**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  June 30, 2002**

 

**or**

** **

| **o** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|-------|-----------------------------------------------------------------------------------------------|

 

**For the transition periodfrom               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.) |
|                                                            |   |                                  |
| **401 Carlson Parkway  Suite 300  Minnetonka, MN**              |   | **55305**                             |
| (Address of principal  executive offices)                       |   | (Zip code)                            |
|                                                            |   |                                  |
| **(952) 258-4000**                                              |
| (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 - FINANCIAL INFORMATION

 

**ITEM1.  FINANCIAL STATEMENTS**

MICHAEL FOODS, INC.

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

CONDENSED CONSOLIDATEDBALANCE SHEETS

(Unaudited)

 
|                                       |   | **June 30,  2002** |        | **December  31,  2001** |   |
|--------------------------------------------|--------|--------------------|-------------|-------------------------|--------|
| ASSETS                                     |   |               |        |                    |   |
|                                       |   |               |        |                    |   |
| CURRENT ASSETS                             |   |               |        |                    |   |
| Cash and  equivalents                      |   | $                  | 38,970,000  |                    | $      | 27,660,000 |   |
| Accounts  receivable, less allowances      |   | 95,497,000         |        | 102,317,000             |   |
| Inventories                                |   | 82,050,000         |        | 78,941,000              |   |
| Prepaid expenses  and other                |   | 10,454,000         |        | 11,370,000              |   |
| Total current  assets                      |   | 226,971,000        |        | 220,288,000             |   |
|                                       |   |               |        |                    |   |
| PROPERTY, PLANT  AND EQUIPMENT-AT COST     |   |               |        |                    |   |
| Land                                       |   | 3,873,000          |        | 3,873,000               |   |
| Buildings and  improvements                |   | 99,480,000         |        | 99,561,000              |   |
| Machinery and  equipment                   |   | 240,626,000        |        | 226,759,000             |   |
|                                       |   | 343,979,000        |        | 330,193,000             |   |
| Less accumulated  depreciation             |   | 65,496,000         |        | 39,039,000              |   |
|                                       |   | 278,483,000        |        | 291,154,000             |   |
|                                       |   |               |        |                    |   |
| OTHER ASSETS                               |   |               |        |                    |   |
| Goodwill, net                              |   | 341,021,000        |        | 341,021,000             |   |
| Joint ventures  and other assets           |   | 43,916,000         |        | 44,670,000              |   |
|                                       |   | 384,937,000        |        | 385,691,000             |   |
|                                       |   | $                  | 890,391,000 |                    | $      | 897,133,000 |   |
|                                       |   |               |        |                    |   |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY |   |               |        |                    |   |
|                                       |   |               |        |                    |   |
| CURRENT  LIABILITIES                       |   |               |        |                    |   |
| Current  maturities of long-term debt      |   | $                  | 16,925,000  |                    | $      | 12,962,000 |   |
| Accounts payable                           |   | 61,434,000         |        | 64,492,000              |   |
| Accrued  liabilities                       |   |               |        |                    |   |
| Compensation                               |   | 9,885,000          |        | 12,582,000              |   |
| Insurance                                  |   | 9,045,000          |        | 8,191,000               |   |
| Customer  programs                         |   | 22,762,000         |        | 21,996,000              |   |
| Income taxes                               |   | 11,382,000         |        | 9,853,000               |   |
| Interest                                   |   | 10,448,000         |        | 10,619,000              |   |
| Other                                      |   | 19,219,000         |        | 14,116,000              |   |
| Total current  liabilities                 |   | 161,100,000        |        | 154,811,000             |   |
|                                       |   |               |        |                    |   |
| LONG-TERM DEBT,  less current maturities   |   | 513,112,000        |        | 540,132,000             |   |
| DEFERRED INCOME  TAXES                     |   | 48,975,000         |        | 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                         |   | 22,490,000         |        | 9,815,000               |   |
| Accumulated  other comprehensive loss      |   | (2,553,000         | )           | (3,617,000              | )      |
|                                       |   | 166,729,000        |        | 152,990,000             |   |
|                                       |   | $                  | 890,391,000 |                    | $      | 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 June30,

(Unaudited)

 
|                                         |   | **2002**    |        | **2001**    |   |
|----------------------------------------------|--------|-------------|-------------|-------------|--------|
| Net sales                                    |   | $           | 289,753,000 |        | $      | 295,109,000 |   |
|                                         |   |        |        |        |   |
| Cost of sales                                |   | 235,549,000 |        | 244,855,000 |   |
|                                         |   |        |        |        |   |
| Gross profit                                 |   | 54,204,000  |        | 50,254,000  |   |
|                                         |   |        |        |        |   |
| Selling, general and administrative expenses |   | 29,826,000  |        | 30,294,000  |   |
|                                         |   |        |        |        |   |
| Operating profit                             |   | 24,378,000  |        | 19,960,000  |   |
|                                         |   |        |        |        |   |
| Interest  expense, net                       |   | 12,332,000  |        | 16,241,000  |   |
|                                         |   |        |        |        |   |
| Earnings before  income taxes                |   | 12,046,000  |        | 3,719,000   |   |
|                                         |   |        |        |        |   |
| Income tax  expense                          |   | 4,730,000   |        | 2,050,000   |   |
|                                         |   |        |        |        |   |
| NET EARNINGS                                 |   | $           | 7,316,000   |        | $      | 1,669,000 |   |

 

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 EARNINGS

 

(Unaudited)

 
|                                                             |   | **Company**                          |        | **Predecessor**                         |   |
|------------------------------------------------------------------|--------|--------------------------------------|-------------|-----------------------------------------|--------|
|                                                             |   | **Six Months  Ended June 30,  2002** |        | **Three  Months  Ended June 30,  2001** |   | **Three  Months  Ended March 31,  2001** |   |
| Net sales                                                        |   | $                                    | 568,182,000 |                                    | $      | 295,109,000 |   | $ | 275,627,000 |   |
|                                                             |   |                                 |        |                                    |   |   |   |
| Cost of sales                                                    |   | 462,862,000                          |        | 244,855,000                             |   | 227,707,000 |   |
|                                                             |   |                                 |        |                                    |   |   |   |
| Gross profit                                                     |   | 105,320,000                          |        | 50,254,000                              |   | 47,920,000 |   |
|                                                             |   |                                 |        |                                    |   |   |   |
| Selling, general  and administrative expenses                    |   | 59,449,000                           |        | 30,294,000                              |   | 27,376,000 |   |
| Transaction  expenses                                            |   | —                               |        | —                                  |   | 11,050,000 |   |
|                                                             |   |                                 |        |                                    |   |   |   |
| Operating profit                                                 |   | 45,871,000                           |        | 19,960,000                              |   | 9,494,000 |   |
|                                                             |   |                                 |        |                                    |   |   |   |
| Interest  expense, net                                           |   | 24,996,000                           |        | 16,241,000                              |   | 3,293,000 |   |
|                                                             |   |                                 |        |                                    |   |   |   |
| Earnings before  income taxes                                    |   | 20,875,000                           |        | 3,719,000                               |   | 6,201,000 |   |
|                                                             |   |                                 |        |                                    |   |   |   |
| Income tax  expense                                              |   | 8,200,000                            |        | 2,050,000                               |   | 2,430,000 |   |
| Earnings before  extraordinary item                              |   | 12,675,000                           |        | 1,669,000                               |   | 3,771,000 |   |
|                                                             |   |                                 |        |                                    |   |   |   |
| Extraordinary  item - early extinguishment of debt, net of taxes |   | —                               |        | —                                  |   | (9,424,000 | ) |
|                                                             |   |                                 |        |                                    |   |   |   |
| NET EARNINGS  (LOSS)                                             |   | $                                    | 12,675,000  |                                    | $      | 1,669,000 |   | $ | (5,653,000 | ) |

 

See accompanying notes to condensed consolidated financial statements.

 

4

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MICHAEL FOODS, INC.

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

CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS

(Unaudited)

 
|                                                 |   | **Company**                          |       | **Predecessor**                         |   |
|------------------------------------------------------|--------|--------------------------------------|------------|-----------------------------------------|--------|
|                                                 |   | **Six Months  Ended June 30,  2002** |       | **Three  Months  Ended June 30,  2001** |   | **Three  Months  Ended March 31,  2001** |   |
|                                                 |   |                                 |       |                                    |   |   |   |
| Net cash  provided by operating activities           |   | $                                    | 48,233,000 |                                    | $      | 39,337,000 |   | $ | 14,016,000 |   |
|                                                 |   |                                 |       |                                    |   |   |   |
| Cash flows from  investing activities:               |   |                                 |       |                                    |   |   |   |
| Capital expenditures                                 |   | (14,263,000                          | )          | (6,299,000                              | )      | (10,837,000 | ) |
| Business  acquisition                                |   | —                               |       | (626,925,000                            | )      | — |   |
| Investments in  joint ventures and other assets      |   | 397,000                              |       | (486,000                                | )      | 3,888,000 |   |
|                                                 |   |                                 |       |                                    |   |   |   |
| Net cash used in  investing activities               |   | (13,866,000                          | )          | (633,710,000                            | )      | (6,949,000 | ) |
|                                                 |   |                                 |       |                                    |   |   |   |
| Cash flows from  financing activities:               |   |                                 |       |                                    |   |   |   |
| Payments on  notes payable                           |   | (5,000,000                           | )          | (46,450,000                             | )      | (52,000,000 | ) |
| Proceeds from  notes payable                         |   | —                               |       | 29,500,000                              |   | 45,500,000 |   |
| Payments on  long-term debt and other                |   | (18,057,000                          | )          | (127,479,000                            | )      | (109,000 | ) |
| Proceeds from  long-term debt and other              |   | —                               |       | 570,000,000                             |   | — |   |
| Extension of  stock options                          |   | —                               |       | —                                  |   | 310,000 |   |
| Proceeds from  issuance of common stock              |   | —                               |       | 174,800,000                             |   | 546,000 |   |
| Dividends                                            |   | —                               |       | —                                  |   | (1,465,000 | ) |
| Net cash (used  in) provided by financing activities |   | (23,057,000                          | )          | 600,371,000                             |   | (7,218,000 | ) |
|                                                 |   |                                 |       |                                    |   |   |   |
| Net increase  (decrease) in cash and equivalents     |   | 11,310,000                           |       | 5,998,000                               |   | (151,000 | ) |
|                                                 |   |                                 |       |                                    |   |   |   |
| Cash and  equivalents at beginning of period         |   | 27,660,000                           |       | 4,270,000                               |   | 4,421,000 |   |
|                                                 |   |                                 |       |                                    |   |   |   |
| Cash and  equivalents at end of period               |   | $                                    | 38,970,000 |                                    | $      | 10,268,000 |   | $ | 4,270,000 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

5

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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 byMichael Foods’ Chairman, President and Chief Executive Officer, GreggOstrander, affiliates of Jeffrey Michael, a member of the Predecessor’s Boardof Directors, and affiliates of two private equity investment firms, VestarCapital Partners and Goldner Hawn Johnson & Morrison Incorporated,(collectively, “M-Foods Investors, LLC”). 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. The purchase of the outstanding shares wasfinanced through new equity financing of approximately $175,000,000, a seniorsecured credit facility of up to $470,000,000 at market-based variable interestrates (effective rate of approximately 6.8% as of June 30, 2002), and$200,000,000 of senior subordinated notes at an 11.75% annual interest rate. Asa result of the Merger, the stock of pre-merger Michael Foods (“Predecessor”)is no longer publicly traded and, therefore, earnings per share calculationsare no longer included 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 ofJune 30, 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 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. 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  |       |

 

6

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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 thesix months ended June 30, 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 six months ended June 30, 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 six months ended June 30, 2002represent actual results for the period.

 
|                                    |   | **Six months  ended** |        |
|-----------------------------------------|--------|-----------------------|-------------|
|                                    |   | **June 30,  2002**    |        | **June 30,  2001** |   |
| Net sales                               |   | $                     | 568,182,000 |   | $ | 570,736,000 |   |
| Net earnings  before extraordinary item |   | 12,675,000            |        | 6,975,000 |   |
|                                         |        |                       |             |  |  |  |  |

 

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 June 30, 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 June 30th.

