |
|                                             |   | **Year Ended December 31, 2001** | ** ** |
|                                             |   | **1st Qtr**                      |       | **2nd Qtr** |   | **3rd Qtr** |   | **4th Qtr** |   |
|                                             |   | **(in thousands)**               |       |
|                                             |   |                             |       |   |   |   |   |   |   |
| Net  sales                                       |   | $                                | 37,598     |   | $ | 38,606 |   | $ | 39,009 |   | $ | 43,657 |   |
| Gross  profit                                    |   | 10,730                           |       | 11,118 |   | 11,807 |   | 13,368 |   |
| Operating  income                                |   | 379                              |       | 698 |   | 1,182 |   | 2,272 |   |
|                                             |   |                             |       |   |   |   |   |   |   |
| Income  (loss) from continuing operations        |   | (132                             | )          | 112 |   | 424 |   | 1,258 |   |
| Income  (loss) from discontinued operations, net |   | (103                             | )          | 330 |   | 168 |   | (317 | ) |
| Net  income (loss)                               |   | $                                | (235       | ) | $ | 442 |   | $ | 592 |   | $ | 941 |   |

 

**Liquidity and Capital Resources**

 

We have generally used funds generated fromoperations, trade payables, bank indebtedness and the sale of equity securitiesto meet our capital requirements.

Net cash provided by (used in) operatingactivities was $8.7 million and $9.8 million provided by operating activitiesfor 2002 and 2001, respectively, and $11.8 million used in operating activitiesin 2000.  Net cash provided byoperations in 2002 was primarily attributable to a decrease in inventories of$2.6 million as well as an increase in income as adjusted by the $3.4 millionnon-cash loss on the disposal of the Idaho Dairy and Colorado herd, net ofincome taxes; depreciation and amortization charges; and an increase in loss onsale of cattle and equipment partially offset by increased prepaid and othercurrent assets and trade accounts receivable. In2001, net cash provided by operating activities was primarily attributable toan increase in net income as adjusted by non-cash goodwill amortization anddepreciation charges along with decreases in inventories.  Net cash used in operating activities in2000 was primarily attributable to increases in inventories of certain productsand in accounts receivable, partially offset by increases in accrued expensesand in non-cash goodwill amortization charges related to the acquisitions ofMeadow Farms and Organic Matters.

 

Net cash used in investing activities was $5.5million, $4.7 million and $28.7 million for 2002, 2001 and 2000 respectively.Net cash used in investing activities in 2002 was primarily attributable to$3.5 million used by discontinued operations reflecting primarily its 2002payments for feed inventories and cattle, $1.6 million used in the purchases ofproperty and equipment net of proceeds from equipment sales and $0.5 millionused in the purchase of cattle for our Maryland farm operations net of proceedsfrom cattle sales. The purchase of property and equipment was primarily thepurchase of processing equipment, office furniture, office equipment and software.Net cash used in investing activities for 2001 was $4.7 million.Expenditures in 2001 were primarily attributable to the ongoing cattlepurchases for herd maintenance, enterprise resource planning software, notereceivable associated with the Dairy Crest agreement and other milk productionand processing equipment.   Expendituresin 2000 were primarily attributable to the $25.9 million acquisition of MeadowFarms and the $2.1 million acquisition of Organic Matters.  In addition, ongoing cattle purchases forherd maintenance at both the discontinued operations and the Maryland Farmoperations, leasehold improvements at the Horizon Organic Farm and EducationCenter in Maryland and enterprise resource planning software were largeexpenditures in 2000.

 

Net cash used in financing activities was $5.7million and $4.0 million in 2002 and 2001, respectively, and net cashprovided by financing activities was $39.2 million in 2000. During 2002 and2001, the principal use of cash was the repayment of debt offset by proceedsfrom stock option exercises.  Cashprovided by financing activities during 2000 reflects the $25.0 million termloan we entered into with US Bank to finance the Meadow Farms and OrganicMatters acquisitions in addition to the increase in the line of credit balancewith US Bank to finance our working capital needs.

 

Our cash and cash equivalents were $1.4 million atDecember 31, 2002 and $3.5 million at December 31, 2001. We have afive year $25.0 million term loan with US Bank, which bears an interestrate of LIBOR plus a variable margin spread ranging from 1.65% to 3.75%. AtDecember 31, 2002, the interest rate was 3.94%. At December 31, 2002we had an outstanding balance of $17.8 million.  In addition, we have a line of credit with US Bank that providesfunding of up to $25.0 million and bears interest primarily at a rate ofLIBOR plus a variable margin spread ranging from 1.65% to 3.75%.  At December 31, 2002, we had borrowed$16.2 million against the credit line facility in addition to letter ofcredit encumbrances on this facility of $2.5 million. Of this $16.2million outstanding credit line balance, $15.4 million was at an interestrate of 3.94% and $0.8 million was at an adjustable interest rate of primeplus 0.75%, or 5.0%. We may borrow additional amounts under the revolving lineof credit, subject to the terms of the credit agreement, until the facility’smaturity date of May 31, 2003.  Weexpect to use a substantial portion of the proceeds from the sale of assetsheld for sale to repay outstanding debt and we are working with US Bank on aplan to extend or replace our line of credit before it matures on May 31, 2003.As discussed in Part I under the heading “Risk Factors”, there can be noassurance that we will be able to consummate the Idaho Dairy sale transaction.

 

Our working capital of $23.3 million includes,among other current assets and liabilities, the Idaho Dairy assets held forsale, including the transferred Colorado herd, and the mortgage associated withthe Idaho Dairy.  It also includes ourcredit line with US Bank because it matures on May 31, 2003, and is, therefore,a current liability at December 31, 2002. However, the maturity of our presentcredit line with US Bank is not dependent on the sale of the Idaho Dairy.

We currently anticipate that our available cashresources, funds generated by operations and available and expected creditfacilities, will be sufficient to meet our presently anticipated capital needs,but may be insufficient for cash acquisitions under our corporate developmentprogram. If additional funds are required, we may seek additional equity ordebt financing. Such financing may not be available to us on terms that areacceptable to us, if at all, or on terms that would not be dilutive to ourstockholders.

 

*Contractual Obligations and Commercial Commitments Summary*

 

The following table summarizes the estimatedfuture undiscounted cash obligations associated with our long-term debt,capital leases, operating leases and purchase obligations by year or group ofyears beginning with January 1, 2003. Long-term debt consists primarily ofour $25.0 million credit line and $25.0 million term note with USBank. These debt facilities may be declared immediately due and payable uponany event of default, as defined in the loan agreement. Events of default, asdefined, include being out of compliance with our loan covenant requirements.Such covenant requirements include measures of working capital, net worth, cashflow leverage and interest and fixed charge coverage ratios. AtDecember 31, 2002 we were in compliance with our loan covenants. Ourlong-term debt interest rate is primarily variable. The table below assumes a4.0% interest rate for year 1 and 7.5% interest rate thereafter. A fullpercentage point fluctuation in interest rates would result in decreasing orincreasing the cash interest paid by approximately $0.3 million in yearone, $0.1 million in year two, and would have minimal or no effectthereafter.

 

Capital leases are for financing a portion of thecost of our computer software system implemented in 2001. The operating leasesare primarily office, real estate and equipment rentals.

 

Purchase obligations are primarily milk productioncontracts in the U.S. and the U.K.  Webelieve that all purchase obligations approximate fair market value at December31, 2002.

 

The table below presents our contractualobligations as of December 31, 2002.

 
|                                                                |   | **Payments Due by Period** |       |
|---------------------------------------------------------------------|--------|----------------------------|------------|
|                                                                |   | **Total**                  | ** ** | **2003** | ** ** | **2004-2005** | ** ** | **2006-2007** | ** ** | **Post 2007** | ** ** |
|                                                                |   | **(in thousands)**         | ** ** |
|                                                                |   |                       | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Contractual Obligations**                                         |   |                       |       |   |   |   |   |   |   |   |   |
| Debt obligations including term loans, line of  credit and interest |   | $                          | 42,592     |   | $ | 27,385 |   | $ | 15,173 |   | $ | 34 |   | $ | — |   |
| Capital  lease obligations including interest                       |   | 519                        |       | 417 |   | 102 |   | — |   | — |   |
| Operating  lease obligations                                        |   | 5,413                      |       | 1,172 |   | 1,864 |   | 1,399 |   | 978 |   |
| Purchase  obligations                                               |   | 74,664                     |       | 53,782 |   | 20,882 |   | — |   | — |   |
| Total contractual obligations                                       |   | $                          | 123,188    |   | $ | 82,756 |   | $ | 38,021 |   | $ | 1,433 |   | $ | 978 |   |

 

## **Related PartyTransactions**

 

*Aurora Dairy Corporation. *We entered into a Dairy Herd Management and SupplyAgreement on March 5, 1999 (subsequently amended on June 9, 1999 and on August9, 2001) with Aurora Dairy Corporation whose majority owner is a former memberof our board.  The agreement allowed usto provide and maintain an organic dairy herd at Aurora’s facilities inPlatteville, Colorado, approximating 1,150 head milking.  Over the life of the contract, we providedthe feed for the animals and paid for approximately $270,000 in equipment andleasehold improvements.  Aurora managedthe herd and paid for operating expenses outside of the feed, breeding, cattlecosts and the depreciation of the leasehold improvements and equipment providedby us.  The management fees variedthroughout the term of the contract but required a minimum of $90,000 per monththrough June 30, 2002.  The contract ranfrom October 1999 through September 2002. The contract expired on September 30,2002, by which time the remaining herd was transferred to our Idaho Dairy.During the “wind-down phase” from July 2002 through September 2002 we paid amanagement fee of $125,000 per month.

We believe the management fees were fair and equitablefor three reasons.  First, the feescharged on a production basis were comparable to a price that was indicative ofan equitable return on operating costs of our own dairies.  Second, the cost of the resulting milkproduction after freight into our dairy processor was a cost that was lessexpensive than other available milk supplies at the inception of the contract.   Finally, we recognized that the contractresulted in a milk supply that would be available much sooner compared toalternative supply sources at the inception of the contract.

 

Payments made to Aurora by us for management fees were$1,248,781, $1,840,352 and $1,460,723 during 2002, 2001 and 2000,respectively.  Additionally during theserespective years, we paid Aurora $121,937, $151,092, and $83,607 for feed andcattle.  Aurora paid us $147,284,$455,475 and $395,637 during 2002, 2001 and 2000, respectively, for thepurchase of cattle, feed and miscellaneous equipment.  Additionally, in April 2000 Aurora and we agreed that we woulddeliver to Aurora 600 head of cattle between April and June 2000.  In exchange, Aurora would deliver 600 headof cattle to us between December 2000 and March 2001.

 

*DeanFoods.*  In 1998, weentered into agreements with a significant shareholder, Dean Foods Company,formerly Suiza Foods Corporation, a manufacturer and distributor of fresh milkand related dairy products. Our agreements with Dean Foods include five-yearprocessing and distribution agreements with three of Dean Food’s subsidiaries:Model Dairy, a fluid milk processor located in Reno, Nevada; Robinson Dairy, afluid milk processor located in Denver, Colorado; and Garelick Farms, a fluidmilk processor and distributor with several locations in the northeast U.S.,which does not currently process any products for us.  The processing and distribution agreement with Model Dairy providesthat it will be the exclusive processor for our milk products in California andNevada, with certain exceptions, and that it will distribute all SKUs of ourorganic fluid milk products which are available for sale in its territory.  The processing and distribution agreementwith Robinson Dairy provides that we will not engage another processor withinthe state of Colorado.  One of ourdirectors controlled Robinson Dairy at the inception of the agreement.  Per the agreement, we will pay minimumco-packing fees for processing product through December 31, 2003.  We also have products processed byMorningstar Foods, a fluid milk processor located in Gustine, California andCultured Specialties, a dairy processor located in Fullerton and Tulare,California. Both companies are subsidiaries of Dean Foods.  We paid Dean Foods and its subsidiariesapproximately $18,697,000, $13,928,000, and $7,822,000 in 2002, 2001 and 2000,respectively.

 

We monitor production costs from various processorlocations.  Based on historical averagesand current trends we routinely compare and analyze our production costs at ourexisting processor plants.  From thisdata, we routinely discuss contract prices, efficiency and quality controltopics with all of our processors.  As aresult, we believe that the processing and distribution fees charged by DeanFoods are fair and equitable in comparison to prices charged for similarservices by other fluid milk and dairy processing plants we engage.

 

*DirectorResignation.*  Inconnection with the resignation of Mark A. Retzloff as a director effectiveJuly 29, 2002, we entered into an agreement with Mr. Retzloff pursuant to whicheach of us released the other from any claim and we agreed to accelerate thevesting of stock options held by Mr. Retzloff as follows:  2,000 shares with an exercise price of$17.25 per share; 10,000 shares with an exercise price of $9.50 per share;6,000 shares with an exercise price of $17.79 per share; and 4,500 shares withan exercise price of $7.00 per share. These options would have terminated absent this agreement.  We incurred an expense of approximately$52,000 with respect to this agreement because the closing price of our stockon July 29, 2002 was $12.29 per share.

**CriticalAccounting Policies**

 

Our consolidated financial statements are impacted by the accountingpolicies used and the estimates and assumptions made by management during theirpreparation. Critical accounting policies and estimates that most impact ourconsolidated financial statements are those that relate to:

 

•                  the reporting of our Idaho Dairy and Colorado herdoperations as discontinued operations and assets held for sale beginning March31, 2002,

•                  the recoverability of goodwill and otherintangible assets,

•                  the valuation of accounts receivable inconjunction with the recognition of routine customer deductions includingreturns and allowances and market development support,

•                  the depreciation and capitalization of costsassociated with fixed assets including cattle and

•                  the pooling accruals associated with the FederalMilk Market Order System.

 

*DiscontinuedOperations and Assets Held for Sale*

 

On March 31, 2002, we determined that our Idaho Dairy and Coloradoherd met the definition of a disposal group under Statement of FinancialAccounting Standards No. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets,* orSFAS 144. We have a plan in place to sell the assets of the Idaho Dairyand Colorado herd. Most of the Colorado herd was transferred to the Idaho Dairyin connection with the September 30, 2002 expiration of the managementagreement for our Colorado herd with Aurora Dairy Corporation. We are innegotiations for the sale of the Idaho Dairy to an experienced dairy farmer andfor a long-term supply agreement with the buyer for organic fluid milk at theexpected fair market value. We currently expect to close the transactionsduring the spring of 2003.

 

Accordingly, approximately $29.9 million of the Idaho Dairy andColorado herd assets which are expected to be disposed of have beenreclassified as current assets held for sale at December 31, 2002. Thiscompares to $5.2 million of current assets held for sale and$25.2 million of long-term assets held for sale as of December 31,2001. Additionally, we have ceased depreciation on the assets as of themeasurement date of March 31, 2002. We expect to use a substantial portionof the proceeds from the sale of such assets to repay outstanding debt or asworking capital. The financial results from these operations for the currentand prior periods are reported as discontinued operations.

 

*Goodwill and Other Intangible Assets*

 

On January 1, 2002, we adopted Statement of Financial AccountingStandards No. 142, *Goodwill and OtherIntangible Assets*, or SFAS 142, which requires that goodwill andcertain identifiable intangible assets not be amortized, but instead will bereviewed for impairment at least annually in accordance with the provisions ofthis statement.  Other identifiableintangibles with finite lives continue to be amortized over their estimateduseful lives.  We performed ourimpairment valuation reviews as of January 1, 2002 and August 31, 2002 andconcluded that there were no goodwill and other intangible asset impairment atthose dates.  Moreover, there were nosignificant changes in our business or industry since August 31, 2002 thatwould have indicated additional impairment valuation reviews were warranted atDecember 31, 2002.  We will performvaluational impairment reviews annually on August 31 and at interim dates as conditionswarrant.  If the U.K. operations fail toprovide positive future net cashflows, the analysis would indicateimpairment.  However, we do not expectthat the results of our 2003 analysis will indicate impairment and have amaterial impact on our financial position.

 

*AccountsReceivable*

We recognize trade accounts receivable in conjunction with therecognition of revenue which is at the time of shipment or pickup by acustomer. We traditionally experience customer payments net of customerdeductions for items such as spoilage allowances or market development supportbefore such deductions can be proven valid by us. This deduction practice iscommon to our industry. The deduction validation procedure generally lagsbecause the customer routinely concentrates on taking the deduction and thendelays in sending the proper paperwork to support the deductions. As a result,our valuation of accounts receivable includes accruals for estimates of suchreturns and allowances, market development support and doubtful accounts.  Upon proper receipt and validation of thededuction paperwork, the amounts accrued are used to reduce the outstandingaccounts receivable balance.

 

*Capitalizationand Depreciation of Fixed Assets Including Cattle*

 

Our property, equipment and cattle are stated at cost. Property (otherthan land and assets held for sale) is depreciated using the straight-linemethod over the estimated useful lives, which range from 3 to 27 years.Equipment and cattle (other than assets held for sale) are depreciated usingthe straight-line method over the estimated useful lives, which range fromthree to seven years. Major improvements are capitalized including, asapplicable, an allocation of interest incurred during the period ofconstruction or major refurbishment. The cost of cattle includes preproductioncosts incurred from the time cattle arrive at the dairy until they enter themilking herd. Preproduction costs include feed and husbandry.

 

When assets are sold, retired or otherwise disposed of, the cost andrelated accumulated depreciation are eliminated from the accounts and a gain orloss is recognized. Repair and maintenance costs are expensed as incurred.

 

We evaluate the realizability of our long-lived assets, includingproperty and equipment, whenever events or changes in circumstances indicatethat the carrying amount of an asset may not be recoverable. An impairment lossexists when estimated undiscounted cash flows expected to result from the useof the asset and its eventual disposition are less than its carrying amount.Any impairment loss recognized represents the excess of the asset’s carryingvalue as compared to its estimated fair value. There were no impairment lossesduring the years ended December 31, 2002, 2001 and 2000.

 

*Federal MilkMarket Order System Pooling Accruals*

 

We are included in the Federal Milk Market Order System. As a result,our processors incur milk pooling charges as calculated by the Federal MilkMarket Order System for which we are, in some cases, responsible. We estimateeach month’s pooling charges and adjust them to actual the following monthbecause the pooling charge assessments are received from the MarketAdministrators one month in arrears.

 

For additional information on our significant accounting policies, seeNote 2 to our accompanying consolidated financial statements.

