**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 
| **ý**                                                                                                                                                                                                                                                                                                    | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                          |                                                                                          |
| **For the quarterly period ended   March 31, 2002**                                                                                                                                                                                                                                                 |
|                                                                                                                                                                                                                                                                                                          |
|                                                                                                                                                                                                                                                                                                          | **or**                                                                                        |
|                                                                                                                                                                                                                                                                                                          |                                                                                          |
| **o**                                                                                                                                                                                                                                                                                                         | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                                                                                                          |                                                                                          |
| **For the transition period  from                      to                      ** |
|                                                                                                                                                                                                                                                                                                          |
| **Commission File Number: 333-63722**                                                                                                                                                                                                                                                                         |

 

**MICHAEL FOODS, INC.**

(Exact name of registrantas specified in its charter)

 

| **Minnesota**                                                   |   | **41-0498850**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                            |   |                                  |
| **Suite  324, Signal Bank Building**                            |   |                                  |
| **5353  Wayzata Boulevard**                                     |   |                                  |
| **Minneapolis,  MN**                                            |   | **55416**                             |
| (Address of principal  executive offices)                       |   | (Zip code)                            |
|                                                            |   |                                  |
| **(952)  546-1500**                                             |
| (Registrant’s telephone  number, including area code)      |

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.       ý     Yes                o     No

 

 

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PART I - FINANCIALINFORMATION

**ITEM1.  FINANCIAL STATEMENTS**

 

MICHAEL FOODS, INC.

(A WHOLLY-OWNEDSUBSIDIARY OF M-FOODS HOLDINGS, INC.)

CONDENSED CONSOLIDATEDBALANCE SHEETS

(Unaudited)

 
|                                       |   | **March 31,  2002** |        | **December 31,  2001** |   |
|--------------------------------------------|--------|---------------------|-------------|------------------------|--------|
| ASSETS                                     |   |                |        |                   |   |
|                                       |   |                |        |                   |   |
| CURRENT ASSETS                             |   |                |        |                   |   |
| Cash and  equivalents                      |   | $                   | 38,213,000  |                   | $      | 27,660,000 |   |
| Accounts  receivable, less allowances      |   | 101,154,000         |        | 102,317,000            |   |
| Inventories                                |   | 81,983,000          |        | 78,941,000             |   |
| Prepaid expenses  and other                |   | 9,572,000           |        | 11,370,000             |   |
| Total current  assets                      |   | 230,922,000         |        | 220,288,000            |   |
|                                       |   |                |        |                   |   |
| PROPERTY, PLANT  AND EQUIPMENT-AT COST     |   |                |        |                   |   |
| Land                                       |   | 3,873,000           |        | 3,873,000              |   |
| Buildings and  improvements                |   | 99,561,000          |        | 99,561,000             |   |
| Machinery and  equipment                   |   | 233,626,000         |        | 226,759,000            |   |
|                                       |   | 337,060,000         |        | 330,193,000            |   |
| Less accumulated  depreciation             |   | 52,382,000          |        | 39,039,000             |   |
|                                       |   | 284,678,000         |        | 291,154,000            |   |
|                                       |   |                |        |                   |   |
| OTHER ASSETS                               |   |                |        |                   |   |
| Goodwill, net                              |   | 341,021,000         |        | 341,021,000            |   |
| Joint ventures  and other assets           |   | 43,288,000          |        | 44,670,000             |   |
|                                       |   | 384,309,000         |        | 385,691,000            |   |
|                                       |   | $                   | 899,909,000 |                   | $      | 897,133,000 |   |
|                                       |   |                |        |                   |   |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY |   |                |        |                   |   |
|                                       |   |                |        |                   |   |
| CURRENT  LIABILITIES                       |   |                |        |                   |   |
| Current  maturities of long-term debt      |   | $                   | 14,204,000  |                   | $      | 12,962,000 |   |
| Accounts payable                           |   | 59,239,000          |        | 64,492,000             |   |
| Accrued  liabilities                       |   |                |        |                   |   |
| Compensation                               |   | 9,903,000           |        | 12,582,000             |   |
| Insurance                                  |   | 9,330,000           |        | 8,191,000              |   |
| Customer  programs                         |   | 25,993,000          |        | 21,996,000             |   |
| Income taxes                               |   | 12,915,000          |        | 9,853,000              |   |
| Interest                                   |   | 15,948,000          |        | 10,619,000             |   |
| Other                                      |   | 13,862,000          |        | 14,116,000             |   |
| Total current  liabilities                 |   | 161,394,000         |        | 154,811,000            |   |
|                                       |   |                |        |                   |   |
| LONG-TERM DEBT,  less current maturities   |   | 529,309,000         |        | 540,132,000            |   |
| DEFERRED INCOME  TAXES                     |   | 49,484,000          |        | 48,725,000             |   |
| COMMITMENTS AND  CONTINGENCIES             |   |                |        |                   |   |
| NON-CONTROLLING  INTEREST                  |   | 475,000             |        | 475,000                |   |
|                                       |   |                |        |                   |   |
| SHAREHOLDERS’  EQUITY                 |   |                |        |                   |   |
| Common stock                               |   | —              |        | —                 |   |
| Additional  paid-in capital                |   | 146,792,000         |        | 146,792,000            |   |
| Retained  earnings                         |   | 15,174,000          |        | 9,815,000              |   |
| Accumulated  other comprehensive loss      |   | (2,719,000          | )           | (3,617,000             | )      |
|                                       |   | 159,247,000         |        | 152,990,000            |   |
|                                       |   | $                   | 899,909,000 |                   | $      | 897,133,000 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

2

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MICHAEL FOODS, INC.

(A WHOLLY-OWNEDSUBSIDIARY OF M-FOODS HOLDINGS, INC.)

CONDENSED CONSOLIDATEDSTATEMENTS OF EARNINGS

Three Months Ended March31,

(Unaudited)

 
|                                                             |   | **Company** |        | **Predecessor** |   |
|------------------------------------------------------------------|--------|-------------|-------------|-----------------|--------|
|                                                             |   | **2002**    | ** **  | **2001**        |   |
| Net sales                                                        |   | $           | 278,429,000 |            | $      | 275,627,000 |   |
|                                                             |   |        |        |            |   |
| Cost of sales                                                    |   | 227,313,000 |        | 227,707,000     |   |
|                                                             |   |        |        |            |   |
| Gross profit                                                     |   | 51,116,000  |        | 47,920,000      |   |
|                                                             |   |        |        |            |   |
| Selling, general  and administrative expenses                    |   | 29,623,000  |        | 27,376,000      |   |
| Transaction  expenses                                            |   | —      |        | 11,050,000      |   |
|                                                             |   |        |        |            |   |
| Operating profit                                                 |   | 21,493,000  |        | 9,494,000       |   |
|                                                             |   |        |        |            |   |
| Interest  expense, net                                           |   | 12,664,000  |        | 3,293,000       |   |
|                                                             |   |        |        |            |   |
| Earnings before  income taxes                                    |   | 8,829,000   |        | 6,201,000       |   |
|                                                             |   |        |        |            |   |
| Income tax  expense                                              |   | 3,470,000   |        | 2,430,000       |   |
| Earnings before  extraordinary item                              |   | 5,359,000   |        | 3,771,000       |   |
|                                                             |   |        |        |            |   |
| Extraordinary  item - early extinguishment of debt, net of taxes |   | —      |        | (9,424,000      | )      |
|                                                             |   |        |        |            |   |
| NET EARNINGS  (LOSS)                                             |   | $           | 5,359,000   |            | $      | (5,653,000 | ) |

 

See accompanying notes to condensed consolidated financial statements.

 

3

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MICHAEL FOODS, INC.

(A WHOLLY-OWNEDSUBSIDIARY OF M-FOODS HOLDINGS, INC.)

CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS

(Unaudited)

 
|                                             |   | **Company**                             | ** ** | **Predecessor**                         |   |
|--------------------------------------------------|--------|-----------------------------------------|------------|-----------------------------------------|--------|
|                                             |   | **Three Months  Ended March 31,  2002** | ** ** | **Three Months  Ended March 31,  2001** |   |
|                                             |   |                                    |       |                                    |   |
| Net cash  provided by operating activities       |   | $                                       | 26,590,000 |                                    | $      | 14,016,000 |   |
|                                             |   |                                    |       |                                    |   |
| Cash flows from  investing activities:           |   |                                    |       |                                    |   |
| Capital expenditures                             |   | (6,878,000                              | )          | (10,837,000                             | )      |
| Investments in  joint ventures and other assets  |   | 422,000                                 |       | 3,888,000                               |   |
|                                             |   |                                    |       |                                    |   |
| Net cash used in  investing activities           |   | (6,456,000                              | )          | (6,949,000                              | )      |
|                                             |   |                                    |       |                                    |   |
| Cash flows from  financing activities:           |   |                                    |       |                                    |   |
| Payments on notes  payable                       |   | (5,000,000                              | )          | (52,000,000                             | )      |
| Proceeds from  notes payable                     |   | —                                  |       | 45,500,000                              |   |
| Payments on  long-term debt and other            |   | (4,581,000                              | )          | (109,000                                | )      |
| Extension of  stock options                      |   | —                                  |       | 310,000                                 |   |
| Proceeds from  issuance of common stock          |   | —                                  |       | 546,000                                 |   |
| Dividends                                        |   | —                                  |       | (1,465,000                              | )      |
| Net cash used in  financing activities           |   | (9,581,000                              | )          | (7,218,000                              | )      |
|                                             |   |                                    |       |                                    |   |
| Net increase  (decrease) in cash and equivalents |   | 10,553,000                              |       | (151,000                                | )      |
|                                             |   |                                    |       |                                    |   |
| Cash and  equivalents at beginning of period     |   | 27,660,000                              |       | 4,421,000                               |   |
|                                             |   |                                    |       |                                    |   |
| Cash and  equivalents at end of period           |   | $                                       | 38,213,000 |                                    | $      | 4,270,000 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

4

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MICHAEL FOODS, INC.

(A WHOLLY-OWNEDSUBSIDIARY OF M-FOODS HOLDINGS, INC.)

NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS

 

(Unaudited)

 

NOTE A - MERGER AGREEMENT

 

On April 10, 2001, Michael Foods, Inc. and its subsidiaries (“MichaelFoods”, “Company”, “we”, “us”, “our”) was acquired in a transaction (the “Merger”)led by an investor group comprised of a management group led by Michael Foods’Chairman, President and Chief Executive Officer, Gregg Ostrander, affiliates ofJeffrey Michael, a member of the Predecessor’s Board of Directors, andaffiliates of two private equity investment firms, Vestar Capital Partners andGoldner Hawn Johnson & Morrison Incorporated, (collectively, “M-FoodsInvestors, LLC”). Under the terms of the Merger agreement, all outstandingshares of Michael Foods common stock were converted into the right to receive$30.10 per share in cash, or value equal thereto, and all outstanding stockoptions were converted into the right to receive, in cash, $30.10 per sharereduced by the exercise price per share for all shares subject to such stockoptions. The purchase of the outstanding shares was financed through new equityfinancing of approximately $175,000,000, a senior secured credit facility of upto $470,000,000 at market-based variable interest rates (effective rate ofapproximately 6.0% as of March 31, 2002), and $200,000,000 of seniorsubordinated notes at an 11.75% annual interest rate. As a result of theMerger, the stock of pre-merger Michael Foods (“Predecessor”) is no longerpublicly traded and, therefore, earnings per share calculations are no longerincluded for financial statement presentation.

 

Immediately after the close of the Merger, we contributed the assets ofour Dairy division into two limited liability corporations, M-Foods Dairy, LLCand M-Foods Dairy TXCT, LLC (collectively, the “Dairy LLCs”) and in exchangereceived voting preferred and voting common units from these entities equal tothe fair value of the net assets contributed, which collectively wereapproximately $35,800,000. The preferred units issued to us have an annual 10%preferred return guarantee and represent 100% of the preferred units issued andoutstanding. In addition, we received 5% of the common units issued by theDairy LLCs, with the common units held by the Company representing 100% of thevoting common units issued and outstanding. These common units have a statedvalue of $25,000. The remaining 95% of the common units, which are non-voting,are owned by M-Foods Dairy Holdings, LLC, which is owned by the same owners oraffiliates of such owners, in the same proportion, as the unit holders ofM-Foods Investors, LLC. The common unit interests owned by M-Foods DairyHoldings, LLC were issued in exchange for $475,000 and are reflected asnon-controlling interest in the accompanying consolidated balance sheet as ofMarch 31, 2002.

