ITEM 1 -- BUSINESS
GENERAL
We are the second largest manufacturer of dry pet food in the United States and the largest provider of private label pet food in the world. We manufacture products for store brands owned by retail customers, also known as private labels. We also manufacture products under contract for national branded pet food companies and produce and sell products under regional brands owned by us.
Globally, we manufacture pet food products primarily for dogs and cats, including dry, wet, semi-moist, soft dry, soft treats and biscuits. We provide products that meet our customers' specifications across all retail channels and price points from super premium to value products. Accordingly, we manufacture products for approximately 600 customers globally. We sell to the top pet food retailers in the United States, including the largest mass merchandisers, grocery chains and pet specialty retailers as well as the top retailers in Europe. We also manufacture dry pet food, biscuits and treats for the largest national branded pet food companies in the United States through co-manufacturing arrangements under which we produce, package and ship a portion of their products. See Note 20 -- "Segment Data" to our accompanying audited consolidated financial statements included herein for financial information about geographic areas.
We operate the most extensive manufacturing and distribution network in the industry; thereby, providing certain operational, cost and competitive advantages. We manufacture and distribute our products through 31 combined manufacturing and distribution facilities and three product distribution centers in the United States and Europe. The broad number of strategically located facilities helps us to reduce distribution expenses, which represent a meaningful portion of the delivered cost of pet food due to its bulk and weight relative to its selling price. We believe our broad distribution network also provides a competitive advantage in that it can reduce our customers' expenses by enabling them to bypass their own distribution centers and by having us deliver products directly to their stores.
We believe our historic sales growth is primarily due to an increase in consumer acceptance of store brands versus national brands. We also have been the primary supplier of store brand pet food to WalMart Stores, Inc. since 1970 and its Sam's Club division since 1990 (collectively "Wal*Mart"). We manufacture and distribute, under a direct delivery program, a variety of products for Wal*Mart, including its store brand, Ol' Roy, which is the largest selling brand of dry pet food in the United States by volume. Net sales to Wal*Mart accounted for approximately 44%, 41% and 41% of our net sales in fiscal 1999, 2000 and 2001, respectively. We anticipate an increase in our Wal*Mart business in fiscal 2002.
Doane Pet Care Enterprises, Inc., our parent corporation, was formed in 1995 by a group of private equity investors led by Summit Capital, Inc. ("SCI"), DLJ Merchant Banking Partners, L.P. ("DLJMB"), J.P. Morgan Partners (BHCA), L.P. ("JPMP") and certain members of existing management to acquire Doane Pet Care Company, formerly known as Doane Products Company. Our parent has no other material assets or activities other than the ownership of our common stock.
RECENT DEVELOPMENTS
At December 29, 2001, we had long-term debt of $587.8 million, excluding trade payables and other accrued liabilities. This amount includes $28.5 million that matures by the end of fiscal 2002. In March 2001, we borrowed $25.0 million pursuant to a sponsor facility with certain shareholders of our parent and certain executive officers (see Item 13 -- "Certain Relationships and Related Transactions -- Sponsor Facility"). In connection with the sponsor facility, we reduced outstanding borrowings and availability under our revolving credit facility. In March 2002, we further amended our senior credit facility primarily to reduce certain financial covenant requirements. During fiscal 2002, we intend to restructure our capitalization with the goal of significantly reducing our leverage and improving our ability to comply with covenants in our senior credit facility. See "Risk Factors -- Our credit agreements could materially affect our operations" and Item 7 -- "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources."
In fiscal 2001, we commenced strategic initiatives which resulted in non-recurring and other expenses totaling $16.9 million. In the second quarter of fiscal 2001, we sold non-strategic businesses and eliminated certain corporate positions which generated $6.7 million of charges, primarily due to non-cash losses. In October 2001, we initiated a new market and operational strategy, Project Focus, which is designed to better focus our resources on providing "best-class" services and products to our customers. Equally important, our goal is to permanently reduce our cost structure through a significant reduction in stock keeping units, or SKUs, optimization of our production facilities and reduction of our workforce. We believe the changes will benefit our customers by simplifying and distinguishing our product offerings and associated pricing, improving our planning and marketing support services, and reducing the complexity of our operations. We seek to be the high quality, low cost global producer of customer branded pet food in our highly competitive markets. See Note 4 -- "Divestitures" and Note 16 -- "Non-Recurring and Project Focus Implementation Expenses" to our accompanying audited consolidated financial statements included herein.
In connection with Project Focus, we had one additional plant closure and a corporate workforce reduction in the fourth quarter of fiscal 2001. We recorded a fourth quarter charge related to these actions of $10.2 million, consisting of $1.4 million of cash outlay, primarily severance costs, and $8.8 million of asset writedowns associated with the estimated reduction in SKUs and the customer mix shift. As we continue to implement Project Focus to reduce complexity in our business, we may incur additional asset impairment charges; however, we do not expect these charges, if any, will have a material impact on our operating cash flows or liquidity.
PRODUCTS AND SERVICES
We provide our customers with comprehensive pet food category management services designed to expand each customer's pet food product lines and to improve the category's profitability. Category management services include:
- product development and testing;
- packaging design services; and
- pricing, formulation and marketing strategy in connection with our customers' store brand programs.
Our store brand program involves the formulation and supply of a wide variety of high quality pet food products, including dry, semi-moist, soft dry, soft treats and dog biscuits as well as wet products in Europe. These products are comparable in quality to competing branded pet food products, except we offer them at a lower price. For our national branded customers, we manufacture dry pet food, treats and dog biscuits that meet those customers' specifications and quality standards. Our regional brands are generally economy priced and marketed by our customers as a complement to their other pet food offerings.
In the United States, we manufacture dry pet food under approximately 370 store brands, including Canine Club, Dura Life, Exceed, Hy Vee, Maxximum Nutrition, NutraCare, Ol' Roy, Pathmark, Pet Club, PMI-Nutrition, Retriever, and Special Kitty. Our regional brands, which include Country Prime, Kozy Kitten, and TrailBlazer, allow our customers to broaden their product offerings. We also offer Bonkers and Pet Lovers branded treats available for our retailers. In Europe, we manufacture pet food under approximately 180 store brands.
In addition to manufacturing pet food products, we maintain an in-house engineering services group. A description of each of our product lines and the services provided by our engineering services group is set forth below:
Dry Pet Food. We are the second largest manufacturer of dry pet food in the United States. We produce, market and distribute a wide selection of high quality dry pet food products, predominately for dogs and cats. Our dry pet food product lines include high protein, chunk style, premium-blended, puppy food, gravy style and super premium meat inclusion products for dogs, and regular and blended products for cats.
Biscuits and Treats. We are the largest manufacturer of dog biscuits in the world and a leading supplier of soft treats. Biscuits undergo a different manufacturing process from dry pet food, which primarily involves baking rather than the use of extruders.
Wet, Semi-Moist and Soft Dry. These products are distinguishable from dry pet food based on their higher moisture level content, the technology used to manufacture such products and their higher packaging costs. Europe has a much stronger market for wet products than the United States. To meet this demand, we manufacture and sell throughout Europe wet products in all forms, including chunks and gravy, pate and loaf, and packages, such as cans, alucups and pouches.