 

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 June 30, 2001 and the three and six month periodsended June 30, 2002 have been prepared in accordance with Regulation S-Xpursuant to the rules and regulations of the SEC using the new basis of assetsand 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 operationsfor the periods indicated. The historical financial results of the Company andPredecessor are not necessarily indicative of their results for a full 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, *Business Combinations*, andSFAS 142, *Goodwilland Other Intangible Assets*. SFAS 141 is effective for all business combinations completed after June30, 2001.  SFAS 142 is effective forfiscal years beginning after December 15, 2001; however, certain provisions ofthis Statement apply to goodwill and other intangible assets acquired betweenJuly 1, 2001 and the effective date of SFAS 142.  We adopted the provisions of SFAS 142 as of January 1, 2002 andhad no acquisitions between July 1, 2001 and January 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 are 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 at January 1, 2002.  Duringthe second quarter of fiscal 2002, we completed the transitional impairmenttest of goodwill and other intangibles with no impairment indicated at January1, 2002.

 

Our carrying amount, net of accumulated amortization, for goodwill asof June 30, 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           |   | 49,516,000 |        |
| Dairy Products            |   | 1,763,000  |        |

 

The carrying amounts, net of accumulated amortization, for otherindefinite-lived intangible assets (trademarks) as of June 30, 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.

 
|                                  |   | **Six months  ended  June 30,  2002** |       | **Three  months ended  June 30,  2001** |   | **Three  months ended  March 31,  2001** |   |
|---------------------------------------|--------|---------------------------------------|------------|-----------------------------------------|--------|------------------------------------------|--------|
|                                  |   | **(Company)**                         |       | **(Predecessor**)                       |   |
| Reported net  earnings (loss)         |   | $                                     | 12,675,000 |                                    | $      | 1,669,000                                |   | $ | (5,653,000 | ) |
| Add back:  goodwill amortization |   | —                                |       | 2,191,000                               |   | 885,000                                  |   |
| Adjusted net  earnings (loss)         |   | $                                     | 12,675,000 |                                    | $      | 3,860,000                                |   | $ | (4,768,000 | ) |

 

Our acquired intangible assets that have been determined to have adefinite life and continue to be amortized as of June 30, 2002 are as follows:

 
|                     |   | **Gross  Carrying  Amount** |      | **Accumulated    Amortization** |   |
|--------------------------|--------|-----------------------------|-----------|---------------------------------|--------|
| Licenses and non-compete |   | $                           | 2,526,000 |                            | $      | (994,000 | ) |
|                          |        |                             |           |                                 |        |  |  |

 

The aggregate amortization expense for the six months ended June 30,2002 was approximately $360,000 and $179,000 for the three months ended June30, 2001.  The Predecessor hadamortization expense of approximately $500,000 during the three months endedMarch 31, 2001.  The estimatedamortization expense for the years ended December 31, 2002 through December 31,2006 is as follows:

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

 

8

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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:

 
|                                |   | **June 30,  2002** |       | **December  31,  2001** |   |
|-------------------------------------|--------|--------------------|------------|-------------------------|--------|
| Raw materials  and supplies         |   | $                  | 17,374,000 |                    | $      | 15,347,000 |   |
| Work in process  and finished goods |   | 45,004,000         |       | 43,027,000              |   |
| Flocks                              |   | 19,672,000         |       | 20,567,000              |   |
|                                |   | $                  | 82,050,000 |                    | $      | 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 from18 to 72 months with prices primarily indexed to grain or Urner Barry marketindices. No single egg supplier provides more than 10% of our egg requirements.

 

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 royalties payable to us and the patent holderon all future product sold. In connection with this settlement, the patentholder received a lump sum payment for the past production and sale of theproduct 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.

 

9

----

 

NOTE F - COMPREHENSIVE INCOME (LOSS)

 

The components and changes in accumulated other comprehensive loss(AOCL), net of taxes, during the six months ended June 30, 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   |   | —                |             | 1,326,000                          |    | 1,326,000       |   |
| Net unrealized change on cash flow hedges  |   | (262,000              | )           | —                             |    | (262,000        | )      |
| Balance at June  30, 2002                  |   | $                     |  (3,818,000 | )                                  | $       |  1,265,000 |   | $ |  (2,553,000 | ) |
|                                       |   |                  |             |                               |    |            |   |
| Balance at April  1, 2001                  |   | $                     |  —     |                               | $       |  —    |   | $ |  — |   |
| Predecessor  carry-over basis              |   | (506,000              | )           | (71,000                            | )  | (577,000        | )      |
| Foreign currency  translation adjustment   |   | —                |             | (27,000                            | )  | (27,000         | )      |
| Net unrealized  change on cash flow hedges |   | 283,000               |             | —                             |    | 283,000         |   |
| Less  reclassification adjustments         |   | 92,000                |             | —                             |    | 92,000          |   |
| Balance at June  30, 2001                  |   | $                     |  (131,000   | )                                  | $       |  (98,000   | )      | $ |  (229,000 | ) |

 
|                                                       |   | **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

----

 

Comprehensive income (loss), net of taxes, for the six months endedJune 30, 2002 and for the three months ended June 30, 2001 and for thepredecessor’s three months ended March 31, 2001 was as follows:

 
| COMPANY                                                              |   |       |   |      |       |
|----------------------------------------------------------------------|--------|------------|--------|-----------|------------|
| Net income for  the six months ended June 30, 2002                   |   |       |   | $         | 12,675,000 |   |
| Net gains (loss)  arising during the period from cash flow hedges:   |   |       |   |      |       |
| Net unrealized  derivative losses during period                      |   | (262,000   | )      |      |       |
| Foreign currency  translation adjustment                             |   | 1,326,000  |   |      |       |
|                                                                 |   |       |   |      |       |
| Other  comprehensive income                                          |   |       |   | 1,064,000 |       |
|                                                                 |   |       |   |      |       |
| Comprehensive  income for the six months ended June 30, 2002         |   |       |   | $         | 13,739,000 |   |
|                                                                 |   |       |   |      |       |
| Net income for  the three months ended June 30, 2001                 |   |       |   | $         | 1,669,000  |   |
| Net gains  (losses) arising during the period from cash flow hedges: |   |       |   |      |       |
| Net unrealized  derivative losses during period                      |   | 283,000    |   |      |       |
| Reclassification  adjustment                                         |   | 92,000     |   |      |       |
| Foreign currency  translation adjustment                             |   | (27,000    | )      |      |       |
|                                                                 |   |       |   |      |       |
| Other  comprehensive income                                          |   |       |   | 348,000   |       |
|                                                                 |   |       |   |      |       |
| Comprehensive  income for the three months ended June 30, 2001       |   |       |   | $         | 2,017,000  |   |
|                                                                 |   |       |   |      |       |
| 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 | ) |
|                                                                      |        |            |        |           |            |  |  |

 

11

----

 

 

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 JUNE 30, 2002: |   |              |    |   |   |   |   |   |   |   |   |   |   |
| External net  sales                          |   | $                 | 161,888 |   | $ | 57,202 |   | $ | 53,122 |   | $ | 17,541 |   | N/A |   | $ | 289,753 |   |
| Intersegment  sales                          |   | 1,728             |    | — |   | — |   | 731 |   | N/A |   | 2,459 |   |
| Operating profit  (loss)                     |   | 18,002            |    | 2,265 |   | 3,778 |   | 2,117 |   | (1,784 | ) | 24,378 |   |
| Depreciation and  amortization               |   | 10,877            |    | 546 |   | 1,166 |   | 1,165 |   | 10 |   | 13,764 |   |
|                                         |   |              |    |   |   |   |   |   |   |   |   |   |   |
| THREE MONTHS  ENDED JUNE 30, 2001: |   |              |    |   |   |   |   |   |   |   |   |   |   |
| External net  sales                          |   | $                 | 162,582 |   | $ | 64,431 |   | $ | 51,821 |   | $ | 16,275 |   | N/A |   | $ | 295,109 |   |
| Intersegment  sales                          |   | 2,862             |    | 1 |   | — |   | 845 |   | N/A |   | 3,708 |   |
| Operating profit  (loss)                     |   | 15,530            |    | 2,235 |   | 1,999 |   | 1,559 |   | (1,363 | ) | 19,960 |   |
| Depreciation and  amortization               |   | 12,380            |    | 642 |   | 1,010 |   | 1,561 |   | 10 |   | 15,603 |   |
|                                         |   |              |    |   |   |   |   |   |   |   |   |   |   |
| SIX MONTHS ENDED  JUNE 30, 2002:   |   |              |    |   |   |   |   |   |   |   |   |   |   |
| External net  sales                          |   | $                 | 317,074 |   | $ | 120,208 |   | $ | 96,302 |   | $ | 34,598 |   | N/A |   | $ | 568,182 |   |
| Intersegment  sales                          |   | 5,773             |    | — |   | — |   | 1,623 |   | N/A |   | 7,396 |   |
| Operating profit  (loss)                     |   | 34,994            |    | 4,558 |   | 5,609 |   | 4,431 |   | (3,721 | ) | 45,871 |   |
| Depreciation and  amortization               |   | 21,755            |    | 983 |   | 2,206 |   | 2,329 |   | 20 |   | 27,293 |   |

 
|                                          |   | **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 June 30, 2002 and December 31, 2001, thestatements of earnings for the three and six months ended June 30, 2002, andthe statements of cash flows for the six months ended June 30, 2002; and thePredecessor’s consolidated statements of earnings and cash flows for the threemonths ended March 31, 2001. These financial statements reflect Michael Foods,Inc. (the parent), the wholly owned guarantor subsidiaries (on a combinedbasis), the non-wholly owned guarantor subsidiaries, and elimination entriesnecessary to combine such entities on a consolidated basis. Included elsewherein this Form 10-Q are the unaudited financial statements of the non-whollyowned guarantor subsidiaries.