 

# **Effectof Recently Issued Accounting Standards**

 

In June 2001, the FASB issuedStatement of Financial Accounting Standards No. 143, *Accounting for Asset RetirementObligations*, or SFAS 143, which addresses financial accounting andreporting for obligations associated with the retirement of tangible long-livedassets and the associated asset retirement costs. The standard applies to legalobligations associated with the retirement of long-lived assets that resultfrom the acquisition, construction, development and/or normal use of theasset.  SFAS 143 requires that the fairvalue of a liability for an asset retirement obligation be recognized in theperiod in which it is incurred if a reasonable estimate of fair value can bemade.  The fair value of the liabilityis added to the carrying amount of the associated asset and this additionalcarrying amount is depreciated over the life of the asset.  The liability is accreted at the end of eachperiod through charges to operating expense. If the obligation is settled for other than the carrying amount of theliability, we will recognize a gain or loss on settlement.  We have adopted the provisions of SFAS 143effective January 1, 2003 and have not experienced any impact on ourfinancial position, results of operations or cash flows as a result of itsimplementation.

In October 2001, the FASB issuedStatement of Financial Accounting Standards No. 144, *Accounting for the Impairment orDisposal of Long-Lived Assets*, or SFAS 144, which addresses financialaccounting and reporting for the impairment or disposal of long-livedassets.  While SFAS 144 supersedes SFAS121, *Accountingfor the Impairment of Long-Lived Assets and for Long-Lived Assets to BeDisposed Of*, it retains many of the fundamental provisions of thatStatement.  SFAS 144 also supersedes theaccounting and reporting provisions of APB Opinion No. 30, *Reporting the Results ofOperations-Reporting the Effects of Disposal of a Segment of a Business, andExtraordinary, Unusual and Infrequently Occurring Events and Transactions*,for the disposal of a segment of a business. We have adopted the provisions of SFAS 144 effective January 1, 2002.

 

In April 2002, the FASB issued Statement of FinancialAccounting Standards No. 145, *Rescission ofFASB Statement No. 4, 44 and 64, Amendment of FASB Statement No. 13, andTechnical Corrections*, or SFAS 145. This statement provides guidanceon the classification of gains and losses from the extinguishment of debt andon the accounting for certain specified lease transactions.  We believe that SFAS 145 will not have anymaterial impact on our financial position, results of operations or cash flowsupon its adoption.

 

In June 2002, the FASB issued Statement of FinancialAccounting Standards No. 146, *Accounting forCosts Associated with Exit or Disposal Activities*, or SFAS 146,which addresses financial accounting and reporting for costs associated withexit or disposal activities and nullifies Emerging Issues Task Force (“EITF”)Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefitsand Other Costs to Exit an Activity (including Certain Costs Incurred in aRestructuring). Generally, SFAS 146 requires that a liability for a costassociated with an exit or disposal activity be recognized as incurred, whereasEITF Issue No. 94-3 required such a liability to be recognized at the time thatan entity committed to an exit play. Since SFAS 146 is effective for exit ordisposal activities that are initiated after December 31, 2002, it will have noimpact on financial statement periods prior to January 1, 2003.

 

In December 2002, the FASB issued Statement ofFinancial Accounting Standards No. 148, *Accountingfor Stock-Based Compensation — Transition and Disclosure*, or SFAS148. This statement amends FASB Statement No. 123, *Accounting for Stock-Based Compensation*,to provide alternative methods of transition for a voluntary change to the fairvalue based method of accounting for stock-based employee compensation. Thisstatement also amends the disclosure requirements of Statement 123 to requireprominent disclosures in both annual and interim financial statements about themethod of accounting for stock-based employee compensation and the effect ofthe method used on reported results. The provisions of this statement relatingto alternative transition methods and annual disclosure requirements areeffective for fiscal years ending after December 15, 2002. The provisionsof this statement relating to interim financial information are effective forthe quarter ending March 31, 2003. The transitional provisions will nothave an impact on our financial statements unless we elect to change from theintrinsic value method to the fair value method. We have adopted SFAS 148 as ofDecember 31, 2002 and we believe that the provisions relating to annual andinterim disclosures have changed the manner in which we disclose informationregarding stock-based compensation.

In November 2002,the Financial Accounting Standards Board issued FASB Interpretation No. 45, *Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others,*orFIN 45, which addresses the disclosure to be made by a guarantor in its interimand annual financial statements about its obligations under guarantees. FIN 45also requires the recognition of a liability by a guarantor at the inception ofcertain guarantees and requires the guarantor to recognize a liability for thenon-contingent component of the guarantee. This is the obligation to standready to perform in the event that specified triggering events or conditionsoccur. The initial measurement of this liability is the fair value of theguarantee at inception. The recognition of the liability is required even if itis not probable that payments will be required under the guarantee or if theguarantee was issued with a premium payment or as part of a transaction withmultiple elements. We are required to adopt the disclosure provisions of FIN 45beginning with our fiscal 2003 consolidated financial statements, and willapply the recognition and measurement provisions for all guarantees enteredinto or modified after December 31, 2002. We have not completed our assessmentof the recognition provisions of the Interpretation; however, the adoption isnot expected to have a significant impact on our consolidated financialstatements.

 

In January 2003,the Financial Accounting Standards Board issued FASB Interpretation No. 46, *Consolidation of Variable Interest Entities*,or FIN 46.  FIN 46 clarifies existingaccounting principles related to the preparation of consolidated financialstatements when the equity investors in an entity do not have thecharacteristics of a controlling financial interest or when the equity at riskis not sufficient for the entity to finance its activities without additionalsubordinated financial support from other parties.  FIN 46 requires a company to evaluate all existing arrangementsto identify situations where a company has a “variable interest” (commonlyevidenced by a guarantee arrangement or other commitment to provide financialsupport) in a “variable interest entity” (commonly a thinly capitalized entity)and further determine when such variable interests require a company toconsolidate the variable interest entities’ financial statements with itsown.  We are required to perform thisassessment by September 30, 2003 and consolidate any variable interest entitiesfor which we will absorb a majority of the entities’ expected losses or receivea majority of the expected residual gains. We have not yet performed this assessment; however we are not aware ofany material variable interest entities that we may be required to consolidate.

 

**ITEM 7****A****.**                    **QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

**QualitativeMarket Risk**

 

Market risk refersto the risk that a change in the level of one or more market prices, interestrates, indices, volatilities, correlations or other market factors such asliquidity, will result in losses for a certain financial instrument or group offinancial instruments.  We occasionallyenter into forward financial instruments with major financial institutions tomanage and reduce the impact of changes in foreign currency rates.  We do not use financial instruments tomanage changes in commodity prices and we do not hold or issue financialinstruments for trading purposes.  Basedon the controls in place and the relative size of the financial instruments weenter into, we believe the risks associated with not using these instrumentswill not have a material adverse effect on our consolidated financial positionor results of operations.

 

**QuantitativeMarket Risk:  Value At Risk**

 

*Foreign Exchange Contracts.*  We occasionally enter into forward financialinstruments to manage and reduce the impact of changes in foreign currencyrates with a financial institution. These instruments are marked-to-market atthe end of each month and gains and losses are recorded in the statement ofoperations.  We had no outstandingforeign exchange contracts at December 31, 2002.

 

*Interest Rates.*  At December 31, 2002, we had approximately$3.0 million of fixed rate long-term debt (including current maturities.) Thefair value of long-term fixed interest rate debt is subject to interest raterisk. Generally, among other factors including credit ratings, the fair valueof fixed interest rate debt will increase as interest rates fall and decreaseas interest rates rise. The estimated fair value of our total fixed ratelong-term debt (including current portion) at December 31, 2002 was $3.1million, which was $100,000 more than the carrying value. Fair values weredetermined primarily from quoted market rates. A full percentage point decreasefrom prevailing interest rates at December 31, 2002, would result in an estimatedincrease in fair value of total fixed interest rate long-term debt ofapproximately $30,000.  Additionally atDecember 31, 2002, we had approximately $37.8 million of floating ratelong-term debt (including current maturities) subject to interest raterisk.  A full percentage pointfluctuation in interest rates would result in decreasing or increasing interestexpense by approximately $378,000 over a twelve month period.

**ITEM 8****.**     **CONSOLIDATED FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

 

The consolidatedfinancial statements and related notes thereto required by this item are listedand set forth herein as Appendix F.

 

**ITEM 9****.**     **CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ONACCOUNTING AND FINANCIAL DISCLOSURE**

 

Not applicable.

 

### **PART III**

 

**ITEM10****.**                      **DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT**

 

This item is incorporated by reference from thesections entitled “Proposal 1 – Election of Directors” and “Management,” in our2003 Definitive Proxy Statement. We anticipate filing the 2003 Definitive ProxyStatement with the Securities and Exchange Commission within 120 days ofDecember 31, 2002.

 

**ITEM 11****.**                      **EXECUTIVECOMPENSATION**

 

This item is incorporated by reference from thesection entitled “Executive Compensation”****in our 2003 Definitive ProxyStatement.  We anticipate filing the2003 Definitive Proxy Statement with the Securities and Exchange Commissionwithin 120 days of December 31, 2002.

 

**ITEM12****.**                      **SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

 

This item isincorporated by reference from the section entitled “Security Ownership ofCertain Beneficial Owners and Management” in our 2003 Definitive ProxyStatement.  We anticipate filing the2003 Definitive Proxy Statement with the Securities and Exchange Commissionwithin 120 days of December 31, 2002.

 

**ITEM13****.**                      **CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

 

This item is incorporated by reference from thesection entitled “Certain Relationships and Related Transactions”****inour 2003 Definitive Proxy Statement.  Weanticipate filing the 2003 Definitive Proxy Statement with the Securities andExchange Commission within 120 days of December 31, 2002.

 

**ITEM14****.**                      **CONTROLS ANDPROCEDURES**

 

***Evaluation ofdisclosure controls and procedures***.

 

Under the supervision and with the participation ofour management, including our chief executive officer and chief financialofficer, we carried out an evaluation of the effectiveness of the design andoperation of our disclosure controls and procedures [as defined inRules 240.13a-14(c) and 15d-14(c) under the Securities Exchange Act of1934] as of a date within ninety days before the filing date of this annualreport.  Based upon this evaluation, the chief executive officer and chieffinancial officer concluded that, as of the evaluation date, our disclosure controlsand procedures were effective for the purposes of recording, processing,summarizing and timely reporting information required to be disclosed by us inthe reports that we file under the Securities Exchange Act of 1934 and thatsuch information is accumulated and communicated to our management in order toallow timely decisions regarding required disclosure.

 

***Changes in internalcontrols***.

 

There have been no significant changes in our internalcontrols or in other factors that could significantly affect our disclosurecontrols and procedures subsequent to the evaluation date, nor were there anysignificant deficiencies or material weaknesses in our internal controls.

 

### **PART IV**

 

**ITEM 15****.**                    **EXHIBITS,CONSOLIDATED FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K**

 

## **(a)**          The following documentsare filed as part of this Annual Report on Form 10-K.

 

1. Consolidated Financial Statements: The consolidatedfinancial statements of Horizon Organic Holding Corporation are included asAppendix F of this report.  See Index toConsolidated Financial Statements (Appendix F).

 

2. Financial Statement Schedules:  The information is presented in theconsolidated financial statements or related notes.

 

3. Exhibits.

 

**Exhibits**

 
| **Exhibit  Number**                             |   | **Description of Document**                                                                                                                                                                                                                                                                                                                                                                                                 |
|-------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1†                                       |   | Amended and Restated Certificate of Incorporation.                                                                                                                                                                                                                                                                                                                                                                          |
| 3.2†                                       |   | Amended and Restated Bylaws of the Company.                                                                                                                                                                                                                                                                                                                                                                                 |
| 4.1†                                       |   | Reference is made to Exhibits 3.1 and 3.2.                                                                                                                                                                                                                                                                                                                                                                                  |
| 4.2†                                       |   | Specimen stock certificate representing shares of  Common Stock of the Company.                                                                                                                                                                                                                                                                                                                                             |
| 10.1†*                                     |   | 1998 Employee Stock Purchase Plan.                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.2†                                      |   | Form of Indemnity Agreement.                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.3†                                      |   | Restatement, Amendment and Assumption Agreement,  dated as of March 20, 1997 among Farm Credit Services, Sunrise, Horizon  Organic Dairy, Inc., Marcus B. Peperzak and Farm Credit Bank of Wichita and  the Modification to Note and Loan Agreement dated June 23, 1995 and addressed  in the Restatement, Amendment and Assumption Agreement dated March 20, 1997  pertaining to Farm Credit Bank of Wichita Loan 2371719. |
| 10.6†                                      |   | Stock Purchase Agreement, dated as of June 5, 1998,  between the Company and Suiza Foods Corporation.                                                                                                                                                                                                                                                                                                                       |
| 10.7†                                      |   | Stockholder Agreement, dated as of June 5, 1998,  between the Company and Suiza Foods Corporation.                                                                                                                                                                                                                                                                                                                          |
| 10.8†††                          |   | Horizon Organic Holding Corporation Dairy Business  Agreement by and among Horizon Organic Holding Corporation, H.P. Hood Inc.  and The Organic Cow L.L.C. dated April 30, 1999.                                                                                                                                                                                                                                            |
| 10.9††††*                   |   | Amended and Restated Employment Agreement, effective  November 29, 1999, between Company and Charles F. Marcy.                                                                                                                                                                                                                                                                                                              |
| 10.10†††††             |   | Share Sale Agreement Dated May 31, 2000 among Roger  Persey & Others, Peter Dunsford and Horizon Organic Dairy Limited.                                                                                                                                                                                                                                                                                                 |
| 10.11††††††       |   | Amended and Restated Loan and Security Agreement,  dated as of May 30, 2000, among US Bank National Association and Horizon  Organic Holding Corporation.                                                                                                                                                                                                                                                                   |
| 10.12††††††       |   | First Amendment to Amended and Restated Loan and  Security Agreement, dated as of September 28, 2000, among US Bank National  Association and Horizon Organic Holding Corporation.                                                                                                                                                                                                                                          |
| 10.14*                                          |   | 1998 Equity Incentive Plan, as amended.                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.15††††††*      |   | Form of Company’s Stock Option Agreement, as  amended.                                                                                                                                                                                                                                                                                                                                                                 |
| 10.16††††††† |   | Employment Agreement, effective May 1, 2001, between  Horizon Organic Dairy, Inc. and Thomas P. Briggs.                                                                                                                                                                                                                                                                                                                     |
| 10.18††††††† |   | Employment Agreement, effective May 1, 2001, between  Horizon Organic Dairy, Inc. and Kevin O’Rell.                                                                                                                                                                                                                                                                                                                    |
| 10.19††††††† |   | Employment Agreement, effective May 1, 2001, between  Horizon Organic Dairy, Inc. and Stephen Jacobson.                                                                                                                                                                                                                                                                                                                     |
| 10.20                                           |   | Employment Agreement, effective May 1, 2001, between  Horizon Organic Holding Corporation and Don Gaidano.                                                                                                                                                                                                                                                                                                                  |
| 10.21                                           |   | Amended and Restated Office Lease for the Company’s  headquarters, dated May 16, 2002, between Horizon Organic Dairy, Inc. and MUM  II, LLC.                                                                                                                                                                                                                                                                           |
| 10.22                                           |   | Addendum to Amended and Restated Office Lease for  the Company’s headquarters, dated May 16, 2002, between Horizon Organic  Dairy, Inc. and MUM II, LLC.                                                                                                                                                                                                                                                               |
| 10.23                                           |   | Agreement and Release Upon Resignation, dated July  29, 2002, between Horizon Organic Holding Corporation and Mark Retzloff.                                                                                                                                                                                                                                                                                                |
| 21.1††††††        |   | Statement re: Subsidiaries of the Company                                                                                                                                                                                                                                                                                                                                                                                   |
| 23.1                                            |   | Consent of KPMG LLP.                                                                                                                                                                                                                                                                                                                                                                                                        |
| 24.1                                            |   | Power of Attorney.   Reference is made to the signature page contained herein.                                                                                                                                                                                                                                                                                                                                         |
| 99.1 † †*                             |   | Form of Non-Qualified Stock Option Agreement dated  January 10, 1998.                                                                                                                                                                                                                                                                                                                                                       |
| 99.2                                            |   | Certification Pursuant to Section 906 of the  Sarbanes–Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                              |

 

----

| Exhibits identified above are incorporated by  reference as follows: |
|----------------------------------------------------------------------|
| †                                                               | Incorporated by reference to the Registrant’s  Registration Statement on Form S-1 No. 333-51465. |
| ††                                                         | Incorporated by reference to the Registrant’s  Registration Statement on Form S-8, No. 333-64905. |
| †††                                                   | Incorporated by reference to the Registrant’s Annual  Report on Form 10-Q for the quarter ended June 30, 1999 |
| ††††                                             | Incorporated by reference to the Registrant’s Annual  Report on Form 10-K for the year ended December 31, 1999. |
| †††††                                       | Incorporated by reference to the Registrant’s  Current Report on Form 8-K dated June 1, 2000 and filed on June 15, 2000, as  amended on August 14, 2000. |
| ††††††                                 | Incorporated by reference to the Registrant’s Annual  Report on Form 10-K for the year ended December 31, 2000. |
| †††††††                           | Incorporated by reference to the Registrant’s Annual  Report on Form 10-K for the year ended December 31, 2001. |
|                                                                 |   |
| *                                                                    | Indicates each management contract or compensatory  plan or arrangement required to be filed as an exhibit to this  Form 10-K. |
|                                                                 |   |
| **(b)**                                                              | **Reports  on Form 8-K.** |

 

On August 14,2002, we filed one Current Report on Form 8-K. The Form 8-K was filed for the purpose of filing our financialstatements reflecting our discontinued operations accounting treatment for ourIdaho Dairy and Colorado herd operations.

 

**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized, on the 13th day of March 2003.

 
|   | **HORIZON ORGANIC HOLDING  CORPORATION** |
|--------|------------------------------------------|
|   |                                     |   |
|   | By:                                      | */s/  Charles F. Marcy* |   |
|   |                                     | Charles F. Marcy |
|   |                                     | *President  and Chief Executive Officer* |

 

 

**POWER OFATTORNEY**

 

KNOW ALL MEN BYTHESE PRESENTS, that each person whose signature appears below constitutes andappoints Charles F. Marcy and Thomas P. Briggs, or any of them, his or herattorney-in-fact, each with the power of substitution, for him or her in anyand all capacities, to sign any amendments to this Report, and to file thesame, with exhibits thereto and other documents in connection therewith, withthe Securities and Exchange Commission, hereby ratifying and confirming allthat each of said attorney-in-fact, or his or her substitute or substitutes,may do or cause to be done by virtue hereof.