Engineering Services Group. Our engineering services group designs and builds extruders, conveyors, dryers and other parts and equipment, including replacement parts, for our pet food manufacturing facilities and for third parties. The engineering services group maintains repair staff that service and repair machinery and equipment at our production facilities, giving us the ability to make timely repairs and minimize downtime. Our in-house engineers generally design and supervise plant construction, thereby reducing plant construction costs and ensuring consistency in manufacturing processes and quality control. We believe our engineering services group provides us with services at a lower cost and more efficiently than we could obtain from third parties.
SEASONALITY OF PET FOOD
Our sales are moderately seasonal. We normally experience an increase in net sales during the first and fourth quarters of each year, which is typical in the pet food industry. Generally, cooler weather results in increased dog food consumption.
SALES AND DISTRIBUTION
Our direct sales force seeks new customers and works directly with mass merchandisers, membership clubs, farm and feed stores, pet specialty stores and grocery chains. We also use independent food brokers. We generate new business, in part, through the expansion of our product lines and the development of new marketing programs to existing customers.
Most of our products are distributed utilizing our customers' transportation networks. Several of our largest customers utilize us as a just-in-time supplier and maintain trailers at our manufacturing and distribution facilities. Our ability to ship directly to certain customers is a key consideration in deciding the location of our manufacturing and distribution facilities and, we believe, is a significant competitive advantage. Our customers' trailers can be loaded for shipment either directly to individual stores or to their own distribution centers. Those customers that require us to ship products directly from our manufacturing and distribution facilities to their retail stores are able to reduce their inventory, freight and handling costs by avoiding shipment to their own distribution centers. Those customers that use their own transportation fleet are able to utilize their trucks that would otherwise be empty to backhaul a load of pet food on return to their distribution center or directly to another store.
For customers that do not utilize their own transportation fleet, we provide transportation on a contract basis through common carriers or those customers can arrange their own transportation. We do not own or operate any transportation equipment.
We provide vendor managed inventory fulfillment services for both direct store and warehouse deliveries. We communicate on-line with our customers' inventory management systems, evaluate their inventory levels and place orders on their behalf to meet their just-in-time inventory requirements while maintaining their optimum inventory levels. Again, we believe this provides our customers with a significant competitive advantage, which includes shorter lead-time requirements, higher inventory turns and reduced out-of-stock positions.
CUSTOMERS
We manufacture products for approximately 600 customers globally. Store brand customers in the United States include mass merchandisers, such as Wal*Mart and Costco, pet specialty stores, such as PetsMart, grocery chains, such as Albertson's, Food Lion, Kroger, Publix, Royal Ahold and Safeway, and farm and feed stores, such as Tractor
Supply, Mid-States and Purina Mills. In addition, we manufacture products for the largest national branded pet food companies in the United States. Our European customer base is similar to the United States. We sell to the leading retailers, pet specialty stores and farm and feed outlets, as well as several national branded customers.
In fiscal 2001, net sales to Wal*Mart accounted for approximately 41% of our net sales. We have been the primary supplier of private label dry pet food products to WalMart Stores, Inc. since 1970 and to its Sam's Club division since 1990. We utilize a computerized order and distribution system to ship products directly to substantially all domestic Wal*Mart stores, a majority of which are located within 250 miles of one of our facilities. We also offer direct delivery programs and electronic data interchange systems to other customers who see these services as beneficial.
COMPETITION
The pet food industry is highly competitive. The companies that produce and market the major national branded pet foods are national or international conglomerates that are substantially larger than us and possess significantly greater financial and marketing resources than us. Our store brand pet food products compete for shelf space with national branded pet food products on the basis of quality and price. In addition, certain national branded companies also manufacture store brands. National branded products compete principally through advertising to create brand awareness and loyalty. We experience some price competition from national branded products. Significant price competition from national branded products or considerably increased store brand presence by the national branded manufacturers could adversely affect our operating results and cash flows. We also compete with regional branded manufacturers and other regional store brand manufacturers.
We believe we differentiate our company from the national branded pet food manufacturers by offering comparable, lower-priced products tailored to each retailer's needs. This provides retailers with the opportunity to increase pet food category profitability and provides a destination purchase item in this important consumer category. In addition, we believe we differentiate our company from other store brand pet food manufacturers by offering higher quality products, national production and distribution capabilities and a reputation for increasing customers' store brand pet food sales.
RAW MATERIALS AND PACKAGING
The principal raw materials required for our manufacturing operations, which we purchase from large national commodity companies and local grain cooperatives, are bulk commodity grains and foodstocks, including corn, soybean meal, wheat middling, poultry meal, meat and bone meal, and corn gluten meal. We generally purchase raw materials one to three months in advance. We purchase the raw material requirements of each of our manufacturing facilities locally due to the high freight costs of transporting bulk commodity products. As a result, raw material costs may vary substantially among our manufacturing facilities due to the impact of local supply and demand and varying freight costs. While we do not maintain long-term contracts with any of our suppliers, we believe alternative suppliers are readily available. Our European operations purchase similar raw materials noted above for the manufacturing of dry pet food. Manufacturing of our wet food in Europe requires fresh or frozen pork, beef and poultry products.
We manage our commodity price risk associated with market fluctuations by using derivative instruments for portions of our corn, soybean meal, alternative proteins and natural gas purchases, principally through exchange traded futures and options contracts. The terms of such contracts are generally less than one year. Our policy does not permit speculative commodity trading. See Item 7A -- "Quantitative and Qualitative Disclosures about Market Risk."
Packaging is a significant component of our material costs. We have five main packaging suppliers and believe that additional packaging suppliers are readily available. Approximately 70% of our packaging requirements are covered by long-term contracts with maturities through 2003.
Our pricing strategy for pet food is based on the costs of raw materials, packaging and certain other costs plus a conversion charge, which includes a profit factor. We periodically adjust our prices based on fluctuations in raw material and packaging costs. We can give no assurance that future selling price increases will be acceptable to our
customers in the event of increased material costs. See Item 7 -- "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Inflation and Changes in Prices."
RESEARCH AND DEVELOPMENT
We continuously develop new and improved products and processes. Our research and development department includes a full-time staff of food technologists, chemists and companion animal nutritionists, a central laboratory used for research and development, and quality control laboratories at each of our production facilities. Our research and development team formulates new recipes, comprised of raw materials, vitamins and minerals, and tests the nutritional content of new products. We also use independent commercial kennels and catteries for comparison taste tests with national branded products to achieve comparable digestibility and palatability as well as to substantiate the nutritional claims of new products.
Quality assurance is an integral part of our research and development process. We maintain a comprehensive program for qualifying new supplies, testing raw materials to ensure nutritional adequacy and screening to detect the presence of bacteria and other harmful substances. We continuously test pet food production at each of our plants by analyzing the finished pet food product against specifications, formula and regulatory requirements. Packaging is inspected to ensure print quality, proper dimensions, construction and compliance with labeling regulations.