 

12

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COMPANY

UNAUDITED CONDENSEDCONSOLIDATING BALANCE SHEETS

JUNE 30, 2002

(in thousands)

 
|                                             |   | **PARENT**                    |    | **WHOLLY  OWNED  GUARANTOR  SUBSIDIARIES** |   | **NON-WHOLLY  OWNED  GUARANTOR SUBSIDIARIES** |   | **ELIMINATIONS** |   | **CONSOLIDATED** |   |
|--------------------------------------------------|--------|-------------------------------|---------|--------------------------------------------|--------|-----------------------------------------------|--------|------------------|--------|------------------|--------|
| **M-FOODS  DAIRY,  LLC**                         |   | **M-FOODS  DAIRY  TXCT, LLC** |
| ASSETS                                           |   |                          |    |                                       |   |                                          |   |             |   |             |   |   |   |
| Current Assets:                                  |   |                          |    |                                       |   |                                          |   |             |   |             |   |   |   |
| Cash and  equivalents                            |   | $                             | 42,314  |                                       | $      | (3,344                                        | )      | $                | — |             | $      | — |   | $ | — |   | $ | 38,970 |   |
| Accounts  receivable, less allowances            |   | 242                           |    | 81,003                                     |   | 8,390                                         |   | 7,220            |   | (1,358           | )      | 95,497 |   |
| Inventories                                      |   | —                        |    | 72,845                                     |   | 4,557                                         |   | 4,648            |   | —           |   | 82,050 |   |
| Notes receivable  - related party                |   | —                        |    | 2,437                                      |   | —                                        |   | —           |   | (2,437           | )      | — |   |
| Prepaid expenses  and other                      |   | 345                           |    | 9,661                                      |   | 339                                           |   | 109              |   | —           |   | 10,454 |   |
| Total current  assets                            |   | 42,901                        |    | 162,602                                    |   | 13,286                                        |   | 11,977           |   | (3,795           | )      | 226,971 |   |
| Property, Plant  and Equipment - net             |   | 59                            |    | 249,112                                    |   | 17,844                                        |   | 11,468           |   | —           |   | 278,483 |   |
| Other assets:                                    |   |                          |    |                                       |   |                                          |   |             |   |             |   |   |   |
| Goodwill, net                                    |   | —                        |    | 339,258                                    |   | 1,763                                         |   | —           |   | —           |   | 341,021 |   |
| Preferred return  receivable for subs            |   | —                        |    | 12,676                                     |   | —                                        |   | —           |   | (12,676          | )      | — |   |
| Joint ventures  and other assets                 |   | 18,103                        |    | 24,858                                     |   | 162                                           |   | 793              |   | —           |   | 43,916 |   |
| Investment in  subsidiaries                      |   | 625,800                       |    | —                                     |   | —                                        |   | —           |   | (625,800         | )      | — |   |
|                                             |   | 643,903                       |    | 376,792                                    |   | 1,925                                         |   | 793              |   | (638,476         | )      | 384,937 |   |
|                                             |   | $                             | 686,863 |                                       | $      | 788,506                                       |   | $                | 33,055 |             | $      | 24,238 |   | $ | (642,271 | ) | $ | 890,391 |   |
|                                             |   |                          |    |                                       |   |                                          |   |             |   |             |   |   |   |
| LIABILITIES  AND  SHAREHOLDERS’ EQUITY |   |                          |    |                                       |   |                                          |   |             |   |             |   |   |   |
| Current Liabilities:                             |   |                          |    |                                       |   |                                          |   |             |   |             |   |   |   |
| Current  maturities of long-term debt            |   | $                             | 14,283  |                                       | $      | 242                                           |   | $                | — |             | $      | 2,400 |   | $ | — |   | $ | 16,925 |   |
| Accounts payable                                 |   | 82                            |    | 52,829                                     |   | 4,142                                         |   | 5,739            |   | (1,358           | )      | 61,434 |   |
| Notes payable -  related party                   |   | —                        |    | —                                     |   | 685                                           |   | 1,844            |   | (2,529           | )      | — |   |
| Accrued  liabilities                             |   | 34,995                        |    | 44,119                                     |   | 2,606                                         |   | 929              |   | 92               |   | 82,741 |   |
| Total current  liabilities                       |   | 49,360                        |    | 97,190                                     |   | 7,433                                         |   | 10,912           |   | (3,795           | )      | 161,100 |   |
| Long-term debt,  less current maturities         |   | 472,932                       |    | 40,180                                     |   | —                                        |   | —           |   | —           |   | 513,112 |   |
| Deferred income  taxes                           |   | (2,633                        | )       | 51,608                                     |   | —                                        |   | —           |   | —           |   | 48,975 |   |
| Preferred  shareholder return payable            |   | —                        |    | —                                     |   | 11,500                                        |   | 1,176            |   | (12,676          | )      | — |   |
| Non-controlling  interest                        |   | 475                           |    | —                                     |   | —                                        |   | —           |   | —           |   | 475 |   |
| Total  liabilities                               |   | 520,134                       |    | 188,978                                    |   | 18,933                                        |   | 12,088           |   | (16,471          | )      | 723,662 |   |
| Shareholders’  Equity                       |   | 166,729                       |    | 599,528                                    |   | 14,122                                        |   | 12,150           |   | (625,800         | )      | 166,729 |   |
|                                             |   | $                             | 686,863 |                                       | $      | 788,506                                       |   | $                | 33,055 |             | $      | 24,238 |   | $ | (642,271 | ) | $ | 890,391 |   |

 

13

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COMPANY

UNAUDITED CONDENSEDCONSOLIDATING BALANCE SHEETS

DECEMBER 31, 2001

(in thousands)

 
|                                             |   | **PARENT**                    |    | **WHOLLY  OWNED  GUARANTOR  SUBSIDIARIES** |   | **NON-WHOLLY  OWNED  GUARANTOR SUBSIDIARIES** |   | **ELIMINATIONS** |   | **CONSOLIDATED** |   |
|--------------------------------------------------|--------|-------------------------------|---------|--------------------------------------------|--------|-----------------------------------------------|--------|------------------|--------|------------------|--------|
| **M-FOODS  DAIRY,  LLC**                         |   | **M-FOODS  DAIRY  TXCT, LLC** |
| Assets                                           |   |                          |    |                                       |   |                                          |   |             |   |             |   |   |   |
| Current Assets                                   |   |                          |    |                                       |   |                                          |   |             |   |             |   |   |   |
| Cash and  equivalents                            |   | $                             | 33,947  |                                       | $      | (6,287                                        | )      | $                | — |             | $      | — |   | $ | — |   | $ | 27,660 |   |
| Accounts  receivable, 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 |   |

 

14

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COMPANY

UNAUDITED CONDENSEDCONSOLIDATING EARNINGS STATEMENTS

THREE MONTHS ENDED JUNE30, 2002

(in thousands)

 
|                                                                        |   | **PARENT**                    |   | **WHOLLY  OWNED  GUARANTOR  SUBSIDIARIES** |   | **NON-WHOLLY  OWNED  GUARANTOR SUBSIDIARIES** |   | **ELIMINATIONS** |   | **CONSOLIDATED** |   |
|-----------------------------------------------------------------------------|--------|-------------------------------|--------|--------------------------------------------|--------|-----------------------------------------------|--------|------------------|--------|------------------|--------|
| **M-FOODS  DAIRY,  LLC**                                                    |   | **M-FOODS  DAIRY  TXCT, LLC** |
| Net sales                                                                   |   | $                             | — |                                       | $      | 239,090                                       |   | $                | 27,975 |             | $      | 25,147 |   | $ | (2,459 | ) | $ | 289,753 |   |
| Cost of sales                                                               |   | —                        |   | 190,879                                    |   | 24,277                                        |   | 22,852           |   | (2,459           | )      | 235,549 |   |
| Gross profit                                                                |   | —                        |   | 48,211                                     |   | 3,698                                         |   | 2,295            |   | —           |   | 54,204 |   |
| Selling, general  and administrative expenses                               |   | 1,784                         |   | 26,802                                     |   | 1,442                                         |   | 976              |   | (1,178           | )      | 29,826 |   |
| Operating profit  (loss)                                                    |   | (1,784                        | )      | 21,409                                     |   | 2,256                                         |   | 1,319            |   | 1,178            |   | 24,378 |   |
| Interest  expense, net                                                      |   | 11,500                        |   | 773                                        |   | 35                                            |   | 24               |   | —           |   | 12,332 |   |
| Other income                                                                |   | 1,178                         |   | —                                     |   | —                                        |   | —           |   | (1,178           | )      | — |   |
| Earnings (loss)  before equity in earnings of subsidiaries and income taxes |   | (12,106                       | )      | 20,636                                     |   | 2,221                                         |   | 1,295            |   | —           |   | 12,046 |   |
| Equity in  earnings of subsidiary                                           |   | 14,682                        |   | 3,516                                      |   | (2,221                                        | )      | (1,295           | )      | (14,682          | )      | — |   |
| Earnings before  income taxes                                               |   | 2,576                         |   | 24,152                                     |   | —                                        |   | —           |   | (14,682          | )      | 12,046 |   |
| Income tax  expense (benefit)                                               |   | (4,740                        | )      | 9,470                                      |   | —                                        |   | —           |   | —           |   | 4,730 |   |
| NET EARNINGS  (LOSS)                                                        |   | 7,316                         |   | 14,682                                     |   | —                                        |   | —           |   | (14,682          | )      | 7,316 |   |
| Other  comprehensive income (loss):                                         |   |                          |   |                                       |   |                                          |   |             |   |             |   |   |   |
| Change in  foreign currency translation                                     |   | —                        |   | 1,315                                      |   | —                                        |   | —           |   | —           |   | 1,315 |   |
| Change in cash  flow hedges                                                 |   | (2,499                        | )      | 1,350                                      |   | —                                        |   | —           |   | —           |   | (1,149 | ) |
| Comprehensive income  (loss)                                                |   | $                             | 4,817  |                                       | $      | 17,347                                        |   | $                | — |             | $      | — |   | $ | (14,682 | ) | $ | 7,482 |   |

 