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in thecapacities and on the dates indicated.

 
| **Signature**                  |                                                         | **Title**                      |           | **Date** |
|--------------------------------|--------------------------------------------------------------|--------------------------------|----------------|----------|
|                           |                                                         |                           |           |     |
| /s/ Charles F. Marcy           |                                                         | President, Chief Executive     | March 13, 2003 |
| Charles F. Marcy               | Officer and Director                                         |                           |
|                           |                                                         |                           |           |
| */s/ Thomas P. Briggs*         |                                                         | Senior Vice President, Finance | March 13, 2003 |
| Thomas  P. Briggs              | & Administration, Chief Financial Officer and  Secretary |                           |
|                           |                                                         |                           |
| */s/ Thomas D. McCloskey, Jr.* |                                                         | Chairman of the Board of       | March 13, 2003 |
| Thomas D. McCloskey, Jr.       | Directors                                                    |                           |
|                           |                                                         |                           |
| */s/ Paul B. Repetto*          |                                                         | Director                       | March 13, 2003 |
| Paul B. Repetto                |                                                         |                           |
|                           |                                                         |                           |
| */s/ Kathryn A. Paul*          |                                                         | Director                       | March 13, 2003 |
| Kathryn A. Paul                |                                                         |                           |
|                           |                                                         |                           |           |
| */s/ Clark R. Mandigo II*      |                                                         | Director                       | March 13, 2003 |
| Clark R. Mandigo II            |                                                         |                           |
|                           |                                                         |                           |           |
| */s/ Richard L. Robinson*      |                                                         | Director                       | March 13, 2003 |
| Richard L. Robinson            |                                                         |                           |
|                           |                                                         |                           |           |
| */s/ G. Irwin Gordon*          |                                                         | Director                       | March 13, 2003 |
| G. Irwin Gordon                |                                                         |                           |
|                           |                                                         |                           |           |
| */s/ Michelle Goolsby*         |                                                         | Director                       | March 13, 2003 |
| Michelle Goolsby               |                                                         |                           |
|                           |                                                         |                           |           |
| */s/ Cynthia T. Jamison*       |                                                         | Director                       | March 13, 2003 |
| Cynthia T. Jamison             |                                                         |                           |
|                                |                                                              |                                |                |          |  |  |  |  |  |  |

 

 

**CERTIFICATIONS**

 

I, Charles F. Marcy, certify that:

 

1. I have reviewed this annual report on Form 10-K of Horizon OrganicHolding Corporation;

 

2. Based on my knowledge, this annual report does not contain anyuntrue statement of a material fact or omit to state a material fact necessaryto make the statements made, in light of the circumstances under which suchstatements were made, not misleading with respect to the years covered by thisannual report;

 

3. Based on my knowledge, the financial statements, and other financialinformation included in this annual report, fairly present in all materialrespects the financial condition, results of operations and cash flows of theregistrant as of, and for, the years presented in this annual report;

 

4. The registrant’s other certifying officer and I are responsible forestablishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a) designed such disclosure controls and procedures to ensure thatmaterial information relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularlyduring the period in which this annual report is being prepared;

 

b) evaluated the effectiveness of the registrant’s disclosure controlsand procedures as of a date within 90 days prior to the filing date of this annualreport (the “Evaluation Date”); and

 

c) presented in this annual report our conclusions about theeffectiveness of the disclosure controls and procedures based on our evaluationas of the Evaluation Date;

 

5. The registrant’s other certifying officer and I have disclosed,based on our most recent evaluation, to the registrant’s auditors and the auditcommittee of registrant’s board of directors:

 

a) all significant deficiencies in the design or operation of internalcontrols which could adversely affect the registrant’s ability to record,process, summarize and report financial data and have identified for theregistrant’s auditors any material weaknesses in internal controls; and

 

b) any fraud, whether or not material, that involves management orother employees who have a significant role in the registrant’s internalcontrols; and

 

6. The registrant’s other certifying officer and I have indicated inthis annual report whether or not there were significant changes in internalcontrols or in other factors that could significantly affect internal controlssubsequent to the date of our most recent evaluation, including any correctiveactions with regard to significant deficiencies and material weaknesses.

 
| Date: March 13, 2003 |                                  |
|----------------------|---------------------------------------|
|                 | /s/ Charles F. Marcy                  |   |
|                 | Charles F. Marcy                      |
|                 | President and Chief Executive Officer |

 

 

I, Thomas P. Briggs, certify that:

 

1. I have reviewed this annual report on Form 10-K of Horizon OrganicHolding Corporation;

 

2. Based on my knowledge, this annual report does not contain any untruestatement of a material fact or omit to state a material fact necessary to makethe statements made, in light of the circumstances under which such statementswere made, not misleading with respect to the years covered by this annualreport;

 

3. Based on my knowledge, the financial statements, and other financialinformation included in this annual report, fairly present in all materialrespects the financial condition, results of operations and cash flows of theregistrant as of, and for, the years presented in this annual report;

 

4. The registrant’s other certifying officer and I are responsible forestablishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a) designed such disclosure controls and procedures to ensure thatmaterial information relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularlyduring the period in which this annual report is being prepared;

 

b) evaluated the effectiveness of the registrant’s disclosure controlsand procedures as of a date within 90 days prior to the filing date of thisannual report (the “Evaluation Date”); and

 

c) presented in this annual report our conclusions about theeffectiveness of the disclosure controls and procedures based on our evaluationas of the Evaluation Date;

 

5. The registrant’s other certifying officer and I have disclosed,based on our most recent evaluation, to the registrant’s auditors and the auditcommittee of registrant’s board of directors:

 

a) all significant deficiencies in the design or operation of internalcontrols which could adversely affect the registrant’s ability to record,process, summarize and report financial data and have identified for theregistrant’s auditors any material weaknesses in internal controls; and

 

b) any fraud, whether or not material, that involves management orother employees who have a significant role in the registrant’s internalcontrols; and

 

6. The registrant’s other certifying officer and I have indicated inthis annual report whether or not there were significant changes in internalcontrols or in other factors that could significantly affect internal controlssubsequent to the date of our most recent evaluation, including any correctiveactions with regard to significant deficiencies and material weaknesses.

 
| Date: March 13, 2003 |                                                                                       |
|----------------------|--------------------------------------------------------------------------------------------|
|                 | /s/ Thomas P. Briggs                                                                       |   |
|                 | Thomas P. Briggs                                                                           |
|                 | Senior Vice President, Finance  and Administration, Chief Financial Officer, and Secretary |

 

 

 

**HORIZONORGANIC HOLDING CORPORATION ANDSUBSIDIARIES**

 

Consolidated FinancialStatements (Appendix F)

 

December 31, 2002 and2001

 

(With IndependentAuditors’ Report Thereon)

 

 

 

**HORIZONORGANIC HOLDING CORPORATION AND SUBSIDIARIES**

** **

**Index toConsolidated Financial Statements (Appendix F)**

 
| Independent Auditors’  Report                                             |
|--------------------------------------------------------------------------------|
|                                                                           |
| Consolidated Balance Sheets                                                    |
|                                                                           |
| Consolidated  Statements of Operations                                         |
|                                                                           |
| Consolidated  Statements of Stockholders’ Equity and Comprehensive Income |
|                                                                           |
| Consolidated  Statements of Cash Flows                                         |
|                                                                           |
| Notes to  Consolidated Financial Statements                                    |

 

 

 

**IndependentAuditors’ Report**

 

The Board of Directors and StockholdersHorizon Organic Holding Corporation:

We have audited theconsolidated balance sheets of Horizon Organic Holding Corporation andsubsidiaries (Company) as of December 31, 2002 and 2001, and the relatedconsolidated statements of operations, stockholders’ equity and comprehensiveincome and cash flows for each of the years in the three-year period endedDecember 31, 2002. These consolidated financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these consolidated financial statements based on our audits.

We conducted our auditsin accordance with auditing standards generally accepted in the United Statesof America. Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of Horizon Organic HoldingCorporation and subsidiaries as of December 31, 2002 and 2001 and theresults of their operations and their cash flows for each of the years in thethree-year period ended December 31, 2002, in conformity with accountingprinciples generally accepted in the United States of America.

 
| /s/ KPMG LLP          |
|-----------------------|
| Boulder, Colorado     |
| February 3, 2003 |

 

 

**HORIZON ORGANICHOLDING CORPORATION AND SUBSIDIARIES**

 

ConsolidatedBalance Sheets

 

(In thousands, except share amounts)

 

December 31, 2002 and 2001

 
|                                                                                                                                                  |   | **2002** |    | **2001** |    |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|---------|----------|---------|
| **Assets**                                                                                                                                            |   |     |    |     |    |
| Current Assets:                                                                                                                                       |   |     |    |     |    |
| Cash and cash equivalents                                                                                                                             |   | $        | 1,382   |     | 3,534   |   |
| Trade accounts receivable, less allowances of $2,260 in 2002 and  $1,580 in 2001                                                                      |   | 19,978   |    | 18,713   |    |
| Inventories                                                                                                                                           |   | 12,124   |    | 14,655   |    |
| Assets held for sale                                                                                                                                  |   | 29,911   |    | 7,040    |    |
| Deferred income tax assets                                                                                                                            |   | 277      |    | 160      |    |
| Prepaid and other current assets                                                                                                                      |   | 5,124    |    | 3,162    |    |
| Total current assets                                                                                                                                  |   | 68,796   |    | 47,264   |    |
|                                                                                                                                                  |   |     |    |     |    |
| Long-term assets held for sale                                                                                                                        |   | 1,851    |    | 25,155   |    |
|                                                                                                                                                  |   |     |    |     |    |
| Property,  Equipment and Cattle:                                                                                                                      |   |     |    |     |    |
| Cattle, net                                                                                                                                           |   | 1,211    |    | 1,060    |    |
| Property and equipment, net                                                                                                                           |   | 13,578   |    | 14,245   |    |
| Total property, equipment and cattle                                                                                                                  |   | 14,789   |    | 15,305   |    |
|                                                                                                                                                  |   |     |    |     |    |
| Other Assets:                                                                                                                                         |   |     |    |     |    |
| Goodwill, net of accumulated amortization of $3,054 in 2002 and  $3,054 in 2001                                                                       |   | 27,040   |    | 24,478   |    |
| Other intangible assets, net of accumulated amortization of $5,136 in  2002 and $3,799 in 2001                                                        |   | 13,046   |    | 14,332   |    |
| Other assets, net                                                                                                                                     |   | 2,685    |    | 2,734    |    |
| Total other assets                                                                                                                                    |   | 42,771   |    | 41,544   |    |
| Total Assets                                                                                                                                          |   | $        | 128,207 |     | 129,268 |   |
|                                                                                                                                                  |   |     |    |     |    |
| **Liabilities  and Stockholders’ Equity**                                                                                                        |   |     |    |     |    |
| Current Liabilities:                                                                                                                                  |   |     |    |     |    |
| Current portion of long-term debt                                                                                                                     |   | $        | 26,703  |     | 7,306   |   |
| Trade accounts payable                                                                                                                                |   | 10,100   |    | 11,625   |    |
| Other accrued expenses                                                                                                                                |   | 8,743    |    | 6,448    |    |
| Total current liabilities                                                                                                                             |   | 45,546   |    | 25,379   |    |
| Long-Term Liabilities:                                                                                                                                |   |     |    |     |    |
| Long-term debt, less current portion                                                                                                                  |   | 14,110   |    | 40,313   |    |
| Deferred income tax liabilities                                                                                                                       |   | 2,898    |    | 2,822    |    |
| Total long-term liabilities                                                                                                                           |   | 17,008   |    | 43,135   |    |
| Total liabilities                                                                                                                                     |   | 62,554   |    | 68,514   |    |
| Stockholders’ Equity:                                                                                                                            |   |     |    |     |    |
| Preferred stock, $.001 par value, authorized 5,000,000 shares; no  shares issued or outstanding                                                       |   | —   |    | —   |    |
| Common stock, $.001 par value; authorized 30,000,000 shares;  10,293,127 and 10,126,285 shares issued and outstanding in 2002 and 2001,  respectively |   | 10       |    | 10       |    |
| Additional paid-in capital                                                                                                                            |   | 61,866   |    | 60,153   |    |
| Accumulated other comprehensive gain (loss) - foreign currency translation  adjustment                                                                |   | 2,034    |    | (1,185   | )       |
| Retained earnings                                                                                                                                     |   | 1,743    |    | 1,776    |    |
| Total stockholders’ equity                                                                                                                       |   | 65,653   |    | 60,754   |    |
| Commitments and contingencies (notes 2, 4, 6, 9, 10, 11, 12, 13, 14,  15, 17, 18, and 23)                                                             |   |     |    |     |    |
| Total Liabilities and Stockholders’ Equity                                                                                                       |   | $        | 128,207 |     | 129,268 |   |

 

Seeaccompanying notes to consolidated financial statements. 

 

 

**HORIZON ORGANICHOLDING CORPORATION AND SUBSIDIARIES**

 

Consolidated Statements of Operations

 

(In thousands, except per shareamounts)

 

Years ended December 31, 2002, 2001 and2000

 
|                                                                                                                        |   | **2002** |    | **2001** |    | **2000** |    |
|-----------------------------------------------------------------------------------------------------------------------------|--------|----------|---------|----------|---------|----------|---------|
|                                                                                                                        |   |     |    |     |    |     |    |
| Net sales                                                                                                                   |   | $        | 187,537 |     | 158,870 |     | 127,206 |   |
| Cost of sales                                                                                                               |   | 127,681  |    | 111,847  |    | 89,406   |    |
| Gross profit                                                                                                                |   | 59,856   |    | 47,023   |    | 37,800   |    |
|                                                                                                                        |   |     |    |     |    |     |    |
| Operating expenses:                                                                                                         |   |     |    |     |    |     |    |
| Selling                                                                                                                     |   | 41,390   |    | 31,341   |    | 25,387   |    |
| General and administrative                                                                                                  |   | 10,704   |    | 8,036    |    | 8,963    |    |
| Intangible asset amortization                                                                                               |   | 1,307    |    | 3,115    |    | 2,389    |    |
| Total operating expenses                                                                                                    |   | 53,401   |    | 42,492   |    | 36,739   |    |
| Operating income                                                                                                            |   | 6,455    |    | 4,531    |    | 1,061    |    |
|                                                                                                                        |   |     |    |     |    |     |    |
| Other income (expense), net:                                                                                                |   |     |    |     |    |     |    |
| Interest income                                                                                                             |   | 139      |    | 127      |    | 266      |    |
| Interest expense, net of interest capitalized of $166 in 2001 and $90  in 2000                                              |   | (439     | )       | (1,695   | )       | (667     | )       |
| Other, net                                                                                                                  |   | (245     | )       | (182     | )       | (147     | )       |
| Total other expense, net                                                                                                    |   | (545     | )       | (1,750   | )       | (548     | )       |
| Income from continuing operations before income taxes                                                                       |   | 5,910    |    | 2,781    |    | 513      |    |
| Income tax expense                                                                                                          |   | (2,305   | )       | (1,119   | )       | (221     | )       |
| Income from continuing operations                                                                                           |   | 3,605    |    | 1,662    |    | 292      |    |
|                                                                                                                        |   |     |    |     |    |     |    |
| Discontinued operations (Note 2(r)):                                                                                        |   |     |    |     |    |     |    |
| Income (loss) from operations of discontinued Idaho Dairy and  Colorado herd (including loss on disposal of $4,633 in 2002) |   | (4,954   | )       | 131      |    | 399      |    |
| Income tax benefit (expense) from discontinued operations                                                                   |   | 1,316    |    | (53      | )       | (172     | )       |
| Income (loss) from discontinued operations                                                                                  |   | (3,638   | )       | 78       |    | 227      |    |
| Net income (loss)                                                                                                           |   | $        | (33     | )        | 1,740   |     | 519     |   |
|                                                                                                                        |   |     |    |     |    |     |    |
| Income from continuing operations per basic share                                                                           |   | $        | .35     |     | .16     |     | .03     |   |
|                                                                                                                        |   |     |    |     |    |     |    |
| Income from continuing operations per diluted share                                                                         |   | $        | .34     |     | .16     |     | .03     |   |
|                                                                                                                        |   |     |    |     |    |     |    |
| Income (loss) from discontinued operations per basic share                                                                  |   | $        | (.35    | )        | .01     |     | .02     |   |
|                                                                                                                        |   |     |    |     |    |     |    |
| Income (loss) from discontinued operations per diluted share                                                                |   | $        | (.34    | )        | .01     |     | .02     |   |
|                                                                                                                        |   |     |    |     |    |     |    |
| Net income (loss) per basic share                                                                                           |   | $        | (.00    | )        | .17     |     | .05     |   |
|                                                                                                                        |   |     |    |     |    |     |    |
| Net income (loss) per diluted share                                                                                         |   | $        | (.00    | )        | .17     |     | .05     |   |
|                                                                                                                        |   |     |    |     |    |     |    |
| Weighted average shares outstanding:                                                                                        |   |     |    |     |    |     |    |
| Basic                                                                                                                       |   | 10,204   |    | 10,007   |    | 9,796    |    |
| Diluted                                                                                                                     |   | 10,583   |    | 10,213   |    | 10,030   |    |

 

Seeaccompanying notes to consolidated financial statements. 