ENVIRONMENTAL AND SAFETY MATTERS
We are subject to a broad range of federal, state, local and foreign environmental laws and regulations, including those governing discharges to the air and water, the storage of petroleum substances and chemicals, the handling and disposal of solid or hazardous wastes and the remediation of contamination arising from spills and releases. Failure to comply with these laws and regulations may result in the assessment of administrative, civil and criminal penalties, permit revocation and modification, as well as, in certain instances, the issuance of injunctions. We have not been subject to any material environmental liabilities, and compliance of our business and operations with environmental laws and regulations has not had a material adverse effect on our capital expenditures, earnings, or competitive position. Environmental laws and regulations have changed substantially over the years and we believe the trend of more expansive and stricter environmental laws and regulations will continue. While we believe we are in substantial compliance with applicable environmental, safety and public health laws, there can be no assurance that additional costs for compliance will not be incurred in the future or such costs will not be material.
Our U.S. operations involve the use of aboveground and underground storage tanks. Under applicable laws and regulations, we are responsible for the proper use, maintenance and abandonment of regulated storage tanks that we own or operate and for remediation of subsurface soils and groundwater impacted by releases from such existing or abandoned aboveground or underground storage tanks.
Our U.S. operations are also subject to laws and regulations governing remediation, recycling or disposal. The Comprehensive Environmental Response, Compensation and Liability Act of 1980, also known as CERCLA or the "Superfund" law, and analogous state laws impose liability, without regard to fault or the legality of the original conduct, on certain classes of persons who are considered statutorily responsible for the release of a "hazardous substance" into the environment. These persons include the owner or operator of a facility where a hazardous substance release occurred and companies that disposed or arranged for the disposal of hazardous substances. Persons who are or were responsible for the releases of hazardous substances under CERCLA may be subject to joint, several and retroactive liability for the costs of environmental response measures, and natural resource damages, and it is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. We also generate wastes that are subject to the federal Resource Conservation and Recovery Act, also known as RCRA, and comparable state statutes. The U.S. Environmental Protection Agency and various state agencies have limited the approved methods of disposal for certain hazardous and nonhazardous wastes and any future changes to such methods that are more rigorous or restrictive can increase the operating and disposal requirements incurred by us as well as by the industry in general. In the past, nearby industries have suffered releases of hazardous substances to the environment that are the subject of CERCLA investigations. It is possible that these neighboring environmental activities may have impacted some of our properties. We have not been advised, nor do we expect to be advised, by any environmental agency that we are considered a potentially responsible party for the neighboring environmental
conditions, and we have no reason to believe that such conditions would have a material adverse effect on our company.
We currently own or lease properties and through acquisitions in the future could own or lease additional properties that, in some instances, have been used for pet food manufacturing or feed mill operations for many years. Although we have utilized operating and disposal practices that were standard in the industry at the time, in some locations environmentally sensitive materials were spilled or released on or under the properties owned or leased by us or on or under other locations where such materials were taken for disposal. In addition, many of these properties have been operated by third parties whose use, handling and disposal of such environmentally sensitive materials or similar wastes were not under our control. These properties and the waste materials spilled, released or otherwise found thereon may be subject to CERCLA, RCRA, and analogous state laws. Under such laws, we can be required to remove or remediate previously spilled or released waste materials (including such materials spilled or released by prior owners or operators) or property contamination (including groundwater contamination caused by prior owners or operators), or to perform monitoring or remedial activities to prevent future contamination (including releases from underground storage tanks or aboveground bulk petroleum storage facilities).
Our U.S. operations are also subject to the federal Clean Water Act and analogous state laws relating to the discharge of pollutants to state and federal waters. These laws also regulate the discharge of stormwater in process areas. Local sewerage authorities have established regulations governing connections to and discharges into their sewer systems and treatment plants. Pursuant to these laws and regulations, we are required to obtain permits at a number of our facilities for the discharge of our wastewater and stormwater. From time to time, we are required to make capital improvements at certain of our facilities to assure compliance with regulatory and permit conditions relating to our wastewaters discharged offsite. Failure to comply with these laws, regulations and permit conditions may result in the imposition of administrative, civil and criminal penalties. We believe that our operations are in substantial compliance with the Clean Water Act and analogous state and local requirements, and that the installation of any wastewater discharge capital improvements will not have a material adverse affect on our operations or financial position.
Our U.S. operations are subject to the federal, state and local requirements pertaining to air emissions. We have been required from time to time to install air emission control or odor control devices to satisfy applicable air requirements. It is possible that in the future, additional air emission or odor control devices may be required to be installed at facilities of ours as deemed necessary to satisfy existing or future requirements.
The manufacturing and marketing of our products in the United States are subject to regulation by federal regulatory agencies, including the Occupational Safety and Health Administration, the Food and Drug Administration and the Department of Agriculture, and by various state and local authorities. The Food and Drug Administration also regulates the labeling of our products. Substantial administrative, civil and criminal penalties may be imposed for violations of Occupational Safety and Health Administration, Food and Drug Administration and Department of Agriculture regulations, and violations may be restrained through injunction proceedings. We procure and maintain the necessary permits and licenses to operate our U.S. facilities and consider our company to be in material compliance with applicable Occupational Safety and Health Administration, Food and Drug Administration and Department of Agriculture requirements.
Our manufacturing, distributing and other operating facilities outside of the United States are potentially subject to similar foreign governmental controls and restrictions pertaining to the environment, safety, and public health. In addition, the European Union is taking a much stronger role in the regulation of raw materials for manufacturing and labeling of pet food. The European Commissioner of Food, which is the controlling body of the European Union, is overseeing this movement towards heightened regulation of pet food.
We believe our U.S. and foreign operations are in material compliance with applicable current environmental, safety and public health laws and regulations; nevertheless, we cannot assure you that those laws and regulations will not change in the future or that we will not incur significant costs in the future to comply with those laws and regulations or in connection with the effect of these matters on our business.
TRADEMARKS
Certain of our brands are protected by trademark registrations in the United States and in certain foreign markets. We believe our registered trademarks are adequate to protect such brand names.
EMPLOYEES
As of February 1, 2002, we had 2,730 employees in the United States and Europe, comprised of 741 management and administrative personnel and 1,989 manufacturing personnel. Of this number, 342 employees are represented by labor unions at four of our plants. The collective bargaining agreement with respect to the Birmingham, Alabama plant covered 82 employees as of February 1, 2002 and expires on January 22, 2005. The collective bargaining agreement with the Joplin, Missouri plant covered 170 employees as of February 1, 2002 and expires on January 31, 2003. The collective bargaining agreement with the Muscatine, Iowa plant covered 49 employees as of February 1, 2002 and expires on December 4, 2003. The collective bargaining agreement with the Hillburn, New York plant covered 41 employees as of February 1, 2002 and expires on May 1, 2004. We consider relations with our employees to be satisfactory.
FORWARD-LOOKING STATEMENTS
Certain of the statements set forth under Item 1 -- "Business" and Item 7 -- "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this annual report on Form 10-K are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements:
- address activities, events or developments that we expect, believe, anticipate or estimate will or may occur in the future;
- are based on certain assumptions and analyses that we have made and we believe are reasonable; and
- are based on various risks and uncertainties, general economic and business conditions, the business opportunities that may be presented to and pursued by us from time to time, changes in laws or regulations and other factors, many of which are beyond our control.