COMPANY

UNAUDITED CONDENSEDCONSOLIDATING EARNINGS STATEMENTS

THREE MONTHS ENDED JUNE30, 2001

(in thousands)

 
|                                                                        |   | **PARENT**                    |   | **WHOLLY  OWNED  GUARANTOR  SUBSIDIARIES** |   | **NON-WHOLLY  OWNED  GUARANTOR SUBSIDIARIES** |   | **ELIMINATIONS** |   | **CONSOLIDATED** |   |
|-----------------------------------------------------------------------------|--------|-------------------------------|--------|--------------------------------------------|--------|-----------------------------------------------|--------|------------------|--------|------------------|--------|
| **M-FOODS  DAIRY,  LLC**                                                    |   | **M-FOODS  DAIRY  TXCT, LLC** |
| Net sales                                                                   |   | $                             | — |                                       | $      | 246,996                                       |   | $                | 22,942 |             | $      | 28,879 |   | $ | (3,708 | ) | $ | 295,109 |   |
| Cost of sales                                                               |   | —                        |   | 200,876                                    |   | 20,128                                        |   | 27,559           |   | (3,708           | )      | 244,855 |   |
| Gross profit                                                                |   | —                        |   | 46,120                                     |   | 2,814                                         |   | 1,320            |   | —           |   | 50,254 |   |
| Selling, general  and administrative expenses                               |   | 1,363                         |   | 27,852                                     |   | 965                                           |   | 1,405            |   | (1,291           | )      | 30,294 |   |
| Operating profit  (loss)                                                    |   | (1,363                        | )      | 18,268                                     |   | 1,849                                         |   | (85              | )      | 1,291            |   | 19,960 |   |
| Interest  expense, net                                                      |   | 16,247                        |   | 100                                        |   | (53                                           | )      | (53              | )      | —           |   | 16,241 |   |
| Other income                                                                |   | 1,291                         |   | —                                     |   | —                                        |   | —           |   | (1,291           | )      | — |   |
| Earnings (loss)  before equity in earnings of subsidiaries and income taxes |   | (16,319                       | )      | 18,168                                     |   | 1,902                                         |   | (32              | )      | —           |   | 3,719 |   |
| Equity in  earnings of subsidiary                                           |   | 9,013                         |   | 1,870                                      |   | (1,902                                        | )      | 32               |   | (9,013           | )      | — |   |
| Earnings before  income taxes                                               |   | (7,306                        | )      | 20,038                                     |   | —                                        |   | —           |   | (9,013           | )      | 3,719 |   |
| Income tax  expense (benefit)                                               |   | (8,975                        | )      | 11,025                                     |   | —                                        |   | —           |   | —           |   | 2,050 |   |
| NET EARNINGS  (LOSS)                                                        |   | 1,669                         |   | 9,013                                      |   | —                                        |   | —           |   | (9,013           | )      | 1,669 |   |
| Other  comprehensive income (loss):                                         |   |                          |   |                                       |   |                                          |   |             |   |             |   |   |   |
| Change in  foreign currency translation                                     |   | —                        |   | (27                                        | )      | —                                        |   | —           |   | —           |   | (27 | ) |
| Change in cash  flow hedges                                                 |   | —                        |   | 375                                        |   | —                                        |   | —           |   | —           |   | 375 |   |
| Comprehensive  income (loss)                                                |   | $                             | 1,669  |                                       | $      | 9,361                                         |   | $                | — |             | $      | — |   | $ | (9,013 | ) | $ | 2,017 |   |

 

15

----

 

COMPANY

UNAUDITED CONDENSEDCONSOLIDATING EARNINGS STATEMENTS

SIX MONTHS ENDED JUNE 30,2002

(in thousands)

 
|                                                                        |   | **PARENT**                    |   | **WHOLLY  OWNED  GUARANTOR  SUBSIDIARIES** |   | **NON-WHOLLY  OWNED  GUARANTOR SUBSIDIARIES** |   | **ELIMINATIONS** |   | **CONSOLIDATED** |   |
|-----------------------------------------------------------------------------|--------|-------------------------------|--------|--------------------------------------------|--------|-----------------------------------------------|--------|------------------|--------|------------------|--------|
| **M-FOODS  DAIRY,  LLC**                                                    |   | **M-FOODS  DAIRY  TXCT, LLC** |
| Net sales                                                                   |   | $                             | — |                                       | $      | 479,276                                       |   | $                | 51,825 |             | $      | 44,477 |   | $ | (7,396 | ) | $ | 568,182 |   |
| Cost of sales                                                               |   | —                        |   | 384,014                                    |   | 44,905                                        |   | 41,339           |   | (7,396           | )      | 462,862 |   |
| Gross profit                                                                |   | —                        |   | 95,262                                     |   | 6,920                                         |   | 3,138            |   | —           |   | 105,320 |   |
| Selling, general  and administrative expenses                               |   | 3,721                         |   | 53,261                                     |   | 2,857                                         |   | 1,994            |   | (2,384           | )      | 59,449 |   |
| Operating profit  (loss)                                                    |   | (3,721                        | )      | 42,001                                     |   | 4,063                                         |   | 1,144            |   | 2,384            |   | 45,871 |   |
| Interest  expense, net                                                      |   | 23,300                        |   | 1,604                                      |   | 63                                            |   | 29               |   | —           |   | 24,996 |   |
| Other income                                                                |   | 2,384                         |   | —                                     |   | —                                        |   | —           |   | (2,384           | )      | — |   |
| Earnings (loss)  before equity in earnings of subsidiaries and income taxes |   | (24,637                       | )      | 40,397                                     |   | 4,000                                         |   | 1,115            |   | —           |   | 20,875 |   |
| Equity in  earnings of subsidiary                                           |   | 27,662                        |   | 5,115                                      |   | (4,000                                        | )      | (1,115           | )      | (27,662          | )      | — |   |
| Earnings before  income taxes                                               |   | 3,025                         |   | 45,512                                     |   | —                                        |   | —           |   | (27,662          | )      | 20,875 |   |
| Income tax  expense (benefit)                                               |   | (9,650                        | )      | 17,850                                     |   | —                                        |   | —           |   | —           |   | 8,200 |   |
| NET EARNINGS  (LOSS)                                                        |   | 12,675                        |   | 27,662                                     |   | —                                        |   | —           |   | (27,662          | )      | 12,675 |   |
| Other  comprehensive income (loss):                                         |   |                          |   |                                       |   |                                          |   |             |   |             |   |   |   |
| Change in foreign  currency translation                                     |   | —                        |   | 1,326                                      |   | —                                        |   | —           |   | —           |   | 1,326 |   |
| Change in cash  flow hedges                                                 |   | (2,707                        | )      | 2,445                                      |   | —                                        |   | —           |   | —           |   | (262 | ) |
| Comprehensive  income (loss)                                                |   | $                             | 9,968  |                                       | $      | 31,433                                        |   | $                | — |             | $      | — |   | $ | (27,662 | ) | $ | 13,739 |   |

 

16

----

 

PREDECESSOR

UNAUDITED CONDENSEDCONSOLIDATING EARNINGS STATEMENTS

THREE MONTHS ENDED MARCH31, 2001

(in thousands)

 
|                                                                                              |   | **PARENT**                    |   | **WHOLLY  OWNED  GUARANTOR  SUBSIDIARIES** |   | **NON-WHOLLY  OWNED  GUARANTOR SUBSIDIARIES** |   | **ELIMINATIONS** |   | **CONSOLIDATED** |   |
|---------------------------------------------------------------------------------------------------|--------|-------------------------------|--------|--------------------------------------------|--------|-----------------------------------------------|--------|------------------|--------|------------------|--------|
| **M-FOODS  DAIRY,  LLC**                                                                          |   | **M-FOODS  DAIRY  TXCT, LLC** |
| Net sales                                                                                         |   | $                             | — |                                       | $      | 245,548                                       |   | $                | 17,684 |             | $      | 17,644 |   | $ | (5,249 | ) | $ | 275,627 |   |
| Cost of sales                                                                                     |   | —                        |   | 200,854                                    |   | 14,994                                        |   | 17,108           |   | (5,249           | )      | 227,707 |   |
| Gross profit                                                                                      |   | —                        |   | 44,694                                     |   | 2,690                                         |   | 536              |   | —           |   | 47,920 |   |
| Selling, general  and administrative expenses                                                     |   | 1,656                         |   | 27,720                                     |   | 1,027                                         |   | 1,712            |   | (1,522           | )      | 30,593 |   |
| Recall insurance  settlement                                                                      |   | —                        |   | —                                     |   | (3,217                                        | )      | —           |   | —           |   | (3,217 | ) |
| Transaction  costs                                                                                |   | 11,050                        |   | —                                     |   | —                                        |   | —           |   | —           |   | 11,050 |   |
| Operating profit  (loss)                                                                          |   | (12,706                       | )      | 16,974                                     |   | 4,880                                         |   | (1,176           | )      | 1,522            |   | 9,494 |   |
| Interest  (income) expense, net                                                                   |   | 3,308                         |   | (14                                        | )      | (1                                            | )      | —           |   | —           |   | 3,293 |   |
| Other income                                                                                      |   | 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 | ) |

 

17

----

 

COMPANY

UNAUDITED CONDENSEDCONSOLIDATING STATEMENTS OF CASH FLOWS

SIX MONTHS ENDED JUNE 30,2002

(in thousands)

 
|                                            |   | **PARENT**                    |   | **WHOLLY  OWNED  GUARANTOR  SUBSIDIARIES** |   | **NON-WHOLLY  OWNED  GUARANTOR SUBSIDIARIES** |   | **CONSOLIDATED** |   |
|-------------------------------------------------|--------|-------------------------------|--------|--------------------------------------------|--------|-----------------------------------------------|--------|------------------|--------|
| **M-FOODS  DAIRY,  LLC**                        |   | **M-FOODS  DAIRY  TXCT, LLC** |
| Net cash  provided by operating activities      |   | $                             | 15,431 |                                       | $      | 24,125                                        |   | $                | 4,943  |   | $ | 3,734 |   | $ | 48,233 |   |
| Cash flows from  investing activities:          |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Capital  expenditures                           |   | —                        |   | (10,192                                    | )      | (3,124                                        | )      | (947             | )      | (14,263 | ) |
| Investments in  joint ventures and other assets |   | (156                          | )      | 714                                        |   | (161                                          | )      | —           |   | 397 |   |
|                                            |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Net cash used in  investing activities          |   | (156                          | )      | (9,478                                     | )      | (3,285                                        | )      | (947             | )      | (13,866 | ) |
|                                            |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Cash flows from  financing activities:          |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Payments on  notes payable                      |   | (5,000                        | )      | —                                     |   | —                                        |   | —           |   | (5,000 | ) |
| Payments on  long-term debt                     |   | (15,507                       | )      | (150                                       | )      | —                                        |   | (2,400           | )      | (18,057 | ) |
| Investment in  subsidiaries                     |   | 13,599                        |   | (11,554                                    | )      | (1,658                                        | )      | (387             | )      | — |   |
| Net cash used in  financing activities          |   | (6,908                        | )      | (11,704                                    | )      | (1,658                                        | )      | (2,787           | )      | (23,057 | ) |
| Net increase in  cash and equivalents           |   | 8,367                         |   | 2,943                                      |   | —                                        |   | —           |   | 11,310 |   |
| Cash and  equivalents at beginning of period    |   | 33,947                        |   | (6,287                                     | )      | —                                        |   | —           |   | 27,660 |   |
| Cash and  equivalents at end of period          |   | $                             | 42,314 |                                       | $      | (3,344                                        | )      | $                | — |   | $ | — |   | $ | 38,970 |   |