 

 

**HORIZON ORGANIC HOLDING CORPORATION AND SUBSIDIARIES**

 

ConsolidatedStatements of Stockholders’ Equity and Comprehensive Income

 

(Inthousands, except share amounts)

 

Yearsended December 31, 2002, 2001 and 2000

 
|                                                       |   |       |   |   |   | **Additional  paid-in  capital** |   | **Retained  earnings/  (deficit)** |   | **Accumulated  other  comprehensive  income (loss)** |   | **Total  stockholders’  equity** |   | **Comprehensive  income** |   |
|------------------------------------------------------------|--------|------------|--------|--------|--------|----------------------------------|--------|------------------------------------|--------|------------------------------------------------------|--------|---------------------------------------|--------|---------------------------|--------|
|                                                       |   |
| **Common stock**                                           |
| **Shares**                                                 |   | **Amount** |
| Balance at December 31, 1999                               |   | 9,743,659  |   | $      | 10     |                             | 58,392 |                               | (483   | )                                                    | (31    | )                                     | 57,888 |                      | 1,371  |   |
| Issuance of common stock for director services             |   | 2,895      |   | — |   | 24                               |   | —                             |   | —                                               |   | 24                                    |   |                      |   |
| Exercise of stock options and warrants, net of tax benefit |   | 130,374    |   | — |   | 359                              |   | —                             |   | —                                               |   | 359                                   |   |                      |   |
| Issuance of common stock under ESPP                        |   | 22,952     |   | — |   | 110                              |   | —                             |   | —                                               |   | 110                                   |   |                      |   |
| Foreign currency translation adjustment                    |   | —     |   | — |   | —                           |   | —                             |   | (255                                                 | )      | (255                                  | )      | (255                      | )      |
| Net income                                                 |   | —     |   | — |   | —                           |   | 519                                |   | —                                               |   | 519                                   |   | 519                       |   |
| Balance at December 31, 2000                               |   | 9,899,880  |   | 10     |   | 58,884                           |   | 36                                 |   | (286                                                 | )      | 58,645                                |   |                      |   |
| Total comprehensive income                                 |   |       |   |   |   |                             |   |                               |   |                                                 |   |                                  |   | $                         | 264    |   |
| Issuance of common stock for director services             |   | 3,192      |   | — |   | 24                               |   | —                             |   | —                                               |   | 24                                    |   |                      |   |
| Exercise of stock options, net of tax benefit              |   | 200,987    |   | — |   | 717                              |   | —                             |   | —                                               |   | 717                                   |   |                      |   |
| Tax benefit from stock option exercises                    |   | —     |   | — |   | 414                              |   | —                             |   | —                                               |   | 414                                   |   |                      |   |
| Issuance of common stock under ESPP                        |   | 22,226     |   | — |   | 113                              |   | —                             |   | —                                               |   | 113                                   |   |                      |   |
| Foreign currency translation adjustment                    |   | —     |   | — |   | —                           |   | —                             |   | (899                                                 | )      | (899                                  | )      | (899                      | )      |
| Net income                                                 |   | —     |   | — |   | —                           |   | 1,740                              |   | —                                               |   | 1,740                                 |   | 1,740                     |   |
| Balance at December 31, 2001                               |   | 10,126,285 |   | 10     |   | 60,153                           |   | 1,776                              |   | (1,185                                               | )      | 60,754                                |   |                      |   |
| Total  comprehensive income                                |   |       |   |   |   |                             |   |                               |   |                                                 |   |                                  |   | $                         | 841    |   |
| Issuance of common stock for director services             |   | 2,493      |   | — |   | 90                               |   | —                             |   | —                                               |   | 90                                    |   |                      |   |
| Exercise of stock options, net of tax benefit              |   | 156,458    |   | — |   | 1,048                            |   | —                             |   | —                                               |   | 1,048                                 |   |                      |   |
| Tax benefit from stock option exercises                    |   | —     |   | — |   | 466                              |   | —                             |   | —                                               |   | 466                                   |   |                      |   |
| Issuance of common stock under ESPP                        |   | 7,891      |   | — |   | 109                              |   | —                             |   | —                                               |   | 109                                   |   |                      |   |
| Foreign currency translation adjustment                    |   | —     |   | — |   | —                           |   | —                             |   | 3,219                                                |   | 3,219                                 |   | 3,219                     |   |
| Net loss                                                   |   | —     |   | — |   | —                           |   | (33                                | )      | —                                               |   | (33                                   | )      | (33                       | )      |
| Balance at December 31, 2002                               |   | 10,293,127 |   | $      | 10     |                             | 61,866 |                               | 1,743  |                                                 | 2,034  |                                  | 65,653 |                      |   |   |
| Total comprehensive income                                 |   |       |   |   |   |                             |   |                               |   |                                                 |   |                                  |   | $                         | 3,186  |   |

 

See accompanying notes to consolidatedfinancial statements.

 

 

**HORIZON ORGANICHOLDING CORPORATION AND SUBSIDIARIES**

** **

ConsolidatedStatements of Cash Flows

 

(In thousands)

 

Years ended December 31, 2002, 2001 and2000

 
|                                                                                                 |   | **2002** |   | **2001** |   | **2000** |   |
|------------------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Cash flows from operating activities:                                                                |   |     |   |     |   |     |   |
| Net income (loss)                                                                                    |   | $        | (33    | )        | 1,740  |     | 519    |   |
| Adjustments to reconcile net income (loss) to net cash from operating  activities:                   |   |     |   |     |   |     |   |
| Loss (income) from discontinued operations, net of income taxes                                      |   | 196      |   | (78      | )      | (227     | )      |
| Loss from anticipated sale of Idaho Dairy and Colorado herd  operations, net of income taxes         |   | 3,442    |   | —   |   | —   |   |
| Depreciation and amortization                                                                        |   | 3,824    |   | 4,952    |   | 3,751    |   |
| Loss on sale of cattle and equipment                                                                 |   | 701      |   | 107      |   | 131      |   |
| Deferred income tax                                                                                  |   | (68      | )      | 520      |   | 1,322    |   |
| Issuance of common stock for director services                                                       |   | 90       |   | 24       |   | 24       |   |
| Changes in operating assets and liabilities:                                                         |   |     |   |     |   |     |   |
| Trade accounts receivable, net                                                                       |   | (823     | )      | (626     | )      | (4,644   | )      |
| Inventories                                                                                          |   | 2,601    |   | 2,606    |   | (12,772  | )      |
| Prepaid and other current assets                                                                     |   | (1,849   | )      | 55       |   | (1,361   | )      |
| Other assets                                                                                         |   | 44       |   | 11       |   | (375     | )      |
| Trade accounts payable                                                                               |   | (1,804   | )      | 213      |   | 654      |   |
| Other accrued expenses                                                                               |   | 1,962    |   | (117     | )      | 1,320    |   |
| Tax benefit from stock option exercises                                                              |   | 466      |   | 414      |   | —   |   |
| Income taxes payable                                                                                 |   | —   |   | —   |   | (130     | )      |
| Net cash provided by (used in) operating activities                                                  |   | 8,749    |   | 9,821    |   | (11,788  | )      |
|                                                                                                 |   |     |   |     |   |     |   |
| Cash flows from investing activities:                                                                |   |     |   |     |   |     |   |
| Net cash generated by (used in) discontinued operations                                              |   | (3,465   | )      | 934      |   | (2,636   | )      |
| Sale of marketable securities                                                                        |   | —   |   | —   |   | 8,218    |   |
| Payments for acquisitions, net of cash acquired                                                      |   | —   |   | —   |   | (28,019  | )      |
| Purchases of property and equipment                                                                  |   | (1,779   | )      | (3,896   | )      | (4,955   | )      |
| Proceeds from equipment sales                                                                        |   | 217      |   | 7        |   | 22       |   |
| Purchases of cattle                                                                                  |   | (774     | )      | (633     | )      | (487     | )      |
| Proceeds from cattle sales                                                                           |   | 258      |   | 245      |   | 157      |   |
| Other assets and other                                                                               |   | 60       |   | (1,391   | )      | (996     | )      |
|                                                                                                 |   |     |   |     |   |     |   |
| Net cash used in investing activities                                                                |   | (5,483   | )      | (4,734   | )      | (28,696  | )      |
|                                                                                                 |   |     |   |     |   |     |   |
| Cash flows from financing activities:                                                                |   |     |   |     |   |     |   |
| Net proceeds from (repayments of) long-term line of credit                                           |   | (415     | )      | 600      |   | 16,028   |   |
| Proceeds from long-term debt, other than line of credit                                              |   | —   |   | 967      |   | 25,636   |   |
| Repayments of long-term debt, other than line of credit                                              |   | (6,426   | )      | (6,380   | )      | (2,919   | )      |
| Proceeds from exercise of stock options and warrants, net of tax  benefit                            |   | 1,048    |   | 717      |   | 359      |   |
| Proceeds from issuance of common stock under ESPP                                                    |   | 109      |   | 113      |   | 110      |   |
| Net cash provided by (used in) financing activities                                                  |   | (5,684   | )      | (3,983   | )      | 39,214   |   |
| Effect of exchange rate changes on cash                                                              |   | 266      |   | (8       | )      | 15       |   |
| Net increase (decrease) in cash and cash equivalents                                                 |   | (2,152   | )      | 1,096    |   | (1,255   | )      |
| Cash and cash equivalents at beginning of year                                                       |   | 3,534    |   | 2,438    |   | 3,693    |   |
| Cash and cash equivalents at end of year                                                             |   | $        | 1,382  |     | 3,534  |     | 2,438  |   |
|                                                                                                 |   |     |   |     |   |     |   |
| Supplemental disclosure of cash flow information:                                                    |   |     |   |     |   |     |   |
| Cash paid during the year for interest, net of interest capitalized  of $166 in 2001 and $90 in 2000 |   | $        | 2,044  |     | 4,010  |     | 2,041  |   |
| Cash paid (refunded) during the year for income taxes                                                |   | 1,005    |   | 340      |   | (180     | )      |
| Noncash investing and financing activities:                                                          |   |     |   |     |   |     |   |
| Additional capital lease obligations                                                                 |   | —   |   | 646      |   | 636      |   |
| Common stock issued to outside directors                                                             |   | 90       |   | 24       |   | 24       |   |
|                                                                                                 |   |     |   |     |   |     |   |
| The Company purchased businesses with assets acquired and liabilities  assumed as follows:           |   |     |   |     |   |     |   |
| Fair value of assets acquired                                                                        |   | $        | — |     | — |     | 32,719 |   |
| Cash paid for common stock                                                                           |   | —   |   | —   |   | (27,766  | )      |
| Liabilities assumed                                                                                  |   | $        | — |     | — |     | 4,953  |   |

 

See accompanying notes to consolidated financialstatements.

 

 

#### **HORIZON ORGANICHOLDING CORPORATION AND SUBSIDIARIES**

 

Notes to Consolidated Financial Statements

December 31, 2002, 2001 and 2000

 

**(1)**                                 **Basis of Presentation and Descriptionof Business**

 

Horizon Organic Holding Corporation (Company or Horizon Organic)produces and markets organic milk, other organic dairy products, desserts andorganic juices.  The Company’s productsare sold to natural and organic retailers, national and regional conventionalsupermarket chains, mass merchant retailers, other specialty food retailers andfood manufacturers who use our products as ingredients.  Horizon Organic also processes and marketsorganic milk, organic cream, organic butter and organic yogurt in the UnitedKingdom.

 

TheCompany was established in October 1991. The Company has dairy farmoperations located in Idaho and Maryland and maintained a milking herd inColorado through September 30, 2002. From these sources Horizon Organic procuredapproximately 45.0%, 50% and 50% of its United States organic farm milk supplyduring 2002, 2001 and 2000, respectively. The Company sources the remainder ofits organic farm milk supply through supply arrangements with independent dairycooperatives and farmers throughout the United States and the United Kingdom.The Company operates in and judges its financial performance according to threeoperating segments; marketing, dairy farm operations and international. Thedairy farm operations exist solely to be a part of the marketing segment’ssupply chain.

 

OnMarch 31, 2002, the Company determined that its Idaho Dairy and Coloradoherd met the definition of a disposal group under Statement of FinancialAccounting Standards No. 144,*******Accountingfor the Impairment or Disposal of Long-Lived Assets*, orSFAS 144. The Company has transferred the remaining Colorado herd to theIdaho Dairy and allowed the management agreement for the Colorado herd toexpire. The Company has a plan in place to sell the assets of the Idaho Dairy.Accordingly, approximately $29.9 million of the Idaho Dairy assetsexpected to be disposed of, including the transferred Colorado herd, have been reclassified as current assets held forsale at December 31, 2002. This compares to $5.2 million of currentassets held for sale and $25.2 million of long-term assets held for saleas of December 31, 2001 upon reclassification caused by the disposal groupdetermination. The financial results from these operations for the current andprior years are reported as discontinued operations consistent with a disposalgroup.

 

**(2)**                                 **Summary of Significant AccountingPolicies**

 

***(a)***                                 ***Principles ofConsolidation***

 

The consolidated financial statements include theaccounts of all the Company’s subsidiaries. All significant intercompanybalances and transactions have been eliminated in consolidation.

 

***(b)***                                 ***Use ofEstimates***

 

The preparation of consolidated financial statements inconformity with generally accepted accounting principles requires management tomake estimates and assumptions that affect the reported amounts of assets andliabilities, the disclosure of contingent assets and liabilities at the date ofthe consolidated financial statements and the reported amounts of sales andexpenses during the reporting period. Actual results could differ significantlyfrom those estimates.

 

***(c)***                                  ***Reclassifications***

 

Certain reclassifications have been made to the 2001 and2000 financial statements to conform to the 2002 presentation.

 

***(d)***                                 ***ForeignExchange Risk***

 

The accounts of the Company’s foreign subsidiaries andaffiliates are generally measured using the local currency as the functionalcurrency. For those operations, assets and liabilities are translated into U.S.dollars at period-end exchange rates. Income and expense accounts aretranslated at average monthly exchange rates. Net exchange gains or lossesresulting from such translation are excluded from results of operations andaccumulated as a separate component of stockholders’ equity.

The Company occasionally enters into foreign exchangecontracts in order to reduce its economic exposure to fluctuations in currencyexchange rates on certain foreign operations through the use of forwarddelivery commitments. Open forward delivery commitments are marked to market atthe end of each accounting period and corresponding gains and losses arerecognized in other income (expense).

 

***(e)***                                  ***Cash and CashEquivalents***

 

The Company considers all highly liquid investments andsecurities with original maturities of three months or less at the time ofpurchase to be cash equivalents.

 

***(f)***                                    ***Trade AccountsReceivable***

 

The Company recognizes trade accounts receivable inconjunction with the recognition of revenue, which is at the time of shipmentor pickup by a customer. The Company reserves against trade accounts receivablefor returns and allowances; market development support, including advertising;and doubtful accounts.

 

The following table presents significant accountsreceivable balances by customer.

 
|                        |   | **Percent of total trade********accounts receivable for the  year ended December 31:** |       |
|-----------------------------|--------|----------------------------------------------------------------------------------------|------------|
| **Customer**                |   | **2002**                                                                               | ** ** | **2001** | ** ** |
|                        |   |                                                                                   | ** ** |   | ** ** |
| J.  Sainsbury plc           |   | 14.1                                                                                   |       | 10.4 |   |
| Safeway,  Inc.              |   | 10.4                                                                                   |       | 9.0 |   |
| United  Natural Foods, Inc. |   | 10.2                                                                                   |       | 12.6 |   |
| H.P.  Hood, Inc.            |   | 7.1                                                                                    |       | 11.5 |   |

 

***(g)***                                 ***Inventories***

 

Inventories are stated at the lower of cost (average costor first-in, first-out method) or market.

 

***(h)***                                 ***Property,Equipment and Cattle***

 

Property, equipment and cattle are stated at cost. Property (other thanland and assets held for sale) is depreciated using the straight-line methodover the estimated useful lives, which range from 3 to 27 years. Equipmentis depreciated using the straight-line method over the estimated useful lives,which range from three to seven years. Cattle are depreciated using thestraight-line method over 5 years to an estimated salvage value of $325per head.

 

Major improvements are capitalized including, asapplicable, an allocation of interest incurred during the period ofconstruction or major refurbishment. The cost of cattle includes preproductioncosts incurred from the time cattle arrive at the dairy until they enter themilking herd. Preproduction costs include feed and husbandry.

 

When assets are sold, retired or otherwise disposed of,the cost and related accumulated depreciation are eliminated from the accountsand a gain or loss is recognized. Repair and maintenance costs are expensed asincurred.

 

The Company evaluates the realizability of its long-livedassets, including property and equipment, whenever events or changes incircumstances indicate that the carrying amount of an asset may not berecoverable. An impairment loss exists when estimated undiscounted net cashflows (without interest costs) expected to be generated by the use of the assetincluding its eventual disposition are less than its carrying amount. Anyimpairment loss recognized is measured by the excess of the asset’s carryingvalue as compared to its estimated fair value. The Company has recorded noimpairment losses except for adjustments during 2002 to reduce the carrying valueof certain assets expected to be disposed of in the sale of the Company’s IdahoDairy to their respective estimated realizable value. The assets to which suchadjustments were made are included in assets held for sale.

***(i)***                                    ***Intangible andLong-Lived Assets***

 

The Company adopted the provisions of FASB StatementNo. 142, Goodwill and Other Intangible Assets (SFAS No. 142) onJanuary 1, 2002. Goodwill and certain identifiable intangible assets withindefinite lives are not amortized under SFAS No. 142, but instead arereviewed for impairment at least annually in accordance with the provisions ofthis statement. Identifiable intangibles with finite lives are amortized overtheir estimated useful lives. Prior to 2002, the Company amortized the excessof purchase price over fair value of net assets acquired on a straight-linebasis over the expected period to be benefited, generally 15 years.

 

The Company performs impairment valuations of itsgoodwill and certain other intangible assets annually on August 31 and reviewslong-lived assets, goodwill and certain intangible assets for impairmentwhenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable. An impairment loss exists when estimatedundiscounted net cash flows (without interest costs) expected to be generatedby the use of the asset including its eventual disposition are less than itscarrying amount. Any impairment loss recognized is measured by the excess ofthe asset’s carrying value as compared to its estimated fair value. Assets tobe disposed of are reported at the lower of the carrying amount or fair valueless costs to sell.  There were noimpairment losses during the years ended December 31, 2002, 2001 and 2000.

 

***(j)***                                    ***Other Assets***

 

Other assets consist principally of notes receivable,loan origination fees, long-term processing arrangement prepayments and artworkand plates. The cost of artwork and plates is amortized using the straight-linebasis over three years. Loan origination fees are amortized over the term ofthe respective loan. The long-term processing arrangement prepayment isexpensed over the processing period not to exceed five years. Accumulatedamortization of artwork and plates and loan origination fees atDecember 31, 2002 and 2001 totaled $765,000 and $606,000, respectively.

 

***(k)***                                 ***RevenueRecognition***

 

Sales are recognized at the time title transfers which isupon shipment to or pickup by a customer, and provisions are made forallowances, returns and guarantees. Sales to new customers are at times made ona 90-day guarantee basis; if the customer is unable to sell all of theCompany’s products during the first 90 days after it becomes a customer,the Company issues a credit for unsold inventory. Estimated returns arerecognized as a reduction to revenue and accounts receivable.

 

The Company conducts trade promotions to increase brandawareness and generate trial of the Company’s products using promotionalvehicles targeted at consumer education and awareness centered around whatorganic means, what it means to the environment and how using the Company’sorganic products benefit consumers. This awareness and education is built through consumer communication atthe point of purchase or in association with a retailer’s promotional vehicle.  Based on this strategy, trade promotiondollars are paid to customers for consumer communication.  The Company accounts for these costs,incurred in exchange for the consideration that is the aforementioned consumercommunication, as selling expenses.  Management believes that this consumer communication constitutesan identifiable benefit that is separable from the customer’s purchase of theCompany’s products and it can reasonably estimate the fair value of the benefitreceived.  If the benefit received asconsideration for trade dollars is not separable from the recipient’s purchaseof the Company’s products, the consideration paid is characterized as areduction of revenue as incurred. Additionally, if the separability requirement is met but the amount ofconsideration paid by the Company exceeds the estimated fair value of thebenefit received, that excess amount is recorded as a reduction of revenue asincurred.