Any of these factors, or any combination of these factors, could materially affect our future results of operations and whether our forward-looking statements ultimately prove to be accurate. Additional important factors that could cause our actual results to differ materially from our expectations are disclosed below. See "Risk Factors." These forward-looking statements are not guarantees of our future performance, and our actual results and future developments may differ materially from those projected in the forward-looking statements.
RISK FACTORS
Our credit agreements could materially affect our operations.
At December 29, 2001, we had long-term debt of $587.8 million, excluding trade payables and other accrued liabilities. Our ability to meet future debt service obligations and reduce our total indebtedness will be dependent upon our future performance, which is subject to general economic conditions and to financial, business and other factors affecting our operations, many of which are beyond our control.
Our senior credit facility requires us to maintain specified financial ratios and satisfy certain financial condition tests. Our ability to meet these financial ratios and tests can be affected by events beyond our control, and we cannot assure you that we will meet the tests. We recently amended the senior credit facility to reduce the financial covenant requirements through March 31, 2003. Although we believe that our expected performance through March 31, 2003 will enable us to comply with these reduced covenants, we cannot assure you that will meet these tests. After March 31, 2003, the financial covenants will increase to levels higher than those for which we obtained waivers from the lenders under the senior credit facility at the end of both fiscal 2000 and 2001.
In fiscal 2002, we intend to restructure our capitalization with the goal of significantly reducing our leverage and improving our ability to comply with the covenants in our credit agreements. We intend to achieve this restructuring through a number of alternatives that we are currently pursuing. We cannot assure you that we will be successful in achieving this restructuring. If we are unable to generate sufficient operating cash flows in the future to service our indebtedness, to comply with covenants and to meet other commitments, we may be required to take certain actions, such as selling material assets or operations. We cannot assure you that we would be able to take any of these actions on a timely basis or on satisfactory terms or that these actions would enable us to continue to satisfy our capital requirements. Certain of these actions may be prohibited by the indenture governing our senior subordinated notes or require the consent of the lenders under our senior credit facility.
Our debt agreements limit certain business activities.
Our senior credit facility and the indenture governing our senior subordinated notes limit our ability to:
- incur additional indebtedness;
- incur liens;
- pay dividends or make certain other restricted payments;
- sell certain assets;
- enter into certain transactions with affiliates;
- merge or consolidate with any other entity; or
- dispose of substantially all of our assets.
We pledged substantially all of our assets as collateral to secure our indebtedness under our senior credit facility. Upon the occurrence of an event of default, our lenders could declare all amounts outstanding under our senior credit facility to be immediately due and payable. If we are unable to repay those amounts, our lenders have the right to foreclose upon the collateral securing the senior credit facility. If the lenders foreclose on the collateral, we cannot assure you that our assets would be sufficient to repay our indebtedness in full. These restrictions could limit our ability to obtain future financings or restrict other corporate activities.
The senior subordinated notes are subordinated in right of payment to all of our existing and future senior indebtedness.
Our senior subordinated notes are generally unsecured obligations and subordinated in the right of payment to all of our existing and future senior indebtedness, including all indebtedness under the senior credit facility and sponsor facility. As of December 29, 2001, we had $439.8 million of senior indebtedness outstanding. As a result of the subordination, the holders of any senior indebtedness must be paid in full before the holders of the senior subordinated notes in the event of the insolvency, liquidation, reorganization, dissolution or other winding-up of our company or upon a default in payment with respect to, or the acceleration of, any senior indebtedness. If we incur any additional debt that is on an equal basis with the senior subordinated notes, the holders of that debt would be entitled to share on an equal basis with the holders of the senior subordinated notes in any proceeds distributed in connection with any insolvency, liquidation, reorganization, dissolution or other winding-up of our company. This may have the effect of reducing the amount of proceeds paid to holders of the senior subordinated notes. In addition, we cannot make cash payments with respect to the senior subordinated notes during a payment default with respect to senior indebtedness and, under certain circumstances, no payments may be made with respect to the principal of, and premium, if any, on the senior subordinated notes for a period of up to 179 days if a non-payment default exists with respect to senior indebtedness.
We may be unable to repurchase the senior subordinated notes as required upon a change of control.
If a change in control of our company occurs, we are required to offer to repurchase all outstanding senior subordinated notes at 101% of the principal amount plus accrued and unpaid interest, if any, to the date of repurchase. We will use our available cash or cash generated from operations or other sources to fund any required repurchases of our senior subordinated notes. However, we cannot assure you that sufficient funds will be available at the time of any change of control to make any required repurchases of our senior subordinated notes.
In addition, our senior credit facility prohibits us from repurchasing the senior subordinated notes, except in certain limited amounts, and also provides that certain change of control events constitute a default under the senior credit facility. Any future credit agreements or other agreements relating to senior indebtedness that we enter into may contain similar restrictions and provisions. In the event a change of control occurs at a time when we are prohibited from repurchasing the senior subordinated notes, we could seek the consent of our lenders to the repurchase of the senior subordinated notes or attempt to refinance the borrowings that contain the prohibition. If we do not obtain the consent or repay the borrowings, we will remain prohibited from repurchasing the senior subordinated notes by the holder of the relevant senior indebtedness. In that case, our failure to repurchase the tendered senior subordinated notes would constitute an event of default under the indenture governing the senior subordinated notes, which would, in turn, constitute a default under the senior credit facility and could constitute a default under other senior indebtedness. In those circumstances, the subordination provisions in the indenture governing the senior subordinated notes would likely restrict payments by us to the holders of the senior subordinated notes.
One of our customers accounts for a substantial portion of our revenue and the loss of this customer could have a material adverse effect on our results of operations.
Net sales to Wal*Mart accounted for approximately 44%, 41% and 41% of our net sales for fiscal 1999, 2000 and 2001, respectively. We do not have a long-term contract with Wal*Mart or any other customer. A significant decrease in business from Wal*Mart could have a material adverse effect on our results of operations, financial condition and cash flows. In addition, our results of operations could be negatively impacted to the extent that Wal*Mart is unable to make payments or does not make timely payments on outstanding accounts receivable.
Increases in the costs of raw materials, packaging and natural gas could adversely affect our results of operations.
Our financial results depend to a large extent on the costs of raw materials, packaging and natural gas, and our ability to pass along increased costs to our customers. Historically, market prices for commodity grains and food stocks have fluctuated in response to a number of factors, including changes in U.S. government farm support programs, changes in international agricultural trading policies, impacts of disease outbreaks on protein sources and the potential effect on supply and demand as well as weather conditions during the growing and related harvesting seasons. Fluctuations in paper prices, which affect our costs for packaging materials, have resulted from changes in supply and demand, general economic conditions and other factors. In addition, we have exposure to changes in pricing of natural gas, which affects our manufacturing costs. We cannot assure you that our results of operations will not be exposed to volatility in the commodity and natural gas market.
In the event of any increases in raw materials, packaging and natural gas costs, we may be required to increase sales prices for our products to avoid margin deterioration. We cannot assure you of the timing or extent of our ability to implement future price adjustments in the event of increased raw materials, packaging and natural gas costs or of whether any price increases implemented by us may affect the volumes of future purchases from our customers.