 

The Merger was accounted for as a purchase in accordance withAccounting Principles Board Opinion 16, *Business Combinations* and EITF 88-16, *Basis inLeveraged Buyout Transactions*. Accordingly, the acquired assets andliabilities have been recorded at fair value for the interests acquired by newinvestors and at the carryover basis for continuing investors. As a result, theassets and

 

5

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liabilities were assigned new values, which are part Predecessor costand part fair value in the same proportions as the carryover basis of theresidual interests retained by the continuing management investors andcontinuing affiliate investors of the Michael family, and the new interestsacquired by the new investors. The amount of carryover basis was reflected as adeemed dividend of $66,631,000.

 

For ease of presentation, the Merger was accounted for as if it hadoccurred on April 1, 2001. Management determined that results of operationswere not significant and no material transactions occurred during the periodfrom April 1 through April 9, 2001. Our consolidated financial statements havebeen presented on a comparative basis with the Predecessor’s historicalconsolidated financial statements prior to the date of Merger. Different basesof accounting have been used to prepare the Company and Predecessorconsolidated financial statements. The primary differences relate to additionalinterest expense for new debt and depreciation and amortization of fixed assetsand other intangible assets recorded at fair value at the date of Merger.

 

For accounting purposes the Merger was considered a leveraged buyout.The total purchase price of approximately $562,881,000 was allocated to theacquired assets and assumed liabilities based on their fair values at April 1,2001, net of the deemed dividend. These allocations were based on a valuationby a third party appraisal firm. The allocation of the purchase price was asfollows:

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

 

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

 

The following unaudited pro forma net sales and net earnings for thethree months ended March 31, 2001 are derived from the application of pro formaadjustments to the Predecessor’s historical statement of earnings, and assumesthe Merger had occurred on January 1, 2001. The pro forma net earnings for the three months ended March 31, 2001 isalso adjusted for goodwill amortization determined in accordance with theprovisions of SFAS 142 (see Note C). The net sales and net earnings for the three months ended March 31, 2002represent actual results for the period.

 
|                                    |   | **Three  months ended** |        |
|-----------------------------------------|--------|-------------------------|-------------|
|                                    |   | **March 31,  2002**     |        | **March 31,  2001** |   |
| Net sales                               |   | $                       | 278,429,000 |   | $ | 275,627,000 |   |
| Net earnings  before extraordinary item |   | 5,359,000               |        | 3,115,000 |   |
|                                         |        |                         |             |  |  |  |  |

 

6

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NOTE B - BASIS OF PRESENTATION

 

The accompanying unaudited condensed consolidated financial statementshave been prepared in accordance with Regulation S-X pursuant to the rules andregulations of the Securities and Exchange Commission. Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America have been condensed or omitted pursuant to such rules andregulations, although management believes that the disclosures are adequate tomake the information presented not misleading.

 

We utilize, and the Predecessor utilized, a fiscal year consisting ofeither 52 or 53 weeks, ending on the Saturday nearest to December 31 each year.The quarters ended March 31, 2002 and 2001 each included thirteen weeks ofoperations. For clarity of presentation, the Company and Predecessor havedescribed both periods presented as if the quarters ended on March 31st.

 

The accompanying unaudited financial statements and footnoteinformation as of and for the three month period ended March 31, 2001 wereprepared in accordance with Regulation S-X pursuant to the rules andregulations of the Securities and Exchange Commission (“SEC”) using thehistorical books and records of the Predecessor and reflect the historical costbasis of assets and liabilities of the Predecessor. The accompanying unauditedfinancial statements and footnote information of the Company as of and for thethree month period ended March 31, 2002 have been prepared in accordance withRegulation S-X pursuant to the rules and regulations of the SEC using the newbasis of assets and liabilities of the Company. In the opinion of management,the unaudited financial statements contain all adjustments (consisting of onlynormal recurring adjustments) necessary to present fairly the results ofoperations for the periods indicated. The historical financial results of theCompany and Predecessor are not necessarily indicative of their results for afull year.

 

USE OF ESTIMATES

Preparation of the Company’s consolidated financial statements requiresmanagement to make estimates and assumptions that affect reported amounts ofassets and liabilities and related revenues and expenses. Actual results coulddiffer from the estimates used by management.

 

NOTE C - ADOPTION OF NEW ACCOUNTING POLICIES

 

Goodwill and Intangible Assets:

In July 2001, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards (“SFAS”) 141, “BusinessCombinations”, and SFAS 142, “Goodwill and Other Intangible Assets”.  SFAS 141 is effective for all businesscombinations completed after June 30, 2001. SFAS 142 is effective for fiscal years beginning after December 15,2001; however, certain provisions of this Statement apply to goodwill and otherintangible assets acquired between July 1, 2001 and the effective date of SFAS142.  We adopted the provisions of SFAS142 as of January 1, 2002 and had no acquisitions between July 1, 2001 andJanuary 1, 2002.

 

As a result of adopting SFAS No. 141 and SFAS No. 142, our accountingpolicies for goodwill and intangible assets changed effective January 1, 2002as described below:

 

7

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Goodwill and Intangible Assets with Indefinite Lives:

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

 

Other Intangibles:

We recognize an acquired intangible apart from goodwill whenever theasset arises from contractual or other legal rights, or whenever it is capableof being separated or divided from the acquired entity and sold, transferred,licensed, rented, or exchanged, either individually or in combination with arelated contract, asset, or liability. An intangible other than goodwill is amortized over its estimated usefullife unless that life is determined to be indefinite.  Impairment losses are recognized if the carrying amount of anintangible subject to amortization is not recoverable from expected future cashflows and its carrying amount exceeds its fair value.

 

During the first quarter of fiscal 2002, we completed the transitionalimpairment test of indefinite-lived intangible assets with no impairmentindicated.  During the second quarter offiscal 2002, we will complete the transitional impairment test of goodwill andother intangibles.  We do not believethe impairment testing will have a material effect on our results of operationsor financial position.

 

Our carrying amount, net of accumulated amortization, for goodwill asof March 31, 2002 and December 31, 2001 was $341,021,000.  Each segment’s share of this goodwill atthese dates was as follows:

 
| Egg Products               |   | $          | 254,182,000 |   |
|----------------------------|--------|------------|-------------|--------|
| Refrigerated  Distribution |   | 35,560,000 |        |
| Potato Products            |   | 49,515,000 |        |
| Dairy Products             |   | 1,764,000  |        |

 

The carrying amounts, net of accumulated amortization, for otherindefinite-lived intangible assets (trademarks) as of March 31, 2002 andDecember 31, 2001 was $13,406,000. The Predecessor had no indefinite-livedintangible assets.

 

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

 
|                                  |   | **Three  months ended March 31,** |      |
|---------------------------------------|--------|-----------------------------------|-----------|
|                                  |   | **2002**                          |      | **2001** |   |
|                                  |   | **(Company)**                     |      | **(Predecessor)** |   |
| Reported net  earnings (loss)         |   | $                                 | 5,359,000 |   | $ | (5,653,000 | ) |
| Add back:  goodwill amortization |   | —                            |      | 885,000 |   |
| Adjusted net  earnings (loss)         |   | $                                 | 5,359,000 |   | $ | (4,768,000 | ) |

 

8

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

 
|                      |   | **Gross  Carrying  Amount** |      | **Accumulated  Amortization** |   |
|---------------------------|--------|-----------------------------|-----------|-------------------------------|--------|
| Licenses and  non-compete |   | $                           | 2,526,000 |                          | $      | (811,000 | ) |
|                           |        |                             |           |                               |        |  |  |

 

The aggregate amortization expense for the three months ended March 31,2002 was approximately $180,000.  ThePredecessor had amortization expense of $500,000 during the period ended March31, 2001.  The estimated amortizationexpense for the years ended December 31, 2002 through December 31, 2006 is asfollows:

 
|   |   | **For the  Years  Ended December 31,** |    |
|--------|--------|----------------------------------------|---------|
| 2002   |   | $                                      | 715,000 |   |
| 2003   |   | 715,000                                |    |
| 2004   |   | 186,000                                |    |
| 2005   |   | 186,000                                |    |
| 2006   |   | 87,000                                 |    |
|        |        |                                        |         |  |

 

Other New Pronouncements:

On January 1, 2002 we adopted SFAS 144 *Accounting for the Impairment orDisposal of Long-Lived Assets*. The adoption of SFAS 144 did not have a material effect on ourconsolidated financial statements.

 

In addition, we adopted Emerging Issues Task Force (EITF) Issue No.00-25 *VendorIncome Statement Characterization of Consideration to a Reseller on the VendorsProducts*, effective January 1, 2002.  The adoption of EITF Issue 00-25 did not have a material effecton our consolidated financial statements.

 

NOTE D - INVENTORIES

 

Inventories, other than flocks, are stated at the lower of cost(determined on a first-in, first-out basis) or market. Flock inventoryrepresents the cost of purchasing and raising flocks to laying maturity, atwhich time their cost is amortized to operations over their expected usefullife of generally one to two years, assuming no salvage value.

 

Inventories consisted of the following:

 
|                                |   | **March 31,  2002** |       | **December  31,  2001** |   |
|-------------------------------------|--------|---------------------|------------|-------------------------|--------|
| Raw materials  and supplies         |   | $                   | 18,154,000 |                    | $      | 15,347,000 |   |
| Work in process  and finished goods |   | 44,466,000          |       | 43,027,000              |   |
| Flocks                              |   | 19,363,000          |       | 20,567,000              |   |
|                                |   | $                   | 81,983,000 |                    | $      | 78,941,000 |   |

 

NOTE E - COMMITMENTS AND CONTINGENCIES

 

Egg Procurement Contracts:

We maintain egg procurement contracts with numerous cooperatives andegg producers throughout the Midwestern and Eastern United States, which supplyapproximately 50% of our egg requirements. These contracts vary in length from

 

9

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18 to 72 months with prices primarily indexed to grain or Urner Barrymarket indices. No single egg supplier provides more than 10% of our eggrequirements.

 

Patent Litigation:

We have an exclusive license agreement for a patented process for theproduction and sale of extended shelf-life liquid egg products. Under thelicense agreement, we have the right to defend and prosecute infringement ofthe underlying patents. We may apply 50% of our costs of defending the patentsto future royalty payments.

 

The U.S. Federal Court of Appeals has upheld the validity of thepatents on two separate occasions. In September 2000, the U.S. Patent andTrademark Office allowed product claims beyond the process claims previouslyallowed for the extended shelf-life egg product. These patents are scheduled toexpire beginning in 2006.

 

In 2000, the Predecessor settled litigation with one party related tothe infringement of these patents and issued a sub-license to the infringingparty granting them the right to manufacture and distribute extended shelf-lifeliquid whole egg product subject to a royalty payable to us and the patentholder on all future product sold. In connection with this settlement, thepatent holder received a lump sum payment for the past production and sale ofthe product and other matters related to the infringement. We are continuing topursue litigation related to other parties who are infringing the product andprocess patents, including Sunny Fresh Foods, Inc., a subsidiary of Cargill,Inc.

 

Other Litigation:

We are engaged in routine litigation incidental to our business. Webelieve the ultimate outcome of this litigation will not have a material effecton our consolidated financial position, liquidity or results of operations.