 

COMPANY

UNAUDITED CONDENSEDCONSOLIDATING STATEMENTS OF CASH FLOWS

THREE MONTHS ENDED JUNE30, 2001

(in thousands)

 

|                                                 |   | **PARENT**                    |   | **WHOLLY  OWNED  GUARANTOR  SUBSIDIARIES** |   | **NON-WHOLLY  OWNED  GUARANTOR SUBSIDIARIES** |   | **CONSOLIDATED** |   |
|------------------------------------------------------|--------|-------------------------------|--------|--------------------------------------------|--------|-----------------------------------------------|--------|------------------|--------|
| **M-FOODS  DAIRY,  LLC**                             |   | **M-FOODS  DAIRY  TXCT, LLC** |
| Net cash  provided by operating activities           |   | $                             | 11,625 |                                       | $      | 22,884                                        |   | $                | 1,136  |   | $ | 3,692 |   | $ | 39,337 |   |
| Cash flows from  investing activities:               |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Capital  expenditures                                |   | (9                            | )      | (3,855                                     | )      | (1,143                                        | )      | (1,292           | )      | (6,299 | ) |
| Business  acquisition                                |   | (626,925                      | )      | —                                     |   | —                                        |   | —           |   | (626,925 | ) |
| Investments in  joint ventures and other assets      |   | (244                          | )      | (242                                       | )      | —                                        |   | —           |   | (486 | ) |
|                                                 |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Net cash used in  investing activities               |   | (627,178                      | )      | (4,097                                     | )      | (1,143                                        | )      | (1,292           | )      | (633,710 | ) |
|                                                 |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Cash flows from  financing activities:               |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Payments on  notes payable                           |   | (46,450                       | )      | —                                     |   | —                                        |   | —           |   | (46,450 | ) |
| Proceeds on  notes payable                           |   | 29,500                        |   | —                                     |   | —                                        |   | —           |   | 29,500 |   |
| Payments on  long-term debt                          |   | (125,000                      | )      | (79                                        | )      | —                                        |   | (2,400           | )      | (127,479 | ) |
| Proceeds from  long-term debt                        |   | 570,000                       |   | —                                     |   | —                                        |   | —           |   | 570,000 |   |
| Proceeds from  issuance of stock                     |   | 174,800                       |   | —                                     |   | —                                        |   | —           |   | 174,800 |   |
| Investment in  subsidiaries                          |   | 20,848                        |   | (20,848                                    | )      | —                                        |   | —           |   | — |   |
| Net cash  provided by (used in) financing activities |   | 623,698                       |   | (20,927                                    | )      | —                                        |   | (2,400           | )      | 600,371 |   |
| Net increase  (decrease) in cash and equivalents     |   | 8,145                         |   | (2,140                                     | )      | (7                                            | )      | —           |   | 5,998 |   |
| Cash and  equivalents at beginning of period         |   | 4,327                         |   | (64                                        | )      | 7                                             |   | —           |   | 4,270 |   |
| Cash and  equivalents at end of period               |   | $                             | 12,472 |                                       | $      | (2,204                                        | )      | $                | — |   | $ | — |   | $ | 10,268 |   |

 

18

----

 

PREDECESSOR

UNAUDITED CONDENSEDCONSOLIDATING STATEMENTS OF CASH FLOWS

THREE MONTHS ENDED MARCH31, 2001

(in thousands)

 
|                                                 |   | **PARENT**                    |   | **WHOLLY  OWNED  GUARANTOR  SUBSIDIARIES** |   | **NON-WHOLLY  OWNED  GUARANTOR SUBSIDIARIES** |   | **CONSOLIDATED** |   |
|------------------------------------------------------|--------|-------------------------------|--------|--------------------------------------------|--------|-----------------------------------------------|--------|------------------|--------|
| **M-FOODS  DAIRY,  LLC**                             |   | **M-FOODS  DAIRY  TXCT, LLC** |
| Net cash  provided by (used in) operating activities |   | $                             | 12,000 |                                       | $      | 4,487                                         |   | $                | (2,440 | ) | $ | (31 | ) | $ | 14,016 |   |
| Cash flows from  investing activities:               |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Capital  expenditures                                |   | —                        |   | (4,923                                     | )      | (3,664                                        | )      | (2,250           | )      | (10,837 | ) |
| Investments in  joint ventures and other assets      |   | 434                           |   | 3,454                                      |   | —                                        |   | —           |   | 3,888 |   |
| Net cash  provided by (used in) investing activities |   | 434                           |   | (1,469                                     | )      | (3,664                                        | )      | (2,250           | )      | (6,949 | ) |
| Cash flows from  financing activities:               |   |                          |   |                                       |   |                                          |   |             |   |   |   |
| Payments on  notes payable                           |   | (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 |   |

 

19

----

 

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 |

 

20

----

 

M-FOODS DAIRY, LLC

(A MAJORITY OWNEDSUBSIDIARY OF MICHAEL FOODS, INC.)

BALANCE SHEETS

(unaudited, in thousands)

 
|                                                   |   | **JUNE 30,  2002** |       | **DECEMBER  31, 2001** |       |
|--------------------------------------------------------|--------|--------------------|------------|------------------------|------------|
| ASSETS                                                 |   |               |       |                   |       |
| CURRENT ASSETS                                         |   |               |       |                   |       |
| Accounts  receivable, less allowances                  |   | $                  | 8,390      |                   | $          | 6,535 |   |
| Inventories                                            |   | 4,557              |       | 3,592                  |       |
| Prepaid expenses  and other                            |   | 339                |       | 496                    |       |
| Total current  assets                                  |   | 13,286             |       | 10,623                 |       |
| PROPERTY, PLANT  AND EQUIPMENT - AT COST               |   |               |       |                   |       |
| Land                                                   |   | 855                |       | 855                    |       |
| Buildings and  improvements                            |   | 4,209              |       | 3,999                  |       |
| Machinery and  equipment                               |   | 14,965             |       | 12,051                 |       |
|                                                   |   | 20,029             |       | 16,905                 |       |
| Less accumulated  depreciation                         |   | 2,185              |       | 1,248                  |       |
|                                                   |   | 17,844             |       | 15,657                 |       |
| OTHER ASSETS                                           |   |               |       |                   |       |
| Goodwill, net                                          |   | 1,763              |       | 1,763                  |       |
| Other assets                                           |   | 162                |       | —                 |       |
|                                                   |   | 1,925              |       | 1,763                  |       |
|                                                   |   | $                  | 33,055     |                   | $          | 28,043 |   |
|                                                   |   |               |       |                   |       |
| LIABILITIES AND UNIT HOLDER AND OPERATING UNIT  EQUITY |   |               |       |                   |       |
| CURRENT LIABILITIES                                    |   |               | ** ** |                   | ** ** |
| Accounts payable                                       |   | $                  | 4,142      |                   | $          | 2,612 |   |
| Note payable -  related party                          |   | 685                |       | —                 |       |
| Accrued  liabilities:                                  |   |               |       |                   |       |
| Compensation                                           |   | 545                |       | 688                    |       |
| Insurance                                              |   | 128                |       | 124                    |       |
| Customer  programs                                     |   | 783                |       | 836                    |       |
| Other                                                  |   | 1,150              |       | 503                    |       |
| Total current  liabilities                             |   | 7,433              |       | 4,763                  |       |
| COMMITMENTS AND  CONTINGENCIES                         |   | —             |       | —                 |       |
| PREFERRED UNIT  HOLDER RETURN PAYABLE                  |   | 11,500             |       | 7,500                  |       |
| UNIT HOLDER AND  OPERATING UNIT EQUITY                 |   | 14,122             |       | 15,780                 |       |
|                                                   |   | $                  | 33,055     |                   | $          | 28,043 |   |

 

The accompanying notes are an integral part of these statements.

 

21

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M-FOODS DAIRY, LLC

(A MAJORITY OWNEDSUBSIDIARY OF MICHAEL FOODS, INC.)

STATEMENTS OF EARNINGS

FOR THE THREE MONTHSENDED JUNE 30,

(unaudited, in thousands)

 
|                                          |   | **2002** |   | **2001** |   |
|-----------------------------------------------|--------|----------|--------|----------|--------|
| Net sales                                     |   | $        | 27,975 |     | $      | 22,942 |   |
|                                          |   |     |   |     |   |
| Cost of sales                                 |   | 24,277   |   | 20,128   |   |
|                                          |   |     |   |     |   |
| Gross profit                                  |   | 3,698    |   | 2,814    |   |
|                                          |   |     |   |     |   |
| Selling, general  and administrative expenses |   | 1,442    |   | 965      |   |
|                                          |   |     |   |     |   |
| Operating profit                              |   | 2,256    |   | 1,849    |   |
|                                          |   |     |   |     |   |
| Other income  (expense)                       |   | (35      | )      | 53       |   |
|                                          |   |     |   |     |   |
| Earnings before  income taxes                 |   | 2,221    |   | 1,902    |   |
| Income tax  expense                           |   | —   |   | —   |   |
|                                          |   |     |   |     |   |
| NET EARNINGS                                  |   | $        | 2,221  |     | $      | 1,902 |   |

 

The accompanying notes are an integral part of these statements.

 

22

----

 

M-FOODS DAIRY, LLC

(A MAJORITY OWNEDSUBSIDIARY OF MICHAEL FOODS, INC.)