 

***(l)***                                    ***SignificantCustomers***

 

The Company’s four largest customers in 2002 were UnitedNatural Foods, Inc., Safeway, Inc., J. Sainsbury plc and H.P.Hood, Inc. United Natural Foods, Inc., is a national distributorheadquartered in Dayville, Connecticut. Safeway, Inc., is one of theUnited States’ largest supermarket chains. J. Sainsbury plc, is the UnitedKingdom’s second largest supermarket chain which also owns a division of storesin New England. H.P. Hood, Inc., is a dairy processor/distributorheadquartered in Boston, Massachusetts. Sales to United Natural Foods, Inc., Safeway, Inc. and H.P.Hood, Inc. are included in the marketing segment. Sales to J. Sainsburyplc, are included in the international segment. The following table presentsthe percent of sales information to these four customers for 2002, 2001 and2000.

 
|                        |   | **Percent of total sales********for the year ended  December 31:** |       |
|-----------------------------|--------|--------------------------------------------------------------------|------------|
| **Customer**                |   | **2002**                                                           | ** ** | **2001** | ** ** | **2000** | ** ** |
|                        |   |                                                               | ** ** |   | ** ** |   | ** ** |
| United  Natural Foods, Inc. |   | 14.2                                                               |       | 13.6 |   | 12.0 |   |
| Safeway,  Inc.              |   | 11.7                                                               |       | 10.9 |   | 9.0 |   |
| J.  Sainsbury plc           |   | 10.7                                                               |       | 10.3 |   | 8.0 |   |
| H.P.  Hood, Inc.            |   | 10.6                                                               |       | 13.4 |   | 12.0 |   |

 

***(m)***                              ***AdvertisingCosts***

 

Advertising costs are expensed in the year incurred.Advertising costs, which are included in selling expenses, totaledapproximately $12,095,000, $7,894,000 and $6,794,000 during 2002, 2001 and2000, respectively.

 

***(n)***                                 ***Income Taxes***

 

Income taxes are accounted for under the asset andliability method. Deferred tax assets and liabilities are recognized for thefuture tax consequences attributable to differences between the financialstatement carrying amounts of existing assets and liabilities and theirrespective tax bases and operating loss and tax credit carryforwards. Deferredtax assets and liabilities are measured using enacted tax rates expected toapply to taxable income in the years in which those temporary differences areexpected to be recovered or settled. The effect on deferred tax assets andliabilities of a change in tax rates is recognized in operations in the periodthat includes the enactment date.

 

***(o)***                                 ***Earnings PerShare***

 
|                                                            |   | **2002**                                     |       | **2001** |       | **2000** |       |
|-----------------------------------------------------------------|--------|----------------------------------------------|------------|----------|------------|----------|------------|
|                                                            |   | **(In thousands, except per share amounts)** | ** ** |
|                                                            |   |                                         | ** ** |     | ** ** |     | ** ** |
| Income from continuing operations                               |   | $                                            | 3,605      |     | 1,662      |     | 292        |   |
| Income (loss) from discontinued operations                      |   | (3,638                                       | )          | 78       |       | 227      |       |
| Net income (loss)                                               |   | $                                            | (33        | )        | 1,740      |     | 519        |   |
| Common and common equivalent shares outstanding:                |   |                                         |       |     |       |     |       |
| Historical common shares outstanding at beginning of  year      |   | 10,126                                       |       | 9,900    |       | 9,744    |       |
| Weighted average common equivalent shares issued during  year   |   | 78                                           |       | 107      |       | 52       |       |
| Weighted average common shares issued—basic                |   | 10,204                                       |       | 10,007   |       | 9,796    |       |
| Weighted average common equivalent shares issued during  period |   | 379                                          |       | 206      |       | 234      |       |
| Weighted average common shares issued—diluted              |   | 10,583                                       |       | 10,213   |       | 10,030   |       |
|                                                            |   |                                         |       |     |       |     |       |
| Earnings per share:                                             |   |                                         |       |     |       |     |       |
| Income from continuing operations per basic share               |   | $                                            | .35        |     | .16        |     | .03        |   |
| Income from continuing operations per diluted share             |   | .34                                          |       | .16      |       | .03      |       |
| Income (loss) from discontinued operations per basic  share     |   | (.35                                         | )          | .01      |       | .02      |       |
| Income (loss) from discontinued operations per diluted  share   |   | (.34                                         | )          | .01      |       | .02      |       |
| Net income (loss) per basic share                               |   | (.00                                         | )          | .17      |       | .05      |       |
| Net income (loss) per diluted share                             |   | $                                            | (.00       | )        | .17        |     | .05        |   |

 

Earnings per share calculations are calculated as follows:

 

Income from continuing operations

 

•                                          **Per basic share.**  Computed by dividing income from continuing operations by theweighted average number of common shares outstanding.

•                                          **Per diluted share.**  Computed by dividing income from continuingoperations by the weighted average number of common shares outstandingincreased for potentially dilutive common shares outstanding during the period.

 

Income(loss) from discontinued operations

 

•                                          **Per basic share.**  Computed by dividing income (loss) from discontinued operationsby the weighted average number of common shares outstanding.

 

•                                          **Per diluted share.**  Computed by dividing income (loss) fromdiscontinued operations by the weighted average number of common sharesoutstanding increased for potentially dilutive common shares outstanding duringthe period.

 

Netincome (loss)

 

•                                          **Per basic share.**  Computed by dividing net income (loss) by the weighted averagenumber of common shares outstanding.

 

•                                          **Per diluted share.**  Computed by dividing net income (loss) bythe weighted average number of common shares outstanding increased forpotentially dilutive common shares outstanding during the period.

 

The dilutive effect ofstock options and their equivalents was calculated using the treasury stockmethod.

 

Stockoptions to purchase 162,300, 331,600 and 425,900 common shares were excludedfrom the treasury stock method calculation in 2002, 2001 and 2000,respectively, because they were anti-dilutive.

 

***(p)***                                 ***Stock OptionPlan and Stock Option Agreements***

 

The Company accounts for its stock option plan and stockoption agreements in accordance with the provisions of Accounting PrinciplesBoard (APB) Opinion No. 25***,****Accounting forStock Issued to Employees,* and related interpretations includingFASB Interpretation No. 44, *Accountingfor Certain Transactions Involving Stock Compensation an Interpretation of APBOpinion No. 25*. As such, compensation expense is recorded onthe date of grant only if the current market price of the underlying stockexceeded the exercise price pursuant to the intrinsic value method. Aspermitted by Statement of Financial Accounting Standards No. 123 (SFAS No. 123),*Accounting for Stock-Based Compensation*,the Company continues to apply the provisions of APB Opinion No. 25 andprovides pro forma net income disclosures for employee stock option grants asif the fair-value-based method defined in SFAS No. 123 had been applied.

 

Pursuant to the Company applying the principles in APBOpinion No. 25 in accounting for its Plan and stock option agreements, nocompensation cost has been recognized for stock options granted to employees inthe accompanying consolidated financial statements. Had the Company determinedcompensation cost based on the fair value at the grant date for its stockoptions under SFAS No. 123, the Company’s net income (loss) would havebeen reduced to the pro forma amounts indicated below (in thousands, except pershare amounts):

 
|                                                      |   | **2002** |       | **2001** |       | **2000** |       |
|-----------------------------------------------------------|--------|----------|------------|----------|------------|----------|------------|
|                                                      |   |     | ** ** |     | ** ** |     | ** ** |
| Net income (loss), as reported                            |   | $        | (33        | )        | 1,740      |     | 519        |   |
| Net income (loss), pro forma                              |   | (1,373   | )          | 888      |       | 57       |       |
| Net income (loss) per basic and diluted share,  pro forma |   | (.13     | )          | .09      |       | .01      |       |
|                                                           |        |          |            |          |            |          |            |  |

 

The above pro forma disclosures are not necessarilyrepresentative of the effect on the reported net income for future periodsbecause options vest over several years and additional awards are generallymade each year.

 

***(q)***                                 ***EmployeeBenefit Plans***

 

The Company adopted a defined contribution retirementplan (Plan) during 1997 under which eligible employees may elect to defercurrent compensation by up to certain statutorily prescribed annual limits andcontribute such amount to the Plan.  ThePlan provides for the Company to match an employee’s contribution in an amountup to 2% of such employee’s compensation. The Company contributed approximately$116,000, $112,000, and $97,000 to the Plan for the years endedDecember 31, 2002, 2001 and 2000, respectively. During 2000, the Planadopted a gain sharing arrangement under which eligible employees are creditedannually at year-end with the Company’s common stock in an amount equal to 1%of such employee’s compensation. The Company contributed $82,000, $65,000 and$64,000 to the Plan in 2002, 2001 and 2000, respectively, in the form of cashand the Company’s stock based on fair value at the date of grant to the Plan.

***(r)***                                   ***DiscontinuedOperations***

 

On March 31, 2002, theCompany determined that its Idaho Dairy and Colorado herd met the definition ofa disposal group under Statement of Financial Accounting StandardsNo. 144,*******Accounting for the Impairment or Disposal ofLong-Lived Assets*, or SFAS 144. The Company has a plan in placeto sell the assets of the Idaho Dairy. The remaining Colorado herd wastransferred to the Idaho Dairy by September 30, 2002 in connection with theSeptember 30, 2002 termination of the Dairy Herd Management and SupplyAgreement with Aurora Dairy Corporation for the Colorado herd. The Company isnegotiating for the sale of the Idaho Dairy, including the transferred Coloradoherd, to an experienced dairy farmer and for a long-term supply agreement withthe buyer for organic fluid milk at the expected fair market value.  The Company expects to finalize the transactionby spring, 2003.  There can be no assurance that the Company willenter into a definitive agreement with this prospective buyer in the time framethe Company expects, or that if it does, that the transaction will close in thetime frame expected, if at all.  In theevent this transaction does not occur, the Company will continue to seek abuyer for the Idaho Dairy.

 

Theterms of the anticipated Idaho Dairy sale agreement contemplate a sale pricebased on net book value, which assumes that depreciation of cattle and fixedassets would continue from the time the terms were agreed to until the salecloses.  Consequently, the resultingprice of the Idaho Dairy continues to decrease over time.  However, pursuant to SFAS 144, the Companyceased depreciating the related assets as of the measurement date, which wasMarch 31, 2002.  Therefore, the net bookvalue of the assets held for sale does not decrease from depreciation since themeasurement date; but it does decrease for the decrease in anticipated sale priceunder the contemplated sale agreement subsequent to the measurement date.  Because of the resulting differences due todepreciation between the anticipated net book value and the anticipated sellingprice, the Company recognized during 2002 a loss on disposal of discontinuedoperations equal to depreciation expected through the spring, 2003 transactionclosing date of $3.0 million.  If theCompany is unable to finalize the transaction by March 31, 2003, an additionalloss on disposal will be recognized by the Company equal to the amount ofdepreciation that would be expected through the anticipated date of finalizingthe transaction. The Company believes that the contemplated sales priceapproximates fair market value.

 

The financial resultsfrom these operations for the current and prior periods are reported asdiscontinued operations consistent with a disposal group.  Included in the loss from discontinuedoperations, before income taxes and including closing and transaction fees andthe decrease in anticipated sale price due to depreciation, in 2002 was anestimated loss on disposal of the Idaho Dairy of $4.2 million and an actualloss on disposal of the Colorado herd of $0.4 million.  The following unaudited financial datapresents the combined results of operations for the Idaho Dairy and Coloradoherd for 2002 and 2001 (in thousands):

 
|                                                   |   | **Year Ended  December 31,** |       |
|--------------------------------------------------------|--------|------------------------------|------------|
|                                                   |   | **2002**                     | ** ** | **2001** | ** ** |
| Sales                                                  |   | $                            | 20,877     |   | 22,546 |   |
| Cost of sales excluding cattle  depreciation           |   | 12,901                       |       | 11,773 |   |
| Cattle depreciation                                    |   | 494                          |       | 1,795 |   |
| Gross profit                                           |   | 7,482                        |       | 8,978 |   |
| Operating expenses excluding  fixed asset depreciation |   | 5,861                        |       | 5,952 |   |
| Fixed asset depreciation                               |   | 248                          |       | 1,023 |   |
| Loss on disposal                                       |   | 4,633                        |       | — |   |
| Goodwill amortization                                  |   | —                       |       | 156 |   |
| Operating income (loss)                                |   | (3,260                       | )          | 1,847 |   |
| Other expense, net                                     |   | 1,694                        |       | 1,716 |   |
| Income (loss) before income  taxes                     |   | (4,954                       | )          | 131 |   |
| Income tax (expense) benefit                           |   | 1,316                        |       | (53 | ) |
| Net income (loss)                                      |   | $                            | (3,638     | ) | 78 |   |

 

Thefollowing unaudited proforma financial data presents the combined results of operationsfor the Idaho Dairy and Colorado herd for 2002 and 2001 if the Company hadconcluded that its Idaho Dairy operation had not met the definition of adisposal group under SFAS 144 and if the Company had not determined to sell itsIdaho Dairy (in thousands):

 
|                                                   |   | **Year Ended  December 31,** |       |
|--------------------------------------------------------|--------|------------------------------|------------|
|                                                   |   | **2002**                     | ** ** | **2001** | ** ** |
| Sales                                                  |   | $                            | 20,877     |   | 22,546 |   |
| Cost of sales excluding cattle  depreciation           |   | 12,901                       |       | 11,773 |   |
| Cattle depreciation                                    |   | 1,956                        |       | 1,795 |   |
| Gross profit                                           |   | 6,020                        |       | 8,978 |   |
| Operating expenses excluding  fixed asset depreciation |   | 5,861                        |       | 5,952 |   |
| Fixed asset depreciation                               |   | 1,028                        |       | 1,023 |   |
| Loss on disposal                                       |   | 217                          |       | — |   |
| Goodwill amortization                                  |   | —                       |       | 156 |   |
| Operating income (loss)                                |   | (1,086                       | )          | 1,847 |   |
| Other expense, net                                     |   | 1,694                        |       | 1,716 |   |
| Income (loss) before income  taxes                     |   | (2,780                       | )          | 131 |   |
| Income tax (expense) benefit                           |   | 1,084                        |       | (53 | ) |
| Net income (loss)                                      |   | $                            | (1,696     | ) | 78 |   |

 

Differencesbetween the 2002 financial results from these operations and the 2002 unauditedproforma financial data presented above include $1,462,000 and $780,000 indepreciation charges for cattle and fixed assets, respectively, that areincluded in loss on disposal in the financial results that are instead shown asdepreciation in their respective categories in the 2002 unaudited proformafinancial data.  Furthermore, thefinancial results include an additional $2,174,000 loss on disposal consistingof transaction costs and write downs to expected net realizable value,including charges equal to normal depreciation from December 31, 2002 throughthe expected transaction close date. These costs are not in the unaudited proforma financial data becausethese costs would not have been incurred if the Company had not determined tosell the Idaho Dairy. In addition, the financial results include an additionalincome tax benefit of $232,000, which is not included in the unaudited proformafinancial data.

Additionally,approximately $29.9 million of the Idaho Dairy assets expected to be disposedof, including the transferred Colorado herd, have been classified as currentassets held for sale at December 31, 2002. This compares to $5.2 million of current assets held for sale and $25.2million of long-term assets held for sale as of December 31, 2001, which werereclassified from the 2001 presentation to conform to the 2002 presentationwhile maintaining their respective current and long-term classifications.Pursuant to SFAS 144, the Company wrote the assets down to the expecteddisposal value, less costs to sell. The Company expects to use a substantialportion of the proceeds from the sale of assets held for sale to repayoutstanding debt.

 

**(3)**                                 **Acquisitions**

 

Thecompany has historically expanded its business by acquiring otherbusinesses.  The excess purchase priceover market value of tangible assets resulted in the recognition ofgoodwill.  Goodwill is no longeramortized but is tested for impairment at least annually or more frequently ifconditions warrant.  The company hasalso historically expanded its business by acquiring brand names.  These brand names are intangible assets andcontinue to be amortized over their expected useful lives of fifteenyears.  Intangible assets are testedannually for impairment or more frequently if conditions warrant.

 

**(4)**                                 **Fair Value of FinancialInstruments**

 

The carrying amounts of cash and cash equivalents, trade accountsreceivable, other current assets, other assets, trade accounts payable andother accrued expenses approximate fair value because of the short maturity ofthese instruments.

 

The Company’s $37.8 million approximate carrying amount of variable ratelong-term debt approximates fair value at December 31, 2002.  The Company’s $3.0 million approximatecarrying amount of fixed rate long-term debt has a fair value at December 31,2002 of approximately $3.1 million based on the current rates of similar debtwith similar maturity terms.

 

**(5)**                                 **Inventories**

 

Inventories consist of the following (in thousands):

 
|                                |   | **December 31** |       |
|-------------------------------------|--------|-----------------|------------|
|                                |   | **2002**        | ** ** | **2001** | ** ** |
|                                |   |            | ** ** |   | ** ** |
| Grain and feed                      |   | $               | 309        |   | 989 |   |
| Crops growing, fertilizer and other |   | 99              |       | 219 |   |
| Finished goods                      |   | 7,854           |       | 9,591 |   |
| Raw materials                       |   | 3,862           |       | 3,856 |   |
|                                |   | $               | 12,124     |   | 14,655 |   |

 

**(6)**                                 **Assets Held for Sale**

 

The Company has concluded that, due to the increased interest in theproduction of organic milk by conventional dairy farmers, it no longer needs tocommit capital to the expansion of its own farms or to build new ones.Accordingly, the Company has determined to sell its assets of the Idaho Dairyincluding the transferred Colorado herd, as described in note 2(r), as well asits farm property near Wilton, California. The Idaho Dairy’s assets, includingthe Colorado herd assets held for sale, are presented as discontinuedoperations while the California farm has never been placed into operations. Allassets held for sale are recorded at the lower of cost or net realizable value(fair value less costs to sell). The Company expects to sell the properties in2003. Assets held for sale consists of the following (in thousands):

 
|                                                                                    |   | **December 31** |       |
|-----------------------------------------------------------------------------------------|--------|-----------------|------------|
|                                                                                    |   | **2002**        | ** ** | **2001** | ** ** |
| Current assets held for sale:                                                           |   |            |       |   |   |
| Grain and feed                                                                          |   | $               | 5,341      |   | 4,744 |   |
| Crops growing, fertilizer and other                                                     |   | 731             |       | 445 |   |
| Land and water rights                                                                   |   | 1,703           |       | — |   |
| Dairy and feedlot facilities                                                            |   | 8,538           |       | — |   |
| Cream separator                                                                         |   | 668             |       | — |   |
| Rolling stock, vehicles and farm equipment                                              |   | 2,544           |       | — |   |
| Employee housing                                                                        |   | 1,035           |       | — |   |
| Cattle                                                                                  |   | 17,461          |       | — |   |
| Intangible Assets                                                                       |   | 2,307           |       | — |   |
| Other (in 2001, the California farm)                                                    |   | 113             |       | 1,851 |   |
|                                                                                    |   | 40,441          |       | 7,040 |   |
| Less accumulated depreciation, amortization and write downs to  expected disposal price |   | (10,530         | )          | — |   |
| Total current assets held for sale                                                      |   | $               | 29,911     |   | 7,040 |   |
| Long-term assets held for sale:                                                         |   |            |       |   |   |
| Land and water rights                                                                   |   | $               | —     |   | 1,703 |   |
| Dairy and feedlot facilities                                                            |   | —          |       | 8,440 |   |
| Cream separator                                                                         |   | —          |       | 638 |   |
| Rolling stock, vehicles and farm equipment                                              |   | —          |       | 2,429 |   |
| Employee housing                                                                        |   | —          |       | 988 |   |
| Leasehold improvements                                                                  |   | —          |       | 171 |   |
| Cattle                                                                                  |   | —          |       | 15,911 |   |
| Intangible Assets                                                                       |   | —          |       | 2,307 |   |
| Other (in 2002, the California farm)                                                    |   | 1,851           |       | 143 |   |
|                                                                                    |   | 1,851           |       | 32,730 |   |
| Less accumulated depreciation and amortization                                          |   | —          |       | (7,575 | ) |
| Total long-term assets held for sale                                                    |   | $               | 1,851      |   | 25,155 |   |