 

NOTE F - COMPREHENSIVE INCOME (LOSS)

 

The components and changes in accumulated other comprehensive loss(AOCL), net of taxes, during the three months ended March 31, 2002 were asfollows:

 
|                                                       |   | **Cash Flow  Hedges** |       | **Foreign  Currency  Translation** |       | **Total  AOCL** |   |
|------------------------------------------------------------|--------|-----------------------|------------|------------------------------------|------------|-----------------|--------|
| COMPANY                                                    |   |                  |       |                               |       |            |   |
|                                                       |   |                  |       |                               |       |            |   |
| Balance at  January 1, 2002                                |   | $                     | (3,556,000 | )                                  | $          | (61,000         | )      | $ | (3,617,000 | ) |
|                                                       |   |                  |       |                               |       |            |   |
| Foreign currency  translation adjustment                   |   | —                |       | 11,000                             |       | 11,000          |   |
| Net unrealized  change on cash flow hedges                 |   | 887,000               |       | —                             |       | 887,000         |   |
| Balance at March  31, 2002                                 |   | $                     | (2,669,000 | )                                  | $          | (50,000         | )      | $ | (2,719,000 | ) |
|                                                       |   |                  |       |                               |       |            |   |
|                                                       |   | **Cash Flow  Hedges** | ** ** | **Foreign Currency  Translation**  | ** ** | **Total  AOCL** |   |
| PREDECESSOR                                                |   |                  |       |                               |       |            |   |
|                                                       |   |                  |       |                               |       |            |   |
| Balance at  January 1, 2001                                |   | $                     | —     |                               | $          | (1,317,000      | )      | $ | (1,317,000 | ) |
| Foreign currency  translation adjustment                   |   | —                |       | (47,000                            | )          | (47,000         | )      |
| Translation loss  realized on termination of joint venture |   | —                |       | 1,135,000                          |       | 1,135,000       |   |
| Transition  adjustment                                     |   | 775,000               |       | —                             |       | 775,000         |   |
| Net unrealized  change on cash flow hedges                 |   | (2,651,000            | )          | —                             |       | (2,651,000      | )      |
| Less  reclassification adjustments                         |   | 244,000               |       | —                             |       | 244,000         |   |
| Balance at March  31, 2001                                 |   | $                     | (1,632,000 | )                                  | $          | (229,000        | )      | $ | (1,861,000 | ) |

 

10

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Comprehensive income (loss), net of taxes, for the three months endedMarch 31, 2002 and 2001 was as follows:

 
| COMPANY                                                              |   |       |   |     |       |
|----------------------------------------------------------------------|--------|------------|--------|----------|------------|
| Net income for the three months ended March 31, 2002                 |   |       |   | $        | 5,359,000  |   |
| Net gains  arising during the period from cash flow hedges:          |   |       |   |     |       |
| Net unrealized  derivative gains during period                       |   | 887,000    |   |     |       |
| Foreign currency  translation adjustment                             |   | 11,000     |   |     |       |
|                                                                 |   |       |   |     |       |
| Other  comprehensive income                                          |   |       |   | 898,000  |       |
|                                                                 |   |       |   |     |       |
| Comprehensive  income for the three months ended March 31, 2002      |   |       |   | $        | 6,257,000  |   |
|                                                                 |   |       |   |     |       |
| PREDECESSOR                                                          |   |       |   |     |       |
| Net loss for the  three months ended March 31, 2001                  |   |       |   | $        | (5,653,000 | ) |
| Net gains (losses)  arising during the period from cash flow hedges: |   |       |   |     |       |
| Net derivative  transition gain                                      |   | 775,000    |   |     |       |
| Net unrealized  derivative losses during period                      |   | (2,651,000 | )      |     |       |
| Reclassification  adjustment                                         |   | 244,000    |   |     |       |
| Foreign currency  translation adjustment                             |   | (47,000    | )      |     |       |
| Foreign currency  loss realized                                      |   | 1,135,000  |   |     |       |
|                                                                 |   |       |   |     |       |
| Other  comprehensive loss                                            |   |       |   | (544,000 | )          |
|                                                                 |   |       |   |     |       |
| Comprehensive  loss for the three months ended March 31, 2001        |   |       |   | $        | (6,197,000 | ) |

 

NOTE G - BUSINESS SEGMENTS

 

We operate in four reportable segments - Egg Products, RefrigeratedDistribution, Dairy Products and Potato Products. The Merger, as more fullydescribed in Note A, did not have an impact on our segment classification orthe interaction between the segments. Certain financial information on ouroperating segments, and the Predecessor’s, is as follows (unaudited, inthousands):

 
|                                |   | **Company**       |    |
|-------------------------------------|--------|-------------------|---------|
|                                |   | **Egg  Products** |    | **Refrigerated  Distribution** |   | **Dairy  Products** |   | **Potato  Products** |   | **Corporate** |   | **Total** | ** ** |
| THREE MONTHS  ENDED March 31, 2002: |   |              |    |   |   |   |   |   |   |   |   |   |   |
| External net  sales                 |   | $                 | 155,186 |   | $ | 63,006 |   | $ | 43,180 |   | $ | 17,057 |   | N/A |   | $ | 278,429 |   |
| Intersegment  sales                 |   | 4,045             |    | — |   | — |   | 892 |   | N/A |   | 4,937 |   |
| Operating profit  (loss)            |   | 16,992            |    | 2,293 |   | 1,831 |   | 2,314 |   | (1,937 | ) | 21,493 |   |
| Depreciation and  amortization      |   | 10,878            |    | 437 |   | 1,040 |   | 1,164 |   | 10 |   | 13,529 |   |
|                                |   |              |    |   |   |   |   |   |   |   |   |   |   |
|                                |   | **Predecessor**   |    |
| THREE MONTHS  ENDED March 31, 2001: |   |              |    |   |   |   |   |   |   |   |   |   |   |
| External net  sales                 |   | $                 | 163,529 |   | $ | 61,185 |   | $ | 35,328 |   | $ | 15,585 |   | N/A |   | $ | 275,627 |   |
| Intersegment  sales                 |   | 4,246             |    | — |   | — |   | 1,003 |   | N/A |   | 5,249 |   |
| Operating profit  (loss)            |   | 12,915            |    | 3,639 |   | 3,958 |   | 1,688 |   | (12,706 | ) | 9,494 |   |
| Depreciation and  amortization      |   | 9,611             |    | 339 |   | 1,274 |   | 1,278 |   | 33 |   | 12,535 |   |

 

NOTE H - SUPPLEMENTAL GUARANTOR FINANCIAL INFORMATION

 

Our revolving line of credit, A and B term loans and seniorsubordinated notes have been guaranteed, on a joint and several basis, by usand our domestic subsidiaries. The revolving line of credit and A and B termloans are also guaranteed by our parent, M-Foods Holdings, Inc.

 

The following condensed consolidating financial information presentsour consolidated balance sheet as of March 31, 2002 and December 31, 2001 andthe statements of earnings and cash flows for the three months ended March 31,2002; and the Predecessor’s consolidated statements of earnings and cash flowsfor the three months ended March 31, 2001. These financial statements reflectMichael

 

11

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Foods, Inc. (the parent), the wholly owned guarantor subsidiaries (on acombined basis), the non-wholly owned guarantor subsidiaries, and eliminationentries necessary to combine such entities on a consolidated basis. Includedelsewhere in this Form 10-Q are the unaudited financial statements of thenon-wholly owned guarantor subsidiaries.

 

COMPANY

UNAUDITED CONDENSEDCONSOLIDATING BALANCE SHEETS

MARCH 31, 2002

(in thousands)

 
|                                      |   |       |    |                                       |   | **NON-WHOLLY  OWNED  GUARANTOR SUBSIDIARIES** |   |                          |   |             |   |
|-------------------------------------------|--------|------------|---------|--------------------------------------------|--------|-----------------------------------------------|--------|-------------------------------|--------|------------------|--------|
|                                      |   | **PARENT** |    | **WHOLLY  OWNED  GUARANTOR  SUBSIDIARIES** |   | **M-FOODS  DAIRY,  LLC**                      |   | **M-FOODS  DAIRY  TXCT, LLC** |   | **ELIMINATIONS** |   | **CONSOLIDATED** |   |
| ASSETS                                    |   |       |    |                                       |   |                                          |   |                          |   |             |   |   |   |
| Current Assets:                           |   |       |    |                                       |   |                                          |   |                          |   |             |   |   |   |
| Cash and equivalents                      |   | $          | 41,322  |                                       | $      | (3,109                                        | )      | $                             | — |             | $      | — |   | $ | — |   | $ | 38,213 |   |
| Accounts receivable, less allowances      |   | 213        |    | 90,826                                     |   | 7,531                                         |   | 5,720                         |   | (3,136           | )      | 101,154 |   |
| Inventories                               |   | —     |    | 72,447                                     |   | 4,806                                         |   | 4,730                         |   | —           |   | 81,983 |   |
| Notes receivable - related party          |   | —     |    | 3,354                                      |   | —                                        |   | —                        |   | (3,354           | )      | — |   |
| Prepaid expenses and other                |   | 830        |    | 8,283                                      |   | 389                                           |   | 70                            |   | —           |   | 9,572 |   |
| Total current assets                      |   | 42,365     |    | 171,801                                    |   | 12,726                                        |   | 10,520                        |   | (6,490           | )      | 230,922 |   |
| Property, Plant and Equipment - net       |   | 69         |    | 256,080                                    |   | 17,150                                        |   | 11,379                        |   | —           |   | 284,678 |   |
| Other assets:                             |   |       |    |                                       |   |                                          |   |                          |   |             |   |   |   |
| Goodwill, net                             |   | —     |    | 339,258                                    |   | 1,763                                         |   | —                        |   | —           |   | 341,021 |   |
| Preferred return receivable for subs      |   | —     |    | 10,208                                     |   | —                                        |   | —                        |   | (10,208          | )      | — |   |
| Joint ventures and other assets           |   | 18,740     |    | 23,446                                     |   | 173                                           |   | 929                           |   | —           |   | 43,288 |   |
| Investment in subsidiaries                |   | 632,224    |    | —                                     |   | —                                        |   | —                        |   | (632,224         | )      | — |   |
|                                      |   | 650,964    |    | 372,912                                    |   | 1,936                                         |   | 929                           |   | (642,432         | )      | 384,309 |   |
|                                      |   | $          | 693,398 |                                       | $      | 800,793                                       |   | $                             | 31,812 |             | $      | 22,828 |   | $ | (648,922 | ) | $ | 899,909 |   |
|                                      |   |       |    |                                       |   |                                          |   |                          |   |             |   |   |   |
| LIABILITIES AND SHAREHOLDERS’ EQUITY |   |       |    |                                       |   |                                          |   |                          |   |             |   |   |   |
| Current Liabilities:                      |   |       |    |                                       |   |                                          |   |                          |   |             |   |   |   |
| Current maturities of long-term debt      |   | $          | 11,497  |                                       | $      | 307                                           |   | $                             | — |             | $      | 2,400 |   | $ | — |   | $ | 14,204 |   |
| Accounts payable                          |   | 172        |    | 54,981                                     |   | 2,752                                         |   | 4,470                         |   | (3,136           | )      | 59,239 |   |
| Notes payable - related party             |   | —     |    | —                                     |   | 2,831                                         |   | 556                           |   | (3,387           | )      | — |   |
| Accrued liabilities                       |   | 38,078     |    | 46,258                                     |   | 2,611                                         |   | 971                           |   | 33               |   | 87,951 |   |
| Total current liabilities                 |   | 49,747     |    | 101,546                                    |   | 8,194                                         |   | 8,397                         |   | (6,490           | )      | 161,394 |   |
| Long-term debt, less current maturities   |   | 485,182    |    | 41,727                                     |   | —                                        |   | 2,400                         |   | —           |   | 529,309 |   |
| Deferred income taxes                     |   | (1,253     | )       | 50,737                                     |   | —                                        |   | —                        |   | —           |   | 49,484 |   |
| Preferred shareholder return payable      |   | —     |    | —                                     |   | 9,279                                         |   | 929                           |   | (10,208          | )      | — |   |
| Non-controlling interest                  |   | 475        |    | —                                     |   | —                                        |   | —                        |   | —           |   | 475 |   |
| Total liabilities                         |   | 534,151    |    | 194,010                                    |   | 17,473                                        |   | 11,726                        |   | (16,698          | )      | 740,662 |   |
| Shareholders’ Equity                 |   | 159,247    |    | 606,783                                    |   | 14,339                                        |   | 11,102                        |   | (632,224         | )      | 159,247 |   |
|                                      |   | $          | 693,398 |                                       | $      | 800,793                                       |   | $                             | 31,812 |             | $      | 22,828 |   | $ | (648,922 | ) | $ | 899,909 |   |

