10-Q 1 d99116e10vq.txt FORM 10-Q FOR QUARTER ENDED JUNE 30, 2002 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NUMBER 001-12755 DEAN FOODS COMPANY (Exact name of the registrant as specified in its charter) [DEAN FOODS LOGO] --------------- DELAWARE 75-2559681 (State or other jurisdiction of (I.R.S. employer incorporation or organization) identification no.) 2515 MCKINNEY AVENUE, SUITE 1200 DALLAS, TEXAS 75201 (214) 303-3400 (Address, including zip code, and telephone number, including area code, of the registrant's principal executive offices) --------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] As of August 9, 2002 the number of shares outstanding of each class of common stock was: Common Stock, par value $.01 90,434,356 ================================================================================ TABLE OF CONTENTS
Page ---- PART I - FINANCIAL INFORMATION Item 1 - Financial Statements.................................................................................... 3 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations................... 23 Item 3 - Quantitative and Qualitative Disclosures About Market Risk.............................................. 41 PART II - OTHER INFORMATION Item 4 - Submission of Matters to a Vote of Security Holders..................................................... 43 Item 6 - Exhibits and Reports on Form 8-K........................................................................ 43
2 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS DEAN FOODS COMPANY CONDENSED CONSOLIDATED BALANCE SHEETS (Dollars in thousands)
JUNE 30, DECEMBER 31, 2002 2001 ----------- ------------ Assets (unaudited) Current assets: Cash and cash equivalents ................................................... $ 67,350 $ 78,260 Accounts receivable, net .................................................... 725,103 775,824 Inventories ................................................................. 415,979 440,247 Refundable income taxes ..................................................... 1,379 3,375 Deferred income taxes ....................................................... 103,649 127,579 Prepaid expenses and other current assets ................................... 67,831 56,899 ----------- ----------- Total current assets .................................................. 1,381,291 1,482,184 Property, plant and equipment, net ............................................. 1,620,119 1,668,592 Goodwill ....................................................................... 3,117,828 2,967,778 Intangible and other assets .................................................... 723,685 613,343 ----------- ----------- Total ................................................................. $ 6,842,923 $ 6,731,897 =========== =========== Liabilities and Stockholders' Equity Current liabilities: Accounts payable and accrued expenses ....................................... $ 988,198 $ 1,044,409 Income taxes payable ........................................................ 60,709 33,582 Current portion of long-term debt and subsidiary lines of credit ............ 139,422 96,972 ----------- ----------- Total current liabilities ............................................. 1,188,329 1,174,963 Long-term debt ................................................................. 2,886,912 2,971,525 Other long-term liabilities .................................................... 248,185 243,695 Deferred income taxes .......................................................... 284,595 281,229 Mandatorily redeemable convertible trust issued preferred securities ........... 584,886 584,605 Commitments and contingencies (See Note 10) Stockholders' equity: Common stock, 90,264,499 and 87,872,980 shares issued and outstanding ....... 903 879 Additional paid-in capital .................................................. 1,051,666 961,705 Retained earnings ........................................................... 624,409 543,139 Accumulated other comprehensive income ...................................... (26,962) (29,843) ----------- ----------- Total stockholders' equity ............................................ 1,650,016 1,475,880 ----------- ----------- Total ................................................................. $ 6,842,923 $ 6,731,897 =========== ===========
See notes to condensed consolidated financial statements. 3 DEAN FOODS COMPANY CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Dollars in thousands, except per share data)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, ------------------------------ ------------------------------ 2002 2001 2002 2001 ------------- ------------- ------------- ------------- (unaudited) (unaudited) Net sales ................................................... $ 2,350,956 $ 1,517,541 $ 4,632,941 $ 2,982,613 Cost of sales ............................................... 1,738,644 1,163,947 3,464,340 2,281,774 ------------- ------------- ------------- ------------- Gross profit ................................................ 612,312 353,594 1,168,601 700,839 Operating costs and expenses: Selling and distribution ................................. 336,620 197,714 659,664 396,004 General and administrative ............................... 88,776 39,522 170,286 90,415 Amortization of intangibles .............................. 1,869 13,456 4,082 26,797 Plant closing costs ...................................... 6,665 7,898 843 ------------- ------------- ------------- ------------- Total operating costs and expenses ................. 433,930 250,692 841,930 514,059 ------------- ------------- ------------- ------------- Operating income ............................................ 178,382 102,902 326,671 186,780 Other (income) expense: Interest expense, net .................................... 52,315 25,934 104,192 53,236 Financing charges on trust issued preferred securities ... 8,394 8,395 16,790 16,791 Equity in earnings of unconsolidated affiliates .......... (1,404) (1,186) (1,807) (2,859) Other (income) expense, net .............................. 739 (189) 453 502 ------------- ------------- ------------- ------------- Total other (income) expense ....................... 60,044 32,954 119,628 67,670 ------------- ------------- ------------- ------------- Income before income taxes and minority interest ............ 118,338 69,948 207,043 119,110 Income taxes ................................................ 45,104 25,982 78,442 44,649 Minority interest in earnings ............................... 7 9,363 16 16,341 ------------- ------------- ------------- ------------- Income before cumulative effect of accounting change ....... 73,227 34,603 128,585 58,120 Cumulative effect of accounting change ...................... (47,316) (1,446) ------------- ------------- ------------- ------------- Net income .................................................. $ 73,227 $ 34,603 $ 81,269 $ 56,674 ============= ============= ============= ============= Average common shares: Basic ................................ 90,049,823 55,120,602 89,466,230 54,916,654 Average common shares: Diluted .............................. 108,988,707 72,227,518 108,483,511 71,896,932 Basic earnings per common share: Income before cumulative effect of accounting change ..... $ 0.81 $ 0.63 $ 1.44 $ 1.06 Cumulative effect of accounting change ................... (0.53) (0.03) ------------- ------------- ------------- ------------- Net income ............................................... $ 0.81 $ 0.63 $ 0.91 $ 1.03 ============= ============= ============= ============= Diluted earnings per common share: Income before cumulative effect of accounting change ..... $ 0.72 $ 0.55 $ 1.29 $ 0.96 Cumulative effect of accounting change ................... (0.44) (0.02) ------------- ------------- ------------- ------------- Net income ............................................... $ 0.72 $ 0.55 $ 0.85 $ 0.94 ============= ============= ============= =============
See notes to condensed consolidated financial statements. 4 DEAN FOODS COMPANY CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands)
SIX MONTHS ENDED JUNE 30, -------------------------- 2002 2001 --------- --------- (unaudited) Cash flows from operating activities: Net income ........................................................................... $ 81,269 $ 56,674 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization .................................................... 91,258 75,960 Loss on disposition of assets .................................................... 1,594 46 Write-down of impaired assets .................................................... 4,449 Minority interest ................................................................ 21 26,995 Equity in earnings of unconsolidated affiliates .................................. (1,807) (2,859) Cumulative effect of accounting change ........................................... 47,316 1,446 Deferred income taxes ............................................................ (17,165) 12,455 Other, net ....................................................................... (191) 593 Changes in operating assets and liabilities, net of acquisitions: Accounts receivable ........................................................... 57,331 18,503 Inventories ................................................................... 18,026 (7,752) Prepaid expenses and other assets ............................................. 10,734 (10,653) Accounts payable, accrued expenses and other liabilities ...................... (64,893) (45,170) Income taxes .................................................................. 65,481 6,984 --------- --------- Net cash provided by operating activities ................................... 293,423 133,222 Cash flows from investing activities: Net additions to property, plant and equipment ........................................ (91,528) (55,317) Cash outflows for acquisitions and investments ........................................ (214,900) (16,047) Net proceeds from divestitures ........................................................ 2,561 Proceeds from sale of fixed assets .................................................... 1,954 1,230 --------- --------- Net cash used in investing activities ....................................... (301,913) (70,134) Cash flows from financing activities: Proceeds from issuance of debt ........................................................ 189,235 107,366 Repayment of debt ..................................................................... (242,102) (185,196) Payment of deferred financing costs ................................................... (762) Issuance of common stock, net of expenses ............................................. 51,209 16,505 Redemption of common stock ............................................................ (6,056) Distribution to minority interest ..................................................... (3,879) --------- --------- Net cash used in financing activities ....................................... (2,420) (71,260) --------- --------- Decrease in cash and cash equivalents .................................................... (10,910) (8,172) Cash and cash equivalents, beginning of period ........................................... 78,260 31,110 --------- --------- Cash and cash equivalents, end of period ................................................. $ 67,350 $ 22,938 ========= =========
See notes to condensed consolidated financial statements. 5 DEAN FOODS COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 2002 1. GENERAL Basis of Presentation -- The unaudited condensed consolidated financial statements contained in this report have been prepared on the same basis as the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2001. In our opinion, we have made all necessary adjustments (which include only normal recurring adjustments) in order to present fairly, in all material respects, our consolidated financial position, results of operations and cash flows as of the dates and for the periods presented. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted. Our results of operations for the period ended June 30, 2002 may not be indicative of our operating results for the full year. The consolidated financial statements contained in this report should be read in conjunction with our 2001 consolidated financial statements contained in our Annual Report on Form 10-K as filed with the Securities and Exchange Commission on April 1, 2002. On April 23, 2002, we effected a two-for-one split of our common stock. Pursuant to the split, all shareholders of record as of April 8, 2002 received one additional share of common stock for each share held on that date. All share numbers contained in our condensed consolidated financial statements, and in these notes, have been adjusted for all periods to reflect the stock split, as if it had already occurred. This Quarterly Report, including these notes, has been written in accordance with the Securities and Exchange Commission's "Plain English" guidelines. Unless otherwise indicated, references in this report to "we," "us" or "our" refer to Dean Foods Company and its subsidiaries, taken as a whole. Recently Issued Accounting Standards -- The Emerging Issues Task Force (the "Task Force") of the Financial Accounting Standards Board ("FASB") has reached a consensus on Issue No. 00-14, "Accounting for Certain Sales Incentives," which became effective for us in the first quarter of 2002. This Issue addresses the recognition, measurement and income statement classification of sales incentives that have the effect of reducing the price of a product or service to a customer at the point of sale. Our historical practice for recording sales incentives within the scope of this Issue, which has been to record estimated coupon expense based on historical coupon redemption experience, is consistent with the requirements of this Issue. Therefore, our adoption of this Issue has no impact on our consolidated financial statements. The Task Force has also reached a consensus on Issue No. 00-25, "Vendor Income Statement Characterization of Consideration Paid to a Reseller of the Vendor's Products." We adopted this Issue in the first quarter of 2002. Under this Issue, certain consideration paid to our customers (such as slotting fees) is required to be classified as a reduction of revenue, rather than recorded as an expense. Adoption of this Issue required us to reduce reported revenue and selling and distribution expense for the second quarter and for the first six months of 2001 by $9.5 million and $18.8 million, respectively. There was no change, however, in reported net income. In June 2001, FASB issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 addresses financial accounting and reporting for business combinations. Under the new standard, all business combinations entered into after June 30, 2001 are required to be accounted for by the purchase method. We have applied, and will continue to apply, the provisions of SFAS No. 141 to all business combinations completed after June 30, 2001. SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets. We adopted SFAS No. 142 in the first quarter of 2002. SFAS No. 142 requires that goodwill no 6 longer be amortized, but instead requires a transitional goodwill impairment assessment and annual impairment tests thereafter. Effective June 30, 2002, we completed the first phase of the transitional goodwill impairment assessment, which indicated that the goodwill related to our Puerto Rico reporting unit is impaired. Prior to December 31, 2002, we will determine the amount of the impairment, and record the impairment in our income statement as the cumulative effect of a change in accounting principle retroactive to the first quarter of 2002. We currently have approximately $67 million recorded as goodwill related to our Puerto Rico reporting unit. Therefore, the maximum transitional goodwill impairment we will recognize as a result of the adoption of SFAS No. 142 will be approximately $67 million. SFAS No. 142 also requires that recognized intangible assets be amortized over their respective estimated useful lives. As part of the adoption, we have re-assessed the useful lives and residual values of all recognized intangible assets. Any recognized intangible asset determined to have an indefinite useful life was tested for impairment in accordance with the standard. These impairment tests were completed during the first quarter of 2002, and resulted in a charge of $47.3 million, net of an income tax benefit of $29.0 million, which was recorded during the first quarter of 2002 as a change in accounting principle. The impairment related to certain trademarks in our Dairy Group and Morningstar/White Wave segments. The fair value of these trademarks was determined using a present value technique. In June 2001, FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." This statement requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which the associated legal obligation for the liability is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset and amortized over the useful life of the asset. SFAS No. 143 will become effective for us in fiscal year 2003. We are currently evaluating the impact of adopting this pronouncement on our consolidated financial statements. FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" in August 2001 and it became effective for us in the first quarter of 2002. SFAS No. 144, which supercedes SFAS No. 121, provides a single, comprehensive accounting model for impairment and disposal of long-lived assets and discontinued operations. Our adoption of this standard did not have a material impact on our consolidated financial statements. SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections," was issued in April 2002 and is applicable to fiscal years beginning after May 15, 2002. One of the provisions of this technical statement is the rescission of SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt," whereby any gain or loss on the early extinguishment of debt that was classified as an extraordinary item in prior periods in accordance with SFAS No. 4, which does not meet the criteria of an extraordinary item as defined by APB Opinion 30, must be reclassified. Adoption of this standard will require us to reclassify extraordinary losses previously reported from the early extinguishment of debt as a component of "other expense". For the year ended December 31, 2001, we recorded an extraordinary loss of $4.3 million, net of an income tax benefit of $3.0 million in connection with the early extinguishment of debt. In June 2002, FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, and is effective for exit or disposal activities that are initiated after December 31, 2002. We are currently evaluating the impact of adopting this pronouncement on our consolidated financial statements. 