Restrictions imposed in reaction to outbreaks of "mad cow disease" and "foot-and-mouth disease" could adversely impact the cost and availability of our raw materials.
In the fourth quarter of fiscal 2000, the cost of our raw materials was impacted by the publicity surrounding Bovine Spongiform Encephalopathy ("BSE") in Europe, which is a terminal brain disease of cattle. BSE is also known as "mad cow disease" and is generally believed to be caused by accumulation of abnormal prions (proteins found in the brain that are transmitted by ingestion of infected brains and spinal cord materials) found in cattle feed
protein supplements. Extensive actions have been undertaken by regulators and the industry worldwide to effectively prevent the spread of BSE. No case of BSE has ever been confirmed in the United States. As a result of the global publicity and recent restrictions imposed to provide safeguards against the disease, the cost of alternative sources for our raw material proteins, such as soybeans, increased significantly in the fourth quarter of fiscal 2000.
In fiscal 2001, the impact of BSE on the cost of our raw materials subsided. In addition, we currently are not incurring any significant disruptions in the supply of our required raw materials. Despite these developments, we can provide no assurance that BSE, or resulting regulations or publicity, will not impact either the cost or availability of our raw materials in the future. The risk of higher costs and/or supply disruption would be significant if bans are placed on the use of meat and bone meal in pet food.
In the first quarter of fiscal 2001, there was an outbreak of foot-and-mouth disease ("FMD") in Europe, which affected animals with cloven hooves, such as cattle, swine, sheep, goats, and deer. No case of FMD has been confirmed in the United States since 1929. While FMD is not considered a threat to humans, people who come in contact with the virus can spread it to animals. FMD has not had a measurable impact on either the cost or the availability of our raw materials. Although the future impact, if any, is not determinable, we believe that our operations could be adversely affected if the disease were to spread throughout Europe or to the United States.
If BSE or FMD impacts the availability of our raw materials, we would be required to locate alternative sources for our raw materials. We can give no assurance that those sources would be available to sustain our volume sales or that these alternative sources would not be more costly. If BSE or FMD impacts the cost of our raw materials, or the cost of alternative raw materials compared to current costs, we would be required to increase the sales price for our products to avoid margin deterioration. We can give no assurance of the timing or extent of our ability to implement future price adjustments in the event of higher costs.
Volatility in the commodity markets could affect our results of operations.
We manage our commodity price risk associated with market fluctuations by using derivative instruments for portions of our corn, soybean meal, alternative proteins and natural gas purchases, principally through exchange traded futures and options contracts. The terms of such contracts are generally less than one year. During the term of a contract, we balance positions daily with cash payments to or from the exchanges. At the termination of a contract, we have the ability to settle financially or by exchange for the physical commodity, in which case, we would deliver the contract against the acquisition of the physical commodity. Our policy does not permit speculative commodity trading. See Item 7A -- "Quantitative and Qualitative Disclosures about Market Risk."
Effective January 1, 1999, our commodity derivative instruments were measured at fair value in our consolidated financial statements under Statement on Financial Accounting Standards No. 133, Accounting for Derivative and Hedging Activities ("SFAS 133"). We cannot assure you our results of operations will not be exposed to volatility in commodity prices under the SFAS 133 fair value accounting of our commodity derivative instruments.
Our acquisition activities, including integration, operation and management of these businesses, may not be successful.
Any acquisition we may pursue would be based on identifying and acquiring businesses engaged in manufacturing and distributing pet food products in markets where we currently do not operate or businesses with products that would complement our product mix. We will evaluate specific acquisition opportunities based on prevailing market and economic conditions. Our lack of experience in new markets we may enter through future acquisitions could have an adverse effect on our results of operations and financial condition. Acquisitions may require investment of operational and financial resources and could require integration of dissimilar operations, assimilation of new employees, diversion of management time and resources, increases in administrative costs, potential loss of key employees of the acquired company and additional costs associated with debt or equity financing. Any future acquisitions that we make could have an adverse effect on our results of operations. We may encounter increased competition for acquisitions in the future, which could result in acquisition prices we do not consider acceptable. We cannot assure you that we will have sufficient available capital resources to execute potential acquisitions. We cannot assure you that we will find suitable acquisition candidates at acceptable prices or succeed in integrating any acquired business into our existing business or in retaining key customers of acquired
businesses. Our operating results and financial condition could be materially and adversely affected if any of the following occur:
- the expected operating efficiencies from the acquisitions do not materialize;
- we fail to integrate the acquisitions into our existing operations; or
- the cost of the acquisition integrations exceed expectations.
The amount of goodwill and other intangible assets we have recorded from our acquisitions may not be realized, which could have a material adverse effect on our results of operations.
We had $347.1 million of net goodwill and other intangible assets as of December 29, 2001. Goodwill has been recorded under the purchase accounting method to represent the excess of the amount paid over the fair value of the assets acquired and liabilities assumed. Other intangible assets consist of trademarks. We cannot assure you our goodwill and other intangible assets will be realized by us in the future. Goodwill and other intangible assets represented 41% of our total assets as of December 29, 2001. Through December 29, 2001, we amortized our goodwill over 20 and 40 years and trademarks over 30 years. In fiscal 2002, we will adopt Statement on Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, ("SFAS 142") which requires that goodwill and other intangible assets with indefinite lives no longer be amortized. We will be required to test for impairment of these assets upon adoption of SFAS 142, and thereafter annually and upon the occurrence of certain events. Our results of operations in future periods could be reduced if our goodwill and other intangible assets are determined to be impaired under SFAS 142. See Item 7 -- "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Recently Issued Accounting Pronouncements."
We face significant competition from national, regional and store brand manufacturers, many of whom are larger than we are and have significantly greater resources than we do.
The pet food industry is highly competitive. The companies that produce and market the major national branded pet foods are national or international conglomerates that are substantially larger than us and possess significantly greater financial and marketing resources than us. Our store brand pet food products compete for shelf space with national branded pet food products on the basis of quality and price. In addition, certain national branded manufacturers also manufacture store brands. National branded products compete principally through advertising to create brand awareness and loyalty. We experience some price competition from national branded products. To the extent significant price competition from national branded products exists or the national branded manufacturers significantly increase their store brand presence, our operating results and cash flows could be adversely affected. We also compete with regional branded manufacturers and other store brand manufacturers.
International operations involve additional business, economic and political risks, which could limit our ability to successfully carry out our business strategy.
We operate a portion of our business and market products internationally, and we plan to increase our international marketing and business activities. We are, therefore, subject to and will increasingly become subject to, the risks customarily attendant to international operations and investments in foreign countries. These risks include nationalization, expropriation, war and civil disturbance, restrictive action by local governments, limitation on repatriation of earnings, change in foreign tax laws and change in currency exchange rates, any of which could have an adverse effect on our operations in foreign countries. Interruption of our international operations could have a material adverse effect on our financial condition and results of operations.
If we lose certain key personnel or are unable to hire additional qualified personnel, we may not be successful.