 

12

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COMPANY

CONDENSED CONSOLIDATINGBALANCE SHEETS

DECEMBER 31, 2001

(in thousands)

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

 

COMPANY

UNAUDITED CONDENSEDCONSOLIDATING EARNINGS STATEMENTS

THREE MONTHS ENDED MARCH31, 2002

(in thousands)

 
|                                                                        |   |       |   |                                       |   | **NON-WHOLLY  OWNED  GUARANTOR SUBSIDIARIES** |       |                                |       |             |       |
|-----------------------------------------------------------------------------|--------|------------|--------|--------------------------------------------|--------|-----------------------------------------------|------------|-------------------------------------|------------|------------------|------------|
|                                                                        |   | **PARENT** |   | **WHOLLY  OWNED  GUARANTOR  SUBSIDIARIES** |   | **M-FOODS  DAIRY,  LLC**                      | ** ** | **M-FOODS  DAIRY  TXCT, LLC ** | ** ** | **ELIMINATIONS** | ** ** | **CONSOLIDATED** |   |
| Net sales                                                                   |   | $          | — |                                       | $      | 240,186                                       |       | $                                   | 23,850     |             | $          | 19,330 |   | $ | (4,937 | ) | $ | 278,429 |   |
| Cost of sales                                                               |   | —     |   | 193,135                                    |   | 20,628                                        |       | 18,487                              |       | (4,937           | )          | 227,313 |   |
| Gross profit                                                                |   | —     |   | 47,051                                     |   | 3,222                                         |       | 843                                 |       | —           |       | 51,116 |   |
| Selling, general and administrative expenses                                |   | 1,937      |   | 26,459                                     |   | 1,415                                         |       | 1,018                               |       | (1,206           | )          | 29,623 |   |
| Operating profit (loss)                                                     |   | (1,937     | )      | 20,592                                     |   | 1,807                                         |       | (175                                | )          | 1,206            |       | 21,493 |   |
| Interest expense, net                                                       |   | 11,800     |   | 831                                        |   | 28                                            |       | 5                                   |       | —           |       | 12,664 |   |
| Other income                                                                |   | 1,206      |   | —                                     |   | —                                        |       | —                              |       | (1,206           | )          | — |   |
| Earnings (loss) before equity in earnings  of subsidiaries and income taxes |   | (12,531    | )      | 19,761                                     |   | 1,779                                         |       | (180                                | )          | —           |       | 8,829 |   |
| Equity in earnings of subsidiary                                            |   | 12,980     |   | 1,599                                      |   | (1,779                                        | )          | 180                                 |       | (12,980          | )          | — |   |
| Earnings before income taxes                                                |   | 449        |   | 21,360                                     |   | —                                        |       | —                              |       | (12,980          | )          | 8,829 |   |
| Income tax expense (benefit)                                                |   | (4,910     | )      | 8,380                                      |   | —                                        |       | —                              |       | —           |       | 3,470 |   |
| NET EARNINGS (LOSS)                                                         |   | 5,359      |   | 12,980                                     |   | —                                        |       | —                              |       | (12,980          | )          | 5,359 |   |
| Other comprehensive income (loss):                                          |   |       |   |                                       |   |                                          |       |                                |       |             |       |   |   |
| Change in foreign currency translation                                      |   | —     |   | 11                                         |   | —                                        |       | —                              |       | —           |       | 11 |   |
| Change in cash flow hedges                                                  |   | (208       | )      | 1,095                                      |   | —                                        |       | —                              |       | —           |       | 887 |   |
| Comprehensive income (loss)                                                 |   | $          | 5,151  |                                       | $      | 14,086                                        |       | $                                   | —     |             | $          | — |   | $ | (12,980 | ) | $ | 6,257 |   |

 

13

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PREDECESSOR

CONDENSED CONSOLIDATINGEARNINGS STATEMENTS

THREE MONTHS ENDED MARCH31, 2001

(in thousands)

 
|                                                                                             |   |       |   |                                     |   | **NON-WHOLLY  OWNED  GUARANTOR SUBSIDIARIES** |   |                        |   |             |   |
|--------------------------------------------------------------------------------------------------|--------|------------|--------|------------------------------------------|--------|-----------------------------------------------|--------|-----------------------------|--------|------------------|--------|
|                                                                                             |   | **PARENT** |   | **WHOLLY  OWNED  GUARANTORSUBSIDIARIES** |   | **M-FOODS  DAIRY,LLC**                        |   | **M-FOODS  DAIRYTXCT, LLC** |   | **ELIMINATIONS** |   | **CONSOLIDATED** |   |
| Net sales                                                                                        |   | $          | — |                                     | $      | 245,548                                       |   | $                           | 17,684 |             | $      | 17,644 |   | $ | (5,249 | ) | $ | 275,627 |   |
| Cost of sales                                                                                    |   | —     |   | 200,854                                  |   | 14,994                                        |   | 17,108                      |   | (5,249           | )      | 227,707 |   |
| Gross profit                                                                                     |   | —     |   | 44,694                                   |   | 2,690                                         |   | 536                         |   | —           |   | 47,920 |   |
| Selling, general and administrative expenses                                                     |   | 1,656      |   | 27,720                                   |   | 1,027                                         |   | 1,712                       |   | (1,522           | )      | 30,593 |   |
| Recall insurance settlement                                                                      |   | —     |   | —                                   |   | (3,217                                        | )      | —                      |   | —           |   | (3,217 | ) |
| Transaction costs                                                                                |   | 11,050     |   | —                                   |   | —                                        |   | —                      |   | —           |   | 11,050 |   |
| Operating profit (loss)                                                                          |   | (12,706    | )      | 16,974                                   |   | 4,880                                         |   | (1,176                      | )      | 1,522            |   | 9,494 |   |
| Interest (income) expense, net                                                                   |   | 3,308      |   | (14                                      | )      | (1                                            | )      | —                      |   | —           |   | 3,293 |   |
| Other income                                                                                     |   | 1,522      |   | —                                   |   | —                                        |   | —                      |   | (1,522           | )      | — |   |
| Earnings (loss) before equity in earnings of subsidiaries, income  taxes, and extraordinary item |   | (14,492    | )      | 16,988                                   |   | 4,881                                         |   | (1,176                      | )      | —           |   | 6,201 |   |
| Equity in earnings of subsidiaries                                                               |   | 12,573     |   | —                                   |   | —                                        |   | —                      |   | (12,573          | )      | — |   |
| Earnings (loss) before income taxes and extraordinary item                                       |   | (1,919     | )      | 16,988                                   |   | 4,881                                         |   | (1,176                      | )      | (12,573          | )      | 6,201 |   |
| Income tax expense (benefit)                                                                     |   | (5,690     | )      | 6,649                                    |   | 1,918                                         |   | (447                        | )      | —           |   | 2,430 |   |
| Earnings (loss) before extraordinary item                                                        |   | 3,771      |   | 10,339                                   |   | 2,963                                         |   | (729                        | )      | (12,573          | )      | 3,771 |   |
| Extraordinary item - early extinguishment of debt, net of taxes                                  |   | (9,424     | )      | —                                   |   | —                                        |   | —                      |   | —           |   | (9,424 | ) |
| NET EARNINGS (LOSS)                                                                              |   | (5,653     | )      | 10,339                                   |   | 2,963                                         |   | (729                        | )      | (12,573          | )      | (5,653 | ) |
| Other comprehensive income (loss):                                                               |   |       |   |                                     |   |                                          |   |                        |   |             |   |   |   |
| Change in foreign currency translation                                                           |   | —     |   | 1,088                                    |   | —                                        |   | —                      |   | —           |   | 1,088 |   |
| Change in cash flow hedges                                                                       |   | —     |   | (1,632                                   | )      | —                                        |   | —                      |   | —           |   | (1,632 | ) |
| Comprehensive income (loss)                                                                      |   | $          | (5,653 | )                                        | $      | 9,795                                         |   | $                           | 2,963  |             | $      | (729 | ) | $ | (12,573 | ) | $ | (6,197 | ) |

 

14

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COMPANY

UNAUDITED CONDENSEDCONSOLIDATING STATEMENTS OF CASH FLOWS

THREE MONTHS ENDED MARCH31, 2002

(in thousands)

 
|                                            |   |       |   |                                       |   | **NON-WHOLLY  OWNED  GUARANTOR SUBSIDIARIES** |   |                                |   |
|-------------------------------------------------|--------|------------|--------|--------------------------------------------|--------|-----------------------------------------------|--------|-------------------------------------|--------|
|                                            |   | **PARENT** |   | **WHOLLY  OWNED  GUARANTOR  SUBSIDIARIES** |   | **M-FOODS  DAIRY,  LLC**                      |   | **M-FOODS  DAIRY  TXCT, LLC ** |   | **CONSOLIDATED** |   |
| Net cash provided by operating activities       |   | $          | 13,915 |                                       | $      | 8,418                                         |   | $                                   | 3,568  |   | $ | 689 |   | $ | 26,590 |   |
| Cash flows from investing activities:           |   |       |   |                                       |   |                                          |   |                                |   |   |   |
| Capital expenditures                            |   | —     |   | (4,620                                     | )      | (1,955                                        | )      | (303                                | )      | (6,878 | ) |
| Investments in joint ventures and other assets  |   | (5         | )      | 600                                        |   | (173                                          | )      | —                              |   | 422 |   |
|                                            |   |       |   |                                       |   |                                          |   |                                |   |   |   |
| Net cash used in investing activities           |   | (5         | )      | (4,020                                     | )      | (2,128                                        | )      | (303                                | )      | (6,456 | ) |
|                                            |   |       |   |                                       |   |                                          |   |                                |   |   |   |
| Cash flows from financing activities:           |   |       |   |                                       |   |                                          |   |                                |   |   |   |
| Payments on notes payable                       |   | (5,000     | )      | —                                     |   | —                                        |   | —                              |   | (5,000 | ) |
| Proceeds on notes payable                       |   | —     |   | —                                     |   | —                                        |   | —                              |   | — |   |
| Payments on long-term debt                      |   | (4,506     | )      | (75                                        | )      | —                                        |   | —                              |   | (4,581 | ) |
| Investment in subsidiaries                      |   | 2,971      |   | (1,145                                     | )      | (1,440                                        | )      | (386                                | )      | — |   |
| Net cash used in financing activities           |   | (6,535     | )      | (1,220                                     | )      | (1,440                                        | )      | (386                                | )      | (9,581 | ) |
| Net increase (decrease) in cash and equivalents |   | 7,375      |   | 3,178                                      |   | —                                        |   | —                              |   | 10,553 |   |
| Cash and equivalents at beginning of period     |   | 33,947     |   | (6,287                                     | )      | —                                        |   | —                              |   | 27,660 |   |
| Cash and equivalents at end of period           |   | $          | 41,322 |                                       | $      | (3,109                                        | )      | $                                   | — |   | $ | — |   | $ | 38,213 |   |

 