 

**(7)**                                 **Cattle**

 

Cattle consists of the following (dollars in thousands):

 
|                                                                      |   | **December 31** |       |
|---------------------------------------------------------------------------|--------|-----------------|------------|
|                                                                      |   | **2002**        | ** ** | **2001** | ** ** |
| Number of head-milking cows and breeding bulls                            |   | 7,052           |       | 7,640 |   |
| Number of head-replacement heifers                                        |   | 2,351           |       | 1,623 |   |
| Less number of head reclassed to assets held for sale                     |   | (8,394          | )          | (8,309 | ) |
| Total head of cattle                                                      |   | 1,009           |       | 954 |   |
|                                                                      |   |            |       |   |   |
| Cost-milking cows and breeding bulls                                      |   | $               | 14,522     |   | 14,176 |   |
| Cost-replacement heifers                                                  |   | 4,539           |       | 3,137 |   |
|                                                                      |   | 19,061          |       | 17,313 |   |
| Less accumulated depreciation and write downs to  expected disposal price |   | (4,788          | )          | (3,340 | ) |
| Less cattle (net) reclassed to assets held for sale                       |   | (13,062         | )          | (12,913 | ) |
| Total cattle                                                              |   | $               | 1,211      |   | 1,060 |   |

 

 

**(8)**                                 **Property and Equipment**

 

Property and equipment consists of the following (in thousands):

 
|                                           |   | **December 31** |       |
|------------------------------------------------|--------|-----------------|------------|
|                                           |   | **2002**        | ** ** | **2001** | ** ** |
| Land and water rights                          |   | $               | 1,177      |   | 1,177 |   |
| Dairy and feedlot facilities                   |   | 2,644           |       | 2,621 |   |
| Dairy processing equipment                     |   | 3,949           |       | 4,060 |   |
| Rolling stock, vehicles and farm equipment     |   | 957             |       | 1,106 |   |
| Employee housing                               |   | 61              |       | 61 |   |
| Leasehold improvements                         |   | 3,247           |       | 3,216 |   |
| Office equipment and computer software         |   | 6,049           |       | 5,272 |   |
| Other                                          |   | 1,687           |       | 1,055 |   |
|                                           |   | 19,771          |       | 18,568 |   |
| Less accumulated depreciation and amortization |   | (6,193          | )          | (4,323 | ) |
| Total property and equipment                   |   | $               | 13,578     |   | 14,245 |   |

 

**(9)**                                 **Long-Term Debt**

 

Long-term debt consists of the following (dollars in thousands):

 
|                                                                                                                                                                                                                                                                                                                                                                                                                     |   | **2002** |       | **2001** |       |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|------------|----------|------------|
|                                                                                                                                                                                                                                                                                                                                                                                                                     |   |     | ** ** |     | ** ** |
| Senior Secured Term Loan note payable to U.S. Bank  National Association (U.S. Bank) bearing interest at LIBOR plus a varying  margin spread of 1.65% to 3.75% requiring quarterly principal payments with  the unpaid balance of $7,300 due May 31, 2005. Interest (3.9% at December 31,  2002) is payable in conjunction with LIBOR pricing maturity dates and is  secured by substantially all assets of the Company. |   | $        | 17,800     |     | 21,000     |   |
| Revolving line of credit with U.S. Bank with collateral  based maximum borrowing of $25,000,000 bearing interest primarily at LIBOR  plus a varying margin spread of 1.65% to 3.75%, secured by substantially all  assets of the Company, available through May 31, 2003. Interest (3.9% at  December 31, 2002) is payable in conjunction with LIBOR pricing period  maturity dates.                                     |   | 16,213   |       | 16,628   |       |
| Note payable to H.P. Hood Inc. bearing interest at  5.3%, payable in annual installments over four years with final due date of  April 26, 2003, backed by a letter of credit with U.S. Bank.                                                                                                                                                                                                                            |   | 2,279    |       | 4,444    |       |
| Note payable to Peoples Bank of Kent County, Maryland  bearing interest at prime (4.3% at December 31, 2002), payable in monthly  installments with the unpaid balance due April 15, 2018, secured by certain  property. The note holder has the right to demand repayment of principal and  interest in full at any time on or after April 15, 2001.                                                                    |   | 421      |       | 453      |       |
| Note payable to Peoples Bank of Kent County, Maryland  bearing interest at prime (4.3% at December 31, 2002), payable in monthly  installments, secured by certain property. The note holder has the right to  demand repayment of principal and interest in full at any time on or after  October 27, 2002.                                                                                                             |   | 571      |       | 615      |       |
| Note payable to Farm Credit Services bearing 5 year  adjustable rate interest (6.5% at December 31, 2002) payable in monthly  installments with the unpaid balance due July 1, 2010, secured by certain property.                                                                                                                                                                                                        |   | 2,677    |       | 2,967    |       |
| Obligations under capital leases with maturities from  one to three years with imputed interest rates (7.93% at December 31, 2002),  secured by related equipment.                                                                                                                                                                                                                                                       |   | 485      |       | 1,044    |       |
| Note payable to Barclays bearing interest at Barclays’  published base rate plus 2% (6.0% at December 31, 2002), payable in monthly  installments with the unpaid balance due August 2, 2006, secured by certain  equipment.                                                                                                                                                                                        |   | 271      |       | 318      |       |
| Other                                                                                                                                                                                                                                                                                                                                                                                                                    |   | 96       |       | 150      |       |
| Total long-term debt                                                                                                                                                                                                                                                                                                                                                                                                     |   | 40,813   |       | 47,619   |       |
| Less current portion                                                                                                                                                                                                                                                                                                                                                                                                     |   | (26,703  | )          | (7,306   | )          |
| Long-term debt, excluding current portion                                                                                                                                                                                                                                                                                                                                                                                |   | $        | 14,110     |     | 40,313     |   |

 

The availability of the $25 million revolving line of credit isreduced by outstanding letters of credit of $2.5 million. Remainingavailability under the line of credit was $6.3 million atDecember 31, 2002.

 

Both U.S. Bank loans contain certain covenants that among other things,limit the Company’s ability to incur additional debt, create liens, paydividends or enter into certain other transactions.

Aggregate maturities of long-term debt are as follows (in thousands):

 
| December 31: |   |   |   |
|--------------|--------|--------|--------|
| 2003         |   | $      | 26,703 |   |
| 2004         |   | 5,197  |   |
| 2005         |   | 8,880  |   |
| 2006         |   | 33     |   |
| Total        |   | $      | 40,813 |   |

 

**(10)**                          **Leases**

 

The Company has noncancelable operating leases, primarily for officespace and office equipment, expiring at various dates from 2003 to 2015. Theseleases generally require the Company to pay all executory costs such asmaintenance and insurance. Total operating lease expense totaled $1,135,000,$973,000 and $775,000 in 2002, 2001 and 2000, respectively.

 

Future minimum lease payments under noncancelable operating and capitalleases as of December 31, 2002 were as follows (in thousands):

 
|                                            |   | **Capital  leases** |       | **Operating  leases** |       |
|-------------------------------------------------|--------|---------------------|------------|-----------------------|------------|
|                                            |   |                | ** ** |                  | ** ** |
| Year ended December 31:                         |   |                |       |                  |       |
| 2003                                            |   | $                   | 417        |                  | 1,172      |   |
| 2004                                            |   | 102                 |       | 1,003                 |       |
| 2005                                            |   | —              |       | 861                   |       |
| 2006                                            |   | —              |       | 859                   |       |
| 2007                                            |   | —              |       | 540                   |       |
| Thereafter                                      |   | —              |       | 978                   |       |
| Total minimum lease payments                    |   | 519                 |       | $                     | 5,413      |   |
|                                            |   |                |       |                  |       |   |
| Less amounts representing interest              |   | 34                  |       |                  |       |
| Present value of minimum capital lease payments |   | 485                 |       |                  |       |
| Less current portion                            |   | 395                 |       |                  |       |
| Capital lease obligations, less current portion |   | $                   | 90         |                  |       |   |

 

**(11)**                          **Purchase Commitments**

 

The Company contracts with various organic farmers and cooperativesthroughout the United States and the United Kingdom to purchase organic farm milk.In the United States, these contracts are generally for original terms oftwelve to twenty-four months and are renewable upon agreement by the Companyand the producer. In the United Kingdom, these contracts are generally fororiginal terms of three months to five years and are renewable upon agreementby the Company and the producer. All United States and United Kingdom milkproduction contracts require that the Company purchase minimum quantities oforganic farm milk and are priced using butterfat differentials and qualitytesting. The Company believes that these contracts approximate organic farmmilk market prices at December 31, 2002. If the Company cannot use theminimum amount as organic fluid milk or other organic products, the Company sellsthe organic milk as organic or conventional milk.

**(12)**                          **Contractual Obligations Summary**

 

The following table summarizes the estimated future undiscounted cashobligations associated with the Company’s long-term debt, capital leases,operating leases and purchase obligations by year or group of years beginningwith January 1, 2003. Long-term debt consists primarily of the Company’s$25 million credit line facility and $25 million term note facilitywith U.S. Bank. These debt facilities may be declared immediately due andpayable upon any event of default, as defined in the loan agreement. Events ofdefault, as defined, include being out of compliance with the loan covenantrequirements. Such covenant requirements include measures of working capital,net worth, cash flow leverage and interest and fixed charge coverage ratios. AtDecember 31, 2002 the Company was in compliance with its loan covenants.The Company’s long-term debt interest rate is primarily variable. The tablebelow assumes a 4% interest rate for year 1 and 7.5% interest rate thereafter.

 

Capital leases are for financing a portion of the cost of the Company’scomputer software system implemented in 2001. The operating leases areprimarily office and equipment rentals.

 

Purchaseobligations are primarily milk production contracts in the U.S. and the U.K.Company management believes that all purchase obligations approximate fairmarket value at December 31, 2002.

 

Thetable below presents the Company’s contractual obligations as of December 31,2002.

 
|                                                                |   | **Payments due by period (in thousands):** |       |
|---------------------------------------------------------------------|--------|--------------------------------------------|------------|
|                                                                |   | **Total**                                  | ** ** | **2003** | ** ** | **2004—2005** | ** ** | **2006—2007** | ** ** | **Post 2007** | ** ** |
| **Contractual obligations**                                         |   |                                       | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Debt obligations including term loans, line of credit  and interest |   | $                                          | 42,592     |   | 27,385 |   | 15,173 |   | 34 |   | — |   |
| Capital lease obligations including interest                        |   | 519                                        |       | 417 |   | 102 |   | — |   | — |   |
| Operating lease obligations                                         |   | 5,413                                      |       | 1,172 |   | 1,864 |   | 1,399 |   | 978 |   |
| Purchase obligations                                                |   | 74,664                                     |       | 53,782 |   | 20,882 |   | — |   | — |   |
| Total contractual obligations                                       |   | $                                          | 123,188    |   | 82,756 |   | 38,021 |   | 1,433 |   | 978 |   |

 

**(13)**                          **Valuation and Qualifying Accounts(in thousands)**

 
| **Description**                                                                  |   | **Balance at  beginning of********year** |       | **Additions********charged to********expense** |       | **Deductions** |       | **Balance********at end********of year** |       |
|----------------------------------------------------------------------------------|--------|------------------------------------------|------------|------------------------------------------------|------------|----------------|------------|------------------------------------------|------------|
|                                                                             |   |                                     | ** ** |                                           | ** ** |           | ** ** |                                     | ** ** |
| Year ended December 31, 2000:                                                    |   |                                     |       |                                           |       |           |       |                                     |       |
| Returns and allowance, market development support and  doubtful accounts reserve |   | $                                        | 686        |                                           | 4,352      |           | 4,348      |                                     | 690        |   |
| Inventory valuation reserve                                                      |   | —                                   |       | 128                                            |       | —         |       | 128                                      |       |
| Year ended December 31, 2001:                                                    |   |                                     |       |                                           |       |           |       |                                     |       |
| Returns and allowance, market development support and  doubtful accounts reserve |   | 690                                      |       | 6,015                                          |       | 5,125          |       | 1,580                                    |       |
| Inventory valuation reserve                                                      |   | 128                                      |       | —                                         |       | —         |       | 128                                      |       |
| Year ended December 31, 2002:                                                    |   |                                     |       |                                           |       |           |       |                                     |       |
| Returns and allowance, market development support and  doubtful accounts reserve |   | 1,580                                    |       | 10,024                                         |       | 9,344          |       | 2,260                                    |       |
| Inventory valuation reserve                                                      |   | 128                                      |       | —                                         |       | 87             |       | 41                                       |       |
|                                                                                  |        |                                          |            |                                                |            |                |            |                                          |            |  |

 

**(14)**                          **Restructuring Costs**

 

During the year ended December 31, 2000 the Company restructuredits international operating segment management. During the year endedDecember 31, 2002 restructuring costs associated with this managementchange were as follows (in thousands):

 
|                                 |   | **Balance at  beginning of  year** |   | **Additions  charged to  expense** |   | **Amounts  paid** |   | **Balance at  end of year** |   |
|--------------------------------------|--------|------------------------------------|--------|------------------------------------|--------|-------------------|--------|-----------------------------|--------|
| Year ended  December 31, 2000:       |   |                               |   |                               |   |              |   |                        |   |
| Termination and severance costs      |   | $                                  | — |                               | 285    |              | — |                        | 285    |   |
| Cancellation of contracts and leases |   | —                             |   | 26                                 |   | —            |   | 26                          |   |
| Other                                |   | —                             |   | 9                                  |   | —            |   | 9                           |   |
|                                 |   |                               |   |                               |   |              |   |                        |   |
| Year ended  December 31, 2001:       |   |                               |   |                               |   |              |   |                        |   |
| Termination and severance costs      |   | 285                                |   | —                             |   | 255               |   | 30                          |   |
| Cancellation of contracts and leases |   | 26                                 |   | —                             |   | 26                |   | —                      |   |
| Other                                |   | 9                                  |   | —                             |   | 9                 |   | —                      |   |
|                                 |   |                               |   |                               |   |              |   |                        |   |
| Year ended  December 31, 2002:       |   |                               |   |                               |   |              |   |                        |   |
| Termination and severance costs      |   | 30                                 |   | —                             |   | 30                |   | —                      |   |
|                                      |        |                                    |        |                                    |        |                   |        |                             |        |  |

 

TheCompany paid the remaining balance from December 31, 2001 of approximately$30,000 during the first quarter of 2002.

 

**(15)**                          **Income Taxes**

 

Income tax (expense) benefit attributable to income before income taxesconsists of (in thousands):

 
|                          |   | **Current** |   | **Deferred** |   | **Total** |   |
|-------------------------------|--------|-------------|--------|--------------|--------|-----------|--------|
| Year ended December 31, 2002: |   |        |   |         |   |      |   |
| U.S. Federal                  |   | $           | (538   | )            | 59     |      | (479   | ) |
| State                         |   | (78         | )      | (36          | )      | (114      | )      |
| Foreign                       |   | (414        | )      | 18           |   | (396      | )      |
|                          |   | $           | (1,030 | )            | 41     |      | (989   | ) |
|                          |   |        |   |         |   |      |   |
| Year ended December 31, 2001: |   |        |   |         |   |      |   |
| U.S. Federal                  |   | $           | (346   | )            | (425   | )         | (771   | ) |
| State                         |   | (62         | )      | (81          | )      | (143      | )      |
| Foreign                       |   | (246        | )      | (12          | )      | (258      | )      |
|                          |   | $           | (654   | )            | (518   | )         | (1,172 | ) |
| Year ended December 31, 2000: |   |        |   |         |   |      |   |
| U.S. Federal                  |   | $           | (47    | )            | (230   | )         | (277   | ) |
| State                         |   | (11         | )      | (27          | )      | (38       | )      |
| Foreign                       |   | (57         | )      | (21          | )      | (78       | )      |
|                          |   | $           | (115   | )            | (278   | )         | (393   | ) |

 

Income tax (expense) benefit attributable to income before income taxesdiffered from the amounts computed by applying the U.S. federal income tax rateof 34% to pretax income as a result of the following (in thousands):

 
|                                                                                                       |   | **December 31,  2002** |       | **December 31,  2001** |       | **December 31,  2000** |       |
|------------------------------------------------------------------------------------------------------------|--------|-----------------------------|------------|-----------------------------|------------|-----------------------------|------------|
|                                                                                                       |   |                        | ** ** |                        | ** ** |                        | ** ** |
| Computed “expected” tax (expense) benefit                                                        |   | $                           | (2,009     | )                           | (946       | )                           | (174       | ) |
| (Increase) reduction in income taxes resulting from:  State and local income taxes, net of federal benefit |   | (107                        | )          | (97                         | )          | (14                         | )          |
| Permanent differences                                                                                      |   | 63                          |       | (79                         | )          | (36                         | )          |
| Rate differential for deferred tax liability                                                               |   | (242                        | )          | —                      |       | —                      |       |
| Other, net                                                                                                 |   | (10                         | )          | 3                           |       | 3                           |       |
|                                                                                                       |   | $                           | (2,305     | )                           | (1,119     | )                           | (221       | ) |

 

The tax effects of temporary differences that give rise to significantportions of deferred tax assets and liabilities are presented below (inthousands):

 
|                                                      |   | **December 31,  2002** |       | **December 31,  2001** |       |
|-----------------------------------------------------------|--------|-----------------------------|------------|-----------------------------|------------|
|                                                      |   |                        | ** ** |                        | ** ** |
| Deferred tax assets:                                      |   |                        |       |                        |       |
| Artwork and plates                                        |   | $                           | 111        |                        | 8          |   |
| Net operating loss carryforwards                          |   | 323                         |       | 329                         |       |
| Idaho Dairy sale transaction costs                        |   | 225                         |       | —                      |       |
| Start-up costs capitalized for tax                        |   | 1                           |       | 34                          |       |
| Accrued compensation and vacation                         |   | 110                         |       | 102                         |       |
| Foreign tax credit                                        |   | 612                         |       | 259                         |       |
| Other, net                                                |   | 153                         |       | 74                          |       |
| Net deferred tax assets                                   |   | 1,535                       |       | 806                         |       |
| Deferred tax liabilities:                                 |   |                        |       |                        |       |
| Write-off of intangibles in purchase accounting, net      |   | (433                        | )          | (96                         | )          |
| New distribution costs                                    |   | (322                        | )          | —                      |       |
| Step-up of property, equipment and cattle in  acquisition |   | (3,401                      | )          | (3,372                      | )          |
| Net deferred tax liabilities                              |   | (2,621                      | )          | (2,662                      | )          |
| Less current net deferred tax assets                      |   | (277                        | )          | (160                        | )          |
| Long term deferred income tax liability                   |   | $                           | (2,898     | )                           | (2,822     | ) |

 

In assessing the realizability of deferred tax assets, managementconsiders whether it is more likely than not that some portion or all of thedeferred tax assets will not be realized. The ultimate realization of deferredtax assets is dependent upon the generation of future taxable income duringperiods in which those temporary differences become deductible. Managementconsiders projected future taxable income and tax planning strategies in makingthis assessment. Based upon management’s projections of future taxable incomeand future taxable income generated from the reversal of deferred taxliabilities over the periods in which the deferred tax assets are deductible,management believes it is more likely than not that the Company will realizethe benefits of these deductible differences. Accordingly, there is novaluation allowance in 2002 or 2001.