7 2. ACQUISITIONS AND DIVESTITURES Acquisition of Dean Foods Company -- On December 21, 2001, we completed our acquisition of Dean Foods Company ("Old Dean"). As a result of this transaction, Old Dean was merged with and into our wholly-owned subsidiary, Blackhawk Acquisition Corp. Blackhawk Acquisition Corp. survived the merger and immediately changed its name to Dean Holding Company. Immediately after completion of the merger, we changed our name to Dean Foods Company. As a result of the merger, each share of common stock of Old Dean was converted into 0.858 shares of our common stock and the right to receive $21.00 in cash. The aggregate purchase price recorded was $1.7 billion, including $756.8 million of cash paid to Old Dean stockholders, common stock valued at $739.4 million and estimated transaction costs of $55.7 million. The value of the approximately 31 million common shares issued was determined based on the average market price of our common stock during the period from April 2 through April 10, 2001 (the acquisition was announced on April 5, 2001). In addition, each of the options to purchase Old Dean's common stock outstanding on December 21, 2001 was converted into an option to purchase 1.504 shares of our stock. As discussed in Note 6, the holders of these options had the right, during the ninety day period following the acquisition, to surrender their stock options to us, in lieu of exercise, in exchange for a cash payment. We paid $17.7 million for stock option surrenders during the first six months of 2002. We decided to acquire Old Dean for the above-described consideration after considering a number of factors, including: o The acquisition would result in us becoming the first truly national dairy and specialty foods company with the geographic reach, management depth and product mix necessary to meet the needs of large customers, who can especially benefit from the added services, convenience and value that a national dairy company can provide; o Combining our business would enable us to reduce our costs by pursuing economies of scale in purchasing, product development and manufacturing, and by eliminating duplicative costs; and o Increasing our scale would provide us with greater resources to invest in marketing and innovation. Also on December 21, 2001, in connection with our acquisition of Old Dean, we purchased Dairy Farmers of America's ("DFA") 33.8% stake in our Dairy Group for consideration consisting of: (1) approximately $145.4 million in cash, (2) a contingent promissory note in the original principal amount of $40 million, and (3) the operations of eleven plants (including seven of our plants and four of Old Dean's plants) located in nine states where we and Old Dean had overlapping operations. As additional consideration, we amended a milk supply agreement with DFA to provide that if we do not, within a specified period following the completion of our acquisition of Old Dean, offer DFA the right to supply raw milk to certain of the Old Dean dairy plants, we could be required to pay liquidated damages of up to $47.0 million. See Note 10 for further discussion of these contingent obligations. As a result of this transaction, we now own 100% of our Dairy Group. In connection with our acquisition of Old Dean, we entered into a new credit facility and expanded our receivables-backed loan facility. See Note 5. We used the proceeds from the credit facility and receivables-backed loan facility to fund the cash portion of the merger consideration and the acquisition of DFA's minority interest, to refinance certain indebtedness and to pay certain transaction costs. Old Dean's operations and the acquisition of DFA's minority interest (and related divestitures) are reflected in our consolidated financial statements after December 21, 2001. 8 We have not completed a final allocation of the purchase price to the fair values of assets and liabilities of Old Dean and the related business integration plans. We expect that the ultimate purchase price allocation may include additional adjustments to the fair values of depreciable tangible assets, identifiable intangible assets (some of which will have indefinite lives) and the carrying values of certain liabilities. Accordingly, to the extent that such assessments indicate that the fair value of the assets and liabilities differ from their preliminary purchase price allocations, such difference would adjust the amounts allocated to those assets and liabilities and would change the amounts allocated to goodwill. The unaudited results of operations on a pro forma basis for the three- and six-month periods ended June 30, 2001 as if the acquisition of Old Dean, and the purchase of DFA's minority interest (including the divestiture of the 11 plants transferred in partial consideration of that interest) had occurred as of the beginning of 2001 are as follows:
PRO FORMA -------------------------------------- THREE MONTHS SIX MONTHS ENDED ENDED JUNE 30, 2001 JUNE 30, 2001 ------------- ------------- (In thousands, except per share data) Net sales........................................................ $2,492,616 $4,862,839 Income before income taxes and minority interest................. 79,950 131,627 Income before cumulative effect of accounting change............. 49,199 81,083 Net income....................................................... 49,199 79,637 Basic earnings per common share: Income before cumulative effect of accounting change........ $ 0.57 $ 0.94 Net income.................................................. 0.57 0.93 Diluted earnings per share: Income before cumulative effect of accounting change........ 0.53 0.89 Net income.................................................. 0.53 0.88
Acquisition of White Wave -- On May 9, 2002, we acquired the 64% equity interest in White Wave, Inc. that we did not already own. White Wave, based in Boulder, Colorado, is the maker of Silk(R) soymilk and other soy-based products, and had sales of approximately $125 million during the 12 months ended March 31, 2002. Prior to May 9, we owned approximately 36.0% of White Wave, as a result of certain investments made by Old Dean beginning in 1999. We purchased the remaining 64% equity interest for a total price of approximately $189.0 million. Existing management of White Wave will remain in place. We have agreed to pay White Wave's management team an incentive bonus based on achieving certain sales growth targets by March 2004. The bonus amount will vary depending on the level of two-year cumulative sales White Wave achieves by the end of March 2004, and is anticipated to range between $30.0 million and $40.0 million. Amounts expected to be payable under the bonus plan are expensed each quarter based on White Wave's performance during the quarter. See Note 10. For financial reporting purposes, White Wave's financial results are aggregated with Morningstar Foods' financial results. Acquisition of Marie's -- On May 17, 2002, we bought the assets of Marie's Quality Foods, Marie's Dressings, Inc. and Marie's Associates, makers of Marie's(R) brand dips and dressings in the western United States for an aggregate purchase price of approximately $23.0 million. Prior to the acquisition, we licensed the Marie's brand to Marie's Quality Foods and Marie's Dressings, Inc. for use in connection with the manufacture and sale of dips and dressings in the western United States. As a result of this acquisition, our Morningstar/White Wave segment is now the sole owner, manufacturer and marketer of Marie's brand products nationwide. Divestitures of DFC Transportation and Boiled Peanut Business -- On January 4, 2002, we completed the sale of the stock of DFC Transportation Company, which was a part of our Specialty Foods segment. On February 7, 2002, we completed the sale of the assets related to the boiled peanut business of Dean Specialty Foods Company, a part of our Specialty Foods segment. 9 3. INVENTORIES
AT JUNE 30, AT DECEMBER 31, 2002 2001 ----------- --------------- (In thousands) Raw materials and supplies ........ $163,341 $161,673 Finished goods .................... 252,638 278,574 -------- -------- Total ........................ $415,979 $440,247 ======== ========
Approximately $72.4 million and $131.7 million of our inventory was accounted for under the last-in, first-out (LIFO) method of accounting at June 30, 2002 and December 31, 2001, respectively. There was no material excess of current cost over the stated value of last-in, first-out inventories at either date. 4. GOODWILL AND OTHER INTANGIBLE ASSETS On January 1, 2002, we adopted SFAS No. 142, which requires, among other things, that goodwill no longer be amortized, and that recognized intangible assets be amortized over their respective useful lives. As required by SFAS No. 142, our results for the second quarter and first half of 2001 have not been restated. The following sets forth a reconciliation of net income and earnings per share information for the three- and six-month periods ended June 30, 2002 and 2001, eliminating goodwill amortization and amortizing recognized intangible assets over their useful lives. We expect to complete our goodwill impairment analysis by December 31, 2002. See Note 1.
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ----------------------------- ----------------------------- 2002 2001 2002 2001 ----------- ----------- ----------- ----------- (In thousands, except per share amounts) Reported net earnings before cumulative effect of accounting change ................................ $ 73,227 $ 34,603 $ 128,585 $ 58,120 Reported net earnings ................................. 73,227 34,603 81,269 56,674 Goodwill amortization, net of tax and minority interest ......................................... 6,951 13,812 Trademark amortization, net of tax and minority interest ......................................... 576 1,189 Adjusted net earnings before cumulative effect of accounting change ................................ 73,227 42,130 128,585 73,121 Adjusted net earnings ................................. 73,227 42,130 81,269 71,675 Basic earnings per share: Reported net earnings before cumulative effect of accounting change ................................ $ 0.81 $ 0.63 $ 1.44 $ 1.06 Adjusted net earnings ............................. $ 0.81 $ 0.76 $ 0.91 $ 1.31 Diluted earnings per share: Reported net earnings before cumulative effect of accounting change ............................. $ 0.72 $ 0.55 $ 1.29 $ 0.96 Adjusted net earnings ............................. $ 0.72 $ 0.66 $ 0.85 $ 1.15
The changes in the carrying amount of goodwill for the six months ended June 30, 2002 are as follows:
MORNINGSTAR/ DAIRY GROUP WHITE WAVE SPECIALTY OTHER TOTAL ---------- ------------ ---------- ---------- ---------- (In thousands) Balance at December 31, 2001 ........... $2,163,702 $ 389,572 $ 290,000 $ 124,504 $2,967,778 Acquisitions ........................... 3,977 101,722 105,699 Purchase accounting adjustments ........ 23,110 15,292 (1,350) 7,299 44,351 ---------- ---------- ---------- ---------- ---------- Balance at June 30, 2002 ............... $2,190,789 $ 506,586 $ 288,650 $ 131,803 $3,117,828 ========== ========== ========== ========== ==========
10 The gross carrying amount and accumulated amortization of our intangible assets other than goodwill as of June 30, 2002 and December 31, 2001 are as follows:
JUNE 30, 2002 DECEMBER 31, 2001 --------------------------------------- --------------------------------------- GROSS NET GROSS NET CARRYING ACCUMULATED CARRYING CARRYING ACCUMULATED CARRYING AMOUNT AMORTIZATION AMOUNT AMOUNT AMORTIZATION AMOUNT -------- ------------ -------- -------- ------------ -------- (In thousands) (In thousands) Intangible assets with indefinite lives: Trademarks ............................. $473,285 $(14,274) $459,011 $391,662 $(14,274) $377,388 Intangible assets with finite lives: Customer-related ....................... 60,277 (13,453) 46,824 61,132 (10,496) 50,636 -------- -------- -------- -------- -------- -------- Total other intangibles ..................... $533,562 $(27,727) $505,835 $452,794 $(24,770) $428,024 ======== ======== ======== ======== ======== ========
Amortization expense on intangible assets for the three months ended June 30, 2002 and 2001 was $1.1 million and $2.0 million respectively, and $3.0 million and $4.1 million for the six months ended June 30, 2002 and 2001, respectively. Estimated aggregate intangible asset amortization expense for the next five years is as follows: 2003 $5.2 million 2004 $4.2 million 2005 $3.2 million 2006 $2.4 million 2007 $1.8 million
5. LONG-TERM DEBT
JUNE 30, 2002 DECEMBER 31, 2001 ---------------------------- ---------------------------- AMOUNT INTEREST AMOUNT INTEREST OUTSTANDING RATE OUTSTANDING RATE ----------- -------- ----------- -------- (Dollars in thousands) Senior credit facility....................... $1,914,450 4.11% $1,900,000 4.67% Subsidiary debt obligations: Senior notes.............................. 655,207 6.625-8.15 658,211 6.625-8.15 Receivables-backed loan................... 339,305 2.37 400,000 2.29 Foreign subsidiary term loan.............. 36,194 5.18 35,172 6.25 Other lines of credit..................... 13,355 4.80 2,317 4.80 Industrial development revenue bonds...... 27,701 1.35-1.80 28,001 1.02-6.63 Capital lease obligations and other....... 40,122 44,796 ---------- ---------- 3,026,334 3,068,497 Less current portion......................... (139,422) (96,972) ---------- ---------- Total...................... $2,886,912 $2,971,525 ========== ==========