PREDECESSOR

CONDENSED CONSOLIDATINGSTATEMENTS OF CASH FLOWS

THREE MONTHS ENDED MARCH31, 2001

(in thousands)

 
|                                                |   |       |   |                                       |   | **NON-WHOLLY  OWNED  GUARANTOR SUBSIDIARIES** |   |                                |   |
|-----------------------------------------------------|--------|------------|--------|--------------------------------------------|--------|-----------------------------------------------|--------|-------------------------------------|--------|
|                                                |   | **PARENT** |   | **WHOLLY  OWNED  GUARANTOR  SUBSIDIARIES** |   | **M-FOODS  DAIRY,  LLC**                      |   | **M-FOODS  DAIRY  TXCT, LLC ** |   | **CONSOLIDATED** |   |
| Net cash provided by (used in) operating activities |   | $          | 12,000 |                                       | $      | 4,487                                         |   | $                                   | (2,440 | ) | $ | (31 | ) | $ | 14,016 |   |
| Cash flows from investing activities:               |   |       |   |                                       |   |                                          |   |                                |   |   |   |
| Capital expenditures                                |   | —     |   | (4,923                                     | )      | (3,664                                        | )      | (2,250                              | )      | (10,837 | ) |
| Investments in joint ventures and other assets      |   | 434        |   | 3,454                                      |   | —                                        |   | —                              |   | 3,888 |   |
| Net cash provided by (used in) investing activities |   | 434        |   | (1,469                                     | )      | (3,664                                        | )      | (2,250                              | )      | (6,949 | ) |
| Cash flows from financing activities:               |   |       |   |                                       |   |                                          |   |                                |   |   |   |
| Payments on notes payable                           |   | (52,000    | )      | —                                     |   | —                                        |   | —                              |   | (52,000 | ) |
| Proceeds on notes payable                           |   | 45,500     |   | —                                     |   | —                                        |   | —                              |   | 45,500 |   |
| Payments on long-term debt                          |   | —     |   | (109                                       | )      | —                                        |   | —                              |   | (109 | ) |
| Proceeds from issuance of stock                     |   | 546        |   | —                                     |   | —                                        |   | —                              |   | 546 |   |
| Extension of stock options                          |   | 310        |   | —                                     |   | —                                        |   | —                              |   | 310 |   |
| Dividends                                           |   | (1,465     | )      | —                                     |   | —                                        |   | —                              |   | (1,465 | ) |
| Investment in subsidiaries                          |   | (9,785     | )      | 1,393                                      |   | 6,111                                         |   | 2,281                               |   | — |   |
| Net cash provided by (used in) financing activities |   | (16,894    | )      | 1,284                                      |   | 6,111                                         |   | 2,281                               |   | (7,218 | ) |
| Net increase (decrease) in cash and equivalents     |   | (4,460     | )      | 4,302                                      |   | 7                                             |   | —                              |   | (151 | ) |
| Cash and equivalents at beginning of period         |   | 8,787      |   | (4,366                                     | )      | —                                        |   | —                              |   | 4,421 |   |
| Cash and equivalents at end of period               |   | $          | 4,327  |                                       | $      | (64                                           | )      | $                                   | 7      |   | $ | — |   | $ | 4,270 |   |

 

15

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M-FOODS DAIRY, LLC

(A MAJORITY OWNEDSUBSIDIARY OF MICHAEL FOODS, INC.)

INDEX TO FINANCIALSTATEMENTS

 
| Balance Sheets                 |
|--------------------------------|
| Statements of Earnings         |
| Statements of Cash Flows       |
| Notes to Financial  Statements |

 

16

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M-FOODS DAIRY, LLC

(A MAJORITY OWNEDSUBSIDIARY OF MICHAEL FOODS, INC.)

BALANCE SHEETS

(unaudited, in thousands)

 
|                                     |   | **MARCH 31,  2002** |   | **DECEMBER  31,  2001** |   |
|------------------------------------------|--------|---------------------|--------|-------------------------|--------|
| ASSETS                                   |   |                |   |                    |   |
| CURRENT ASSETS                           |   |                |   |                    |   |
| Cash and  equivalents                    |   | $                   | — |                    | $      | — |   |
| Accounts  receivable, less allowances    |   | 7,531               |   | 6,535                   |   |
| Inventories                              |   | 4,806               |   | 3,592                   |   |
| Prepaid expenses  and other              |   | 389                 |   | 496                     |   |
| Total current assets                     |   | 12,726              |   | 10,623                  |   |
| PROPERTY, PLANT  AND EQUIPMENT - AT COST |   |                |   |                    |   |
| Land                                     |   | 855                 |   | 855                     |   |
| Buildings and  improvements              |   | 3,999               |   | 3,999                   |   |
| Machinery and  equipment                 |   | 14,006              |   | 12,051                  |   |
|                                     |   | 18,860              |   | 16,905                  |   |
| Less accumulated  depreciation           |   | 1,710               |   | 1,248                   |   |
|                                     |   | 17,150              |   | 15,657                  |   |
| OTHER ASSETS                             |   |                |   |                    |   |
| Goodwill, net                            |   | 1,763               |   | 1,763                   |   |
| Other assets                             |   | 173                 |   | —                  |   |
|                                     |   | 1,936               |   | 1,763                   |   |
|                                     |   | $                   | 31,812 |                    | $      | 28,043 |   |

 

LIABILITIES AND UNITHOLDER AND

OPERATING UNIT EQUITY

 
| CURRENT  LIABILITIES                   |   |   |   |   |   |
|----------------------------------------|--------|--------|--------|--------|--------|
| Accounts payable                       |   | $      | 2,752  |   | $      | 2,612 |   |
| Note payable -  related party          |   | 2,831  |   | — |   |
| Accrued  liabilities:                  |   |   |   |   |   |
| Compensation                           |   | 494    |   | 688    |   |
| Insurance                              |   | 115    |   | 124    |   |
| Customer  programs                     |   | 1,331  |   | 836    |   |
| Other                                  |   | 671    |   | 503    |   |
| Total current  liabilities             |   | 8,194  |   | 4,763  |   |
| COMMITMENTS AND  CONTINGENCIES         |   | — |   | — |   |
| PREFERRED UNIT  HOLDER RETURN PAYABLE  |   | 9,279  |   | 7,500  |   |
| UNIT HOLDER AND  OPERATING UNIT EQUITY |   | 14,339 |   | 15,780 |   |
|                                   |   | $      | 31,812 |   | $      | 28,043 |   |

 

The accompanying notes are an integral part of these statements.

 

17

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M-FOODS DAIRY, LLC

(A MAJORITY OWNEDSUBSIDIARY OF MICHAEL FOODS, INC.)

STATEMENTS OF EARNINGS

FOR THE THREE MONTHSENDED MARCH 31,

(unaudited, in thousands)

 
|                                          |   | **Company** |   | **Predecessor** |   |
|-----------------------------------------------|--------|-------------|--------|-----------------|--------|
|                                          |   | **2002**    |   | **2001**        |   |
| Net sales                                     |   | $           | 23,850 |            | $      | 17,684 |   |
|                                          |   |        |   |            |   |
| Cost of sales                                 |   | 20,628      |   | 14,994          |   |
|                                          |   |        |   |            |   |
| Gross profit                                  |   | 3,222       |   | 2,690           |   |
|                                          |   |        |   |            |   |
| Selling, general  and administrative expenses |   | 1,415       |   | 1,027           |   |
| Recall insurance  settlement                  |   | —      |   | (3,217          | )      |
|                                          |   |        |   |            |   |
| Operating profit                              |   | 1,807       |   | 4,880           |   |
|                                          |   |        |   |            |   |
| Other income (expense)                        |   | (28         | )      | 1               |   |
|                                          |   |        |   |            |   |
| Earnings before  income taxes                 |   | 1,779       |   | 4,881           |   |
| Income tax  expense                           |   | —      |   | 1,918           |   |
|                                          |   |        |   |            |   |
| NET EARNINGS                                  |   | $           | 1,779  |            | $      | 2,963 |   |

 

The accompanying notes are an integral part of these statements.

 

18

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M-FOODS DAIRY, LLC

(A MAJORITY OWNEDSUBSIDIARY OF MICHAEL FOODS, INC.)

STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHSENDED MARCH 31,

(unaudited, in thousands)

 
|                                                 |   | **COMPANY** |   | **PREDECESSOR** |   |
|------------------------------------------------------|--------|-------------|--------|-----------------|--------|
|                                                 |   | **2002**    |   | **2001**        |   |
| Net cash  provided by (used in) operating activities |   | $           | 3,568  |            | $      | (2,440 | ) |
|                                                 |   |        |   |            |   |
| Cash flows from  investing activities:               |   |        |   |            |   |
| Capital  expenditures                                |   | (1,955      | )      | (3,664          | )      |
| Other assets                                         |   | (173        | )      | —          |   |
| Net cash used in  investing activities               |   | (2,128      | )      | (3,664          | )      |
|                                                 |   |        |   |            |   |
| Cash flows from  financing activities:               |   |        |   |            |   |
| Net additional  capital invested or (dividends paid) |   | (1,440      | )      | 6,111           |   |
| Net cash  provided (used in) by financing activities |   | (1,440      | )      | 6,111           |   |
| Net increase  (decrease) in cash and equivalents     |   | —      |   | 7               |   |
| Cash and  equivalents at beginning of period         |   | —      |   | —          |   |
| Cash and  equivalents at end of period               |   | $           | — |            | $      | 7 |   |

 

The accompanying notes are an integral part of these statements.

 

19

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M-FOODS DAIRY, LLC

(A MAJORITY OWNEDSUBSIDIARY OF MICHAEL FOODS, INC.)

NOTES TO FINANCIAL STATEMENTS

 

NOTE A — ORGANIZATION, BUSINESS AND MERGER

 

Organization

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

 

Business

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

 

Merger

On April 10, 2001, Michael Foods, Inc. and its subsidiaries (“MichaelFoods”) was acquired in a transaction (the “Merger”) led by an investor groupcomprised of a management group led by Michael Foods’ Chairman, President andChief Executive Officer, Gregg Ostrander, affiliates of Jeffrey Michael, amember of the Predecessor Board of Directors, and affiliates of two privateequity investment firms, Vestar Capital Partners and Goldner HawnJohnson & Morrison Incorporated, collectively, M-Foods Investors, LLC.  Under the terms of the Merger agreement, alloutstanding shares of Michael Foods com­mon stock were converted into the rightto receive $30.10 per share in cash, or value equal thereto, and alloutstanding stock options were converted into the right to receive, in cash,$30.10 per share reduced by the exercise price per share for all shares subjectto such stock options.  The purchase ofthe outstand­ing shares was financed through new equity financing ofapproximately $175,000,000, a senior secured credit facility of up to$470,000,000 at market-based variable interest rates (effective rate ofapproximately 6.0% as of March 31, 2002), and $200,000,000 of seniorsubordinated notes at an 11.75% annual inter­est rate.

 

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

 

20

----

 

 

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

 

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

 

For ease of presentation, the Merger has been reflected in theaccompanying financial statements as if it had occurred on April 1, 2001.  Management determined that no materialtransactions occurred during the period from April 1 through April 9, 2001.  The Company’s financial statements have beenpresented on a comparative basis with the Predecessor’s historical operatingunit financial statements, prior to the date of Merger.  Different bases of accounting have been usedto prepare the Company and Predecessor financial statements.  The primary differences relate to the 10%yield on preferred units, depreciation and amortization of fixed assets andother intangible assets recorded at fair value at the date of acquisition, andincome taxes which are payable by the Company’s unit holders.

 

The fair value contributed by Michael Foods to M-Foods Dairy, LLC was$26,850,000.  In addition, $356,250 wascontributed by new investors in exchange for Class B non-voting common units.  This combined amount was allocated to theacquired assets and liabilities based on their fair values at April 1, 2001,net of the deemed dividend.  The fairvalues of long-term assets were obtained from a valuation report issued by athird party appraisal firm.  Theallocations were as follows:

 
| Working capital                   |   | $          | 10,426,000 |   |
|-----------------------------------|--------|------------|------------|--------|
| Property, plant  & equipment  |   | 15,135,000 |       |
| Other assets,  including goodwill |   | 3,962,000  |       |

 

The following unaudited pro forma net sales and net earnings for thethree months ended March 31, 2001 are derived from the application of pro formaadjustments to the Predecessor’s historical statement of earnings, and assumesthe Merger had occurred on January 1, 2001. The pro forma net earnings for the three months ended March 31, 2001 isalso adjusted for goodwill amortization determined in accordance with theprovisions of SFAS 142 (see Note B). The net sales and net earnings for the three months ended March 31, 2002represent actual results for the period.