STATEMENTSOF EARNINGS

(unaudited, in thousands)

 
|                                          |   | **Company**                          |   | **Predecessor**                         |   |
|-----------------------------------------------|--------|--------------------------------------|--------|-----------------------------------------|--------|
|                                          |   | **Six Months  Ended June 30,  2002** |   | **Three  Months  Ended June 30,  2001** |   | **Three  Months  Ended March 31,  2001** |   |
| Net sales                                     |   | $                                    | 51,825 |                                    | $      | 22,942 |   | $ | 17,684 |   |
|                                          |   |                                 |   |                                    |   |   |   |
| Cost of sales                                 |   | 44,905                               |   | 20,128                                  |   | 14,994 |   |
|                                          |   |                                 |   |                                    |   |   |   |
| Gross profit                                  |   | 6,920                                |   | 2,814                                   |   | 2,690 |   |
|                                          |   |                                 |   |                                    |   |   |   |
| Selling, general  and administrative expenses |   | 2,857                                |   | 965                                     |   | 1,027 |   |
| Recall insurance  settlement                  |   | —                               |   | —                                  |   | (3,217 | ) |
|                                          |   |                                 |   |                                    |   |   |   |
| Operating profit                              |   | 4,063                                |   | 1,849                                   |   | 4,880 |   |
|                                          |   |                                 |   |                                    |   |   |   |
| Other income  (expense)                       |   | (63                                  | )      | 53                                      |   | 1 |   |
|                                          |   |                                 |   |                                    |   |   |   |
| Earnings before  income taxes                 |   | 4,000                                |   | 1,902                                   |   | 4,881 |   |
|                                          |   |                                 |   |                                    |   |   |   |
| Income tax  expense                           |   | —                               |   | —                                  |   | 1,918 |   |
|                                          |   |                                 |   |                                    |   |   |   |
| NET EARNINGS                                  |   | $                                    | 4,000  |                                    | $      | 1,902 |   | $ | 2,963 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

23

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M-FOODS DAIRY, LLC

(A MAJORITY OWNEDSUBSIDIARY OF MICHAEL FOODS, INC.)

STATEMENTS OF CASH FLOWS

(unaudited, in thousands)

 
|                                                 |   | **Company**                          |   | **Predecessor**                         |   |
|------------------------------------------------------|--------|--------------------------------------|--------|-----------------------------------------|--------|
|                                                 |   | **Six Months  Ended June 30,  2002** |   | **Three  Months  Ended June 30,  2001** |   | **Three  Months  Ended March 31,  2001** |   |
| Net cash  provided by (used in) operating activities |   | $                                    | 4,943  |                                    | $      | 1,136 |   | $ | (2,440 | ) |
|                                                 |   |                                 |   |                                    |   |   |   |
| Cash flows from  investing activities:               |   |                                 |   |                                    |   |   |   |
| Capital  expenditures                                |   | (3,124                               | )      | (1,143                                  | )      | (3,664 | ) |
| Investments in  joint ventures and other assets      |   | (161                                 | )      | —                                  |   | — |   |
|                                                 |   |                                 |   |                                    |   |   |   |
| Net cash used in  investing activities               |   | (3,285                               | )      | (1,143                                  | )      | (3,664 | ) |
|                                                 |   |                                 |   |                                    |   |   |   |
| Cash flows from  financing activities:               |   |                                 |   |                                    |   |   |   |
| Net additional  capital invested or (dividends paid) |   | (1,658                               | )      | —                                  |   | 6,111 |   |
| Net cash  provided by (used in) financing activities |   | (1,658                               | )      | —                                  |   | 6,111 |   |
|                                                 |   |                                 |   |                                    |   |   |   |
| Net increase  (decrease) in cash and equivalents     |   | —                               |   | (7                                      | )      | 7 |   |
|                                                 |   |                                 |   |                                    |   |   |   |
| Cash and  equivalents at beginning of period         |   | —                               |   | 7                                       |   | — |   |
|                                                 |   |                                 |   |                                    |   |   |   |
| Cash and  equivalents at end of period               |   | $                                    | — |                                    | $      | — |   | $ | 7 |   |

 

The accompanying notes are an integral part of these statements.

 

24

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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-high temperaturepasteurized, 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 Hawn Johnson &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 6.8% as of June 30, 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.

 

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

 

For ease of presentation, the Merger has been reflected in theaccompanying financial statements as if it had occurred on April 1, 2001.  Management determined that no materialtransactions occurred during the period from April 1 through April 9,2001.  The Company’s financialstatements have been presented on a comparative basis with the Predecessor’shistorical operating unit financial statements, prior to the date 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.

 

25

----

 

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

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

 

The following unaudited pro forma net sales and net earnings for thesix months ended June 30, 2001 include results for the three months ended March31, 2001, which were derived from the application of pro forma adjustments tothe Predecessor’s historical statement of earnings, and assumes the Merger hadoccurred on January 1, 2001.  The proforma net earnings for the six months ended June 30, 2001 are also adjusted forgoodwill amortization determined in accordance with the provisions of SFAS 142(see Note B).  The net sales and netearnings for the six months ended June 30, 2002 represent actual results forthe period.

 
|         |   | **Six months  ended** |       |
|--------------|--------|-----------------------|------------|
|         |   | **June 30,  2002**    |       | **June 30,  2001** |   |
| Net sales    |   | $                     | 51,825,000 |   | $ | 40,626,000 |   |
| Net earnings |   | 4,000,000             |       | 4,910,000 |   |
|              |        |                       |            |  |  |  |  |

 

NOTE B  — 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 TXCT,LLC.  The accompanying Company unau­ditedfinancial statements and footnote information as of and for the six monthperiod ended June 30, 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.

 

Use of Estimates

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

 

NOTE C — INVENTORIES

 

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

 

Inventories consisted of the following:

 
|                               |   | **June 30,  2002** |      | **December  31,  2001** |   |
|------------------------------------|--------|--------------------|-----------|-------------------------|--------|
| Raw materials and supplies         |   | $                  | 2,430,000 |                    | $      | 1,625,000 |   |
| Work in process and finished goods |   | 2,127,000          |      | 1,967,000               |   |
|                               |   | $                  | 4,557,000 |                    | $      | 3,592,000 |   |

 

26

----

 

NOYE D — 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, *Business Combinations*, andSFAS 142, *Goodwilland Other Intangible Assets*. SFAS 141 is effective for all business combinations completed after June30, 2001.  SFAS 142 is effective forfiscal years beginning after December 15, 2001; however, certain provisions ofthis Statement apply to goodwill and other intangible assets acquired betweenJuly 1, 2001 and the effective date of SFAS 142.  The Company adopted the provisions of SFAS 142 as of January 1,2002 and had no acquisitions between July 1, 2001 and 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 completed thetransitional impairment test of goodwill with no impairment indicated atJanuary 1, 2002.

 

The Company’s carrying amount, net of accumulated amortization, forgoodwill as of June 30, 2002 and December 31, 2001 was $1,763,000.

 

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.

 
|                                  |   | **Six months  ended June 30,  2002** |       | **Three  months  ended June 30,  2001** |       | **Three  months  ended March 31,  2001** |   |
|---------------------------------------|--------|--------------------------------------|------------|-----------------------------------------|------------|------------------------------------------|--------|
|                                  |   | **(Company)**                        | ** ** | **(Predecessor)**                       | ** ** |
|                                  |   |                                 |       |                                    |       |
| Reported net  earnings                |   | $                                    | 4,000,000  |                                    | $          | 1,902,000                                |   | $ | 2,963,000 |   |
| Add back:  goodwill amortization |   | —                               |       | 28,000                                  |       | 26,000                                   |   |
| Adjusted net  earnings                |   | $                                    | 4,000,000  |                                    | $          | 1,930,000                                |   | $ | 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.

 

NOTE E — 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 F — 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 beenreflected on the Company’s financial statements.

 

27

----

 

NOTE G — 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.

 

28

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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 |

 

29

----

 

 

M-FOODS DAIRY TXCT, LLC

(A MAJORITY OWNEDSUBSIDIARY OF MICHAEL FOODS, INC.)

BALANCE SHEETS

(unaudited, in thousands)

 
|                                                   |   | **JUNE 30,  2002** |   | **DECEMBER  31,  2001** |   |
|--------------------------------------------------------|--------|--------------------|--------|-------------------------|--------|
| ASSETS                                                 |   |               |   |                    |   |
| CURRENT ASSETS                                         |   |               |   |                    |   |
| Accounts  receivable, less allowances                  |   | $                  | 7,220  |                    | $      | 5,765 |   |
| Inventories                                            |   | 4,648              |   | 3,315                   |   |
| Prepaid expenses  and other                            |   | 109                |   | 52                      |   |
| Total current  assets                                  |   | 11,977             |   | 9,132                   |   |
| PROPERTY, PLANT  AND EQUIPMENT— AT COST           |   |               |   |                    |   |
| Leasehold  improvements                                |   | 3,023              |   | 3,023                   |   |
| Machinery and  equipment                               |   | 10,945             |   | 9,997                   |   |
|                                                   |   | 13,968             |   | 13,020                  |   |
| Less accumulated  depreciation                         |   | 2,500              |   | 1,494                   |   |
|                                                   |   | 11,468             |   | 11,526                  |   |
| OTHER ASSETS                                           |   |               |   |                    |   |
| Non-compete  agreement, net                            |   | 793                |   | 1,058                   |   |
|                                                   |   | $                  | 24,238 |                    | $      | 21,716 |   |
| LIABILITIES AND  UNIT HOLDER AND OPERATING UNIT EQUITY |   |               |   |                    |   |
| CURRENT  LIABILITIES                                   |   |               |   |                    |   |
| Current  maturities of non-compete commitment          |   | $                  | 2,400  |                    | $      | 2,400 |   |
| Accounts payable                                       |   | 5,739              |   | 3,342                   |   |
| Note payable —  related party                     |   | 1,844              |   | —                  |   |
| Accrued  liabilities:                                  |   |               |   |                    |   |
| Compensation                                           |   | 242                |   | 292                     |   |
| Insurance                                              |   | 93                 |   | 37                      |   |
| Customer  programs                                     |   | 117                |   | 200                     |   |
| Other                                                  |   | 477                |   | 447                     |   |
| Total current  liabilities                             |   | 10,912             |   | 6,718                   |   |
| NON-COMPETE  COMMITMENT, less current maturities       |   | —             |   | 2,400                   |   |
| COMMITMENTS AND  CONTINGENCIES                         |   | —             |   | —                  |   |
| PREFERRED UNIT  HOLDER RETURN PAYABLE                  |   | 1,176              |   | 688                     |   |
| UNIT HOLDER AND  OPERATING UNIT EQUITY                 |   | 12,150             |   | 11,910                  |   |
|                                                   |   | $                  | 24,238 |                    | $      | 21,716 |   |

 

The accompanying notes are an integral part of these statements.

 

30

----

 

M-FOODS DAIRY TXCT, LLC

(A MAJORITY OWNEDSUBSIDIARY OF MICHAEL FOODS, INC.)

STATEMENTSOF EARNINGS

FOR THE THREE MONTHSENDED JUNE 30,

(unaudited, in thousands)

 
|                                          |   | **2002** |   | **2001** |   |
|-----------------------------------------------|--------|----------|--------|----------|--------|
| Net sales                                     |   | $        | 25,147 |     | $      | 28,879 |   |
|                                          |   |     |   |     |   |
| Cost of sales                                 |   | 22,852   |   | 27,559   |   |
|                                          |   |     |   |     |   |
| Gross profit                                  |   | 2,295    |   | 1,320    |   |
|                                          |   |     |   |     |   |
| Selling, general  and administrative expenses |   | 976      |   | 1,405    |   |
|                                          |   |     |   |     |   |
| Operating profit  (loss)                      |   | 1,319    |   | (85      | )      |
|                                          |   |     |   |     |   |
| Other income  (expense)                       |   | (24      | )      | 53       |   |
|                                          |   |     |   |     |   |
| Earnings (loss)  before income taxes          |   | 1,295    |   | (32      | )      |
| Income tax  benefit                           |   | —   |   | —   |   |
|                                          |   |     |   |     |   |
| NET EARNINGS  (LOSS)                          |   | $        | 1,295  |     | $      | (32 | ) |

 

The accompanying notes are an integral part of these statements.