Our success depends, in part, upon the continued services of our highly skilled personnel involved in management, production and distribution, and, in particular, upon the efforts and abilities of our executive management group. If we lose the service of any of the members of our executive management group, the loss could have a material adverse effect on our business, financial condition and results of operations. We have entered into employment agreements with members of our executive management group. We do not have key person life
insurance covering any of our employees. Our success also depends upon our ability to attract and retain highly qualified employees.
We are subject to extensive regulation, and changes in laws or regulations could increase our expenses.
We are subject to a broad range of federal, state, local and foreign laws and regulations intended to protect the public health and the environment, including those governing discharges to the air and water, the storage of petroleum substances and chemicals, the handling and disposal of solid or hazardous wastes and the remediation of contamination associated with releases of wastes or hazardous substances. Our U.S. operations are also subject to regulation by the Occupational Safety and Health Administration, the Food and Drug Administration and the Department of Agriculture, and by various state and local authorities. Our foreign operations are subject to similar environmental and safety laws and regulations that are enforced by governmental agencies, such as the European Commissioner of Foods. Violations of any of these laws and regulations may result in administrative, civil or criminal penalties being levied against us, permit revocation or modification, or a cease and desist order against operations that are not in compliance.
We believe our operations are in material compliance with applicable current environmental and safety laws and regulations. We cannot assure you that these laws and regulations will not change in the future, that we will not incur material costs in the future to comply with current or future laws and regulations, or that these matters will not have a material adverse effect on our business.
ITEM 2
ITEM 2 -- PROPERTIES
Our corporate headquarters are located in Brentwood, Tennessee. We own combined manufacturing and distribution facilities in the following states: one each in Alabama, Colorado, Georgia, Indiana, Iowa, Minnesota, New York, Ohio, South Carolina, Tennessee, Texas and Virginia; two each in California, Oklahoma, Pennsylvania and Wisconsin; and three in Missouri. In Europe, we own combined manufacturing and distribution facilities in the following countries: one each in Austria, Spain and the United Kingdom, and three in Denmark. In addition, we own or lease three product distribution warehouses in the United States. We also have a 50% joint venture interest in combined manufacturing and distribution facilities located in Texas and Italy.
Our manufacturing facilities are generally located in rural areas in proximity to our customers, raw materials and transportation networks, including rail transportation. We believe the broad number of strategically located facilities enhances our position as a low cost provider by reducing freight costs for raw materials and finished goods and facilitating direct delivery programs. The rural locations also minimize land and labor costs. We believe we can construct new manufacturing facilities at a lower cost than competitors by using our engineering services group to design and construct most of the necessary production equipment.
ITEM 3
ITEM 3 -- LEGAL PROCEEDINGS
In the ordinary course of business, we are party to litigation from time to time; however, we are not a party to any material pending legal proceedings that we believe would have a material adverse effect on our financial condition or results of operations.
ITEM 4
ITEM 4 -- SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our parent executed a Written Consent of Sole Shareholder in Lieu of an Annual Meeting, effective as of November 15, 2001. Pursuant to this consent, Messrs. Cahill, Finney, Kelly, Lori, Peets, Sherrill and Walker were elected to our Board of Directors to serve for the ensuing year. See Item 10 -- "Directors and Executive Officers of the Registrant." Also pursuant to the consent, our Bylaws were amended.
PART II
ITEM 5
ITEM 5 -- MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
All of our common stock is owned by our parent, and there is no established public trading market for our common stock. We did not sell any unregistered equity securities in fiscal 2001.
ITEM 6
ITEM 6 -- SELECTED FINANCIAL DATA
The selected consolidated financial data presented below, except for pet food sold, as of and for fiscal 1999, 2000 and 2001 is derived from our accompanying audited consolidated financial statements included elsewhere in this annual report on Form 10-K. For the years ended December 31, 1997 and 1998, our fiscal year end was a calendar year end. Effective January 1, 1999, we changed our fiscal year end to the Saturday nearest to the end of December; and therefore, fiscal 1999, 2000 and 2001 ended on January 1, 2000, December 30, 2000 and December 29, 2001, respectively. The selected consolidated financial data presented below, except for pet food sold, as of and for fiscal 1997 and 1998 is derived from our audited consolidated financial statements not included elsewhere in this annual report on Form 10-K. The information set forth below is qualified in its entirety in conjunction with Item 7
ITEM 7 - - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The reader is encouraged to refer to Item 1 -- "Business" which describes our company and, in particular, "Risk Factors," which describes the risks related to our business and our company. The reader should also refer to Item 7A
ITEM 7A -- QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks, which may give rise to losses from adverse changes in market prices and rates. Our market risks could arise from changes in commodity prices, interest rates and foreign currency exchange rates.
Commodity price risk. We manage our commodity price risk associated with market fluctuations by using derivative instruments for portions of our corn, soybean meal, alternative proteins and natural gas purchases, principally through exchange traded futures and options contracts. The terms of such contracts are generally less than one year. During the term of a contract, we balance positions daily with cash payments to or from the exchanges. At the termination of a contract, we have the ability to settle financially or by exchange for the physical commodity, in which case, we would deliver the contract against the acquisition of the physical commodity. Our policy does not permit speculative commodity trading. At December 29, 2001, we had open commodity contracts with a fair value loss of $7.5 million.
Based upon an analysis we completed as of December 29, 2001 in which we utilized our actual derivative contractual volumes and assumed a 5% adverse movement in commodity prices, we determined the potential decrease in the fair value of our commodity derivative instruments would be approximately $3.0 million, net of deferred tax benefit of $1.9 million.
Interest rate risk. We are exposed to market risk related to changes in interest rates. We periodically use interest rate swap and cap contracts to limit our exposure to the interest rate risk associated with our floating rate debt, which totaled $402.6 million at December 29, 2001. Of that amount, $115.0 million of our floating rate debt was hedged by interest rate swap contracts and $50.0 million was hedged by an interest rate cap contract. Changes in market values of these financial instruments are highly correlated with changes in market values of the hedged item both at inception and over the life of the contract. Amounts received or paid under interest rate swap contracts and gains and losses on interest rate cap contracts are recorded as interest income (expense) in the accompanying audited consolidated financial statements included herein. Gains and losses on interest rate swap contracts are recorded in accumulated other comprehensive income (loss) in the accompanying audited consolidated financial statements included herein. We had a cumulative deferred loss on our interest rate swap contracts of $2.7 million, net of deferred tax benefit of $1.7 million, at December 29, 2001.
Accordingly, our net income is affected by changes in interest rates. Assuming a 100 basis point increase in interest rates on our current floating rate debt and interest rate swap and cap contracts, our net loss would increase by approximately $1.5 million for fiscal 2001. In addition, such a change would result in a decrease of approximately $6.6 million in the fair value of our fixed rate debt at December 29, 2001. In the event of an adverse change in interest rates, we could take action to mitigate our exposure; however, due to the uncertainty of these potential actions and their possible effects, our analysis assumes no such actions. Furthermore, our analysis does not consider the effect of any changes in the level of overall economic activity that may exist in such an environment.