 

AtDecember 31, 2002, the Company has net operating loss carryforwards forU.S. federal income tax purposes of approximately $1,787,000, which areavailable to offset future federal taxable income and expire in the followingyears (in thousands):

 
| 2011  |   | $   | 222    |   |
|-------|--------|-----|--------|--------|
| 2012  |   | 598 |   |
| 2022  |   | 967 |   |
| Total |   | $   | 1,787  |   |

 

**(16)**                          **Stockholders’ Equity**

 

During2002 and 2001, respectively, the Company recorded in stockholders’ equitybenefits of $466,000 and $414,000 from income tax deductions from stock optionexercises of Company stock.

 

**(17)**                          **Stock Option Plan and StockOption Agreements**

 

AtDecember 31, 2002, the Company could grant up to 2,250,000 options topurchase shares of its common stock pursuant to an incentive stock option plan(Plan) it implemented for key employees. Options are granted at the discretionof the Board of Directors with an exercise price equal to the stock’s fairvalue on date of grant.

In2002, the Board granted a total of 536,000 options. 64,000 nonqualified optionswere granted to outside agents that vest 25% per year beginning one year aftergrant date and expire in 2012. 156,414 nonqualified options were granted toemployees that vest 25% per year beginning one year after grant date and expirein 2012. 315,586 qualified options were granted to employees that vest 25% peryear beginning one year after grant date and expire in 2012.

 

In2001, the Board granted a total of 352,000 options. 59,000 nonqualified optionswere granted to outside agents that vest 25% per year beginning one year aftergrant date and expire in 2006. 89,282 nonqualified options were granted toemployees that vest 25% per year beginning one year after grant date and expirein 2006. 203,718 qualified options were granted to employees that vest 25% peryear beginning one year after grant date with 184,218 and 19,500 to expire in2006 and 2011, respectively.

 

In2000, the Board granted a total of 306,150 options. 36,000 nonqualified optionswere granted to outside agents that vest 25% per year beginning one year aftergrant date and expire in 2005. 71,764 nonqualified options were granted toemployees that vest 25% per year beginning one year after grant date and expirein 2005. 198,386 qualified options were granted to employees that vest 25% peryear beginning one year after grant date and expire in 2005.

 

Theper share weighted-average fair value of stock options granted during 2002,2001 and 2000 was $7.24, $4.08, and $5.41, respectively, on the date of grantusing the Black Scholes option-pricing model with the followingweighted-average assumptions: 2002–no expected dividend yield, expectedvolatility of 48%, risk free rates ranging from 3.3% to 5.3%, and expectedlives of 5 years; 2001–no expected dividend yield, expected volatility of70%, risk free rates ranging from 3.7% to 5.0%, and expected lives of5 years and 2000–no expected dividend yield, expected volatility of 70%,risk free rates ranging from 5.3% to 6.7%, and expected lives of 5 years.

 

TheCompany applies the principles in APB Opinion No. 25 in accounting for itsPlan and stock option agreements and, accordingly, no compensation cost hasbeen recognized for stock options granted to employees in the accompanyingconsolidated financial statements. Had the Company determined compensation costbased on the fair value at the grant date for its stock options under SFASNo. 123, the Company’s net income (loss) would have been reduced to thepro forma amounts indicated below (in thousands, except per share amounts):

 
|                                                      |   | **2002** |       | **2001** |       | **2000** |       |
|-----------------------------------------------------------|--------|----------|------------|----------|------------|----------|------------|
|                                                      |   |     | ** ** |     | ** ** |     | ** ** |
| Net income (loss), as reported                            |   | $        | (33        | )        | 1,740      |     | 519        |   |
| Net income (loss), pro forma                              |   | (1,373   | )          | 888      |       | 57       |       |
| Net income (loss) per basic and diluted share, pro  forma |   | (.13     | )          | .09      |       | .01      |       |
|                                                           |        |          |            |          |            |          |            |  |

 

Theabove pro forma disclosures are not necessarily representative of the effect onthe reported net income for future periods because options vest over severalyears and additional awards are generally made each year.

 

Stockoption activity during the years indicated was as follows:

 
|                                               |   | **Number of  shares** |       | **Range of exercise********Prices** |            | **Weighted average********exercise price** |       |
|----------------------------------------------------|--------|-----------------------|------------|-------------------------------------|-----------------|--------------------------------------------|------------|
|                                               |   |                  | ** ** |                                | ** **      |                                       | ** ** |
| Balance at December 31, 1999                       |   | 953,063               |       | $                                   | 1.25—17.25 |                                       | $          | 7.03 |   |
| Granted                                            |   | 306,150               |       | 6.50—17.25                     |            | 9.23                                       |       |
| Exercised                                          |   | (126,874              | )          | 1.25—6.50                      |            | 2.61                                       |       |
| Canceled                                           |   | (100,811              | )          | 3.22—17.25                     |            | 10.41                                      |       |
| Balance at December 31, 2000                       |   | 1,031,528             |       | 1.25—17.25                     |            | 8.04                                       |       |
| Granted                                            |   | 352,000               |       | 4.69—16.52                     |            | 6.65                                       |       |
| Exercised                                          |   | (200,987              | )          | 2.10—11.00                     |            | 3.57                                       |       |
| Canceled                                           |   | (165,315              | )          | 4.94—17.25                     |            | 11.37                                      |       |
| Balance at December 31, 2001                       |   | 1,017,226             |       | 1.25—17.25                     |            | 7.90                                       |       |
| Granted                                            |   | 536,000               |       | 12.98—18.17                    |            | 15.14                                      |       |
| Exercised                                          |   | (160,099              | )          | 1.25—17.25                     |            | 6.93                                       |       |
| Canceled                                           |   | (115,464              | )          | 4.94—17.79                     |            | 10.29                                      |       |
| Balance at December 31, 2002                       |   | 1,277,663             |       | 1.25—18.17                     |            | 10.84                                      |       |
| Number of options exercisable at December 31, 2002 |   | 427,048               |       |                                |            |                                       |       |
|                                                    |        |                       |            |                                     |                 |                                            |            |  |  |

 

 
| **Exercise price** |                                            | **Number  outstanding** |       | **Weighted average  remaining contractual  life (years)** |       | **Number  exercisable  December 31,  2002** |       | **Weighted average  exercise price** |       |
|--------------------|-------------------------------------------------|-------------------------|------------|-----------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------|------------|
|               |                                            |                    | ** ** |                                                      | ** ** |                                             | ** ** |                                 | ** ** |
| $                  |         1.25 |                    | 37,500     |                                                      | 1.2        |                                             | 37,500     |                                 | $          | 1.25 |   |
| 4.69—7.88     |                                            | 332,813                 |       | 2.6                                                       |       | 147,578                                          |       | 6.04                                 |       |
| 8.25—11.60    |                                            | 333,650                 |       | 2.5                                                       |       | 199,038                                          |       | 9.14                                 |       |
| 12.99—17.25   |                                            | 516,700                 |       | 8.4                                                       |       | 42,932                                           |       | 14.97                                |       |
| 17.79—18.17   |                                            | 57,000                  |       | 9.4                                                       |       | —                                           |       | 17.83                                |       |
|               |                                            | 1,277,663               |       | 5.2                                                       |       | 427,048                                          |       | 10.84                                |       |
|                    |                                                 |                         |            |                                                           |            |                                                  |            |                                      |            |  |  |

 

Canceled options are a result of employee terminations and forfeitures.The company had 724,440, 394,976 and 581,661 options available for grant underthe Plan as of December 31, 2002, 2001, and 2000, respectively.  The Company had 43,500, 68,250 and 170,250options outstanding outside of the Plan as of December 31, 2002, 2001 and 2000,respectively, which were granted prior to establishing the Plan.

 

**(18)**                          **Related Party Transactions**

 

***(a)***                                 ***Aurora DairyCorporation***

 

The Company entered into a Dairy Herd Management andSupply Agreement on March 5, 1999 (subsequently amended on June 9,1999 and on August 9, 2001) with Aurora Dairy Corporation whose majorityowner is a former member of our board. The agreement allowed the Company toprovide and maintain an organic dairy herd at Aurora’s facilities inPlatteville, Colorado, approximating 1,150 head milking. Over the life of thecontract, the Company provided the feed for the animals and paid forapproximately $270,000 in equipment and leasehold improvements. Aurora managedthe herd and paid for operating expenses outside of the feed, breeding, cattlecosts and the depreciation of the leasehold improvements and equipment providedby the Company. The management fees varied throughout the term of the contractbut required a minimum of $90,000 per month through June 30, 2002. Thecontract ran from October 1999 through September 2002. The contractexpired on September 30, 2002, by which time the remaining herd was transferredto the Company’s Idaho Dairy. During the “wind-down phase” from July 2002through September 2002 the Company paid a management fee of $125,000 permonth.

 

Payments made to Aurora by the Company for managementfees were $1,248,781, $1,840,352 and $1,460,723 during 2002, 2001 and 2000,respectively. Additionally during these respective years, the Company paidAurora $121,937, $151,092, and $83,607 for feed and cattle. Aurora paid theCompany $147,284, $455,475 and $395,637 during 2002, 2001 and 2000,respectively, for the purchase of cattle, feed and miscellaneous equipment.Additionally, in April 2000 Aurora and the Company agreed that the Companywould deliver to Aurora 600 head of cattle between April and June 2000. Inexchange, Aurora would deliver 600 head of cattle to the Company betweenDecember 2000 and March 2001.

 

***(b)***                                 ***Dean Foods***

 

                In 1998, theCompany entered into agreements with a significant shareholder, Dean FoodsCompany, formerly Suiza Foods Corporation, a manufacturer and distributor offresh milk and related dairy products. The Company’s agreements with Dean Foodsinclude five-year processing and distribution agreements with three of DeanFood’s subsidiaries: Model Dairy, a fluid milk processor located in Reno,Nevada; Robinson Dairy, a fluid milk processor located in Denver, Colorado; andGarelick Farms, a fluid milk processor and distributor with several locationsin the northeast U.S., which does not currently process any products for theCompany. The processing and distribution agreement with Model Dairy providesthat it will be the exclusive processor for the Company’s milk products inCalifornia and Nevada, with certain exceptions, and that it will distribute allSKUs of the Company’s organic fluid milk products which are available for salein its territory. The processing and distribution agreement with Robinson Dairyprovides that the Company will not engage another processor within the state ofColorado. One of the Company’s directors controlled Robinson Dairy at theinception of the agreement. Per the agreement, the Company will pay minimumco-packing fees for processing product through December 31, 2003. TheCompany also has products processed by Morningstar Foods, a fluid milkprocessor located in Gustine, California and Cultured Specialties, a dairyprocessor located in Fullerton and Tulare, California. Both companies aresubsidiaries of Dean Foods. The Company paid to Dean Foods and its subsidiariesapproximately $18,697,000, $13,928,000 and $7,822,000 in 2002, 2001 and 2000,respectively.

**(c)**                                  ***DirectorResignation***

 

In connection with the resignation ofMark A. Retzloff as a director effective July 29, 2002, the Company enteredinto an agreement with Mr. Retzloff pursuant to which he and the Companyreleased the other from any claim and the Company agreed to accelerate thevesting of stock options held by Mr. Retzloff as follows:  2,000 shares with an exercise price of$17.25 per share; 10,000 shares with an exercise price of $9.50 per share;6,000 shares with an exercise price of $17.79 per share; and 4,500 shares withan exercise price of $7.00 per share. These options would have terminated absent this agreement.  The Company incurred an expense ofapproximately $52,000 with respect to this agreement because the closing priceof the Company’s stock on July 29, 2002 was $12.29 per share.

 

**(19)**                          **Employee Stock Purchase Plan**

 

InApril 1998, the Board adopted the 1998 Employee Stock Purchase Plan(“ESPP”), to provide employees of the Company with an opportunity to purchasecommon stock through payroll deductions. Under the ESPP, 250,000 shares ofcommon stock have been reserved for issuance. The ESPP is intended to qualifyas an employee stock purchase plan within the meaning of Section 423 ofthe Internal Revenue Code. The Board may authorize participation by eligibleemployees, including officers, in periodic offerings following the adoption ofthe ESPP. A new offering period begins every January and July.

 

Allemployees are eligible to participate in the ESPP if they are employed on, andtheir ESPP participation application is completed by, the biannual offeringdates. Employees can have up to 10% of their earnings withheld pursuant to theESPP and applied on specific purchase dates (currently the last day of eachauthorized offering) to the purchase of shares of common stock. The price ofcommon stock purchased under the ESPP is equal to 85% of the lower of the fair valueof the common stock on the commencement date of each offering or the purchasedate. Employees may end their participation in the offering at any time duringthe offering, and participation ends automatically upon termination ofemployment. Holders of five percent or more of the Company’s outstanding commonstock are not eligible to participate in the ESPP.

 

Inthe event of certain changes in control, the Company and the Board havediscretion to provide that each right to purchase common stock will be assumedor an equivalent right substituted by the successor corporation, or the Boardmay shorten an offering and provide for all sums collected by payrolldeductions to be applied to purchase stock immediately prior to the change incontrol. The ESPP may be terminated at the Board’s discretion.

 

**(20)**                          **Quarterly Results (Unaudited)**

 

The following table sets forth quarterly unaudited financial data forthe quarters of 2002 and 2001 (in thousands, except share and per share data).

 
|                                                  |   | **Year Ended December 31, 2002** |   |
|-------------------------------------------------------|--------|----------------------------------|--------|
|                                                  |   | **1st Qtr**                      |   | **2nd Qtr** |   | **3rd Qtr** |   | **4th Qtr** |   |
|                                                  |   |                             |   |   |   |   |   |   |   |
| Net sales                                             |   | $                                | 42,218 |   | $ | 44,713 |   | $ | 47,631 |   | $ | 52,975 |   |
| Cost of sales                                         |   | 28,368                           |   | 30,646 |   | 32,681 |   | 35,986 |   |
| Gross  profit                                         |   | 13,850                           |   | 14,067 |   | 14,950 |   | 16,989 |   |
| Selling expenses                                      |   | 9,431                            |   | 9,900 |   | 10,762 |   | 11,297 |   |
| General and administrative expense                    |   | 2,520                            |   | 2,659 |   | 2,490 |   | 3,035 |   |
| Intangible asset amortization                         |   | 325                              |   | 326 |   | 328 |   | 328 |   |
| Total operating expense                               |   | 12,276                           |   | 12,885 |   | 13,580 |   | 14,660 |   |
| Operating income                                      |   | 1,574                            |   | 1,182 |   | 1,370 |   | 2,329 |   |
| Other income (expense)                                |   | (189                             | )      | (122 | ) | (184 | ) | (50 | ) |
| Income from continuing operations before income taxes |   | 1,385                            |   | 1,060 |   | 1,186 |   | 2,279 |   |
| Income tax expense                                    |   | (540                             | )      | (413 | ) | (463 | ) | (889 | ) |
| Income from continuing operations                     |   | $                                | 845    |   | $ | 647 |   | $ | 723 |   | $ | 1,390 |   |
|                                                  |   |                             |   |   |   |   |   |   |   |
| Loss from discontinued operations, net                |   | (2,519                           | )      | (294 | ) | (399 | ) | (426 | ) |
| Net income (loss)                                     |   | $                                | (1,674 | ) | $ | 353 |   | $ | 324 |   | $ | 964 |   |
|                                                  |   |                             |   |   |   |   |   |   |   |
| Income from continuing operations per basic share     |   | $                                | 0.08   |   | $ | 0.06 |   | $ | 0.07 |   | $ | 0.13 |   |
|                                                  |   |                             |   |   |   |   |   |   |   |
| Income from continuing operations per diluted share   |   | $                                | 0.08   |   | $ | 0.06 |   | $ | 0.07 |   | $ | 0.13 |   |
|                                                  |   |                             |   |   |   |   |   |   |   |
| Loss from discontinued operations per basic share     |   | $                                | (0.25  | ) | $ | (0.03 | ) | $ | (0.04 | ) | $ | (0.04 | ) |
|                                                  |   |                             |   |   |   |   |   |   |   |
| Loss from discontinued operations per diluted share   |   | $                                | (0.24  | ) | $ | (0.03 | ) | $ | (0.04 | ) | $ | (0.04 | ) |
|                                                  |   |                             |   |   |   |   |   |   |   |
| Net income (loss) per basic share                     |   | $                                | (0.17  | ) | $ | 0.03 |   | $ | 0.03 |   | $ | 0.09 |   |
|                                                  |   |                             |   |   |   |   |   |   |   |
| Net income (loss) per diluted share                   |   | $                                | (0.16  | ) | $ | 0.03 |   | $ | 0.03 |   | $ | 0.09 |   |
|                                                  |   |                             |   |   |   |   |   |   |   |
| Weighted average shares outstanding—basic        |   | 10,143                           |   | 10,179 |   | 10,221 |   | 10,272 |   |
| Weighted average shares outstanding—diluted      |   | 10,545                           |   | 10,617 |   | 10,556 |   | 10,609 |   |

 

 
|                                                                    |   | **Year Ended December 31, 2001** |   |
|-------------------------------------------------------------------------|--------|----------------------------------|--------|
|                                                                    |   | **1st Qtr**                      |   | **2nd Qtr** |   | **3rd Qtr** |   | **4th Qtr** |   |
|                                                                    |   |                             |   |   |   |   |   |   |   |
| Net sales                                                               |   | $                                | 37,598 |   | $ | 38,606 |   | $ | 39,009 |   | $ | 43,657 |   |
| Cost of sales                                                           |   | 26,868                           |   | 27,488 |   | 27,202 |   | 30,289 |   |
| Gross profit                                                            |   | 10,730                           |   | 11,118 |   | 11,807 |   | 13,368 |   |
| Selling expenses                                                        |   | 7,641                            |   | 7,651 |   | 7,900 |   | 8,149 |   |
| General and administrative expense                                      |   | 1,925                            |   | 1,996 |   | 1,947 |   | 2,168 |   |
| Intangible asset amortization                                           |   | 785                              |   | 773 |   | 778 |   | 779 |   |
| Total operating expense                                                 |   | 10,351                           |   | 10,420 |   | 10,625 |   | 11,096 |   |
| Operating income                                                        |   | 379                              |   | 698 |   | 1,182 |   | 2,272 |   |
| Other income (expense)                                                  |   | (585                             | )      | (514 | ) | (477 | ) | (174 | ) |
| Income (loss) from continuing operations before income  taxes           |   | (206                             | )      | 184 |   | 705 |   | 2,098 |   |
| Income tax benefit (expense)                                            |   | 74                               |   | (72 | ) | (281 | ) | (840 | ) |
| Income (loss) from continuing operations                                |   | $                                | (132   | ) | $ | 112 |   | $ | 424 |   | $ | 1,258 |   |
|                                                                    |   |                             |   |   |   |   |   |   |   |
| Income (loss) from discontinued operations, net                         |   | (103                             | )      | 330 |   | 168 |   | (317 | ) |
| Net income (loss)                                                       |   | $                                | (235   | ) | $ | 442 |   | $ | 592 |   | $ | 941 |   |
|                                                                    |   |                             |   |   |   |   |   |   |   |
| Income (loss) from continuing operations per basic and  diluted share   |   | $                                | (0.01  | ) | $ | 0.01 |   | $ | 0.04 |   | $ | 0.12 |   |
|                                                                    |   |                             |   |   |   |   |   |   |   |
| Income (loss) from discontinued operations per basic  and diluted share |   | $                                | (0.01  | ) | $ | 0.03 |   | $ | 0.02 |   | $ | (0.03 | ) |
|                                                                    |   |                             |   |   |   |   |   |   |   |
| Net income (loss) per basic and diluted share                           |   | $                                | (0.02  | ) | $ | 0.04 |   | $ | 0.06 |   | $ | 0.09 |   |
|                                                                    |   |                             |   |   |   |   |   |   |   |
| Weighted average shares outstanding—basic                          |   | 9,901                            |   | 9,945 |   | 10,068 |   | 10,110 |   |
| Weighted average shares outstanding—diluted                        |   | 9,901                            |   | 10,076 |   | 10,333 |   | 10,441 |   |

 

 

**HORIZONORGANIC HOLDING CORPORATION****ANDSUBSIDIARIES**

Notesto Consolidated Financial Statements

 

December31, 2002, 2001 and 2000

 

**(21)**                          **Reportable Segments (inthousands)**

 

TheCompany has three segments of business, the marketing company, the dairy farmoperations and international.  Themarketing company is responsible for acquiring, processing and marketingorganic fluid milk, organic dairy products and organic non-dairy products.  The dairy farm operations are responsiblefor producing farm milk for use by the marketing company in the production ofits products.  International is theUnited Kingdom entities responsible for acquiring, processing and marketingorganic fluid milk and organic dairy products.