 

21

----

 
|         |   | **Three  months ended** |       |
|--------------|--------|-------------------------|------------|
|         |   | **March 31,  2002**     |       | **March 31,  2001** |   |
| Net sales    |   | $                       | 23,850,000 |   | $ | 17,684,000 |   |
| Net earnings |   | 1,779,000               |       | 2,980,000 |   |
|              |        |                         |            |  |  |  |  |

 

NOTE B  — SUMMARY OF SIGNIFICANTACCOUNTING POLICIES

 

Basis of Presentation

The Predecessor Statements of Earnings and Cash Flows for the threemonths ended March 31, 2001 have been prepared from the historical booksand records of Michael Foods.  Therespective Statements of Earnings include an allocation of general and administrativecosts incurred by Michael Foods and allocations from this Operating Unit to theother Dairy LLC operating unit, M-Foods Dairy TXCT, LLC.  The accompanying Company unau­ditedfinancial statements and footnote information as of and for the three monthperiod ended March 31, 2002, and as of December 31, 2001, have been prepared inaccordance with Regulation S-X pursuant to the rules and regulations of the SECusing the adjusted cost basis of assets and liabilities of the Company.  In the opinion of management, the unauditedfinancial statements contain all adjustments (consisting of only normalrecurring adjustments) necessary to present fairly the results of operationsand cash flows for the periods indicated. The Unit’s financial statements include an allocation for general andadministrative costs incurred by Michael Foods.  Management believes its allocations to these Operating Unitfinancial statements are reasonable. Additionally, Operating Unit equity includes the cumulative net advancesbetween the Operating Unit and Michael Foods, which are considered additionalcapital invested from or, constructive dividends to, Michael Foods.  Accordingly, the accompanying financialstatements may not necessarily be indicative of the results that could havebeen obtained if the Operating Unit had been operated as a stand-aloneentity.  The historical results of theCompany and Predecessor for the periods indicated are not necessarilyindicative of the results of the Company for a full year.

 

The accounting policies of the Predecessor have been adopted by theCompany.

 

Use of Estimates

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

 

Inventories

Inventories are stated at the lower of cost (determined on a first-in,first-out basis) or market.

 

Inventories consisted of the following:

 
|                                |   | **March 31,  2002** |      | **December 31,  2001** |   |
|-------------------------------------|--------|---------------------|-----------|------------------------|--------|
| Raw  materials and supplies         |   | $                   | 2,537,000 |                   | $      | 1,625,000 |   |
| Work  in process and finished goods |   | 2,269,000           |      | 1,967,000              |   |
|                                |   | $                   | 4,806,000 |                   | $      | 3,592,000 |   |

 

22

----

 

Adoption of New Accounting Policies

 

Goodwill and Intangible Assets:

In July 2001, the Financial Accounting Standards Board (FASB) issuedStatement of Financial Accounting Standards (SFAS) 141, “BusinessCombinations”, and SFAS 142, “Goodwill and Other Intangible Assets”.  SFAS 141 is effective for all businesscombinations completed after June 30, 2001. SFAS 142 is effective for fiscal years beginning after December 15,2001; however, certain provisions of this Statement apply to goodwill and otherintangible assets acquired between July 1, 2001 and the effective date of SFAS142.  The Company adopted the provisionsof SFAS 142 as of January 1, 2002 and had no acquisitions between July 1, 2001and January 1, 2002.

 

As a result of adopting SFAS No. 141 and SFAS No. 142, the Company’saccounting policies for goodwill and intangible assets changed effectiveJanuary 1, 2002 as described below:

 

Goodwill:

The Company recognizes the excess cost of an acquired entity over thenet amount assigned to assets acquired and liabilities assumed asgoodwill.  Goodwill will be tested forimpairment on an annual basis and between annual tests whenever there is animpairment indicated.  Impairment losseswill be recognized whenever the implied fair value is less than the carryingvalue of the related asset.  Prior toJanuary 1, 2002, goodwill was amortized over 40 years.  Beginning January 1, 2002, goodwill is nolonger amortized.

 

During the second quarter of fiscal 2002, the Company will complete thetransitional impairment test of goodwill. The Company does not believe the impairment testing will have a materialeffect on the results of operations or the financial position of the Company.

 

The Company’s carrying amount, net of accumulated amortization, forgoodwill as of March 31, 2002 and December 31, 2001 was $1,764,000.

 

The following table presents a reconciliation of net earnings, asreported in the financial statements, to those amounts adjusted for goodwill asdetermined in accordance with the provisions of SFAS 142.

 
|                                  |   | **Three  months ended March 31,** |      |
|---------------------------------------|--------|-----------------------------------|-----------|
|                                  |   | **2002**                          |      | **2001** |   |
|                                  |   | **(Company)**                     |      | **(Predecessor)** |   |
|                                  |   |                              |      |   |   |
| Reported net  earnings                |   | $                                 | 1,778,000 |   | $ | 2,963,000 |   |
| Add back:  goodwill amortization |   | —                            |      | 26,000 |   |
| Adjusted net  earnings                |   | $                                 | 1,778,000 |   | $ | 2,989,000 |   |

 

Other New Pronouncements:

On January 1, 2002the Company adopted SFAS 144 *Accounting for the Impairment or Disposal ofLong-Lived Assets.*  Theadoption of SFAS 144 did not have a material effect on the Company’s financialstatements.

 

In addition, theCompany adopted Emerging Issues Task Force (EITF) Issue No. 00-25 *VendorIncome Statement Characterization of Consideration to a Reseller on the VendorsProducts,*effective January 1, 2002*.* The adoption of EITF Issue 00-25 did not have a material effect onthe Company’s financial statements.

 

23

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NOTE C — SETTLEMENT OF RECALL INSURANCE CLAIM

 

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

 

NOTE D — INCOME TAXES

 

Predecessor

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

 

Company

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

 

NOTE E — COMMITMENTS AND CONTINGENCIES

 

Litigation

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

 

24

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M-FOODS DAIRY TXCT, LLC

(A MAJORITY OWNEDSUBSIDIARY OF MICHAEL FOODS, INC.)

INDEX TO FINANCIALSTATEMENTS

 
| Balance  Sheets                |
|--------------------------------|
| Statements of Earnings         |
| Statements of Cash Flows       |
| Notes to Financial  Statements |

 

25

----

 

 

M-FOODS DAIRY TXCT, LLC

(A MAJORITY OWNEDSUBSIDIARY OF MICHAEL FOODS, INC.)

BALANCE SHEETS

(unaudited, in thousands)

 
|                                                   |   | **MARCH 31,  2002** |   | **DECEMBER  31,  2001** |   |
|--------------------------------------------------------|--------|---------------------|--------|-------------------------|--------|
| ASSETS                                                 |   |                |   |                    |   |
| CURRENT ASSETS                                         |   |                |   |                    |   |
| Cash and  equivalents                                  |   | $                   | — |                    | $      | — |   |
| Accounts  receivable, less allowances                  |   | 5,720               |   | 5,765                   |   |
| Inventories                                            |   | 4,730               |   | 3,315                   |   |
| Prepaid expenses  and other                            |   | 70                  |   | 52                      |   |
| Total current  assets                                  |   | 10,520              |   | 9,132                   |   |
| PROPERTY, PLANT  AND EQUIPMENT— AT COST           |   |                |   |                    |   |
| Leasehold  improvements                                |   | 3,023               |   | 3,023                   |   |
| Machinery and  equipment                               |   | 10,300              |   | 9,997                   |   |
|                                                   |   | 13,323              |   | 13,020                  |   |
| Less accumulated  depreciation                         |   | 1,944               |   | 1,494                   |   |
|                                                   |   | 11,379              |   | 11,526                  |   |
| OTHER ASSETS                                           |   |                |   |                    |   |
| Non-compete  agreement, net                            |   | 929                 |   | 1,058                   |   |
|                                                   |   | $                   | 22,828 |                    | $      | 21,716 |   |
| LIABILITIES AND  UNIT HOLDER AND OPERATING UNIT EQUITY |   |                |   |                    |   |
| CURRENT  LIABILITIES                                   |   |                |   |                    |   |
| Current  maturities of non-compete commitment          |   | $                   | 2,400  |                    | $      | 2,400 |   |
| Accounts payable                                       |   | 4,470               |   | 3,342                   |   |
| Note payable —  related party                     |   | 556                 |   | —                  |   |
| Accrued  liabilities:                                  |   |                |   |                    |   |
| Compensation                                           |   | 306                 |   | 292                     |   |
| Insurance                                              |   | 109                 |   | 37                      |   |
| Customer  programs                                     |   | 25                  |   | 200                     |   |
| Other                                                  |   | 531                 |   | 447                     |   |
| Total current  liabilities                             |   | 8,397               |   | 6,718                   |   |
| NON-COMPETE  COMMITMENT, less current maturities       |   | 2,400               |   | 2,400                   |   |
| COMMITMENTS AND  CONTINGENCIES                         |   | —              |   | —                  |   |
| PREFERRED UNIT  HOLDER RETURN PAYABLE                  |   | 929                 |   | 688                     |   |
| UNIT HOLDER AND  OPERATING UNIT EQUITY                 |   | 11,102              |   | 11,910                  |   |
|                                                   |   | $                   | 22,828 |                    | $      | 21,716 |   |

 

The accompanying notes are an integral part of these statements.

 

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M-FOODS DAIRY TXCT, LLC

(A MAJORITY OWNEDSUBSIDIARY OF MICHAEL FOODS, INC.)

STATEMENTS OF EARNINGS

FOR THE THREE MONTHSENDED MARCH 31,

(unaudited, in thousands)

 
|                                          |   | **COMPANY** |   | **PREDECESSOR** |   |
|-----------------------------------------------|--------|-------------|--------|-----------------|--------|
|                                          |   | **2002**    |   | **2001**        |   |
| Net sales                                     |   | $           | 19,330 |            | $      | 17,644 |   |
|                                          |   |        |   |            |   |
| Cost of sales                                 |   | 18,487      |   | 17,108          |   |
|                                          |   |        |   |            |   |
| Gross profit                                  |   | 843         |   | 536             |   |
|                                          |   |        |   |            |   |
| Selling, general  and administrative expenses |   | 1,018       |   | 1,712           |   |
|                                          |   |        |   |            |   |
| Operating loss                                |   | (175        | )      | (1,176          | )      |
|                                          |   |        |   |            |   |
| Other expense                                 |   | (5          | )      | —          |   |
|                                          |   |        |   |            |   |
| Loss before  income taxes                     |   | (180        | )      | (1,176          | )      |
| Income tax  benefit                           |   | —      |   | (447            | )      |
|                                          |   |        |   |            |   |
| NET LOSS                                      |   | $           | (180   | )               | $      | (729 | ) |

 

The accompanying notes are an integral part of these statements.

 

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M-FOODS DAIRY TXCT, LLC

(A MAJORITY OWNEDSUBSIDIARY OF MICHAEL FOODS, INC.)

STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHSENDED MARCH 31,

(unaudited, in thousands)

 
|                                                 |   | **COMPANY** |   | **PREDECESSOR** |   |
|------------------------------------------------------|--------|-------------|--------|-----------------|--------|
|                                                 |   | **2002**    |   | **2001**        |   |
|                                                 |   |        |   |            |   |
| Net cash  provided by (used in) operating activities |   |        |   |            |   |
|                                                 |   | $           | 689    |            | $      | (31 | ) |
| Cash flows from  investing activities:               |   |        |   |            |   |
| Capital  expenditures                                |   | (303        | )      | (2,250          | )      |
| Net cash used in  investing activities               |   | (303        | )      | (2,250          | )      |
|                                                 |   |        |   |            |   |
| Cash flows from  financing activities:               |   |        |   |            |   |
| Net additional  capital invested or (dividends paid) |   | (386        | )      | 2,281           |   |
| Net cash  provided by (used in) financing activities |   | (386        | )      | 2,281           |   |
| Net decrease in  cash and equivalents                |   | —      |   | —          |   |
| Cash and  equivalents at beginning of period         |   | —      |   | —          |   |
| Cash and  equivalents at end of period               |   | $           | — |            | $      | — |   |

 

The accompanying notes are an integral part of these statements.

 

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M-FOODS DAIRY TXCT, LLC

(A MAJORITY OWNEDSUBSIDIARY OF MICHAEL FOODS, INC.)