Senior Credit Facility -- Simultaneously with the completion of our acquisition of Old Dean, we obtained a new $2.7 billion credit facility with a syndicate of lenders, which replaced our then existing credit facilities. The senior credit facility provides an $800.0 million revolving line of credit, a Tranche A $900.0 million term loan and a Tranche B $1.0 billion term loan. At closing, we borrowed $1.9 billion under this facility's term loans. At June 30, 2002 there were outstanding borrowings of $1.914 billion under this facility, in addition to $56.6 million of issued but undrawn letters of credit. Credit Facility Terms -- Amounts outstanding under the revolver and the Tranche A term loan bear interest at a rate per annum equal to one of the following rates, at our option: 11 o a base rate equal to the higher of the Federal Funds rate plus 50 basis points or the prime rate, plus a margin that varies from 25 to 150 basis points, depending on our leverage ratio (which is the ratio of defined indebtedness to EBITDA), or o the London Interbank Offering Rate ("LIBOR") computed as LIBOR divided by the product of one minus the Eurodollar Reserve Percentage, plus a margin that varies from 150 to 275 basis points, depending on our leverage ratio. On April 30, 2002, we entered into an amendment to our credit facility pursuant to which the interest rate for amounts outstanding under the Tranche B term loan was lowered by 50 basis points, to the following, at our option: o a base rate equal to the higher of the Federal Funds rate plus 50 basis points or the prime rate, plus a margin that varies from 75 to 150 basis points, depending on our leverage ratio, or o LIBOR divided by the product of one minus the Eurodollar Reserve Percentage, plus a margin that varies from 200 to 275 basis points, depending on our leverage ratio. Prior to the effective date of the amendment, the margin for Tranche B base rate borrowings was a range of 125 to 200 basis points and the margin for Tranche B LIBOR borrowings was a range of 250 to 325 basis points. The blended interest rate in effect on borrowings under the senior credit facility, including the applicable interest rate margin, was 4.11% at June 30, 2002. However, we have interest rate swap agreements in place that hedge $925.0 million of our borrowings under this facility at an average rate of 5.95%, plus the applicable interest rate margin. Interest is payable quarterly or at the end of the applicable interest period. Scheduled principal payments on the Tranche A $900.0 million term loan are due in the following installments: o $16.87 million quarterly from March 31, 2002 through December 31, 2002; o $33.75 million quarterly from March 31, 2003 through December 31, 2004; o $39.38 million quarterly from March 31, 2005 through December 31, 2005; o $45.0 million quarterly from March 31, 2006 through December 31, 2006; o $56.25 million quarterly from March 31, 2007 through June 30, 2007; and o A final payment of $112.5 million on July 15, 2007. Scheduled principal payments on the Tranche B $1.0 billion term loan are due in the following installments: o $1.25 million quarterly from March 31, 2002 through December 31, 2002; o $2.5 million quarterly from March 31, 2003 through December 31, 2007; o A payment of $472.5 million on March 31, 2008; and 12 o A final payment of $472.5 million on July 15, 2008. No principal payments are due on the $800.0 million revolving line of credit until maturity on July 15, 2007. The credit agreement also requires mandatory principal prepayments in certain circumstances including without limitation: (1) upon the occurrence of certain asset dispositions not in the ordinary course of business, (2) upon the occurrence of certain debt and equity issuances when our leverage ratio is greater than 3.0 to 1.0, and (3) beginning in 2003, annually when our leverage ratio is greater than 3.0 to 1.0. As of June 30, 2002, our leverage ratio was 3.4 to 1.0. In consideration for the revolving commitments, we pay a commitment fee on unused amounts of the senior credit facility that ranges from 37.5 to 50 basis points, based on our leverage ratio. The senior credit facility contains various financial and other restrictive covenants and requirements that we maintain certain financial ratios, including a leverage ratio (computed as the ratio of the aggregate outstanding principal amount of defined indebtedness to EBITDA) and an interest coverage ratio (computed as the ratio of EBITDA to interest expense). In addition, this facility requires that we maintain a minimum level of net worth (as defined by the agreement). Our leverage ratio must be less than or equal to:
PERIOD RATIO ------------------------------------ ------------ 12-21-01 through 12-31-02........... 4.25 to 1.00 01-01-03 through 12-31-03........... 4.00 to 1.00 01-01-04 through 12-31-04........... 3.75 to 1.00 01-01-05 and thereafter............. 3.25 to 1.00
Our interest coverage ratio must be greater than or equal to 3.00 to 1.00. Our consolidated net worth must be greater than or equal to $1.2 billion, as increased each quarter (beginning with the quarter ended March 31, 2002) by an amount equal to 50% of our consolidated net income for the quarter, plus 75% of the amount by which stockholders' equity is increased by certain equity issuances. As of June 30, 2002, the minimum net worth requirement was $1.239 billion. Our credit agreement permits us to complete acquisitions that meet the following conditions: (1) the acquired company is involved in the manufacture, processing and distribution of food or packaging products or any other line of business in which we are currently engaged, (2) the total cash consideration is not greater than $100 million (which amount will be increased to $300 million when our leverage ratio is less than 3.0 to 1.0), (3) we acquire at least 51% of the acquired entity, and (4) the transaction is approved by the Board of Directors or shareholders, as appropriate, of the target. All other acquisitions must be approved in advance by the required lenders. Our credit agreement also permits us to repurchase stock under our open market share repurchase program, provided that, until our leverage ratio is less than 3.0 to 1.0, total Restricted Payments (as defined in the agreement, which definition includes stock repurchases) cannot exceed $50 million per year, plus the amount of payments required to be made on our outstanding convertible preferred securities during that year. The facility also contains limitations on liens, investments, the incurrence of additional indebtedness and acquisitions, and prohibits certain dispositions of property and restricts certain payments, including dividends. The credit facility is secured by liens on substantially all of our domestic 13 assets (including the assets of our subsidiaries, but excluding the capital stock of Old Dean's subsidiaries, and the real property owned by Old Dean and its subsidiaries). The agreement contains standard default triggers, including without limitation: failure to maintain compliance with the financial and other covenants contained in the agreement, default on certain of our other debt, a change in control and certain other material adverse changes in our business. The agreement does not contain any default triggers based on our debt rating. We are currently in compliance with all covenants contained in the credit agreement. Senior Notes -- Old Dean had certain senior notes outstanding at the time of the acquisition which remain outstanding. The notes carry the following interest rates and maturities: o $96.2 million ($100 million face value), at 6.75% interest, maturing in 2005; o $250.5 million ($250 million face value), at 8.15% interest, maturing in 2007; o $183.5 million ($200 million face value), at 6.625% interest, maturing in 2009; and o $125.0 million ($150 million face value), at 6.9% interest, maturing in 2017. These notes were issued by Old Dean. The related indentures do not contain financial covenants but they do contain certain restrictions including a prohibition against Old Dean and its subsidiaries granting liens on their respective real estate interests and a prohibition against Old Dean granting liens on the stock of its subsidiaries. The indentures also place certain restrictions on Old Dean's ability to divest assets not in the ordinary course of business. Receivables-Backed Loan -- We have entered into a $400.0 million receivables securitization facility pursuant to which certain of our subsidiaries sell their accounts receivable to two wholly-owned special purpose entities intended to be bankruptcy-remote. The special purpose entities then transfer the receivables to two third party asset-backed commercial paper conduits sponsored by major financial institutions. The assets and liabilities of these special purpose entities are fully reflected on our balance sheet, and the securitization is treated as a borrowing for accounting purposes. During the first six months of 2002, we made net payments of $60.7 million on this facility leaving an outstanding balance of $339.3 million at June 30, 2002. The receivables-backed loan bears interest at a variable rate based on the commercial paper yield as defined in the agreement. Foreign Subsidiary Term Loan -- In connection with our acquisition of Leche Celta in February 2000, our Spanish subsidiary obtained a 7 billion peseta (as of June 30, 2002, approximately $41.5 million) non-recourse term loan from a Spanish lender, all of which was borrowed at closing and used to finance a portion of the purchase price. The loan, which is secured by the stock of Leche Celta, will expire on February 21, 2007, bears interest at a variable rate based on the ratio of Leche Celta's debt to EBITDA (as defined in the corresponding loan agreement), and requires semi-annual principal payments. Other Lines of Credit -- Leche Celta, our Spanish subsidiary, is our only subsidiary with its own lines of credit separate from the credit facilities described above. Leche Celta's primary line of credit, which is in the principal amount of 2.5 billion pesetas (as of June 30, 2002 approximately $14.8 million), was obtained on July 12, 2000, bears interest at a variable interest rate based on the ratio of Leche Celta's 14 debt to EBITDA (as defined in the corresponding loan agreement), is secured by our stock in Leche Celta and will expire in June 2007. Leche Celta also utilizes other local commercial lines of credit. At June 30, 2002, a total of $13.4 million was drawn on these lines of credit. Industrial Development Revenue Bonds -- Certain of our subsidiaries have revenue bonds outstanding, some of which require nominal annual sinking fund redemptions. Typically, these bonds are secured by irrevocable letters of credit issued by financial institutions, along with first mortgages on the related real property and equipment. Interest on these bonds is due semiannually at interest rates that vary based on market conditions. Other Subsidiary Debt -- Other subsidiary debt includes various promissory notes for the purchase of property, plant, and equipment and capital lease obligations. The various promissory notes payable provide for interest at varying rates and are payable in monthly installments of principal and interest until maturity, when the remaining principal balances are due. Capital lease obligations represent machinery and equipment financing obligations which are payable in monthly installments of principal and interest and are collateralized by the related assets financed. Letters of Credit -- At June 30, 2002 there were $56.6 million of issued but undrawn letters of credit secured by our senior credit facility. In addition to the letters of credit secured by our credit facility, an additional $64.0 million of letters of credit were outstanding at June 30, 2002. These letters of credit were required by various utilities and government entities for performance and insurance guarantees. Interest Rate Agreements -- We have interest rate swap agreements in place that have been designated as cash flow hedges against variable interest rate exposure on a portion of our debt, with the objective of minimizing our interest rate risk and stabilizing cash flows. These swap agreements provide hedges for loans under our senior credit facility by limiting or fixing the LIBOR interest rates specified in the senior credit facility at the interest rates noted below until the indicated expiration dates of these interest rate swap agreements. The following table summarizes our various interest rate agreements in effect as of June 30, 2002 and December 31, 2001:
FIXED INTEREST RATES EXPIRATION DATE NOTIONAL AMOUNTS --------------------- --------------- ---------------- (In millions) 4.90% to 4.93%....... December 2002 $275.0 6.07% to 6.24%....... December 2002 325.0 6.23%................ June 2003 50.0 6.69%................ December 2004 100.0 6.69% to 6.74%....... December 2005 100.0 6.78%................ December 2006 75.0
In March and June of 2002, we entered into forward starting swaps that begin in December 2002 with a notional amount of $750.0 million and fixed interest rates of 4.005% to 5.315%. These swaps have been designated as hedges against interest rate exposure on loans under our senior credit facility and under one of our subsidiary's term loans.
FIXED INTEREST RATES EXPIRATION DATE NOTIONAL AMOUNTS -------------------- --------------- ---------------- (In millions) 4.290% to 4.6875% December 2003 $275.0 4.005% to 4.855% December 2004 175.0 5.190% to 5.315% December 2005 300.0
We have also entered into interest rate swap agreements that provide hedges for loans under Leche Celta's term loan. The following table summarizes these agreements:
FIXED INTEREST RATES EXPIRATION DATE NOTIONAL AMOUNTS -------------------- --------------- -------------------------------------------------------- 5.54% November 2003 1,500,000,000 pesetas (approximately $8.9 million as of June 30, 2002) 5.6% November 2004 2,000,000,000 pesetas (approximately $11.9 million as of June 30, 2002
These swaps are required to be recorded as an asset or liability on our consolidated balance sheet at fair value, with an offset to other comprehensive income to the extent the hedge is effective. Derivative 15 gains and losses included in other comprehensive income are reclassified into earnings as the underlying transaction occurs. Any ineffectiveness in our hedges is recorded as an adjustment to interest expense. As of June 30, 2002, our derivative liability totaled $48.3 million on our consolidated balance sheet including approximately $32.8 million recorded as a component of accounts payable and accrued expenses and $15.5 million recorded as a component of other long-term liabilities. There was no hedge ineffectiveness, as determined in accordance with SFAS No. 133, for the quarter or the six months ended June 30, 2002. Approximately $5.8 million and $11.5 million of losses (net of taxes) were reclassified to interest expense from other comprehensive income during the quarter and the six months ended June 30, 2002, respectively. We estimate that approximately $20.6 million of net derivative losses (net of income taxes) included in other comprehensive income will be reclassified into earnings within the next 12 months. These losses will partially offset the lower interest payments recorded on our variable rate debt. We are exposed to market risk under these arrangements due to the possibility of interest rates on the credit facilities falling below the rates on our interest rate swap agreements. Credit risk under these arrangements is remote since the counterparties to our interest rate swap agreements are major financial institutions. 6. STOCKHOLDERS' EQUITY The following table summarizes activity during the first two quarters of 2002 under our stock-based compensation programs:
WEIGHTED AVERAGE AWARDS EXERCISE PRICE ---------- ---------------- Options outstanding at December 31, 2001 ........................ 14,063,860(1) $21.16 Options granted during first quarter(2) .................... 4,826,170 30.53 Options canceled or surrendered during first quarter(3) .... (1,644,002) 22.46 Options exercised during first quarter ..................... (1,830,268) 20.80 ---------- Options outstanding at March 31, 2002 ........................... 15,415,760 23.98 Options granted during second quarter(2) ................... 121,000 36.61 Options canceled during second quarter ..................... (1,155,679) 22.13 Options exercised during second quarter .................... (463,967) 21.71 ---------- Options outstanding at June 30, 2002 ............................ 13,917,114 24.31 ==========
---------- (1) Options to purchase Old Dean stock outstanding at the time of the acquisition were automatically converted into options to purchase our stock. Upon conversion, those options represented options to purchase a total of approximately 5.4 million shares of our common stock. (2) Options vest as follows: one-third on the first anniversary of the grant date, one-third on the second anniversary of the grant date, and one-third on the third anniversary of the grant date. (3) The acquisition of Old Dean triggered certain "change in control" rights contained in the Old Dean option agreements, which consisted of the right to surrender the options to us, in lieu of exercise, in exchange for cash, provided the options were surrendered prior to March 21, 2002. Options to purchase approximately 1.6 million shares were surrendered. We issued 1,876 shares of restricted stock during the first quarter of 2002 and 2,968 shares of restricted stock during the second quarter of 2002. All shares of restricted stock were granted to independent directors as compensation for services rendered as directors during the immediately preceding quarter. Shares of restricted stock vest one-third on grant, one-third on the first anniversary of grant and one-third on the second anniversary of grant. 16 7. COMPREHENSIVE INCOME Comprehensive income consists of net income plus all other changes in equity from non-owner sources. Consolidated comprehensive income was $75.5 million and $84.2 million for the three-months and six-months ended June 30, 2002. The amounts of income tax (expense) benefit allocated to each component of other comprehensive income during the six months ended June 30, 2002 are included below.