Foreign currency exchange risk. Our financial position and results of operations are affected by foreign currency exchange rate fluctuations. We currently have European operations that sell pet food products throughout Europe. In connection with our acquisition of Arovit, we funded a portion of the acquisition with Euro-denominated debt and designated our Euro-denominated debt as a hedge of our net investment in Europe. As of December 29, 2001, the cumulative translation adjustment for the net investment in our foreign operations was a net loss of $6.3 million, which includes an unrealized gain of $1.0 million for the translation of our Euro-denominated debt to U.S. dollars. The cumulative translation adjustment is recorded in accumulated other comprehensive income (loss) in the accompanying audited consolidated financial statements included herein.
We are exposed to foreign currency exchange risk arising from transactions in the normal course of business in Europe. To mitigate the risk from foreign currency exchange rate fluctuations in those transactions, we enter into foreign currency forward contracts for the purchase or sale of a currency. Accordingly, changes in market values of these financial instruments are highly correlated with changes in the market values of the hedged items both at inception and over the life of the contracts. Gains and losses on foreign currency forward contracts are recorded in accumulated other comprehensive income (loss) in the accompanying audited consolidated financial statements included herein. At December 29, 2001, we had a cumulative deferred gain on foreign currency forward contracts of $1.5 million, net of deferred tax expense of $0.6 million. At December 29, 2001, we had open foreign currency forward contracts that mature within the next 12 months with a notional value of $7.4 million and a fair value loss of $0.7 million.
ITEM 8
ITEM 8 -- FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the information beginning on page, which is filed as a part of this annual report on Form 10-K.
ITEM 9
ITEM 9 - - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10
ITEM 10 -- DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth the names, ages and titles of the current directors and executive officers of Doane and Doane Pet Care Enterprises, Inc. Each of the members of the board of directors of Doane named below also serves on the board of directors of Doane Pet Care Enterprises, Inc. The boards of directors of both Doane and Doane Pet Care Enterprises, Inc. are currently composed of seven members, which are designated pursuant to an investors' agreement. See Item 13 -- "Certain Relationships and Related Transactions -- Investors' Agreement." Officers serve at the discretion of the boards of directors. For information regarding employment agreements with the executive officers of Doane, see Item 11
ITEM 11 -- EXECUTIVE COMPENSATION
The following table sets forth information with respect to the Chief Executive Officer of Doane and the other four most highly compensated individuals serving as executive officers for the fiscal year ended December 29, 2001 who earned $100,000 or more in combined salary and bonus during such year (collectively, the "Named Executive Officers"):
- ------------
(1) Amounts exclude perquisites and other personal benefits that did not exceed the lesser of $50,000 or 10% of the total annual salary and bonus reported for each executive officer.
(2) Amounts include a company match and profit sharing contribution under the Doane Pet Care Retirement Savings Plan as follows: Mr. Cahill -- $5,400 in 1999, $5,650 in 2000 and $5,000 in 2001; Mr. Woodlief -- $6,943 in 1999, $7,518 in 2000 and $2,250 in 2001; Mr. Horton -- $5,400 in 1999, $5,650 in 2000 and $4,875 in 2001; Mr. Meyers -- $5,025 in 1999, $5,248 in 2000 and $4,865 in 2001; and Mr. Bechtel -- $400 in 2000.
(3) Amounts include term life insurance premiums as follows: Mr. Cahill -- $174 in 1999 and $192 in 2000 and 2001; Mr. Woodlief -- $84 in 1999, $84 in 2000 and $100 in 2001; Mr. Horton -- $174 in 1999, $84 in 2000 and $93 in 2001; Mr. Meyers -- $174 in 1999, $84 in 2000 and $89 in 2001; and Mr. Bechtel -- $174 in 1999, $84 in 2000 and $86 in 2001.
(4) Amounts include disability insurance premiums in 2000 and 2001 of $1,814, respectively, each for Messrs. Cahill, Woodlief, Horton, Meyers; and Bechtel.
(5) Amount includes reimbursement for the payment of taxes associated with relocation.
(6) Amount includes bonus received in connection with the acquisition of Arovit in 2000 for Mr. Woodlief of $25,000.
(7) Amounts include relocation expenses for Mr. Woodlief of $3,948 in 1999 and $10,107 in 2000.
(8) Annual compensation amount for 1999 represents compensation for the portion of the year that Doane employed Mr. Woodlief.
(9) Amount includes annual vested benefit under the non-qualified salary continuation agreement for Mr. Bechtel of $21,000 in 1999, $70,680 in 2000 and $117,120 in 2001.
EMPLOYMENT AND RETIREMENT AGREEMENTS
We entered into employment agreements with Messrs. Cahill, Horton, Meyers and Bechtel effective January 1, 1998 and Mr. Woodlief effective February 15, 1999. The terms of their employment agreements are substantially similar except for salary and bonus amounts. Mr. Cahill's current base salary is $400,000 with a base bonus of 100% of base salary. Messrs. Woodlief and Horton each have current base salaries of $225,000 with base bonuses of 50% of base salary. Messrs. Meyers and Bechtel each have current base salaries of $200,000 with base bonuses of 50% of base salary. Earnings targets are established annually by our board of directors under our annual bonus program. Base bonuses are linked to achievement of targeted earnings. There is no cap on additional bonuses in the employment agreements. Each employment agreement provides for a term of two to three years with automatic one year extensions. The agreements are subject to early termination for cause without severance. The employment agreements for Messrs. Woodlief, Horton and Meyers provide (1) that terminations without cause entitle the executive to receive severance payments equal to two year's base salary and bonus and (2) for a two year non-competition agreement commencing upon termination for any reason. The employment agreements of Mr. Cahill and Mr. Bechtel contain similar provisions except that the severance and non-competition terms are three years and one year, respectively.
COMPENSATION OF DIRECTORS
Terry R. Peets serves as an independent director of Doane and Doane Pet Care Enterprises, Inc. He was paid $5,000 in 2001 pursuant to an agreement in which he receives a $1,500 per month retainer fee and $2,000 for each board of directors meeting he attends. Pursuant to his agreement to become a director, Mr. Peets was also granted stock options covering 20,000 shares under the 1999 Stock Incentive Plan. These options have a "time-vesting" schedule pursuant to which one-third of the stock options will vest after each of the first three years following the grant date. No compensation was paid by us to our other directors.
STOCK OPTION PLANS
Effective November 1, 1996, our parent adopted its 1996 Stock Option Plan, as amended. On July 14, 1999, our parent adopted the 1999 Stock Incentive Plan. In connection with the adoption of the 1999 Stock Incentive Plan, no new grants could be made under the 1996 Stock Option Plan. Effective October 31, 2001, our parent approved the "repricing" of all vested and unvested stock options under the 1996 Stock Option Plan and the 1999 Stock Incentive Plan that had an exercise price exceeding $2.50 per share. All such eligible stock options were given a new exercise price of $2.50 per share. However, because there was a change in the vesting of the stock options, with all eligible stock options being put on a new "time-vesting" schedule, the repricing involved a surrender of the eligible stock options in exchange for a grant of new stock options covering an equivalent number of shares at the new exercise price. Stock options covering 566,000 shares under the 1996 Stock Option Plan and stock options covering 950,300 shares under the 1999 Stock Incentive Plan were surrendered. Stock options covering a total of 1,516,300 shares were granted at the $2.50 per share exercise price, and all such grants were made under the 1999 Stock Incentive
Plan and are accounted for as variable plan awards. Since the fair value of our Parent's Class A common stock is less than $2.50 per share at December 29, 2001, no compensation expense for these variable awards has been recorded. Pursuant to the time-vesting schedule for the granted stock options, 50% of an individual's stock options will vest two years after the grant date, 25% will vest after the third year, and the remaining 25% will vest after the fourth year. Generally, all stock options vest upon a change of control of our parent. Under the 1999 Stock Incentive Plan, 4,200,000 shares are authorized for issuance, and as of March 15, 2002, options covering 3,230,300 shares had been granted and remain outstanding.