NOTES TO FINANCIAL STATEMENTS

 

# **NOTE A — ORGANIZATION, BUSINESS ANDMERGER**

 

###### **Organization**

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

 

###### **Business**

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

 

###### **Merger**

On April 10, 2001, Michael Foods, Inc. and itssubsidiaries (“Michael Foods”) was acquired in a transaction (the “Merger”) ledby an investor group comprised of a management group led by Michael Foods’Chairman, President and Chief Executive Officer, Gregg Ostrander, affiliates ofJeffrey Michael, a member of the Predecessor Board of Directors, and affiliatesof two private equity investment firms, Vestar Capital Partners and GoldnerHawn Johnson & Morrison Incorporated, collectively, M-Foods Investors,LLC.  Under the terms of the Mergeragreement, all outstanding shares of Michael Foods com­mon stock were convertedinto the right to receive $30.10 per share in cash, or value equal thereto, andall outstanding stock options were converted into the right to receive, incash, $30.10 per share reduced by the exercise price per share for all sharessubject to such stock options.  Thepurchase of the outstand­ing shares was financed through new equity financingof approximately $175,000,000, a senior secured credit facility of up to$470,000,000 at market-based variable interest rates (effective rate ofapproximately 6.0% as of March 31, 2002), and $200,000,000 of seniorsubordinated notes at an 11.75% annual inter­est rate.

 

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

 

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Following the Merger, Michael Foods, Inc. became anindirect wholly-owned subsidiary of M-Foods Investors, LLC and M-Foods DairyTXCT, LLC became a majority owned subsidiary of Michael Foods, Inc.

###### ** **

The Merger was accounted for as a purchase in accordancewith Accounting Principles Board Opinion 16, Business Combinations and EITF88-16, Basis in Leveraged Buyout Transac­tions.  Accordingly, the acquired assets and liabilities were recorded atfair value for the interests acquired by new investors and at the carryoverbasis for continuing investors.  As aresult, the assets and liabilities were assigned new values, which are partPredecessor cost and part fair value, in the same proportions as the carryoverbasis of the residual interests retained by the continuing management investorsand continuing affiliate investors of the Michael family and the new interestsacquired by the new investors.  Thedeemed dividend related to the Michael Foods investment in the assets andliabilities of the Dairy LLCs was pushed down to these majority ownedsubsidiaries, as if they were wholly owned subsidiaries since Michael Foodsowns all of the voting stock and the Dairy LLCs are being operated by themanagement of Michael Foods.  The amountof the deemed dividend at Michael Foods was $66,631,000.  However, the historical cost basis equity ofthe continuing investors of the Company was $21,623,000, which exceeded theCompany’s fair market value by $12,673,000. This resulted in an allocation of carryover basis in excess of the fairmarket value of the Company in the amount of $3,928,000.

###### ** **

For ease of presentation, the Merger has beenreflected in the accompanying financial statements as if it had occurred onApril 1, 2001.  Management determinedthat no material transactions occurred during the period from April 1 throughApril 9, 2001. The Company’s financial statements have been presented on acomparative basis with the Predecessor’s historical operating unit financialstatements, prior to the date of Merger. Different bases of accounting have been used to prepare the Company andPredecessor financial statements.  Theprimary differences relate to the 10% yield on preferred units, depreciationand amortization of fixed assets and other intangible assets recorded at fair valueat the date of acquisition, and income taxes which are payable by the Company’sunit holders.

 

The fair value contributed by Michael Foods to M-FoodsDairy TXCT, LLC was $8,950,000 and this amount, plus an additional carryoverbasis of $3,928,000, was allocated to the acquired assets and liabilities basedon their fair values at April 1, 2001. In addition, $118,750 was contributed by new investors in exchange forClass B - non voting common units.  Thefair values of long-term assets was obtained from a valuation report issued bya third party appraisal firm.  Theallocations were as follows:

 
| Working capital                   |   | $         | 7,420,000 |   |
|-----------------------------------|--------|-----------|-----------|--------|
| Property, plant &  equipment  |   | 8,980,000 |      |
| Other assets, including  goodwill |   | 1,397,000 |      |
| Other liabilities                 |   | 4,800,000 |      |

 

The following unaudited pro forma net sales and net loss for the threemonths ended March 31, 2001 are derived from the application of pro formaadjustments to the Predecessor’s historical statement of earnings, and assumesthe Merger had occurred on January 1, 2001. The net sales and net loss for the three months ended March 31, 2002represent actual results for the period.

 

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|      |   | **Three  months ended** |       |
|-----------|--------|-------------------------|------------|
|      |   | **March 31,  2002**     |       | **March 31,  2001** |   |
| Net sales |   | $                       | 19,330,000 |   | $ | 17,644,000 |   |
| Net loss  |   | (180,000                | )          | (573,000 | ) |
|           |        |                         |            |  |  |  |  |

 

NOTE B  — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

# **Basis of Presentation**

The Predecessor Statements of Earnings and Cash Flows for the threemonths ended March 31, 2001 have been prepared from the historical booksand records of Michael Foods.  Therespective Statements of Earnings include an allocation of general andadministrative costs incurred by Michael Foods and allocations from thisOperating Unit to the other Dairy LLC operating unit, M-Foods Dairy, LLC. Theaccompanying Company unau­dited financial statements and footnote informationas of and for the three month period ended March 31, 2002, and as of December31, 2001, have been prepared in accordance with Regulation S-X pursuant to therules and regulations of the SEC using the adjusted cost basis of assets andliabilities of the Company.  In theopinion of management, the unaudited financial statements contain alladjustments (consisting of only normal recurring adjustments) necessary topresent fairly the results of operations and cash flows for the periodsindicated.  The Unit’s financialstatements include an allocation for general and administrative costs incurredby Michael Foods.  Management believesits allocations to these Operating Unit financial statements arereasonable.  Additionally, OperatingUnit equity includes the cumulative net advances between the Operating Unit andMichael Foods, which are considered additional capital invested from or, constructivedividends to, Michael Foods.  Accordingly,the accompanying financial statements may not necessarily be indicative of theresults that could have been obtained if the Operating Unit had been operatedas a stand-alone entity.  The historicalresults of the Company and Predecessor for the periods indicated are notnecessarily indicative of the results of the Company for a full year.

 

The accounting policies of the Predecessor have been adopted by theCompany.

 

**Use of Estimates**

Preparation of the accompanying financial statementsin conformity with account­ing principles generally accepted in the UnitedStates of America requires management to make estimates and assumptions thataffect reported amounts of assets and liabilities, related revenues andexpenses and disclosure about contingent assets and liabilities at the date ofthe financial statements. Actual results could differ from the estimates usedby management.

 

# **Inventories**

Inventories are stated atthe lower of cost (determined on a first-in, first-out basis) or market. 

Inventories consistedof the following: 

 
|                                |   | **March 31,  2002** |      | **December  31,  2001** |   |
|-------------------------------------|--------|---------------------|-----------|-------------------------|--------|
| Raw  materials and supplies         |   | $                   | 2,651,000 |                    | $      | 1,880,000 |   |
| Work  in process and finished goods |   | 2,079,000           |      | 1,435,000               |   |
|                                |   | $                   | 4,730,000 |                    | $      | 3,315,000 |   |

 

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Adoption of New Accounting Policies

 

Goodwill and Intangible Assets:

In July 2001, the Financial Accounting Standards Board (FASB) issuedStatement of Financial Accounting Standards (SFAS) 141, “BusinessCombinations”, and SFAS 142, “Goodwill and Other Intangible Assets”.  SFAS 141 is effective for all businesscombinations completed after June 30, 2001. SFAS 142 is effective for fiscal years beginning after December 15,2001; however, certain provisions of this Statement apply to goodwill and otherintangible assets acquired between July 1, 2001 and the effective date of SFAS142.  The Company adopted the provisionsof SFAS 142 as of January 1, 2002 and had no acquisitions between July 1, 2001and January 1, 2002.

 

As a result of adopting SFAS No. 141 and SFAS No. 142, the Company’saccounting policies for goodwill and intangible assets changed effectiveJanuary 1, 2002 as described below:

 

Goodwill:

The Company recognizes the excess cost of an acquired entity over thenet amount assigned to assets acquired and liabilities assumed asgoodwill.  The Company had no goodwillas of March 31, 2002 or December 31, 2001. If goodwill is acquired in the future, it will be tested for impairmenton an annual basis and between annual tests whenever there is an impairmentindicated.  Impairment losses will berecognized whenever the implied fair value is less than the carrying value ofthe related asset.

 

Other Intangibles:

The Company recognizes an acquired intangible apart from goodwillwhenever the asset arises from contractual or other legal rights, or wheneverit is capable of being separated or divided from the acquired entity and sold,transferred, licensed, rented, or exchanged, either individually or incombination with a related contract, asset, or liability.  An intangible other than goodwill isamortized over its estimated useful life unless that life is determined to beindefinite.  Impairment losses arerecognized if the carrying amount of an intangible subject to amortization isnot recoverable from expected future cash flows and its carrying amount exceedsits fair value.

 

Acquired intangible assets of the Company that have been determined tohave a definite life and continue to be amortized as of March 31, 2002 are asfollows:

 
|        |   | **Gross  Carrying  Amount** |      | **Accumulated  Amortization** |   |
|-------------|--------|-----------------------------|-----------|-------------------------------|--------|
| Non-compete |   | $                           | 1,398,000 |                          | $      | (468,000 | ) |
|             |        |                             |           |                               |        |  |  |

 

The aggregate amortization expense for the three months ended March 31,2002 was approximately $130,000.  ThePredecessor had amortization expense of $500,000 during the period ended March31, 2001.  The estimated amortizationexpense for the years ended December 31, 2002 through December 31, 2003 is asfollows:

 
|   |   | **For the  Years   Ended December 31,** |    |
|--------|--------|-----------------------------------------|---------|
| 2002   |   | $                                       | 529,000 |   |
| 2003   |   | 529,000                                 |    |
|        |        |                                         |         |  |

 

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Other New Pronouncements:

On January 1, 2002the Company adopted SFAS 144 *Accounting for the Impairment or Disposal ofLong-Lived Assets.*  Theadoption of SFAS 144 did not have a material effect on the Company’s financialstatements.

 

In addition, theCompany adopted Emerging Issues Task Force (EITF) Issue No. 00-25 *VendorIncome Statement Characterization of Consideration to a Reseller on the VendorsProducts,*effective January 1, 2002*.* The adoption of EITF Issue 00-25 did not have a material effect onthe Company’s financial statements.

###### ** **

###### **NOTE C — INCOME TAXES**

 

###### **Predecessor**

# **Theactivity of the Operating Unit has been included in the income tax return ofMichael Foods, Inc. for financial reporting purposes.  The Unit has been allocated a provision for income taxes in anamount generally equivalent to the provision that would have resulted had theUnit filed a separate income tax return.**

 

# **Company**

For income tax purposes the Company is a pass throughentity, therefore, income taxes have not been reflected on the Company’sfinancial statements.

###### ** **

###### **NOTE D — COMMITMENTS AND CONTINGENCIES**

 

###### **Litigation**

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

 

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**ITEM 2 -MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS**

**OFOPERATIONS**

 

THREE MONTHS ENDED MARCH 31, 2002 AS COMPARED TO PREDECESSOR’S THREEMONTHS ENDED MARCH 31, 2001

 

RESULTS OF OPERATIONS

 

Readers are directed to Note G - Business Segments for data on theunaudited financial results of our four business segments for the three monthsended March 31, 2002 and for data on the unaudited financial results of thePredecessor’s four business segments for the three months ended March 31, 2001.

 

Net sales for the 2002 period were $278,429,000, an increase of 1%compared to the Predecessor’s net sales of $275,627,000 in the 2001 period. Netsales increased because of the factors discussed in the below divisionalreviews, but were higher in the 2002 period due largely to unit sales growth intwo divisions.