PRE-TAX INCOME TAX BENEFIT (LOSS) (EXPENSE) NET AMOUNT -------- ------------ ---------- (In thousands) Accumulated other comprehensive income, December 31, 2001 ................. $(51,021) $ 21,178 $(29,843) Cumulative translation adjustment arising during period .............. (1,402) 533 (869) Net change in fair value of derivative instruments ................... (7,177) 2,938 (4,239) Amounts reclassified to income statement related to derivatives ...... 9,716 (3,973) 5,743 -------- -------- -------- Accumulated other comprehensive income, March 31, 2002 .................... $(49,884) 20,676 (29,208) -------- -------- -------- Cumulative translation adjustment arising during period .............. 9,273 (3,404) 5,869 Net change in fair value of derivative instruments ................... (15,283) 5,885 (9,398) Amounts reclassified to income statement related to derivatives ...... 9,391 (3,616) 5,775 -------- -------- -------- Accumulated other comprehensive income, June 30, 2002 ..................... $(46,503) $ 19,541 $(26,962) ======== ======== ========
8. PLANT CLOSING COSTS Plant Closing Costs -- As part of an overall integration and cost reduction program, we recorded plant closing costs during the first quarter of 2002 in the amount of $1.2 million related to the closing of our Port Huron, Michigan, Dairy Group plant during the fourth quarter of 2001. During the second quarter of 2002, we recorded plant closing costs in the amount of $6.7 million related to the closing of one plant in Puerto Rico, one Dairy Group plant in Bennington, Vermont, and one Dairy Group distribution facility in Winchester, Virginia. The principal components of the cost reduction plans included within this program include the following: o Workforce reductions as a result of plant closings, plant rationalizations and consolidation of administrative functions. To date, we have identified 303 employees, who were primarily plant employees associated with the plant closings and rationalization, for termination pursuant to the plans. Costs are charged to our earnings in the period that the plan is established in detail and employee severance and benefits are appropriately communicated. As of June 30, 2002, 298 employees had been terminated under the program; o Shutdown costs, including those costs that are necessary to prepare plant facilities for re-sale or closure; o Costs incurred after shutdown, such as lease obligations or termination costs, utilities and property taxes; and o Write-downs of property, plant and equipment and other assets, primarily for asset impairments as a result of facilities that are no longer used in operations. The impairments relate primarily to owned building, land and equipment at the facilities which are being sold and were written down to their estimated fair value. The effects of suspending depreciation on the buildings and equipment related to the closed facilities were not significant. The carrying value of closed facilities held for sale at June 30, 2002 was approximately 17 $8.5 million. We are marketing these properties for sale. Divestitures of closed facilities has not resulted in significant modifications to the estimate of fair value. Activity with respect to plant closing costs for 2002 to date is summarized below:
SIX MONTHS ENDED BALANCE JUNE 30, 2002 BALANCE AT ---------------------- AT DECEMBER 31, 2001 CHARGES PAYMENTS JUNE 30, 2002 ----------------- ------- -------- ------------- Cash charges: (In thousands) Workforce reduction costs....................... $668 $1,997 $(1,105) $ 1,560 Shutdown costs.................................. 460 549 (324) 685 Lease obligations after shutdown................ 119 46 (10) 155 Other........................................... 253 857 (5) 1,105 ------ ------- ------- Subtotal............................................ $1,500 $(1,444) $ 3,505 ====== ======= ======= Noncash charges: Write-down of assets............................ 4,449 ------ Total charges....................................... $7,898 ======
There have not been significant adjustments to any plan included within our integration and cost reduction program, and the majority of future cash requirements to reduce the liabilities under the plans are expected to be completed within one year. Acquired facility closing costs -- As part of our purchase price allocations, we accrue costs from time to time pursuant to plans to exit certain activities and operations of acquired businesses in order to rationalize production and reduce costs and inefficiencies. We have implemented a plan to close several plants and the Old Dean administrative offices in connection with our acquisition of Old Dean. We will continue to finalize and implement our initial integration and rationalization plan and expect to refine our estimate of amounts in our purchase price allocations associated with this plan. The principal components of the plan include the following: o Workforce reductions as a result of plant closings, plant rationalizations and consolidation of administrative functions and offices, resulting in an overall reduction of 677 plant and administrative personnel which have been identified for termination to date. The costs incurred are charged against our acquisition liabilities for these costs. As of June 30, 2002, 183 employees identified for termination had not yet been terminated; o Shutdown costs, including those costs that are necessary to clean and prepare the plant facilities for re-sale or closure; and o Costs incurred after shutdown such as lease obligations or termination costs, utilities and property taxes after shutdown of the plant or administrative office. Activity with respect to these acquisition liabilities during the first six months of 2002 are summarized below:
ACCRUED ACCRUED CHARGES AT CHARGES AT DECEMBER 31, JUNE 30, 2001 ACCRUALS PAYMENTS 2002 ------------ -------- -------- ---------- (In thousands) Workforce reduction costs .... $ 20,029 $ 3,425 $ (9,470) $ 13,984 Shutdown costs ............... 12,621 6,279 (5,842) 13,058 -------- -------- -------- -------- Total ........................ $ 32,650 $ 9,704 $(15,312) $ 27,042 ======== ======== ======== ========
18 9. SHIPPING AND HANDLING FEES Our shipping and handling costs are included in both cost of sales and selling and distribution expense, depending on the nature of such costs. Shipping and handling costs included in cost of sales reflect the cost of shipping products to customers through third party carriers, inventory warehouse costs and product loading and handling costs. Shipping and handling costs included in selling and distribution expense consist primarily of route delivery costs for both company-owned delivery routes and independent distributor routes, to the extent that such independent distributors are paid a delivery fee. Shipping and handling costs that were recorded as a component of selling and distribution expense were approximately $240.1 million and $477.7 million during the second quarter and first half of 2002, respectively, compared to $162.0 million and $322.6 million during the second quarter and first six months, respectively, of 2001. 10. COMMITMENTS AND CONTINGENCIES Guaranty of Certain Indebtedness of Consolidated Container Company -- We own a 43.1% interest in Consolidated Container Company ("CCC"), the nation's largest manufacturer of rigid plastic containers and our primary supplier of plastic bottles and bottle components. During 2001, as a result of various operational difficulties, CCC became unable to comply with the financial covenants in its credit facility. In February 2002, CCC's lenders agreed to restructure the credit agreement to modify the financial covenants, subject to the agreement of CCC's primary shareholders to guarantee certain of CCC's debt. Because CCC is an important and valued supplier of ours, and in order to protect our interest in CCC, we agreed to provide a limited guaranty. The guaranty, which expires on January 5, 2003, is limited in amount to the lesser of (1) 49% of the principal, interest and fees of CCC's "Tranche 3" revolver, and (2) $10 million. CCC's "Tranche 3" revolver can only be drawn upon by CCC when its Tranche 1 and Tranche 2 revolvers are fully drawn. If CCC draws on the Tranche 3 revolver, no voluntary pre-payments may be made on the Tranche 1 and 2 revolvers until the Tranche 3 revolver is fully re-paid. Our guaranty cannot be drawn upon until the Tranche 3 loan is due and payable (whether at its January 5, 2003 maturity or by acceleration), and no more than one demand for payment may be made by the banks. We have entered into an agreement with Alan Bernon (who is a member of our Board of Directors) and his brother, Peter Bernon, who collectively own 6% of CCC, pursuant to which, collectively, they have agreed to reimburse us for 12% of any amounts paid by us under the guaranty. Contingent Obligations Related to Milk Supply Arrangements and Divested Operations -- On December 21, 2001, in connection with our acquisition of Old Dean, we purchased Dairy Farmers of America's ("DFA") 33.8% stake in our Dairy Group for consideration consisting of (1) approximately $145.4 million in cash, (2) a contingent promissory note in the original principal amount of $40.0 million, and (3) the operations of 11 plants located in nine states where we and Old Dean had overlapping operations (which plants were actually transferred to National Dairy Holdings, L.P., as assignee of DFA). As additional consideration, we amended a milk supply agreement with DFA to provide that if we do not, within a certain period of time after the completion of the Old Dean acquisition, offer DFA the right to supply raw milk to certain of the Old Dean dairy plants, we could be required to pay liquidated damages of up to $47.0 million. Specifically, the liquidated damages to DFA provision provides that: o If we have not offered DFA the right to supply all of our raw milk requirements for certain of Old Dean's plants by either (i) the end of the 18th full month after December 21, 2001, or (ii) with respect to certain other plants, the end of the 6th full calendar month following the expiration of milk supply agreements in existence at those plants on December 21, 2001, or 19 o If DFA is prohibited from supplying those plants because of an injunction, restraining order or otherwise as a result of or arising from a milk supply contract to which we are party, we must pay DFA liquidated damages determined and paid on a plant-by-plant basis, based generally on the amount of raw milk used by that plant. Liquidated damages would be payable in arrears in equal, quarterly installments over a 5-year period, without interest. If we are required to pay any such liquidated damages, the principal amount of the $40.0 million contingent promissory note will be reduced by an amount equal to 25% of the liquidated damages paid. The contingent promissory note is designed to ensure that DFA, one of our primary suppliers of raw milk, has the opportunity to continue to supply raw milk to certain of our plants until 2021, or be paid for the loss of that business. The contingent promissory note has a 20-year term and bears interest based on the consumer price index. Interest will not be paid in cash. Instead, interest will be added to the principal amount of the note annually, up to a maximum principal amount of $96.0 million. We may prepay the note in whole or in part at any time, without penalty. The note will only become payable if we ever materially breach or terminate one of our milk supply agreements with DFA without renewal or replacement. Otherwise, the note will expire at the end of 20 years, without any obligation to pay any portion of the principal or interest. We retained certain liabilities of the businesses of the 11 plants divested to National Dairy Holdings, where those liabilities were deemed to be "non-ordinary course" liabilities. We also have the obligation to indemnify National Dairy Holdings for any damages incurred by it in connection with those retained liabilities, or in connection with any breach of the divestiture agreement. We do not expect any liability that we may have for these retained liabilities, or any indemnification liability, to be material. We believe we have created adequate reserves for any such potential liability. Leases -- We lease certain property, plant and equipment used in our operations under both capital and operating lease agreements. Such leases, which are primarily for machinery, equipment and vehicles, have lease terms ranging from 1 to 20 years. Certain of the operating lease agreements require the payment of additional rentals for maintenance, along with additional rentals based on miles driven or units produced. Contingent Obligations Related to White Wave Acquisition -- On May 9, 2001, we completed the acquisition of White Wave, Inc. In connection with the acquisition, we established a Performance Bonus Plan pursuant to which we agreed to pay performance bonuses to certain employees of White Wave if certain performance targets are achieved. Specifically, we agreed that if the cumulative net sales (as defined in the plan) of White Wave equal or exceed $382.5 million during the period beginning April 1, 2002 and ending March 31, 2004 (the "Incentive Period") and White Wave does not exceed the budgetary restrictions set forth in the plan by more than $1 million during the Incentive Period, we will pay employee bonuses as follows: o If cumulative net sales during the Incentive Period are between $382.5 million and $450.0 million, the bonus paid will scale ratably (meaning $129,630 for each $1 million of net sales) between $26.025 million and $35.0 million; and o If cumulative net sales exceed $450 million during the Incentive Period, additional amounts will be paid as follows: - First $50 million above $450 million net sales: 10% of amount in excess of $450 million, plus 20 - Second $50 million above $450 million net sales: 15% of amount in excess of $500 million, plus - In excess of $550 million net sales: 20% of amount in excess of $550 million. Key employees of White Wave are also entitled to receive certain payments if they are terminated without cause (or as a result of death or incapacity) during the Incentive Period. Litigation, Investigations and Audits -- We and our subsidiaries are parties, in the ordinary course of business, to certain other claims, litigation, audits and investigations. We believe we have created adequate reserves for any liability we may incur in connection with any such currently pending or threatened matter. In our opinion, the settlement of any such currently pending or threatened matter is not expected to have a material adverse impact on our financial position, results of operations or cash flows. 11. BUSINESS AND GEOGRAPHIC INFORMATION AND MAJOR CUSTOMERS We currently have three reportable segments: Dairy Group, Morningstar/White Wave and Specialty Foods. Our Dairy Group segment manufactures and distributes fluid milk, ice cream and novelties, half-and-half, whipping cream, sour cream, cottage cheese, yogurt and dips, as well as fruit juices, flavored drinks and bottled water. Our Morningstar/White Wave segment manufactures dairy and non-dairy coffee creamers, whipping cream and pre-whipped toppings, dips and dressings, cultured dairy products, and specialty products such as lactose-reduced milk and extended shelf-life flavored milks and milk-based beverages, soymilk and other soy products. We obtained Specialty Foods as part of our acquisition of Old Dean on December 21, 2001. Specialty Foods processes and markets pickles, powdered products such as non-dairy coffee creamers, and sauces and puddings. Neither our Puerto Rico nor our Spanish operations meet the definition of a reportable segment. Therefore, they are both reported in the "Corporate/Other" line. The accounting policies of our segments are the same as those described in the summary of significant accounting policies set forth in Note 1 to our 2001 consolidated financial statements contained in our 2001 Annual Report on Form 10-K. We evaluate performance based on operating profit not including non-recurring gains and losses and foreign exchange gains and losses. We do not allocate income taxes, management fees or unusual items to segments. In addition, there are no significant non-cash items other than depreciation and amortization in reported segment income.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, ------------------------------ ------------------------------ 2002 2001 2002 2001 ----------- ----------- ----------- ----------- (In thousands) Net sales from external customers: Dairy Group ....................... $ 1,798,714 $ 1,240,098 $ 3,576,218 $ 2,440,772 Morningstar/White Wave ............ 263,796 178,938 502,376 345,627 Specialty Foods ................... 177,364 338,578 Corporate/Other ................... 111,082 98,505 215,769 196,214 ----------- ----------- ----------- ----------- Total ......................... $ 2,350,956 $ 1,517,541 $ 4,632,941 $ 2,982,613 =========== =========== =========== ===========
21
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, ------------------------------ ------------------------------ 2002 2001 2002 2001 ----------- ----------- ----------- ----------- (In thousands) Intersegment sales: Dairy Group ....................... $ 8,802 $ 3,969 $ 14,879 $ 8,095 Morningstar/White Wave ............ 28,218 22,839 57,368 42,397 Specialty Foods ................... 3,898 7,774 Corporate/Other ................... ----------- ----------- ----------- ----------- Total ......................... $ 40,918 $ 26,808 $ 80,021 $ 50,492 =========== =========== =========== =========== Operating income: Dairy Group(1) .................... $ 137,113 $ 75,681 $ 263,347 $ 142,312 Morningstar/White Wave ............ 30,835 24,748 53,940 46,265 Specialty Foods ................... 25,367 46,154 Corporate/Other(2) ................ (14,933) 2,473 (36,770) (1,797) ----------- ----------- ----------- ----------- Total ......................... $ 178,382 $ 102,902 $ 326,671 $ 186,780 =========== =========== =========== ===========
Assets at June 30: 2002 2001 ---------- ---------- (In thousands) Dairy Group .................. $4,501,475 $2,878,309 Morningstar/White Wave ....... 1,038,049 438,753 Specialty Foods .............. 598,163 Corporate/Other .............. 705,236 443,907 ---------- ---------- Total .................... $6,842,923 $3,760,969 ========== ==========
---------- (1) Operating income includes plant closing costs of $5.3 million in the second quarter of 2002 and $6.5 million and $0.8 million in the first six months of 2002 and 2001, respectively. (2) Operating income includes plant closing costs of $1.4 million in the second quarter and first six months of 2002. Geographic information for the three-month and six-month periods ended June 30:
REVENUE ------------------------------------------------------------- LONG-LIVED ASSETS THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, AT JUNE 30, --------------------------- --------------------------- --------------------------- 2002 2001 2002 2001 2002 2001 ---------- ---------- ---------- ---------- ---------- ---------- (In thousands) (In thousands) (In thousands) United States ........... $2,235,627 $1,419,036 $4,408,744 $2,786,399 $5,138,671 $2,711,862 Puerto Rico ............. 55,713 56,261 111,479 111,948 122,089 125,621 Europe .................. 59,616 42,244 112,718 84,266 110,687 100,582 ---------- ---------- ---------- ---------- ---------- ---------- Total ................... $2,350,956 $1,517,541 $4,632,941 $2,982,613 $5,371,447 $2,938,065 ========== ========== ========== ========== ========== ==========
We have no single customer within any segment which represents greater than ten percent of our consolidated revenues. 22 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS We are the leading processor and distributor of fresh milk and other dairy products in the United States and a leader in the specialty foods industry. We currently have three reportable segments: Dairy Group, Morningstar/White Wave and Specialty Foods. Our Dairy Group segment manufactures and sells fluid milk, ice cream and novelties, half-and-half, whipping cream, sour cream, cottage cheese, yogurt and dips, as well as fruit juices, flavored drinks and bottled water. Our Morningstar/White Wave segment consists of our Morningstar Foods division and, as of May 9, 2002, our White Wave, Inc. subsidiary. It manufactures and sells dairy and non-dairy coffee creamers, whipping cream and pre-whipped toppings, dips and dressings, cultured dairy products, specialty products such as lactose-reduced milks and extended shelf-life milks and milk-based beverages, soymilks and other soy products. Specialty Foods manufactures and sells pickles, powdered products such as non-dairy coffee creamers, and sauces and puddings. We also have operations in Puerto Rico and Spain that are aggregated in our segment discussions into the "Corporate/Other" category. RESULTS OF OPERATIONS The following table presents certain information concerning our results of operations, including information presented as a percentage of net sales:
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, --------------------------------------------- --------------------------------------------- 2002 2001 2002 2001 -------------------- -------------------- -------------------- -------------------- DOLLARS PERCENT DOLLARS PERCENT DOLLARS PERCENT DOLLARS PERCENT ---------- ------- ---------- ------- ---------- ------- ---------- ------- (Dollars in thousands) (Dollars in thousands) Net sales ......................... $2,350,956 100.0% $1,517,541 100.0% $4,632,941 100.0% $2,982,613 100.0% Cost of sales ..................... 1,738,644 74.0 1,163,947 76.7 3,464,340 74.8 2,281,774 76.5 ---------- ------- ---------- ------- ---------- ------- ---------- ------- Gross profit .................... 612,312 26.0 353,594 23.3 1,168,601 25.2 700,839 23.5 Operating expenses Selling and distribution ........ 336,620 14.3 197,714 13.0 659,664 14.2 396,004 13.3 General and administrative ...... 88,776 3.7 39,522 2.6 170,286 3.6 90,415 3.0 Amortization of intangibles ..... 1,869 0.1 13,456 0.9 4,082 0.1 26,797 0.9 Plant closing and other costs ... 6,665 0.3 7,898 0.2 843 ---------- ------- ---------- ------- ---------- ------- ---------- ------- Total operating expenses ...... 433,930 18.4 250,692 16.5 841,930 18.1 514,059 17.2 ---------- ------- ---------- ------- ---------- ------- ---------- ------- Total operating income ........ $ 178,382 7.6% $ 102,902 6.8% $ 326,671 7.1% $ 186,780 6.3% ========== ======= ========== ======= ========== ======= ========== =======
Note: We completed our acquisition of the former Dean Foods Company ("Old Dean") on December 21, 2001. We obtained our Specialty Foods segment as part of our acquisition of Old Dean. More complete segment data can be found in Note 11 to our condensed consolidated financial statements. Effective January 1, 2002, we adopted SFAS No. 142, "Goodwill and Other Intangible Assets," which eliminates the amortization of goodwill and certain other intangible assets. As a result of the acquisition of Old Dean and the adoption of SFAS No. 142, comparisons with the first two quarters of 2001 are less meaningful than they would be otherwise. Where appropriate, we have provided comparisons eliminating the amortization of goodwill and amortizing our recognized intangible assets over their useful lives. See Notes 1 and 4 to our condensed consolidated financial statements for more information regarding SFAS 142. SECOND QUARTER 2002 COMPARED TO SECOND QUARTER 2001 Net Sales -- Net sales increased $0.83 billion, or 55%, to $2.35 billion during the second quarter of 2002, from $1.52 billion in the second quarter of 2001. 23 Net sales for the Dairy Group increased $558.6 million, or 45%, in the second quarter of 2002. The acquisition of Old Dean (net of the plants divested as part of the transaction) contributed approximately $635 million to the Dairy Group's second quarter sales. That increase was offset primarily by the effects of decreased raw milk costs compared to the prior year second quarter, and also by lower ice cream volumes. In general, we change the prices that we charge our customers for our products on a monthly basis, as the costs of our raw materials fluctuate. Therefore, sales generally decrease as raw material prices decrease. The average monthly price for Class I raw skim milk decreased approximately 11% in the second quarter of 2002 from the same period in 2001, to $6.99 per hundredweight from $7.88 per hundredweight. The average monthly price for Class I butterfat decreased approximately 32% in the same periods, to $1.29 per pound from $1.89 per pound. We process Class I raw skim milk and butterfat into fluid milk products. Average monthly prices for Class II butterfat, which we use for products such as cottage cheese, creams, ice cream and sour cream, decreased approximately 43% in the second quarter of 2002 compared to 2001, to $1.19 per pound to $2.10 per pound. The Dairy Group's fluid milk volumes during the second quarter of 2002 were relatively flat compared to the second quarter of 2001, while ice cream volumes during the second quarter of 2002 were down approximately 9% compared to the second quarter of 2001. Our ice cream products are sold under private labels and local brands, and we lost sales during the quarter to stronger premium branded products, which are promoted more aggressively than our products. Cooler than average temperatures in the early part of the summer also contributed to decreased ice cream volumes during the second quarter of 2002. Net sales for Morningstar/White Wave increased $84.9 million or 47%, in the second quarter of 2002, compared to the year earlier period. We estimate that the acquisition of Old Dean added approximately $75 million of sales at our Morningstar/White Wave segment during the second quarter of 2002; although precise measurement of the impact of the Old Dean acquisition on Morningstar/White Wave's sales is no longer possible because Old Dean's NRP group has now been fully integrated into Morningstar from an accounting standpoint, and is no longer accounted for separately. The acquisition of White Wave contributed approximately $24 million in the second quarter of 2002. These gains were offset by (i) lower raw milk and butterfat prices, (ii) lower cultured dairy product volumes, and (iii) the previously-announced phase-out of the Lactaid, Nestle Quik and Nestle Coffeemate co-packing businesses. Sales of Morningstar/White Wave's strategic brands, which include Hershey's(R) flavored milks, International Delight(R) coffee creamers, Silk(R) soy products, SunSoy(R) soymilk, Folger's Jakada(R) milk and coffee beverage, Dairy Ease(R) lactose-free milk and Marie's(R) dips and dressings and Dean's dips, totaled approximately $105 million during the second quarter of 2002. Strategic brand volumes were up over 20% in the second quarter of 2002 compared to the second quarter of 2001 (including the effect of brands acquired in both periods). Our Specialty Foods segment reported net sales of $177.4 million in the second quarter of 2002. Cost of Sales -- Our cost of sales ratio was 74.0% in the second quarter of 2002 compared to 76.7% in the same period of 2001. The cost of sales ratio for the Dairy Group decreased to 74.4% in the second quarter of 2002 from 77.2% in the second quarter of 2001 due primarily to lower raw milk costs and also to realized merger synergies. The cost of sales ratio for Morningstar/White Wave decreased to 66.8% in the second quarter of 2002 from 70.7% in the same period of 2001, due primarily to lower butterfat costs in the second quarter of 2002 compared to the year earlier period and also to realized merger synergies. Specialty Foods' cost of sales ratio was 74.0% in the second quarter of 2002. Operating Costs and Expenses -- Our operating expense ratio was 18.4% in the second quarter of 2002 compared to 16.5% in the second quarter of 2001. These ratios were affected by our adoption of SFAS 142 on January 1, 2002. Excluding 2001 amortization, our operating expense ratio would have been 15.7% in 2001, as compared to 18.4% in 2002. The operating expense ratio at the Dairy Group was 17.9% in the second quarter of 2002 compared to 16.7% in the same period last year. Excluding approximately $9.9 million of amortization in the second quarter of 2001, 24 the Dairy Group's operating expense ratio would have been 15.9% in 2001, compared to 17.9% in 2002. The increase in 2002 was due to plant closing costs of $6.7 million as well as higher selling and marketing expenses incurred in support of our regional Dairy Group brands. The operating expense ratio at Morningstar/White Wave was 21.6% in the second quarter of 2002 compared to 15.4% in the second quarter of 2001. Excluding approximately $1.8 million of amortization in the second quarter of 2001, the operating expense ratio would have been 14.4% in 2001, compared to 21.6% in 2002. This increase was caused by (i) higher selling and marketing expenses related to the introduction of new products and additional promotions of existing products, (ii) the addition of White Wave, which has higher selling and marketing costs, and (iii) higher distribution expenses due primarily to the acquisition of White Wave. The increase in 2002 was partly caused by corporate office expenses, which increased approximately $14.0 million in the second quarter of 2002 compared to 2001 as a result of the acquisition of Old Dean. The operating expense ratio for Specialty Foods was 11.7% in the second quarter of 2002. Operating Income -- Operating income in the second quarter of 2002 was $178.4 million, an increase of $75.5 million from 2001 operating income of $102.9 million. Our operating margin in the second quarter of 2002 was 7.6% compared to 6.8% in the same period of 2001. Excluding 2001 amortization that would have been eliminated had SFAS 142 been in effect last year, our operating income would have increased $62.8 million in the second quarter of 2002 and our operating margin would have been 7.6% in both years. The Dairy Group's operating margin, after excluding amortization expense from the second quarter of 2001, increased to 7.6% in the second quarter of 2002 from 6.9% in the second quarter of 2001. This increase was primarily due to lower raw milk costs during 2002 and to realized synergies from our acquisition of Old Dean, partly offset by higher spending on regional brands. The operating margin for our Morningstar/White Wave segment, again excluding amortization expense from the second quarter of 2001, declined to 11.7% in the second quarter of 2002 from 14.8% in 2001. This decrease was due primarily to higher distribution, selling and marketing expenses, offset by certain realized merger synergies. Specialty Foods' operating margin was 14.3% in the second quarter of 2002. Other (Income) Expense -- Total other expense increased by $27.1 million in the second quarter of 2002 compared to 2001. Interest expense increased to $52.3 million in the second quarter of 2002 from $25.9 million in 2001. This increase was the result of higher debt used to finance the acquisitions of Old Dean and White Wave. Financing charges on preferred securities were $8.4 million in both years. Income from investments in unconsolidated affiliates increased to $1.4 million in the second quarter of 2002 from $1.2 million in the same period of 2001. The income in 2002 primarily related to our 36.0% interest in White Wave through May 9, 2002. On May 9, 2002 we acquired the remaining equity interest in White Wave and began consolidating White Wave's results with our financial results. Our income in 2001 related primarily to our 43.1% minority interest in Consolidated Container Company ("CCC"). In the fourth quarter of 2001 we concluded that our investment in CCC was impaired and that the impairment was not temporary, and as a result we wrote off our remaining investment in CCC. Income Taxes -- Income tax expense was recorded at an effective rate of 38.1% in the second quarter of 2002 compared to 37.1% in 2001. Our tax rate varies as the mix of earnings contributed by our various business units changes, and as tax savings initiatives are adopted. 25 Minority Interest -- Minority interest in earnings decreased significantly to $7.0 thousand in the second quarter of 2002 from $9.4 million in the second quarter of 2001. In 2002, management of a subsidiary of our Specialty Foods segment owned a small minority interest in that subsidiary. In 2001, Dairy Farmers of America owned a 33.8% minority interest in our Dairy Group. On December 21, 2001, in connection with our acquisition of Old Dean, we purchased the 33.8% stake that was owned by Dairy Farmers of America. See Note 2 to our condensed consolidated financial statements. FIRST SIX MONTHS OF 2002 COMPARED TO FIRST SIX MONTHS OF 2001 Net Sales -- Net sales increased 55% to $4.63 billion during the first six months of 2002 from $2.98 billion in the first six months of 2001. Net sales for the Dairy Group increased 47%, or $1.14 billion, in the first half of 2002 compared to the first half of 2001. The acquisition of Old Dean contributed a net increase of approximately $1.24 billion to the Dairy Group. That increase was offset primarily by the effects of decreased raw milk costs compared to the first half of the prior year, and also by lower ice cream volumes. The average monthly price for Class I raw skim milk decreased approximately 10% in the first half of 2002 from the same period in 2001, to $7.07 per hundredweight from $7.88 per hundredweight. The average monthly price for Class I butterfat decreased approximately 20% in the same periods, to $1.35 per pound from $1.70 per pound. We process Class I raw skim milk and butterfat into fluid milk products. Average monthly prices for Class II butterfat, which we use for products such as cottage cheese, creams, ice cream and sour cream, decreased approximately 27% in the first six months of 2002 compared to 2001, to $1.30 per pound from $1.79 per pound. Net sales for Morningstar/White Wave increased 45%, or $156.7 million in the first half of 2002, compared to the year earlier period. We estimate that the acquisition of Old Dean added approximately $161 million of sales at our Morningstar/White Wave segment during the first half of 2002; although precise measurement of the impact of the acquisition of Old Dean on Morningstar/White Wave's sales is no longer possible because Old Dean's NRP segment has now been fully integrated into Morningstar from an accounting standpoint, and is no longer accounted for separately. The acquisition of White Wave contributed approximately $24 million in the first half of 2002. These gains were offset by (i) lower raw milk and butterfat costs, (ii) cultured dairy product volume declines and (iii) the previously announced phase-out of the Lactaid(R), Nestle Nesquik(R) and Nestle Coffeemate(R) a co-packing businesses. Our Specialty Foods segment reported net sales of $338.6 million in the first six months of 2002. Cost of Sales -- Our cost of sales ratio was 74.8% in the first six months of 2002 compared to 76.5% in the same period of 2001. The cost of sales ratio for the Dairy Group decreased to 74.8% in the first half of 2002 from 76.9% in the first half of 2001 due primarily to lower raw milk costs. The cost of sales ratio for Morningstar/White Wave decreased slightly to 70.2% in the first six months of 2002 from 70.3% in the same period of 2001. This decrease in 2002 was due to lower butterfat costs, largely offset by higher sales incentives and the addition of Old Dean's operations which have higher costs of sales. Specialty Foods cost of sales ratio was 74.9% in the first half of 2002. Operating Costs and Expenses -- Our operating expense ratio was 18.1% in the first half of 2002 compared to 17.2% in the same period of 2001. These ratios were affected by our implementation of SFAS 142 on January 1, 2002. Excluding 2001 amortization, our operating expense ratio would have been 16.4% in 2001. The operating expense ratio at the Dairy Group was 17.8% in the first half of 2002 compared to 17.2% in the same period last year. Excluding approximately $19.7 million of amortization in the first half of 2001, the Dairy Group's 26 operating expense ratio would have been 16.4% in 2001. The increase in 2002 was due to plant closing costs of $7.9 million in 2002 compared to only $0.8 million in 2001, as well as higher selling and marketing expenses incurred in support of our regional brands. The operating expense ratio at Morningstar/White Wave was 19.1% in the first six months of 2002 compared to 16.4% in the first half of 2001. Excluding approximately $3.6 million of amortization in the first half of 2001, the operating expense ratio would have been 15.3% in 2001. This increase was caused by higher distribution, selling and marketing expenses related to the introduction of new products and increased spending on promotions of existing products, and to the addition of White Wave, which has a higher operating expense ratio. The operating expense ratio for Specialty Foods was 11.5% in the first six months of 2002. Operating Income -- Operating income in the first half of 2002 was $326.7 million, an increase of $139.9 million from 2001 operating income of $186.8 million. Our operating margin in the first half of 2002 was 7.1% compared to 6.3% in the same period of 2001. Excluding 2001 amortization that would have been eliminated had SFAS 142 been in effect last year, our operating income would have increased $114.6 million in the first half of 2002 and our operating margin would have been 7.1% both years. The Dairy Group's operating margin, excluding amortization expense from the first half of 2001, increased to 7.4% in the first six months of 2002 from 6.6% in the same period of 2001. This increase was primarily due to lower raw milk costs during 2002 and to realized synergies from our acquisition of Old Dean, partly offset by higher spending on regional brands. The operating margin for our Morningstar/White Wave segment, again excluding amortization expense from the first half of 2001, declined to 10.7% in the first half of 2002 from 14.4% in 2001. This decrease was due to the planned phase-out of the Lactaid, Nestle Quik and Nestle Coffeemate co-packing businesses, higher selling, distribution and marketing expense, and the addition of Old Dean's operations which have higher costs of sales, offset by certain realized merger synergies. Specialty Foods' operating margin was 13.6% in the first half of 2002. Other (Income) Expense -- Total other expense increased by $52.0 million in the first six months of 2002 compared to 2001. Interest expense increased to $104.2 million in the first half of 2002 from $53.2 million in 2001. This increase was the result of higher debt used primarily to finance the acquisition of Old Dean. Financing charges on preferred securities were $16.8 million in both years. Income from investments in unconsolidated affiliates declined to $1.8 million in the first half of 2002 from $2.9 million in the same period of 2001. The income in 2002 primarily related to our 36.0% interest in White Wave through May 9, 2002. On May 9, 2002 we acquired the remaining equity interest in White Wave and began consolidating White Wave's results with our financial results. Our income in 2001 related primarily to our 43.1% minority interest in Consolidated Container Company ("CCC"). In the fourth quarter of 2001 we concluded that our investment in CCC was impaired and that the impairment was not temporary, and as a result we wrote off our remaining investment in CCC. Income Taxes -- Income tax expense was recorded at an effective rate of 37.9% in the first half of 2002 compared to 37.5% in 2001. Our tax rate varies as the mix of earnings contributed by our various business units changes, and as tax savings initiatives are adopted. Minority Interest -- Minority interest in earnings decreased significantly to $16.0 thousand in the first six months of 2002 from $16.3 million in the same period of 2001. In 2002, management of a subsidiary of our 27 Specialty Foods segment owned a small minority interest in that subsidiary. In 2001, Dairy Farmers of America owned a 33.8% minority interest in our Dairy Group. On December 21, 2001, in connection with our acquisition of Old Dean, we purchased the 33.8% stake that was owned by Dairy Farmers of America. See Note 2 to our condensed consolidated financial statements. Cumulative Effect of Accounting Change -- As part of our adoption of SFAS 142 on January 1, 2002 we wrote down the value of certain trademarks which our analysis indicated were impaired, and recorded a charge during the first quarter of 2002 of $47.3 million, net of an income tax benefit of $29.0 million. Effective January 1, 2001 we adopted Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities (as amended). Our adoption of this accounting standard resulted in the recognition of $1.4 million, net of an income tax benefit of $1.5 million and minority interest benefit of $0.7 million, as a charge to earnings. RECENT DEVELOPMENTS License Agreement with Land O'Lakes On July 31, 2002, we entered into a license agreement with Land O'Lakes, pursuant to which we acquired a perpetual license to use the Land O'Lakes(R) brand nationally on a broad range of fluid milk, juices and cultured dairy products, including ice cream, sour cream, creams and creamers, and on certain other value-added products, such as aseptic dairy products and extended shelf-life products, including soy beverages. The royalty structure varies by product type from 0% to 3%. We are also required to sell minimum volumes of certain Land O'Lakes branded value-added products. Our rights to use the Land O'Lakes brand on the licensed products are exclusive, subject to limited rights previously granted to a third party dairy processor to use the Land O'Lakes brand on certain dairy products in specified distribution channels in parts of the United States through 2005. As a result of our new arrangement with Land O'Lakes, we are entitled to receive all royalties paid by such third party processor on Land O'Lakes branded products. We are also entitled to include sales by such dairy processor in our minimum sales requirements. In August 2002, we intend to launch Land O'Lakes(R) Dairy Ease(R) lactose-free milk, which will be the first new product that we will launch under the new Land O'Lakes license agreement. Our prior joint venture with Land O'Lakes (called Dairy Marketing Alliance), in which we owned a 50% interest, was dissolved in connection with the new arrangement. Acquisition of Marie's We acquired the Marie's(R) brand as a result of our acquisition of Old Dean in December 2001. Old Dean had licensed the Marie's brand to Marie's Quality Foods and Marie's Dressings, Inc. for use in connection with the manufacture and sale of dips and dressings in the western United States. On May 17, 2002, we acquired the assets of those licensees, including the licenses. See Note 2 to our condensed consolidated financial statements. As a result of this acquisition, we are now the sole owner, manufacturer and marketer of Marie's brand products nationwide. Acquisition of White Wave In May 2002, we completed the acquisition of the 64% equity interest in White Wave, Inc. which we did not already own. White Wave, based in Boulder, Colorado, is the maker of Silk(R) soymilk and other soy-based products, and had sales of approximately $125 million during the twelve months ended March 31, 2002. Prior to May 9, we owned approximately 36.0% of White Wave, as a result of certain investments made by Old Dean beginning in 1999. We purchased the remaining equity interests for a total price of approximately $189.0 million. Existing management of White Wave will remain in place. We have agreed to pay White Wave's management team an incentive bonus based on achieving certain sales growth targets by March 2004. The bonus amount will vary depending on the level of two-year cumulative sales White Wave achieves by March 2004, and is anticipated to range between $30 million and $40 million. See Note 10 to our condensed consolidated financial statements. For financial reporting purposes, White Wave's financial results are now aggregated with Morningstar Foods' financial results. 28 Integration and Rationalization Activities As a result of our acquisition of Old Dean in December 2001, we expect to achieve annual cost-savings of at least $100 million in 2002, increasing to up to $150 million per year by the end of 2004. Our current synergy expectations are significantly higher than our initial annual synergy estimate of $60 million in 2002, increasing to $120 million per year by the end of 2004. The increase in our estimate has resulted from certain merger synergies being realized more quickly than we had anticipated, and in some cases in greater amounts than we had expected. We realized approximately $28 million and $50 million in merger synergies during the second quarter and first six months of 2002, respectively, including such items as purchasing savings, headcount reduction savings, pension elimination savings, new business, manufacturing synergies and various depreciation savings. As part of our integration activities, we have closed, or announced the closure of, 9 facilities since completion of the Old Dean acquisition and reduced (or intend to reduce) our workforce accordingly. Facilities that have been closed, or identified for closing, include:
Dairy Group Specialty Foods Other ----------- --------------- ----- Bennington, Vermont Atkin, Arkansas Aguadilla, Puerto Rico Port Huron, Michigan Cairo, Georgia Escondido, California Fort Worth, Texas Parker Ford, Pennsylvania Winchester, Virginia
Part of our strategy as a result of the Old Dean acquisition is to divest certain non-core assets. Since the completion of the Old Dean acquisition, we have sold two small non-core businesses that we acquired as part of Old Dean's Specialty Foods division, including a transportation business and Old Dean's boiled peanut business. Sworn Statements Regarding Financial Statements On August 8, 2002, our Chief Executive Officer and Chief Financial Officer filed sworn statements with the Securities and Exchange Commission ("SEC") regarding the integrity of our financial statements, as required by SEC Order No. 4-460. The statements were signed in the form mandated by the SEC without exception. Stock Split On February 21, 2002, our Board of Directors declared a two-for-one split of our common stock, which entitled shareholders of record on April 8, 2002 to receive one additional share of common stock for each share held on that date. The new shares were issued after the market closed on April 23, 2002. As a result of the split, the total number of shares of our common stock outstanding increased from approximately 45 million to approximately 90 million. All of the share numbers in this Quarterly Report on Form 10-Q have been adjusted for all periods to reflect the stock split, as if it had already occurred. Launch of Folger's(R) Jakada(TM) In the first quarter of 2002, we launched Folger's Jakada, a new single-serve coffee and milk-based beverage. Pursuant to our licensing agreement with Procter & Gamble, we produce, promote and distribute Folger's Jakada and Procter & Gamble shares in revenue generated from all Folger's Jakada sales while retaining rights to the Folger's trademark. Adoption of Certain Recently Issued Accounting Pronouncements We adopted EITF Issue Nos. 00-14 and 00-25, as well as SFAS Nos. 142 and 144 in the first quarter of 2002. See Note 1 to our condensed consolidated financial statements and "--Known Trends and Uncertainties." 29 LIQUIDITY AND CAPITAL RESOURCES HISTORICAL CASH FLOW Cash flow provided by operating activities was $293.4 million in the first six months of 2002 compared to $133.2 million in the first six months of 2001. This increase was primarily due to changes in working capital components which improved by $124.8 million and higher earnings in 2002 after adjusting for the cumulative accounting change, which was a non-cash item. Net cash used in investing activities was $301.9 million in the first six months of 2002 compared to $70.1 million in the first six months of 2001. We spent $91.5 million during the first six months of 2002 for capital expenditures, which were funded using cash flow from operations. We also spent approximately $214.9 million in the first six months of 2002 primarily on the acquisitions of White Wave, Marie's and stock option surrenders related to our acquisition of Old Dean. See Notes 2 and 6 to our condensed consolidated financial statements. CURRENT DEBT OBLIGATIONS Effective December 21, 2001, in connection with our acquisition of Old Dean, we replaced our former credit facilities with a new $2.7 billion credit facility provided by a syndicate of lenders. This facility provides us with a revolving line of credit of up to $800.0 million and two term loans in the amounts of $900.0 million and $1.0 billion, respectively. Both term loans were fully funded upon closing of the Old Dean acquisition. The senior credit facility contains various financial and other restrictive covenants and requires that we maintain certain financial ratios, including a leverage ratio (computed as the ratio of the aggregate outstanding principal amount of defined indebtedness to EBITDA) and an interest coverage ratio (computed as the ratio of EBITDA to interest expense). In addition, this facility requires that we maintain a minimum level of net worth (as defined by the agreement). The agreement contains standard default triggers, including without limitation: failure to maintain compliance with the financial and other covenants contained in the agreement, default on certain of our other debt, a change in control and certain other material adverse changes in our business. The agreement does not contain any default triggers based on our debt rating. See Note 5 to our condensed consolidated financial statements for more detailed information regarding the terms of our credit agreement, including interest rates, principal payment schedules and mandatory prepayment provisions. At June 30, 2002 we had outstanding borrowings of $1.914 billion under our senior credit facility. In addition, $56.6 million of letters of credit secured by the credit facility were issued but undrawn. As of June 30, 2002, approximately $692.7 million was available for future borrowings under the revolver, subject to satisfaction of certain conditions contained in the loan agreement. We are currently in compliance with all covenants contained in our credit agreement. We also have a $400.0 million receivables securitization facility. During the first six months of 2002 we made net payments of $60.7 million on this facility and at June 30, 2002 had a balance of $339.3 million outstanding. See Note 5 to our condensed consolidated financial statements for more information about our receivables securitization facility. In addition, certain of Old Dean's indebtedness remains outstanding after the acquisition, including $700.0 million of outstanding indebtedness under certain senior notes, approximately $21.7 million of industrial development revenue bonds, and certain capital lease obligations. See Note 5 to our condensed consolidated financial statements. In addition to the letters of credit secured by our credit facility, we had at June 30, 2002 approximately $64.0 million of letters of credit that were issued but undrawn. These letters of credit were required by various utilities and government entities for performance and insurance guarantees. 30 The table below summarizes our obligations for indebtedness and lease obligations at June 30, 2002 (dollars in thousands):
PAYMENTS DUE BY PERIOD -------------------------------------------------------------------------- 7/1/02 TO 7/1/03 TO 7/1/04 TO 7/1/05 TO 7/1/06 TO INDEBTEDNESS & LEASE OBLIGATIONS TOTAL 6/30/03 6/30/04 6/30/05 6/30/06 6/30/07 THEREAFTER -------------------------------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Senior credit facility ................. $1,914,450 $ 108,750 $ 145,000 $ 156,250 $ 178,750 $ 212,500 $1,113,200 Senior notes(1) ........................ 700,000 100,000 600,000 Receivables-backed loan ................ 339,305 339,305 Foreign subsidiary term loan ........... 36,194 5,333 8,033 8,016 7,406 7,406 Other lines of credit .................. 13,355 13,355 Industrial development revenue bonds ... 27,701 555 555 555 555 555 24,926 Capital lease obligations and other .... 40,122 11,430 22,280 5,430 263 483 236 Operating leases ....................... 361,789 76,696 59,111 50,494 42,519 30,674 102,295 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Total ...................... $3,432,916 $ 216,119 $ 234,979 $ 560,050 $ 329,493 $ 251,618 $1,840,657 ========== ========== ========== ========== ========== ========== ==========
---------- (1) Represents face value of notes. We do have certain other commitments and contingent obligations. Please see Note 10 to our condensed consolidated financial statements for a description of these commitments and contingent obligations. We do not have any ownership interests or relationships with any special-purpose entities (or "bankruptcy remote" entities), other than our ownership of the special purpose entities formed to facilitate our receivables securitization program and our mandatorily redeemable preferred securities. The assets and liabilities of those entities are fully reflected on our balance sheet. We have no other significant off-balance sheet arrangements, special purpose entities, financing partnerships or guaranties, nor any debt or equity triggers based on our stock price or credit rating. PREFERRED SECURITIES On March 24, 1998, we issued $600.0 million of company-obligated 5.5% mandatorily redeemable convertible preferred securities of a Delaware business trust in a private placement to "qualified institutional buyers" under Rule 144A under the Securities Act of 1933. The 5.5% preferred securities, which are recorded net of related fees and expenses, mature 30 years from the date of issue. Holders of these securities are entitled to receive preferential cumulative cash distributions at an annual rate of 5.5% of their liquidation preference of $50 each. These distributions are payable quarterly in arrears on January 1, April 1, July 1 and October 1 of each year. These trust issued preferred securities are convertible at the option of the holders into an aggregate of approximately 15.3 million shares of our common stock, subject to adjustment in certain circumstances, at a conversion price of $39.125. These preferred securities are also redeemable, at our option, at any time after April 2, 2001 at specified amounts and are mandatorily redeemable at their liquidation preference amount of $50 per share at maturity or upon occurrence of certain specified events. 31 FUTURE CAPITAL REQUIREMENTS During 2002, we intend to invest a total of approximately $250.0 million in capital expenditures primarily for our existing manufacturing facilities and distribution capabilities. We intend to fund these expenditures using cash flow from operations. Of this amount, we intend to spend it as follows:
OPERATING DIVISION AMOUNT ------------------ -------------------- (Dollars in millions) Dairy Group...................... $178.0 Morningstar/White Wave........... 50.0 Specialty Foods.................. 12.0 Other............................ 10.0 ------ $250.0 ======