 

The Company has included allof its subsidiaries in the consolidated financial statements.

 
|                                                                                                               |   | **Year ended December 31, 2002** |         |
|--------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|--------------|
|                                                                                                               |   | **Marketing**                    |         | **Dairy farm  operations** |   | **U.S.  eliminations** |   | **U.S.  adjustments** |   | **U.S.  subtotal** |   | **International** |   | **U.S. and  International  subtotal** |   | **International  eliminations  with U.S.** |   | **Total** |   |
| Net sales                                                                                                          |   | $                                | 154,433      |   | 2,790 |   | (2,790 | ) | — |   | 154,433 |   | 33,104 |   | 187,537 |   | — |   | 187,537 |   |
| Cost of sales                                                                                                      |   | 102,521                          |         | 1,627 |   | (1,627 | ) | (98 | ) | 102,423 |   | 25,258 |   | 127,681 |   | — |   | 127,681 |   |
| Gross profit                                                                                                       |   | 51,912                           |         | 1,163 |   | (1,163 | ) | 98 |   | 52,010 |   | 7,846 |   | 59,856 |   | — |   | 59,856 |   |
|                                                                                                               |   |                             |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating expenses  excluding intangible  asset amortization                                                       |   | 45,956                           |         | 1,065 |   | (1,065 | ) | — |   | 45,956 |   | 6,138 |   | 52,094 |   | — |   | 52,094 |   |
| Intangible asset amortization                                                                                      |   | 1,176                            |         | — |   | — |   | — |   | 1,176 |   | 131 |   | 1,307 |   | — |   | 1,307 |   |
| Operating income (loss)                                                                                            |   | 4,780                            |         | 98 |   | (98 | ) | 98 |   | 4,878 |   | 1,577 |   | 6,455 |   | — |   | 6,455 |   |
| Interest income                                                                                                    |   | 1,774                            |         | — |   | (284 | ) | (1,447 | ) | 43 |   | 96 |   | 139 |   | — |   | 139 |   |
| Interest expense                                                                                                   |   | (441                             | )            | (333 | ) | 284 |   | 1,447 |   | 957 |   | (1,396 | ) | (439 | ) | — |   | (439 | ) |
| Other, net                                                                                                         |   | (250                             | )            | — |   | — |   | — |   | (250 | ) | 5 |   | (245 | ) | — |   | (245 | ) |
|                                                                                                               |   |                             |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income (loss) from continuing  operations before income  taxes                                                     |   | 5,863                            |         | (235 | ) | (98 | ) | 98 |   | 5,628 |   | 282 |   | 5,910 |   | — |   | 5,910 |   |
| Income tax benefit (expense)                                                                                       |   | (2,287                           | )            | 92 |   | — |   | — |   | (2,195 | ) | (110 | ) | (2,305 | ) | — |   | (2,305 | ) |
|                                                                                                               |   |                             |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income (loss) from continuing  operations                                                                          |   | 3,576                            |         | (144 | ) | (98 | ) | 98 |   | 3,433 |   | 172 |   | 3,605 |   | — |   | 3,605 |   |
|                                                                                                               |   |                             |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Discontinued operations*:                                                                                          |   |                             |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss from operations of discontinued  Idaho Dairy and Colorado herd including  intangible asset amortization of $0 |   | —                           |         | (4,954 | ) | — |   | — |   | (4,954 | ) | — |   | (4,954 | ) | — |   | (4,954 | ) |
| Income tax benefit from discontinued  operations                                                                   |   | —                           |         | 1,316 |   | — |   | — |   | 1,316 |   | — |   | 1,316 |   | — |   | 1,316 |   |
| Loss from discontinued operations                                                                                  |   | —                           |         | (3,638 | ) | — |   | — |   | (3,638 | ) | — |   | (3,638 | ) | — |   | (3,638 | ) |
| Net income (loss)                                                                                                  |   | $                                | 3,576        |   | (3,782 | ) | (98 | ) | 98 |   | (205 | ) | 172 |   | (33 | ) | — |   | (33 | ) |
|                                                                                                               |   |                             |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Segment assets                                                                                                     |   | $                                | 115,386      |   | 41,988 |   | (37,350 | ) | — |   | 120,024 |   | 41,016 |   | 161,040 |   | (32,833 | ) | 128,207 |   |
|                                                                                                               |   |                             |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| The following additional  supplemental information is included above:                                              |   |                             |         |   |   |   |   |   |   |   |   |
| **Continuing Operations:**                                                                                         |   |                             |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Depreciation and amortization                                                                                      |   | $                                |  2,904  |   | 459 |   | — |   | — |   | 3,363 |   | 461 |   | 3,824 |   | — |   | 3,824 |   |
|                                                                                                               |   |                             |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss on sale of cattle and equipment                                                                               |   | 12                               |         | 162 |   | — |   | — |   | 174 |   | 527 |   | 701 |   | — |   | 701 |   |
|                                                                                                               |   |                             |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Discontinued Operations:**                                                                                       |   |                             |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Depreciation and amortization                                                                                      |   | $                                |  — |   | 755 |   | — |   | — |   | 755 |   | — |   | 755 |   | — |   | 755 |   |
|                                                                                                               |   |                             |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss on sale of cattle and equipment                                                                               |   | —                           |         | 5,970 |   | — |   | — |   | 5,970 |   | — |   | 5,970 |   | — |   | 5,970 |   |
|                                                                                                               |   |                             |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Company Total:**                                                                                                 |   |                             |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Depreciation and amortization                                                                                      |   | $                                |  2,904  |   | 1,214 |   | — |   | — |   | 4,118 |   | 461 |   | 4,579 |   | — |   | 4,579 |   |
|                                                                                                               |   |                             |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss on sale of cattle and equipment                                                                               |   | 12                               |         | 6,132 |   | — |   | — |   | 6,144 |   | 527 |   | 6,671 |   | — |   | 6,671 |   |
|                                                                                                                    |        |                                  |              |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

*** Revenue and operating expenses(including loss on sale of discontinued operations of $4,633) associated withthe discontinued dairy farm operations were $20,877 and $24,137, respectively.**

 

 
|                                                                                                                          |   | **Year ended December 31, 2001** |       |
|-------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|------------|
|                                                                                                                          |   | **Marketing**                    | ** ** | **Dairy farm  operations** | ** ** | **U.S.  eliminations** | ** ** | **U.S.  adjustments** | ** ** | **U.S.  subtotal** | ** ** | **International** | ** ** | **U.S. and  International  subtotal** | ** ** | **International  eliminations  with U.S.** | ** ** | **Total** | ** ** |
|                                                                                                                          |   |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net sales                                                                                                                     |   | $                                | 126,996    |   | 2,822 |   | (2,822 | ) | — |   | 126,996 |   | 31,874 |   | 158,870 |   | — |   | 158,870 |   |
| Cost of sales                                                                                                                 |   | 87,126                           |       | 1,518 |   | (1,518 | ) | (64 | ) | 87,062 |   | 24,784 |   | 111,847 |   | — |   | 111,847 |   |
| Gross profit                                                                                                                  |   | 39,870                           |       | 1,304 |   | (1,304 | ) | 64 |   | 39,934 |   | 7,090 |   | 47,023 |   | — |   | 47,023 |   |
|                                                                                                                          |   |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating expenses excluding intangible  asset amortization                                                                   |   | 34,616                           |       | 1,240 |   | (1,240 | ) | (19 | ) | 34,597 |   | 4,780 |   | 39,376 |   | — |   | 39,376 |   |
| Intangible asset amortization                                                                                                 |   | 1,176                            |       | — |   | — |   | — |   | 1,176 |   | 1,939 |   | 3,115 |   | — |   | 3,115 |   |
| Operating income (loss)                                                                                                       |   | 4,078                            |       | 64 |   | (64 | ) | 83 |   | 4,161 |   | 371 |   | 4,531 |   | — |   | 4,531 |   |
| Interest income                                                                                                               |   | 1,854                            |       | — |   | (267 | ) | (1,489 | ) | 97 |   | 30 |   | 127 |   | — |   | 127 |   |
| Interest expense                                                                                                              |   | (944                             | )          | (339 | ) | 267 |   | 1,489 |   | 473 |   | (2,168 | ) | (1,695 | ) | — |   | (1,695 | ) |
| Other, net                                                                                                                    |   | (182                             | )          | — |   | — |   | — |   | (182 | ) | — |   | (182 | ) | — |   | (182 | ) |
|                                                                                                                          |   |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income (loss) from continuing  operations before income taxes                                                                 |   | 4,806                            |       | (275 | ) | (64 | ) | 83 |   | 4,549 |   | (1,767 | ) | 2,781 |   | — |   | 2,781 |   |
| Income tax benefit (expense)                                                                                                  |   | (1,912                           | )          | 111 |   | — |   | (7 | ) | (1,808 | ) | 689 |   | (1,119 | ) | — |   | (1,119 | ) |
|                                                                                                                          |   |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income (loss) from continuing  operations                                                                                     |   | 2,894                            |       | (165 | ) | (64 | ) | 76 |   | 2,741 |   | (1,078 | ) | 1,662 |   | — |   | 1,662 |   |
|                                                                                                                          |   |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Discontinued operations*:                                                                                                     |   |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income (loss) from operations of discontinued  Idaho Dairy and Colorado herd including  intangible asset amortization of $156 |   | —                           |       | 150 |   | — |   | (19 | ) | 131 |   | — |   | 131 |   | — |   | 131 |   |
|                                                                                                                          |   |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income tax benefit (expense) from discontinued  operations                                                                    |   | —                           |       | (60 | ) | — |   | 7 |   | (53 | ) | — |   | (53 | ) | — |   | (53 | ) |
| Income (loss) from discontinued operations                                                                                    |   | —                           |       | 90 |   | — |   | (12 | ) | 78 |   | — |   | 78 |   | — |   | 78 |   |
| Net income (loss)                                                                                                             |   | $                                | 2,894      |   | (76 | ) | (64 | ) | 64 |   | 2,818 |   | (1,078 | ) | 1,740 |   | — |   | 1,740 |   |
|                                                                                                                          |   |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Segment assets                                                                                                                |   | $                                | 117,112    |   | 44,176 |   | (36,270 | ) | — |   | 125,018 |   | 37,442 |   | 162,460 |   | (33,192 | ) | 129,268 |   |
|                                                                                                                          |   |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| The following additional  supplemental information is included above:                                                         |   |                             |       |   |   |   |   |   |   |   |   |
| **Continuing Operations:**                                                                                                    |   |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Depreciation and amortization                                                                                                 |   | $                                | 2,171      |   | 439 |   | — |   | — |   | 2,610 |   | 2,342 |   | 4,952 |   | — |   | 4,952 |   |
|                                                                                                                          |   |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss on sale of cattle and equipment                                                                                          |   | —                           |       | 107 |   | — |   | — |   | 107 |   | — |   | 107 |   | — |   | 107 |   |
|                                                                                                                          |   |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Discontinued Operations:**                                                                                                  |   |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Depreciation and amortization                                                                                                 |   | $                                | —     |   | 2,975 |   | — |   | — |   | 2,975 |   | — |   | 2,975 |   | — |   | 2,975 |   |
|                                                                                                                          |   |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss on sale of cattle and equipment                                                                                          |   | —                           |       | 1,577 |   | — |   | — |   | 1,577 |   | — |   | 1,577 |   | — |   | 1,577 |   |
|                                                                                                                          |   |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Company Total:**                                                                                                            |   |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Depreciation and amortization                                                                                                 |   | $                                | 2,171      |   | 3,414 |   | — |   | — |   | 5,585 |   | 2,342 |   | 7,927 |   | — |   | 7,927 |   |
|                                                                                                                          |   |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss on sale of cattle and equipment                                                                                          |   | —                           |       | 1,684 |   | — |   | — |   | 1,684 |   | — |   | 1,684 |   | — |   | 1,684 |   |

 

----

*** Revenue and operating expensesassociated with the discontinued dairy farm operations were $22,546 and$20,699, respectively.**

 

 

**(22)**                          **Goodwill and Intangible Assets**

 

                At December 31, 2002 intangibleassets consisted primarily of goodwill resulting from the Company’s acquisitionof Meadow Farms Limited and Rachel’s Dairy Limited in 2000 and 1999,respectively, and The Organic Cow of Vermont brand name and the Juniper ValleyFarms brand name.  Effective January 1,2002, all goodwill is no longer amortized. The brand names are amortized over their expected useful lives, which isfifteen years.  Amortization is recordedusing the straight-line method.  Thefollowing table presents the effect of the adoption of this standard on incomefrom continuing operations, income (loss) from discontinued operations, and netincome (loss) for the years ended December 31, 2002 and 2001, as well as theeffect on the respective earnings (loss) per share for each year (in thousands,except per share amounts):

** **
|                                                                      |   | **For the Year Ended  December 31,** |   |
|---------------------------------------------------------------------------|--------|--------------------------------------|--------|
|                                                                      |   | **2002**                             |   | **2001** |   |
| Income from continuing operations                                         |   | $                                    | 3,605  |   | 1,662 |   |
| Add back:   Goodwill amortization, net of tax                        |   | —                               |   | 1,113 |   |
| As adjusted income from continuing operations                             |   | $                                    | 3,605  |   | 2,775 |   |
|                                                                      |   |                                 |   |   |   |
| Income (loss) from discontinued operations                                |   | $                                    | (3,638 | ) | 78 |   |
| Add back:   Goodwill amortization, net of tax                        |   | —                               |   | 94 |   |
| As adjusted income (loss) from discontinued operations                    |   | $                                    | (3,638 | ) | 172 |   |
|                                                                      |   |                                 |   |   |   |
| Net income (loss)                                                         |   | $                                    | (33    | ) | 1,740 |   |
| Add back:   Goodwill amortization, net of tax                        |   | —                               |   | 1,207 |   |
| As adjusted net income (loss)                                             |   | $                                    | (33    | ) | 2,947 |   |
|                                                                      |   |                                 |   |   |   |
| Income from continuing operations per basic share                         |   | $                                    | .35    |   | .16 |   |
| Add back:   Goodwill amortization, net of tax per basic share        |   | —                               |   | .11 |   |
| As adjusted income from continuing operations per basic  share            |   | $                                    | .35    |   | .27 |   |
|                                                                      |   |                                 |   |   |   |
| Income from continuing operations per diluted share                       |   | $                                    | .34    |   | .16 |   |
| Add back:   Goodwill amortization, net of tax per diluted share      |   | —                               |   | .11 |   |
| As adjusted income from continuing operations per  diluted share          |   | $                                    | .34    |   | .27 |   |
|                                                                      |   |                                 |   |   |   |
| Income (loss) from discontinued operations per basic  share               |   | $                                    | (.35   | ) | .01 |   |
| Add back:   Goodwill amortization, net of tax per basic share        |   | —                               |   | .01 |   |
| As adjusted income (loss) from discontinued operations  per basic share   |   | $                                    | (.35   | ) | .02 |   |
|                                                                      |   |                                 |   |   |   |
| Income (loss) from discontinued operations per diluted  share             |   | $                                    | (.34   | ) | .01 |   |
| Add back:   Goodwill amortization, net of tax per diluted share      |   | —                               |   | .01 |   |
| As adjusted income (loss) from discontinued operations  per diluted share |   | $                                    | (.34   | ) | .02 |   |
|                                                                      |   |                                 |   |   |   |
| Net income (loss) per basic share                                         |   | $                                    | (.00   | ) | .17 |   |
| Add back:   Goodwill amortization, net of tax per basic share        |   | —                               |   | .12 |   |
| As adjusted net income (loss) per basic share                             |   | $                                    | (.00   | ) | .29 |   |
|                                                                      |   |                                 |   |   |   |   |
| Net income (loss) per diluted share                                       |   | $                                    | (.00   | ) | .17 |   |
| Add back:   Goodwill amortization, net of tax per diluted share      |   | —                               |   | .12 |   |
| As adjusted net income (loss) per diluted share                           |   | $                                    | (.00   | ) | .29 |   |

 

**(23)**                          **Contingencies**

 

The Company is a party to legaland regulatory proceedings and claims in the ordinary course of its business.The Company believes that the outcome of these matters will not have a materialadverse effect on its consolidated financial position, results of operations orliquidity.