 

Egg Products Division net sales for the 2002 period reflected slightlydecreased unit sales and slight deflation for industrial egg products, with thelatter tied to weaker pricing in the national egg market. Unit sales rose foregg substitutes, hardcooked items and precooked products, and declined slightlyfor other products. Graded shell egg prices decreased approximately 5% comparedto first quarter 2001 levels, as reported by Urner Barry Publications - awidely quoted industry pricing service. Related egg market decreases loweredthe cost of purchased eggs slightly. Approximately two-thirds of the Division’sannual egg needs are purchased under contracts or in the spot market. Asubstantial majority of these eggs are priced according to the cost of graininputs or to egg market prices as reported by Urner Barry. Approximatelyone-third of annual egg needs are sourced from internal flocks, where feedcosts typically represent roughly two-thirds of the cost of producing sucheggs. Feed costs were slightly higher in the 2002 period, compared to the 2001period, due mainly to higher prices for corn. Overall, decreased egg costs inthe 2002 period, as compared to the 2001 period, were generally met with flategg products prices.  This resulted inhigher margins for certain egg products, particularly egg substitutes,hardcooked products and dried products, and higher divisional margins in total.

 

Refrigerated Distribution Division net sales for the 2002 periodreflected generally higher pricing, which more than offset slightly lower unitsales. Unit sales rose for butter and ethnic items, while cheese, margarine,and baked goods showed weaker unit sales. Unit sales trends reflected, in part,a change in national dairy market conditions year-over-year, with butterfatpricing significantly reduced.  Thiscaused consumers to “trade-up” to butter from margarine, reversing the trend oftwelve months prior. Regarding cheese unit sales, we believe a combination ofweak economic conditions, the relative value of private label cheeses comparedto branded cheeses, such as we sell, and store closures by certain retailcustomers all affected results. Margins declined in the key cheese category. Amore rapid decline than expected in national cheese prices, as compared to ourcosts for inventoried cheese and the Division’s cheese ownership via hedging,caused margin compression.

 

34

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Dairy Products Division net sales for the 2002 period reflected higherunit sales, due mainly to strong creamer and specialty cartoned product sales.Improved pricing for certain product categories also added to dollar salesgrowth. Excluding an insurance settlement of approximately $3,218,000 in the2001 period, the divisional operating profit margin and dollars increased as aresult of the strong volume growth, an improved sales mix, and more efficientplant operations.

 

Potato Products Division net sales for the 2002 period reflected unitsales increases in all product categories. Sales were particularly strong forretail items. New account activity, same-account sales growth and highermarketing spending levels all contributed to the sales gain. The operatingprofit increase in the 2002 period reflected improved operating costs and theimpact of a favorable sales mix, with retail sales rising as a percent of thedivisional total.

 

The increase in our gross profit margin for the 2002 period, ascompared to the results of the Predecessor in the 2001 period, reflected thefactors discussed above, particularly sales mix improvements, decreased rawmaterial costs and improved processing yields. It is our strategy to increasevalue-added product sales as a percent of total sales over time, whiledecreasing commodity-sensitive products’ contribution to consolidated sales.These efforts historically have been beneficial to gross profit margins in mostperiods.

 

Selling, general and administrative expenses increased as a percent ofsales in the 2002, as compared to the results of the Predecessor in the 2001period. This increased expense ratio reflected higher expenses to supportretail and foodservice marketing efforts and broadened sales efforts, and forour centralized purchasing department. Separate from selling, general andadministrative expenses in the 2001 period, the Predecessor recorded non-recurringexpenses related to the Merger for financial, legal, advisory and regulatoryfiling fees.  These expenses ofapproximately $11.1 million are reflected in the Predecessor’s ConsolidatedStatements of Earnings as transaction expenses.

 

GENERAL

 

Certain of our products are sensitive to changes in commodity prices.Value-added egg products, such as extended shelf-life liquid and precookedproducts, account for approximately 60% of the Egg Products Division’s netsales. The remainder of Egg Products Division sales is derived from the sale ofother egg products and shell eggs, which vary from being verycommodity-sensitive to somewhat value-added. Gross profit from shell eggs isprimarily dependent upon the relationship between shell egg prices and the costof feed, both of which can fluctuate significantly. Graded shell egg pricing inthe 2002 period was approximately 5% below 2001 levels, as measured by a widelyquoted

 

35

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pricing service, while feed costs rose slightly year-over-year. Grossprofit margins for extended shelf-life liquid eggs, egg substitutes, andprecooked and hardcooked egg products are less sensitive to commodity pricefluctuations than are other egg products or shell eggs. Our RefrigeratedDistribution Division derives approximately 75% of its net sales fromrefrigerated products produced by others, thereby reducing the effects ofcommodity price swings. The balance of refrigerated distribution sales aremainly from shell eggs, some of which are produced by the Egg ProductsDivision, sold on a distribution, or non-commodity, basis.

 

The Dairy Products Division sells its products primarily on a cost-plusbasis and, therefore, the Division’s earnings are not typically affectedgreatly by raw ingredient price fluctuations, except over short time periods.

 

The Potato Products Division typically purchases 75%-95% of its rawpotatoes from contract producers under annual contracts. The remainder ispurchased at market prices to satisfy short-term production requirements or totake advantage of market prices when they are lower than contracted prices.Moderate variations in the purchase price of raw materials or the selling priceper pound of finished products can have a significant effect on Potato ProductsDivision operating results.

 

Inflation is not expected to have a significant impact on our business.We have generally been able to offset the impact of inflation through acombination of productivity gains and price increases.

 

CAPITAL RESOURCES AND LIQUIDITY

 

Acquisitions and capital expenditures have been, and will likelycontinue to be, a significant capital requirement. We plan to continue toinvest in state-of-the-art production facilities to enhance our competitiveposition. Historically, we have financed our growth principally from internallygenerated funds, bank borrowings, and the issuance of senior debt. We believesuch sources remain viable financing alternatives to meet our anticipatedneeds.

 

We invested $6,878,000 in capital expenditures during the three monthsended March 31, 2002. The Predecessor invested $10,837,000 in capitalexpenditures during the three months ended March 31, 2001. We plan to spendapproximately $42,000,000 on capital expenditures in 2002, the majority of whichis to expand or update production capacity for value-added products.

 

Earnings before interest, taxes, depreciation and amortization(“EBITDA”) in the 2002 period were $35,845,000, an increase of 13% compared tothe Predecessor’s EBITDA of $31,745,000 in the 2001 period. EBITDA increasedbecause of the factors discussed in the above results of operations divisionalreviews. Our management believes that EBITDA is a relevant measurement of ourfinancial results, as it is indicative of the relative strength of our cashflows and is a key measurement contained in the financial

 

36

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covenants of our senior indebtedness. In addition, as a highlyleveraged company, the holders of our debt have a significant interest in ourcash flows. We compute EBITDA as it is defined in our senior credit agreement(see Exhibit 10.1 of our Amendment No. 1 to Form S-4 filed with the Securitiesand Exchange Commission on July 18, 2001). This definition may not becomparable to that used by other companies reporting similar financialinformation.

 

We believe EBITDA is a widely accepted financial indicator used toanalyze and compare companies on the basis of operating performance. It shouldnot be considered in isolation or as a substitute for measures of performanceprepared in accordance with generally accepted accounting principles and is notindicative of operating profit or cash flow from operations as determined undergenerally accepted accounting principles.

 

We have a senior secured credit facility with numerous banks, otherfinancial institutions and investment groups, which totaled $470,000,000 at thetime of the Merger. At March 31, 2002, there were no borrowings under the$100,000,000 line of credit portion of this facility, while the term A portiontherein approximated $84,200,000 and the term B portion approximated$253,800,000.

 

The senior credit facility contains various restrictive covenants. Itprohibits us from prepaying other indebtedness, including the notes, and it requiresus to maintain specified financial ratios, such as a minimum ratio of EBITDA tointerest expense, a minimum fixed charge coverage ratio and a maximum ratio oftotal debt to EBITDA, and satisfy financial condition tests. In addition, thesenior credit facility prohibits us from declaring or paying any dividends andprohibits us from making any payments with respect to the notes if we fail toperform our obligations under, or fail to meet the conditions of, the seniorcredit facility or if payment creates a default under the senior creditfacility.

 

The indenture governing the notes, among other things, (a) restrictsthe ability of the issuer and its subsidiaries, including the guarantors of thenotes, to incur additional indebtedness, issue shares of preferred stock, incurliens, pay dividends or make certain other restricted payments and enter intocertain transactions with affiliates, (b) prohibits certain restrictions on theability of certain of the issuer’s subsidiaries, including the guarantors ofthe notes, to pay dividends or make certain payments to the issuer and (c)places restrictions on the ability of the issuer and its subsidiaries,including the guarantors of the notes, to merge or consolidate with any otherperson or sell, assign, transfer, lease, convey or otherwise dispose of all orsubstantially all of the assets of the issuer. The indenture related to thesenotes and the senior credit facility also contain various covenants which limitour discretion in the operation of our businesses.

 

Our principal sources of funds are anticipated to be cash flows fromoperating activities and borrowings under our senior credit facility. Webelieve that these funds will provide us with sufficient liquidity and

 

37

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capital resources for us to meet our current and future financialobligations, as well as to provide funds for our working capital, capitalexpenditures and other needs for at least the next 12 months. No assurance canbe given, however, that this will be the case. We may require additional equityor debt financing to meet our working capital requirements or to fund ouracquisition activities, if any. There can be no assurance that additionalfinancing will be available when required or, if available, will be on termssatisfactory to us.

 

SEASONALITY

 

Consolidated quarterly operating results are affected by theseasonality of our net sales and operating profits. Specifically, shell eggprices typically rise seasonally in the first and fourth quarters of the yeardue to increased demand during holiday periods. Generally, refrigerateddistribution operations experience higher net sales and operating profits inthe fourth quarter, coinciding with incremental consumer demand during theholiday season. Net sales and operating profits from dairy operations typicallyare significantly higher in the second and third quarters due to increasedconsumption of ice milk and ice cream products during the summer months.Operating profits from potato products are less seasonal, but tend to be higherin the second half of the year coinciding with the potato harvest.

 

FORWARD-LOOKING STATEMENTS

 

Certain items in this Form 10-Q may be forward-looking statements,which are made in reliance upon the safe harbor provisions of the PrivateSecurities Litigation Reform Act of 1995. Such forward-looking statements aresubject to numerous risks and uncertainties, including variances in the demandfor our products due to consumer developments and industry developments, as wellas variances in the costs to produce such products, including normal volatilityin egg, feed and dairy ingredients costs. Our actual financial results coulddiffer materially from the results estimated by, forecasted by, or implied byus in such forward-looking statements.

 

ITEM 3.  QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

There were no material changes in our market risk during the threemonth period ended March 31, 2002.

 

PART II - OTHERINFORMATION

 

ITEM 6.  EXHIBITS AND REPORTS ONFORM 8-K

 

(a)                          Exhibits

 

None

 

38

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ITEM 6.  EXHIBITS AND REPORTS ONFORM 8-K, CONT.

 

(b)                         Reportson Form 8-K

 

We filed a Form 8-K on February 21, 2002 regarding a news releaseissued to our debtholders pertaining to our financial results for the threemonths ended December 31, 2001 and the pro forma financial results for the yearended December 31, 2001.

 

Subsequent to the reporting period herein, we filed a Form 8-K on April26, 2002 regarding a news release issued to our debtholders pertaining to ourfinancial results for the three months ended March 31, 2002.

 

SIGNATURES

 

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

 
|                      | MICHAEL FOODS, INC. |
|---------------------------|---------------------|
|                      | (Registrant)        |
|                      |                |   |   |
| Date:  May  13, 2002 |                | By: | /s/ Gregg A. Ostrander |
|                      |                |   | Gregg A.  Ostrander |
|                      |                |   | (Chairman, President  and   Chief Executive Officer) |
|                      |                |   |   |
|                      |                |   |   |
| Date:  May  13, 2002 |                | By: | /s/ John D. Reedy |
|                      |                |   | John D. Reedy |
|                      |                |   | (Executive Vice  President, Treasurer,   Chief Financial Officer and   Principal Accounting Officer) |
|                      |                |   |   |
|                      |                |   |   |
|                      |                |   |   |

 

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