We expect that cash flow from operations will be sufficient to meet our requirements for our existing businesses for the foreseeable future. In the future, we may pursue additional acquisitions that are compatible with our core business strategy. Any such acquisitions will be funded through cash flows from operations or borrowings under our credit facility. If necessary, we believe that we have the ability to secure additional financing for our future capital requirements. CRITICAL ACCOUNTING POLICIES "Critical accounting policies" are those that are both most important to the portrayal of a company's financial condition and results, and that require management's most difficult, subjective or complex judgments. In many cases the accounting treatment of a particular transaction is specifically dictated by generally accepted accounting principles with no need for the application of our judgment. In certain circumstances, however, the preparation of our financial statements in conformity with generally accepted accounting principles requires us to use our judgment to make certain estimates and assumptions. These estimates affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We have identified the policies described below as our critical accounting policies. For a detailed discussion of these and other accounting policies see Note 1 to our 2001 consolidated financial statements contained in our Annual Report on Form 10-K, as filed with the Securities and Exchange Commission on April 1, 2002. Revenue Recognition and Accounts Receivable -- Revenue is recognized when persuasive evidence of an arrangement exists, the price is fixed or determinable, the product has been shipped to the customer and there is a reasonable assurance of collection of the sales proceeds. Revenue is reduced by sales incentives that are estimated based on our historical experience. We provide credit terms to customers generally ranging up to 30 days, perform ongoing credit evaluation of our customers and maintain allowances for potential credit losses based on historical experience. Insurance Accruals -- We retain selected levels of property and casualty risks, primarily related to employee health care, workers' compensation claims and other casualty losses. Many of these potential losses are covered under conventional insurance programs with third party carriers with high deductible limits. In other areas, we are self-insured with stop-loss coverages. Accrued liabilities for incurred but not reported losses related to these retained risks are calculated based upon loss development factors provided by our external insurance brokers and actuaries. The loss development factors are subject to change based upon actual history and expected trends in costs, among other factors. 32 Valuation of Long-Lived and Intangible Assets and Goodwill -- We adopted SFAS 142 effective January 1, 2002 and as a result, goodwill is no longer amortized. In lieu of amortization, we are required to perform a transitional impairment assessment of our goodwill in 2002 and annual impairment tests thereafter. SFAS No. 142 also requires that recognized intangible assets be amortized over their respective estimated useful lives. As part of the adoption, we have reassessed the useful lives of all intangible assets. Any recognized intangible asset determined to have an indefinite useful life is not amortized, but instead tested for impairment in accordance with the standard. For more information regarding the values assigned to our intangible assets and to goodwill, see Note 1 and Note 4 to our condensed consolidated financial statements. Purchase Price Allocation -- We allocate the cost of acquisitions to the assets acquired and liabilities assumed. All identifiable assets acquired, including identifiable intangibles, and liabilities assumed are assigned a portion of the cost of the acquired company, normally equal to their fair values at the date of acquisition. The excess of the cost of the acquired company over the sum of the amounts assigned to identifiable assets acquired less liabilities assumed is recorded as goodwill. We record the initial purchase price allocation based on evaluation of information and estimates available at the date of the financial statements. As final information regarding fair value of assets acquired and liabilities assumed is evaluated and estimates are refined, appropriate adjustments are made to the purchase price allocation. To the extent that such adjustments indicate that the fair value of assets and liabilities differ from their preliminary purchase price allocations, such difference would adjust the amounts allocated to those assets and liabilities and would change the amounts allocated to goodwill. The final purchase price allocation includes the consideration of a number of factors to determine the fair value of individual assets acquired and liabilities assumed including quoted market prices, forecast of expected cash flows, net realizable values, estimates of the present value of required payments and determination of remaining useful lives. For significant acquisitions, we utilize valuation specialists and appraisers to assist in the determination of the fair value of long-lived assets, including identifiable intangibles. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS The Emerging Issues Task Force (the "Task Force") of the Financial Accounting Standards Board has reached a consensus on Issue No. 00-14, "Accounting for Certain Sales Incentives," which became effective for us in the first quarter of 2002. This Issue addresses the recognition, measurement and income statement classification of sales incentives that have the effect of reducing the price of a product or service to a customer at the point of sale. Our historical practice for recording sales incentives within the scope of this Issue, which has been to record estimated coupon expense based on historical coupon redemption experience, is consistent with the requirements of this Issue. Therefore, our adoption of this Issue has no impact on our Condensed Consolidated Financial Statements. The Task Force was also reached a consensus on Issue No. 00-25, "Vendor Income Statement Characterization of Consideration Paid to a Reseller of the Vendor's Products." We adopted this Issue in the first quarter of 2002. Under this Issue, certain consideration paid to our customers (such as slotting fees) is required to be classified as a reduction of revenue, rather than recorded as an expense. Adoption of this Issue required us to reduce reported revenue and selling and distribution expense for the second quarter and the first six months of 2001 by $9.5 million and $18.8 million, respectively. There was no change in reported net income. In June 2001, FASB issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 addresses financial accounting and reporting for business combinations. Under the new standard, all business combinations entered into after June 30, 2001 are required to be accounted for by the purchase method. We have applied , and will continue to apply, the provisions of SFAS No. 141 to all business combinations completed after June 30, 2001, 33 including the acquisition of Old Dean. SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets. We adopted SFAS No. 142 in the first quarter of 2002. SFAS No. 142 requires that goodwill no longer be amortized, but instead requires a transitional goodwill impairment assessment and annual impairment tests thereafter. Effective June 30, 2002, we completed the first phase of the transitional goodwill impairment assessment, which indicated that the goodwill related to our Puerto Rico reporting unit is impaired. Prior to December 31, 2002, we will determine the amount of the impairment, and record the impairment in our income statement as the cumulative effect of a change in accounting principle retroactive to the first quarter of 2002. We currently have $67 million recorded as goodwill related to our Puerto Rico reporting unit. Therefore, the maximum transitional goodwill impairment we will recognize as a result of the adoption of SFAS No. 142 will be $67 million. SFAS No. 142 also requires that recognized intangible assets be amortized over their respective estimated useful lives. As part of the adoption, we have re-assessed the useful lives and residual values of all recognized intangible assets. Any recognized intangible asset determined to have an indefinite useful life was tested for impairment in accordance with the standard. These impairment tests were completed during the first quarter of 2002, and resulted in a charge of $47.3 million, net of an income tax benefit of $29.0 million, which was recorded during the first quarter of 2002 as a change in accounting principle. The impairment related to certain trademarks in our Dairy Group and Morningstar/White Wave segments. The fair value of these trademarks was determined using a present value technique. See Note 1 to our condensed consolidated financial statements. In June 2001, FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." This statement requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which the associated legal obligation for the liability is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset and amortized over the life of the asset. SFAS No. 143 will become effective for us in fiscal year 2003. We are currently evaluating the impact of adopting this pronouncement on our consolidated financial statements. FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" in August 2001 and it became effective for us beginning January 1, 2002. SFAS No. 144, which supercedes SFAS No. 121, provides a single, comprehensive accounting model for impairment and disposal of long-lived assets and discontinued operations. Our adoption of this standard did not have a material impact on our consolidated financial statements. SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections," was issued in April 2002 and is applicable to fiscal years beginning after May 15, 2002. One of the provisions of this technical statement is the rescission of SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt," whereby any gain or loss on the early extinguishment of debt that was classified as an extraordinary item in prior periods in accordance with SFAS No. 4, which does not meet the criteria of an extraordinary item as defined by APB Opinion 30, must be reclassified. Adoption of this standard will require us to reclassify extraordinary losses previously reported from the early extinguishment of debt as a component of "other expense." For the year ended December 31, 2001, we recorded an extraordinary loss of $4.3 million, net of an income tax benefit of $3.0 million. In June, 2002, FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, and is effective for exit or disposal activities that are initiated after December 31, 2002. We are currently evaluating the impact of adopting this pronouncement on our consolidated financial statements. KNOWN TRENDS AND UNCERTAINTIES ACQUISITIONS AND DIVESTITURES We have announced that we intend to continue to make acquisitions in our core businesses and, over the next several years, to divest non-core businesses. 34 RAW MATERIAL PRICES The primary raw materials used in our operations are raw milk and butterfat. The prices we pay for these materials are regulated by the federal government, and in some cases by state and other regulatory agencies. Prices of raw milk and butterfat can be volatile. In general, we change the prices that we charge our customers for our products on a monthly basis, as the costs of our raw materials fluctuate. However, there can be a lag between the time of a raw material cost increase or decrease and the effectiveness of a corresponding price change to our customers, and in some cases we are contractually restrained with respect to the means and timing of implementing price changes. Also, at some point price increases do erode our volumes. These factors can cause volatility in our earnings. Our sales and operating profit margin tend to fluctuate with the price of our raw materials. GOODWILL IMPAIRMENT We adopted SFAS No. 142 in the first quarter of 2002. SFAS No. 142 requires that goodwill no longer be amortized, but instead requires a transitional goodwill impairment assessment and annual impairment tests thereafter. Effective June 30, 2002, we completed the first phase of the transitional goodwill impairment assessment, which indicated that the goodwill related to our Puerto Rico reporting unit is impaired. Prior to December 31, 2002, we will determine the amount of the impairment, and record the impairment in our income statement as the cumulative effect of a change in accounting principle retroactive to the first quarter of 2002. We currently have approximately $67 million recorded as goodwill related to our Puerto Rico reporting unit. Therefore, the maximum transitional goodwill impairment we will recognize as a result of the adoption of SFAS No. 142 will be approximately $67 million. INTEREST RATES We have hedged a portion of our variable interest rate exposure by entering into interest rate swap agreements that have the effect of "converting" the hedged debt from variable rate debt to fixed rate debt. Approximately 40% of our variable rate debt is currently hedged. The percentage of our total debt that is hedged fluctuates as our debt level fluctuates. Moveover, we constantly monitor the prevailing interest rate environment, and may increase the percentage of our debt that is hedged if interest rates threaten to increase to substantially higher levels, or become more volatile. RATIONALIZATION ACTIVITIES As part of our overall integration and cost reduction strategy, we recorded plant closing and other non-recurring costs of $7.9 million during the first six months of 2002 and $0.8 million in the first six months of 2001. These charges included the following costs: o Workforce reductions as a result of plant closings, plant rationalizations and consolidation of administrative functions. The costs were charged to our earnings in the period that the plan was established in detail and employee severance and benefits had been appropriately communicated; o Shutdown costs, including those costs necessary to prepare the plant facilities for re-sale or closure; o Costs incurred after shutdown such as lease obligations or termination costs, utilities and property taxes; and o Write-downs of property, plant and equipment and other assets, primarily for asset impairments as a result of facilities no longer used in operations. The impairments related primarily to owned building, land and equipment at the facilities that were sold and written down to their estimated fair value. As part of our acquisition purchase price allocations, we accrue costs from time to time pursuant to plans to exit certain activities and operations of acquired businesses in order to rationalize production and reduce costs and inefficiencies. We will continue to finalize and implement our initial integration and 35 rationalization plan related to the Old Dean acquisition and we expect to refine our estimate of amounts in our purchase price allocations associated with this plan. We do not expect any of these costs to have a material adverse impact on our results of operations. For more information, see Note 8. TAX RATE Our tax rate in the first half of 2002 was approximately 37.9%. We believe that our effective tax rate will range between approximately 37.0% to 38.0% over the next several years, as Old Dean's tax rate was higher than our tax rate prior to the Old Dean acquisition. See "-- Risk Factors" for a description of various other risks and uncertainties concerning our business. RISK FACTORS This report contains statements about our future that are not statements of historical fact. Most of these statements are found in this report under the following subheadings: "Liquidity and Capital Resources," "Known Trends and Uncertainties" and "Quantitative and Qualitative Disclosures About Market Risk." In some cases, you can identify these statements by terminology such as "may," "will," "should," "could," "expects," "seek to," "anticipates," "plans," "believes," "estimates," "intends," "predicts," "potential" or "continue" or the negative of such terms and other comparable terminology. These statements are only predictions, and in evaluating those statements, you should carefully consider the risks outlined below. Actual performance or results may differ materially and adversely. WE MAY HAVE DIFFICULTIES MANAGING OUR GROWTH We have expanded our operations rapidly in recent years, particularly with the acquisition of Old Dean in December 2001. This rapid growth places a significant demand on our management and our financial and operational resources, which subjects us to various risks, including among others: o inability to successfully integrate or operate acquired businesses, o inability to retain key customers of acquired or existing businesses, and o inability to realize or delays in realizing expected benefits from our increased size. The integration of businesses we have acquired or may acquire in the future may also require us to invest more capital than we expected or require more time and effort by management than we expected. If we fail to effectively manage the integration of the businesses we have acquired, particularly Old Dean, our operations and financial results will be affected, both materially and adversely. OUR BRANDING EFFORTS MAY NOT SUCCEED We have invested, and intend to continue to invest, significant resources toward the growth of our branded, value-added portfolio of products, particularly at our Morningstar/White Wave segment. We believe that sales of these products could be a significant source of growth for our business. However, the success of our efforts will depend on customer and consumer acceptance of our branded products, of which there can be no assurance. If our efforts do not succeed, we may not be able to continue to significantly increase sales or profit margins. 