 

31

----

 

M-FOODS DAIRY TXCT, LLC

(A MAJORITY OWNEDSUBSIDIARY OF MICHAEL FOODS, INC.)

STATEMENTS OF EARNINGS

 (unaudited, in thousands)

 
|                                          |   | **Company**                          |   | **Predecessor**                         |   |
|-----------------------------------------------|--------|--------------------------------------|--------|-----------------------------------------|--------|
|                                          |   | **Six Months  Ended June 30,  2002** |   | **Three  Months  Ended June 30,  2001** |   | **Three  Months  Ended March 31,  2001** |   |
| Net sales                                     |   | $                                    | 44,477 |                                    | $      | 28,879 |   | $ | 17,644 |   |
|                                          |   |                                 |   |                                    |   |   |   |
| Cost of sales                                 |   | 41,339                               |   | 27,559                                  |   | 17,108 |   |
|                                          |   |                                 |   |                                    |   |   |   |
| Gross profit                                  |   | 3,138                                |   | 1,320                                   |   | 536 |   |
|                                          |   |                                 |   |                                    |   |   |   |
| Selling, general  and administrative expenses |   | 1,994                                |   | 1,405                                   |   | 1,712 |   |
|                                          |   |                                 |   |                                    |   |   |   |
| Operating profit  (loss)                      |   | 1,144                                |   | (85                                     | )      | (1,176 | ) |
|                                          |   |                                 |   |                                    |   |   |   |
| Other income  (expense)                       |   | (29                                  | )      | 53                                      |   | — |   |
|                                          |   |                                 |   |                                    |   |   |   |
| Earnings (loss)  before income taxes          |   | 1,115                                |   | (32                                     | )      | (1,176 | ) |
|                                          |   |                                 |   |                                    |   |   |   |
| Income tax  expense                           |   | —                               |   | —                                  |   | (447 | ) |
|                                          |   |                                 |   |                                    |   |   |   |
| NET EARNINGS  (LOSS)                          |   | $                                    | 1,115  |                                    | $      | (32 | ) | $ | (729 | ) |

 

32

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M-FOODS DAIRY TXCT, LLC

(A MAJORITY OWNEDSUBSIDIARY OF MICHAEL FOODS, INC.)

STATEMENTSOF CASH FLOWS

 (unaudited, in thousands)

 
|                                                    |   | **Company**                          |   | **Predecessor**                         |   |
|---------------------------------------------------------|--------|--------------------------------------|--------|-----------------------------------------|--------|
|                                                    |   | **Six Months  Ended June 30,  2002** |   | **Three  Months  Ended June 30,  2001** |   | **Three  Months  Ended March 31,  2001** |   |
| Net cash  provided by (used in) operating activities    |   | $                                    | 3,734  |                                    | $      | 3,692 |   | $ | (31 | ) |
|                                                    |   |                                 |   |                                    |   |   |   |
| Cash flows from  investing activities:                  |   |                                 |   |                                    |   |   |   |
| Capital  expenditures                                   |   | (947                                 | )      | (1,292                                  | )      | (2,250 | ) |
|                                                    |   |                                 |   |                                    |   |   |   |
| Net cash used in  investing activities                  |   | (947                                 | )      | (1,292                                  | )      | (2,250 | ) |
|                                                    |   |                                 |   |                                    |   |   |   |
| Cash flows from  financing activities:                  |   |                                 |   |                                    |   |   |   |
| Payments on  long-term debt                             |   | (2,400                               | )      | (2,400                                  | )      | — |   |
| Net additional  capital invested or (dividends paid)    |   | (387                                 | )      | —                                  |   | 2,281 |   |
| Net cash  provided by (used in) by financing activities |   | (2,787                               | )      | (2,400                                  | )      | 2,281 |   |
|                                                    |   |                                 |   |                                    |   |   |   |
| Net increase  (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 describedbelow, Kohler Mix — TXCT (the “Predecessor,” “Operating Unit” or the “Unit”)was an operating unit of Michael Foods, Inc. The change in control of Michael Foods, Inc. and the reorganization ofthe operating unit into M-Foods Dairy TXCT, LLC are more fully described below.

 

###### **Business**

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

 

###### **Merger**

On April 10, 2001, Michael Foods, Inc. and 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 Merger agreement,all outstanding shares of Michael Foods com­mon stock were converted into theright to receive $30.10 per share in cash, or value equal thereto, and alloutstanding stock options were converted into the right to receive, in cash,$30.10 per share reduced by the exercise price per share for all shares subjectto such stock options.  The purchase 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 6.8% as of June 30, 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.

 

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

###### ** **

The Merger was accounted for as a purchase inaccordance with Accounting Principles Board Opinion 16, *Business Combinations* andEITF 88-16, *Basisin 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.  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 fairvalue at the date of acquisition, and income taxes which are payable by theCompany’s unit

 

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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 earnings (loss) forthe six months ended June 30, 2001 include results for the three months endedMarch 31, 2001, which were 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 earnings for the six months ended June 30, 2002represent actual results for the period.

 
|                 |   | **Six months  ended** |       |
|----------------------|--------|-----------------------|------------|
|                 |   | **June 30,  2002**    |       | **June 30,  2001** |   |
| Net sales            |   | $                     | 44,477,000 |   | $ | 46,523,000 |   |
| Net earnings  (loss) |   | 1,115,000             |       | (605,000 | ) |
|                      |        |                       |            |  |  |  |  |

 

NOTE B  — 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 are reasonable.  Additionally, Operating Unit equity includesthe cumulative net advances between the Operating Unit and Michael Foods, whichare considered additional capital invested from or, constructive dividends to,Michael Foods.  Accordingly, theaccompanying financial statements may not necessarily be indicative of the resultsthat could have been obtained if the Operating Unit had been operated as astand-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.

 

**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.

 

# **NOTE C — INVENTORIES**

 

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

Inventoriesconsisted of the following: 

 
|                                |   | **June 30,  2002** |      | **December  31,  2001** |   |
|-------------------------------------|--------|--------------------|-----------|-------------------------|--------|
| Raw  materials and supplies         |   | $                  | 2,639,000 |                    | $      | 1,880,000 |   |
| Work  in process and finished goods |   | 2,009,000          |      | 1,435,000               |   |
|                                |   | $                  | 4,648,000 |                    | $      | 3,315,000 |   |

 

NOTE D — ADOPTION OF NEW ACOUNTING POLICIES

 

Goodwill and Intangible Assets

In July 2001, the Financial Accounting Standards Board (FASB) issuedStatement of Financial Accounting Standards (SFAS) 141, *Business Combinations*, andSFAS 142, *Goodwilland Other Intangible Assets*. SFAS 141 is effective for all business combinations

 

35

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completed after June30, 2001.  SFAS 142 is effective forfiscal years beginning after December 15, 2001; however, certain provisions ofthis Statement apply to goodwill and other intangible assets acquired betweenJuly 1, 2001 and the effective date of SFAS 142.  The Company adopted the provisions of SFAS 142 as of January 1,2002 and had no acquisitions between July 1, 2001 and 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 June 30, 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 are recognizedif the carrying amount of an intangible subject to amortization is notrecoverable from expected future cash flows and its carrying amount exceeds itsfair value.

 

Acquired intangible assets of the Company that have been determined tohave a definite life and continue to be amortized as of June 30, 2002 are asfollows:

 
|        |   | **Gross  Carrying  Amount** |      | **Accumulated  Amortization** |   |
|-------------|--------|-----------------------------|-----------|-------------------------------|--------|
| Non-compete |   | $                           | 1,398,000 |                          | $      | (605,000 | ) |
|             |        |                             |           |                               |        |  |  |

 

The aggregate amortization expense for the six months ended June 30,2002 was approximately $265,000 and $128,000 for the three months ended June30, 2001.  The Predecessor hadamortization expense of $500,000 during the period ended March 31, 2001.  The estimated amortization expense for theyears ended December 31, 2002 through December 31, 2003 is as follows:

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

 

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.

###### ** **

###### **NOTE E — 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 havenot been reflected on the Company’s financial statements.

###### ** **

###### **NOTE F — COMMITMENTS AND CONTINGENCIES**

 

###### **Litigation**

The Company is engaged in routine litigation incidental to its business.  Management believes the ultimate outcome ofthis litigation will not have a material effect on the accompanying statementsof financial position, liquidity or results of operations.

 

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

 

THREE MONTHS ENDED JUNE 30, 2002 AS COMPARED TO THREE MONTHS ENDED JUNE30, 2001

 

RESULTS OF OPERATIONS

 

Readers are directed to Note G - Business Segments for data on the unauditedfinancial results of our four business segments for the three months ended June30, 2002 and June 30, 2001.

 

Net sales for the 2002 period were $289,753,000, a decrease of 2%compared to net sales of $295,109,000 in the 2001 period. Net sales decreasedbecause of the factors discussed in the below divisional reviews, but werelower in the 2002 period due largely to deflationary impacts in two divisionsand weak units sales in another division.

 

Egg Products Division net sales for the 2002 period reflected slightlyincreased unit sales and deflation for industrial egg products, with the formerrelated to gains in most categories and the latter tied to weaker pricing inthe national egg market. Unit sales rose for most value-added products and weremixed for other products. Graded shell egg prices decreased approximately 4%compared to second quarter 2001 levels, as reported by Urner Barry Publications- a widely quoted industry pricing service. Related egg market decreaseslowered the cost of purchased eggs slightly. Approximately two-thirds of theDivision’s annual egg needs are purchased under contracts or in the spotmarket. A substantial majority of these eggs are priced according to the costof grain inputs or to egg market prices as reported by Urner Barry.Approximately one-third of annual egg needs are sourced from internal flocks,where feed costs typically represent roughly two-thirds of the cost ofproducing such eggs. Feed costs were higher in the 2002 period, compared to the2001 period, due mainly to higher prices for corn. Overall, egg costs decreasedslightly in the 2002 period, as compared to the 2001 period, while pricing forvalue-added egg products was generally flat. This resulted in higher margins for certain egg products, particularlyegg substitutes, precooked products and dried products, and higher divisionalmargins in total.