36 OUR FAILURE TO SUCCESSFULLY COMPETE COULD ADVERSELY AFFECT OUR PROSPECTS AND FINANCIAL RESULTS Our business is subject to significant competition based on a number of factors. If we fail to successfully compete against our competitors, our business will be adversely affected. The consolidation trend is continuing in the retail grocery and foodservice industries. As our customer base continues to consolidate, we expect competition among us and our competitors to intensify as we compete for the business of fewer customers. As the consolidation continues, there can be no assurance that we will be able to keep our existing customers, or to gain new customers. Winning new customers is particularly important to the growth of our Dairy Group, as demand tends to be relatively flat in the dairy industry. Moreover, as our customers become larger, they will have greater purchasing leverage, and could force prices and margins lower than current levels. We could also be adversely affected by any expansion of capacity by our existing competitors or by new entrants in our markets. CHANGES IN RAW MATERIAL AND OTHER INPUT COSTS CAN ADVERSELY AFFECT US The most important raw materials that we use in our operations are raw milk, butterfat and high density polyethylene resin. The prices of these materials increase and decrease depending on supply and demand and, in some cases, governmental regulation. Prices of raw milk, butterfat and certain other raw materials can fluctuate widely over short periods of time. In many cases we are able to adjust our pricing to reflect changes in raw material costs. Volatility in the cost of our raw materials can adversely affect our performance, however, as price changes often lag changes in costs. These lags tend to erode our profit margins. Extremely high raw material costs can also put downward pressure on our margins and our volumes. We were adversely affected in 2001 by raw material costs. Although raw material costs have returned to normal levels in 2002 to date, we cannot predict future changes in raw material costs. Because we deliver a majority of our products directly to our customers through our "direct store delivery" system, we are a large consumer of gasoline. Increases in fuel prices can adversely affect our results of operations. Also, since we lost our energy supply agreement with Enron as a result of Enron's decision to reject our discounted-rate supply agreement in its bankruptcy, we will pay market prices for electricity in the foreseeable future. As we are a significant consumer of electricity, any significant increase in energy prices could adversely affect our financial performance. WE HAVE SUBSTANTIAL DEBT AND OTHER FINANCIAL OBLIGATIONS AND WE MAY INCUR EVEN MORE DEBT We have substantial debt and other financial obligations and significant unused borrowing capacity. See "-- Liquidity and Capital Resources." We have pledged substantially all of our assets (including the assets of our subsidiaries) to secure our indebtedness. Our high debt level and related debt service obligations: o require us to dedicate significant cash flow to the payment of principal and interest on our debt which reduces the funds we have available for other purposes, o may limit our flexibility in planning for or reacting to changes in our business and market conditions, o impose on us additional financial and operational restrictions, and o expose us to interest rate risk since a portion of our debt obligations are at variable rates. 37 Our ability to make scheduled payments on our debt and other financial obligations depends on our financial and operating performance. Our financial and operating performance is subject to prevailing economic conditions and to financial, business and other factors, some of which are beyond our control. A significant increase in interest rates could adversely impact our financial results. If we do not comply with the financial and other restrictive covenants under our credit facilities (see Note 5 to our condensed consolidated financial statements), we may default under them. Upon default, our lenders could accelerate the indebtedness under the facilities, foreclose against their collateral or seek other remedies. LOSS OF RIGHTS TO ANY OF OUR LICENSED BRANDS COULD ADVERSELY AFFECT US We sell certain of our products under licensed brand names such as Hershey's(R), Borden(R), Pet(R), Folgers(R) Jakada(TM), Land-O-Lakes(R) and others. In some cases, we have invested, and intend to continue to invest, significant capital in product development and marketing and advertising related to these licensed brands. Should our rights to manufacture and sell products under any of these names be terminated for any reason, our financial performance and results of operations could be materially and adversely affected. NEGATIVE PUBLICITY AND/OR SHORTAGES OF MILK SUPPLY RELATED TO MAD COW DISEASE AND/OR FOOT AND MOUTH DISEASE COULD ADVERSELY AFFECT US Recent incidences of bovine spongiform encephalopathy ("BSE" or "mad cow disease") in other countries have raised public concern about the safety of eating beef and using or ingesting certain other animal-derived products. The World Health Organization, the U.S. Food and Drug Administration and the United States Department of Agriculture have all affirmed that BSE is not transmitted to milk. However, we are still subject to risk as a result of public misperception that milk products may be affected by mad cow disease. To date, we have not seen any measurable impact on our milk sales resulting from concerns about mad cow disease. However, should public concerns about the safety of milk or milk products escalate as a result of further occurrences of mad cow disease, we could suffer a loss of sales, which could have a material and adverse affect our financial results. Foot and Mouth Disease ("FMD") is a highly contagious disease of cattle, swine, sheep, goats, deer and other cloven-hooved animals. FMD causes severe losses in the production of meat and milk; however, FMD does not pose a health risk to humans. While there have been several recent occurrences of FMD in Europe, the United States has been free of FMD since 1929. To date, we have not seen a measurable impact on our supply of raw milk in Spain as a result of FMD. However, should FMD become widespread in Spain, a milk supply shortage could develop, which would affect our ability to obtain raw milk for our Spanish operations and the price that we are required to pay for raw milk in Spain. If we are unable to obtain a sufficient amount of raw milk to satisfy our Spanish customers' needs, and/or if we are forced to pay a significantly higher price for raw milk in Spain, our financial results in Spain could be materially and adversely affected. Likewise, if there is an outbreak of FMD in the United States, a shortage of raw milk could develop in the United States, which would affect our ability to obtain raw milk and the price that we are required to pay for raw milk in the United States. If we are unable to obtain a sufficient amount of raw milk to satisfy our U.S. customers' needs and/or if we are forced to pay a significantly higher price for raw milk in the United States, our consolidated financial results could be materially and adversely affected. WE COULD BE REQUIRED TO PAY SUBSTANTIAL LIQUIDATED DAMAGES TO DAIRY FARMERS OF AMERICA, IF WE FAIL TO OFFER THEM THE RIGHT TO SUPPLY RAW MILK TO CERTAIN OF OLD DEAN'S PLANTS In connection with our purchase of the minority interest in our Dairy Group, we entered into an agreement with Dairy Farmers of America ("DFA"), the nation's largest dairy farmers' cooperative and 38 our primary supplier of raw milk, pursuant to which we have agreed to pay to DFA liquidated damages in an amount of up to $47.0 million if we fail to offer them the right, within a specified period of time after completion of the Old Dean acquisition, to supply raw milk to certain of Old Dean's plants. The amount of damages to be paid, if any, would be determined on a plant-by-plant basis for each Old Dean plant's milk supply that is not offered to DFA, based generally on the amount of raw milk used by the plant. We would be required to pay the liquidated damages even if we were prohibited from offering the business to DFA by an injunction, restraining order or contractual obligation. See Note 10 to our condensed consolidated financial statements for further information regarding this agreement. Old Dean currently has milk supply agreements with several raw milk suppliers other than DFA. If any such supplier believes that it has rights to continue to supply Old Dean's plants beyond the deadline dates contained in our agreement with DFA, and is successful in legally establishing any such rights, we may be prohibited from offering DFA the right to supply certain of the Old Dean plants and, therefore, be required to pay all or a portion of the liquidated damages to DFA. WE COULD BE REQUIRED TO SATISFY OUR PAYMENT OBLIGATIONS UNDER OUR GUARANTY OF CONSOLIDATED CONTAINER COMPANY'S DEBT In February 2002, we executed a limited guarantee of certain indebtedness of Consolidated Container Company ("CCC"), in which we own a 43.1% interest. See Note 10 to our condensed consolidated financial statements for information concerning the terms of the guaranty. CCC has experienced various operational difficulties in the past, which has adversely affected its financial performance. CCC's ability to repay the guaranteed indebtedness will depend on a variety of factors, including its ability to successfully implement its business plan, of which there can be no assurance. WE MAY BE SUBJECT TO PRODUCT LIABILITY CLAIMS We sell food products for human consumption, which involves risks such as: o product contamination or spoilage, o product tampering, and o other adulteration of food products. Consumption of an adulterated, contaminated or spoiled product may result in personal illness or injury. We could be subject to claims or lawsuits relating to an actual or alleged illness or injury, and we could incur liabilities that are not insured or that exceed our insurance coverages. Although we maintain quality control programs designed to address food quality and safety issues, an actual or alleged problem with the quality, safety or integrity of our products at any of our facilities could result in: o product withdrawals, o product recalls, o negative publicity, o temporary plant closings, and o substantial costs of compliance or remediation. 39 Any of these events could have a material and adverse effect on our financial condition, results of operations or cash flows. POOR WEATHER CAN ADVERSELY AFFECT US Our Specialty Foods segment purchases cucumbers under seasonal grower contracts with a variety of growers located near our plants. Bad weather in one of the growing areas can damage or destroy the crop in that area. If we are not able to buy cucumbers from one of our local growers due to bad weather, we are forced to purchase cucumbers from non-local sources at substantially higher prices, which can have an adverse affect on Specialty Foods' results of operations. Our White Wave operating unit is also sensitive to adverse weather due its reliance on soy beans. Finally, prices of other raw materials, such as raw milk and butterfat, can be adversely affected by adverse weather. LOSS OF OR INABILITY TO ATTRACT KEY PERSONNEL COULD ADVERSELY AFFECT OUR BUSINESS Our success depends to a large extent on the skills, experience and performance of our key personnel. The loss of one or more of these persons could hurt our business. We do not maintain key man life insurance on any of our executive officers, directors or other employees. If we are unable to attract and retain key personnel, our business will be adversely affected. CERTAIN PROVISIONS OF OUR CERTIFICATE OF INCORPORATION, BYLAWS AND DELAWARE LAW COULD DETER TAKEOVER ATTEMPTS Some provisions in our certificate of incorporation and bylaws could delay, prevent or make more difficult a merger, tender offer, proxy contest or change of control. Our stockholders might view any such transaction as being in their best interests since the transaction could result in a higher stock price than the current market price for our common stock. Among other things, our certificate of incorporation and bylaws: o authorize our board of directors to issue preferred stock in series with the terms of each series to be fixed by our board of directors, o divide our board of directors into three classes so that only approximately one-third of the total number of directors is elected each year, o permit directors to be removed only for cause, and o specify advance notice requirements for stockholder proposals and director nominations. In addition, with certain exceptions, the Delaware General Corporation Law restricts mergers and other business combinations between us and any stockholder that acquires 15% or more of our voting stock. We also have a stockholder rights plan. Under this plan, after the occurrence of specified events, our stockholders will be able to buy stock from us or our successor at reduced prices. These rights do not extend, however, to persons participating in takeover attempts without the consent of our board of directors. Accordingly, this plan could delay, defer, make more difficult or prevent a change of control. WE ARE SUBJECT TO ENVIRONMENTAL REGULATIONS We, like others in similar businesses, are subject to a variety of federal, foreign, state and local environmental laws and regulations including, but not limited to, those regulating waste water and storm water, air emissions, storage tanks and hazardous materials. We believe that we are in material 40 compliance with these laws and regulations. Future developments, including increasingly stringent regulations, could require us to make currently unforeseen environmental expenditures. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK INTEREST RATE FLUCTUATIONS In order to reduce the volatility of earnings that arises from changes in interest rates, we manage interest rate risk through the use of interest rate swap agreements. These swaps have been designated as hedges against variable interest rate exposure on loans under our senior credit facility. The following table summarizes our various interest rate swap agreements in effect at June 30, 2002 and at December 31, 2001:
FIXED INTEREST RATES EXPIRATION DATE NOTIONAL AMOUNTS -------------------- --------------- ---------------- (In millions) 4.90% to 4.93%.......... December 2002 $275.0 6.07% to 6.24%.......... December 2002 325.0 6.23%................... June 2003 50.0 6.69%................... December 2004 100.0 6.69% to 6.74%.......... December 2005 100.0 6.78%................... December 2006 75.0
In March and June of 2002, we entered into forward starting swaps that begin in December 2002 with a notional amount of $750.0 million and fixed interest rates of 4.005% to 5.315%. These swaps have been designated as hedges against interest rate exposure on loans under our senior credit facility and under one of our subsidiary's term loans.
FIXED INTEREST RATES EXPIRATION DATE NOTIONAL AMOUNTS -------------------- --------------- ---------------- (In millions) 4.290% to 4.6875%....... December 2003 $275.0 4.005% to 4.855%........ December 2004 175.0 5.190% to 5.315%........ December 2005 300.0
These swap agreements provide hedges for loans under our credit facility by limiting or fixing the LIBOR interest rates specified in the credit facility at the interest rates noted above until the indicated expiration dates of these interest rate derivative agreements. We have also entered into interest rate swap agreements that provide hedges for loans under Leche Celta's term loan. See Note 5 to our condensed consolidated financial statements. The following table summarizes these agreements:
FIXED INTEREST RATES EXPIRATION DATE NOTIONAL AMOUNTS -------------------- --------------- ---------------- 5.54% November 2003 1,500,000,000 pesetas (approximately $8.9 million as of June 30, 2002) 5.6% November 2004 2,000,000,000 pesetas (approximately $11.9 million as of June 30, 2002)
We are exposed to market risk under these arrangements due to the possibility of interest rates on our credit facilities falling below the rates on our interest rate derivative agreements. We incurred $5.8 million and $11.5 million of additional interest expense, net of income taxes, during the second quarter and the first half of 2002, respectively as a result of interest rates on our variable rate debt falling below the agreed-upon interest rate on our existing swap agreements. Credit risk under these arrangements is remote since the counterparties to our interest rate derivative agreements are major financial institutions. A majority of our debt obligations are currently at variable rates. We have performed a sensitivity analysis assuming a hypothetical 10% adverse movement in interest rates. As of June 30, 2002, the analysis indicated that such interest rate movement would not have a material effect on our financial position, results of operations or cash flows. However, actual gains and losses in the future may differ 41 materially from that analysis based on changes in the timing and amount of interest rate movement and our actual exposure and hedges. FOREIGN CURRENCY We are exposed to foreign currency risk due to operating cash flows and various financial instruments that are denominated in foreign currencies. Our most significant foreign currency exposures relate to the British pound and the euro. At this time, we believe that potential losses due to foreign currency fluctuations would not have a material impact on our consolidated financial position, results of operations or operating cash flow. 42 PART II - OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On May 30, 2002, we held our annual meeting of stockholders. At the annual meeting, we submitted the following matters to a vote of our stockholders: o the re-elections of Tom C. Davis, Stephen L. Green, John R. Muse, P. Eugene Pender and J. Christopher Reyes as members of our Board of Directors, and o the ratification of our Board of Directors' selection of Deloitte & Touche LLP as our independent auditor for fiscal year 2002. At the annual meeting, the stockholders re-elected the directors named above and ratified the selection of Deloitte & Touche LLP as our independent auditor. The vote of the stockholders with respect to each such matter was as follows: o Re-election of directors: Tom C. Davis 39,572,407 votes for 221,719 votes withheld Stephen L. Green 39,559,905 votes for 234,221 votes withheld John R. Muse 39,571,842 votes for 222,284 votes withheld P. Eugene Pender 39,549,173 votes for 244,953 votes withheld J. Christopher Reyes 39,562,040 votes for 232,096 votes withheld o Ratification of our selection of Deloitte & Touche LLP as our independent auditor: 38,251,630 votes for 1,508,066 votes against; 34,430 abstentions ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits See attached Exhibit Index. (b) Reports on Form 8-K and 8-K/A o Current Report on Form 8-K dated April 17, 2002 regarding the retirement of Howard Dean; and o Current Report on Form 8-K dated August 9, 2002 regarding the sworn statements filed by our Chief Executive Officer and Chief Financial Officer with the Securities and Exchange Commission. 43 SIGNATURES Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. DEAN FOODS COMPANY /s/ Barry A. Fromberg ------------------------------------------- Barry A. Fromberg Executive Vice President, Chief Financial Officer (Principal Accounting Officer) Date: August 14, 2002 44 EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION 11 Statement re computation of per share earnings.