 

Refrigerated Distribution Division net sales for the 2002 periodreflected lower unit sales, especially in the key cheese and butter categories.Unit sales were down due to several factors, including a national trend wherebyprivate label cheeses have been taking market share from branded cheeses,generally weak retail grocery sales, and store closures by certain grocerychains served by the Division. Despite lower sales, earnings rose in theimportant cheese category.  Cheesepricing improved year-over-year while product costs declined, raising margins.This margin expansion was subdued, however, due to hedging activities thatresulted in significant cheese ownership at above-market levels.

 

Dairy Products Division net sales for the 2002 period reflected higherunit sales, due mainly to strong creamer and specialty cartoned product sales.General dairy products deflation reduced pricing for certain product categories,which somewhat constrained dollar sales growth. The combination of salesgrowth, reduced ingredient costs and improved plant operating costs, the latterpartially reflecting volume-induced economies of scale, raised gross, andoperating, profit margins significantly.

 

Potato Products Division net sales for the 2002 period reflected unitsales increases in all product categories. Sales were particularly strong formashed items — both at retail and at foodservice. New account activity,same-account sales growth and higher marketing spending levels all contributedto the sales gain. The operating profit increase in the 2002 period reflectedimproved operating costs and the impact of a favorable sales mix, with retailsales rising as a percent of the divisional total.

 

The increase in our gross profit margin for the 2002 period, ascompared to the results of the 2001 period, reflected the factors discussedabove, particularly sales mix improvements, decreased raw material costs incertain divisions and generally improved operating costs. It is our strategy toincrease value-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 were stable as a percentof sales in the 2002 period, as compared to the results of the  2001 period, with both net sales andoperating expenses declining by about 2% year-over-year.

 

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SIX MONTHS ENDED JUNE 30, 2002 AS COMPARED TO SIX MONTHS ENDED JUNE 30,2001

 

RESULTS OF OPERATIONS

 

Readers are directed to Note G - Business Segments for data on theunaudited financial results of the Company’s and the Predecessor’s fourbusiness segments and must combine 2001 three month periods to evaluate the sixmonths ended June 30, 2001 as compared to the six months ended June 30, 2002.

 

Net sales in the 2002 period were $568,182,000, a decrease of less than1% compared to net sales of $570,736,000 for the Company and the Predecessor inthe 2001 period. Net sales decreased because of the factors discussed in thebelow divisional reviews, but were slightly lower in the 2002 period duelargely to lower unit sales and deflationary impacts in one division and weakunits sales in another division.

 

Egg Products Division net sales for the 2002 period reflected decreasedunit sales and slight deflation for industrial egg products, with the formerrelated mainly to planned shell egg sales decreases and the latter tied toweaker pricing in the national egg market. Unit sales rose for egg substitutes,hardcooked items and precooked products, and declined slightly for otherproducts. Graded shell egg prices decreased approximately 4% compared to firsthalf 2001 levels, as reported by Urner Barry Publications. Related egg marketdecreases lowered the cost of purchased eggs slightly. Approximately two-thirdsof the Division’s annual egg needs are purchased under contracts or in the spotmarket. A substantial majority of these eggs are priced according to the costof grain inputs or to egg market prices as reported by Urner Barry.Approximately one-third of annual egg needs are sourced from internal flocks,where feed costs typically represent roughly two-thirds of the cost ofproducing such eggs. Feed costs were slightly higher in the 2002 period,compared to the 2001 period, due mainly to higher prices for corn. Overall, eggcosts decreased slightly in the 2002 period, as compared to the 2001 period,while pricing for value-added egg products was generally flat.  This resulted in higher margins for certainegg products, particularly egg substitutes, precooked products, hardcookedproducts and dried products, and higher divisional margins in total.

 

Refrigerated Distribution Division net sales for the 2002 periodreflected lower unit sales, especially in the key cheese category. Unit saleswere down due to several factors, including a national trend whereby privatelabel cheeses have been taking market share from branded cheeses, generallyweak retail grocery sales, and store closures by certain grocery chains servedby the Division. Cheese pricing increased year-over-year, but our cheesesourcing costs rose more rapidly than did our selling prices.  This was largely due to hedging activitiesthat resulted in significant cheese ownership at above-market levels. Cheesemargins, and divisional margins, were lower in the 2002 period as a result ofthese conditions. By the end of the 2002 period cheese hedging activities hadreturned to more normal levels.

 

Dairy Products Division net sales for the 2002 period reflected higherunit sales, due mainly to strong creamer and specialty cartoned product sales. Thecombination of sales growth, reduced ingredient costs and improved plantoperating costs, the latter partially reflecting volume-induced economies ofscale, raised gross, and operating, profit margins significantly. Excluding aninsurance settlement of approximately $3,218,000 from operating profit in the2001 period would provide the reader with a better perspective of the strengthof core operating results for the Division.

 

Potato Products Division net sales for the 2002 period reflected unitsales increases in all product categories. Sales were particularly strong formashed items — both at retail and at foodservice. New account activity,same-account sales growth and higher marketing spending levels all contributedto the sales gain. The operating profit increase in the 2002 period reflectedimproved operating costs and the impact of a favorable sales mix, with retailsales rising as a percent of the divisional total.

 

The increase in our gross profit margin for the period ended June 30,2002, as compared to the results of the 2001 period, reflected the factorsdiscussed above, particularly sales mix improvements, decreased raw materialcosts in certain divisions and generally improved operating costs. It is ourstrategy to increase value-added product sales as a percent of total sales overtime, while decreasing commodity-sensitive products’ contribution toconsolidated sales. These efforts historically have been beneficial to grossprofit margins in most periods.

 

Selling, general and administrative expenses decreased as a percent ofsales for the period ended June 30, 2002, as compared to the results of the2001 period. However, within the 2001 period the Predecessor recordednon-recurring  expenses related to theMerger for financial, legal, advisory and regulatory filing fees. Theseexpenses of  $11,050,000 are reflectedin the Predecessor Consolidated Statement of Earnings for the three monthsended March 31, 2001 as transaction expenses. Exclusive of these one-timetransaction expenses, selling, general and administrative expenses increased asa percent of sales in the 2002 period as compared to the 2001 period. Thisincreased expense ratio reflected higher expenses to support retail andfoodservice marketing efforts and broadened sales efforts, and for ourcentralized purchasing department.

 

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GENERAL

 

Certain of our products are sensitive to changes in commodity prices.Value-added egg products, such as extended shelf-life liquid and precooked products,account for approximately 60% of the Egg Products Division’s net sales. Theremainder of Egg Products Division sales is derived from the sale of other eggproducts and shell eggs, which vary from being very commodity-sensitive tosomewhat value-added. Gross profit from shell eggs is primarily dependent uponthe relationship between shell egg prices and the cost of feed, both of whichcan fluctuate significantly. Graded shell egg pricing in the 2002 six monthperiod was approximately 4% below 2001 levels, as measured by a widely quotedpricing service, while feed costs rose slightly year-over-year. Gross profitmargins for extended shelf-life liquid eggs, egg substitutes, and precooked andhardcooked egg products are less sensitive to commodity price fluctuations thanare other egg products or shell eggs. Our Refrigerated Distribution Divisionderives approximately 75% of its net sales from refrigerated products producedby others, thereby reducing the effects of commodity price swings. The balanceof refrigerated distribution sales are mainly from shell eggs, some of whichare produced by the Egg Products Division, sold on a distribution, ornon-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 a combinationof 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 $7,386,000 in capital expenditures during the three monthsended June 30, 2002 and $14,263,000 during the six months ended June 30, 2002.We plan to spend approximately $38,000,000 on capital expenditures in 2002, themajority of which is to expand or update production capacity for value-addedproducts.

 

Earnings before interest, taxes, depreciation and amortization(“EBITDA”) in the 2002 six month period were $74,767,000, an increase of 9%compared to the Company’s and Predecessor’s combined $68,800,000 in thecomparable 2001 period. EBITDA increased because of the factors discussed inthe above results of operations divisional reviews. Our management believesthat EBITDA is a relevant measurement of our financial results, as it isindicative of the relative strength of our cash flows and is a key measurementcontained in the financial covenants of our senior indebtedness. In addition,as a highly leveraged company, the holders of our debt have a significantinterest in our cash flows. We compute EBITDA as it is defined in our seniorcredit agreement (see Exhibit 10.1 of our Amendment No. 1 to Form S-4 filedwith the Securities and Exchange Commission on July 18, 2001). This definitionmay not be comparable to that used by other companies reporting similarfinancial information.

 

We believe EBITDA is 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 June 30, 2002, there were no borrowings under the$100,000,000 line of credit portion of this facility, while the term A portiontherein approximated $81,600,000 and the term B portion approximated$245,600,000.

 

The senior credit facility contains various restrictive covenants. Itprohibits us from prepaying other indebtedness, including the notes, and itrequires us to maintain specified financial ratios, such as a minimum ratio ofEBITDA to interest expense, a minimum fixed charge coverage ratio and a maximumratio of total debt to EBITDA, and satisfy financial condition tests. Inaddition, the senior credit facility prohibits us from declaring or paying anydividends and prohibits us from making any payments with respect to the notesif we fail to perform our obligations under, or fail to meet the conditions of,the senior credit facility or if payment creates a default under the seniorcredit facility.

 

39

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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 capitalresources for us to meet our current and future financial obligations, as wellas to provide funds for our working capital, capital expenditures and otherneeds for at least the next 12 months. No assurance can be given, however, thatthis will be the case. We may require additional equity or debt financing tomeet our working capital requirements or to fund our acquisition activities, ifany. There can be no assurance that additional financing will be available whenrequired or, if available, will be on terms satisfactory 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, aswell as variances in the costs to produce such products, including normalvolatility in egg, feed and dairy ingredients costs. Our actual financialresults could differ materially from the results estimated by, forecasted by,or implied by us in such forward-looking statements.

 

ITEM 3.  QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

There were no material changes in our market risk during the six monthperiod ended June 30, 2002.

 

PART II - OTHERINFORMATION

 

ITEM 6.  EXHIBITS AND REPORTS ONFORM 8-K

 

(a)                          Exhibits

 

99.1  Certification of Chief Executive Officer

99.2  Certification of Chief Financial Officer

 

(b)                         Reportson Form 8-K

 

We filed a Form 8-K on April 26, 2002 regarding a news release issuedto our debtholders pertaining to our financial results for the three monthsended March 31, 2002.

 

Subsequent to the reporting period herein, we filed a Form 8-K on July25, 2002 regarding a news release issued to our debtholders pertaining to ourfinancial results for the three months and six months ended June 30, 2002.

 

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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:  August  13, 2002 | By:    | /s/  Gregg A.  Ostrander |   |
|                         |   |                          |   |   |   | Gregg A. Ostrander |
|                         |   |                          |   |   |   | (Chairman, President and |
|                         |   |                          |   |   |   | Chief Executive Officer) |
|                         |   |                          |   |   |   |   |
| Date:  August  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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