STOCK OPTION GRANTS
The following table sets forth certain information on options granted in fiscal 2001 under the 1999 Stock Incentive Plan to the Named Executive Officers.
(1) The stock options granted to the Named Executive Officers under the 1999 Stock Incentive Plan were time-vesting options pursuant to which 50% of an individual's stock options will vest two years after the grant date, 25% will vest after the third year, and the remaining 25% will vest after the fourth year.
(2) Number of securities underlying options granted do not include repriced options in fiscal 2001 as follows: Mr. Cahill -- 602,200; Mr. Woodlief -- 106,200; Mr. Horton -- 146,200; Mr. Meyers -- 121,200; and Mr. Bechtel -- 42,400.
STOCK OPTION EXERCISES
The following table sets forth certain information with respect to exercises of stock options during fiscal 2001 by the Named Executive Officers and the number of shares underlying unexercised stock options held by such officers as of December 29, 2001:
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Douglas J. Cahill, our President and Chief Executive Officer, served as a member of our Compensation Committee in fiscal 2001.
OTHER COMPENSATORY ARRANGEMENTS
401(k) Plans. We currently have two active plans. On January 1, 2000, we adopted the Doane Pet Care Retirement Savings Plan, which was formed through the merger of two predecessor plans. The merged plan was
amended and restated and is intended to be a qualified plan under the Internal Revenue Code. The plan provides coverage for eligible employees and permits employee contributions from 1% to 15% of pre-tax earnings, subject to annual dollar limits set by the IRS. We match 50% of the first 6% of the participant's contribution with a provision for other contributions at the board of directors' discretion. Employer contributions are vested 25% per year for each full year of service.
The Doane Pet Care Savings and Investment Plan -- Union Plan covers eligible union employees at the Joplin, Missouri and Muscatine, Iowa plants. This plan is intended to be a qualified retirement plan under the Internal Revenue Code and permits employee contributions between 1% and 15% of pre-tax earnings, subject to annual dollar limits set by the IRS, and provides for a variety of investment options.
Non-Qualified Salary Continuation Agreements. Doane has entered into agreements with all of the Named Executive Officers to provide benefits to those employees or their beneficiaries in the event of the death of the employee or retirement by the employee at age 65 or on or after age 55 with 10 years of service with Doane. If the employee remains employed until age 65, the employee or the employee's beneficiary will receive an annual retirement benefit payable for 10 years in accordance with a specified formula. If the employee terminates employment before age 65 but after age 55 and with 10 years of service with Doane, the employee's retirement benefit will be reduced in accordance with percentages specified in the agreement, depending upon the employee's age at retirement ranging from 100% at age 65 to 55.8% at age 55.
ITEM 12
ITEM 12 -- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
All of our issued and outstanding shares of common stock are held by Doane Pet Care Enterprises, Inc. As of March 15, 2002 we had 1,200,000 shares of preferred stock issued and outstanding, 200,000 of which were held by JPMP and 1,000,000 of which were held by qualified institutional buyers, as defined in Rule 144A under the Securities Act of 1933. The following table sets forth certain information regarding the beneficial ownership of Doane Pet Care Enterprises, Inc.'s common stock as of March 15, 2002 by (i) each director; (ii) each Named Executive Officer; (iii) each person who is known by Doane to own beneficially 5% or more of the common stock of Doane Pet Care Enterprises, Inc.; (iv) all parties to the investors' agreement as a group; and (v) all directors and executive officers as a group. Unless otherwise indicated, each person has sole voting and dispositive power over the shares indicated as owned by that person. Certain of Doane Pet Care Enterprises, Inc.'s principal stockholders are parties to the investors' agreement. See Item 13
ITEM 13 -- CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
INVESTORS' AGREEMENT
Doane Pet Care Enterprises, Inc, Doane, SCI, JPMP and an affiliate thereof, DLJMB and certain of its affiliates, BRS and certain affiliated entities and individuals, all of the former stockholders of Windy Hill and certain other stockholders of Doane are parties to a Second Amended and Restated Investors' Agreement. The investors' agreement contains provisions concerning the governance of Doane Pet Care Enterprises, Inc. and Doane, restrictions on the transferability of the securities of Doane Pet Care Enterprises, Inc. and Doane and registration rights for such securities.
The governance provisions of the investors' agreement provide that the boards of directors of Doane and Doane Pet Care Enterprises, Inc. both consist of seven members. At any time the number of shares of common stock of Doane Pet Care Enterprises, Inc. owned of record by JPMP (which, for the purposes of the investors' agreement, includes warrants on an as-if exercised basis) is 5% or more, JPMP will have the right to designate two individuals as directors. At any time the
number of shares of common stock of Doane Pet Care Enterprises, Inc. owned of record by DLJMB is 5% or more, DLJMB will have the right to designate one individual as director. At any time the number of shares of common stock of Doane Pet Care Enterprises, Inc. owned of record by the former investors in Summit/DPC Partners, L.P. (including after its dissolution and the distribution of its shares) is 50% or more of the number of shares of common stock of Doane Pet Care Enterprises, Inc. it owned as of August 3, 1998, SCI will have the right to designate one individual as director. At any time the number of shares of common stock of Doane Pet Care Enterprises, Inc. owned of record by the Windy Hill investors is 50% or more of the number of shares of common stock of Doane Pet Care Enterprises, Inc. owned by them as of August 3, 1998, BRS will have the right to designate one individual. Additionally, one designee as director shall be the Chief Executive Officer of Doane Pet Care Enterprises, Inc. and one will be an independent director designated by a majority of the board of directors.
SPONSOR FACILITY
In March 2001, we refinanced $25.0 million of indebtedness under our senior credit facility with loans from shareholders of our parent and Messrs. Cahill, Woodlief and Horton, and certain other executive officers. The sponsor facility was used to pay down the senior credit facility. The sponsor facility is a senior unsecured loan bearing interest at 15.0%. Principal and accrued interest under the loan is due on March 15, 2007. Our senior credit facility restricts the payment of any interest or principal on the sponsor facility until the ratio of our Average Senior Debt to EBITDA, calculated on a pro forma basis giving effect to any such principal or interest payments, is no greater that 2.75 to 1.00 and we maintain at least $35.0 million of credit availability (the "Payment Test"). The sponsor facility requires that all unpaid interest and principal be paid at the end of each quarter in which the Payment Test is achieved, to the extent allowed by the senior credit facility. No payments were made in 2001 and we do not believe any payments will be made on the sponsor facility in 2002. Our parent issued warrants in connection with the sponsor facility that give the warrantholders the right to purchase 30.0% of the outstanding stock of our parent for a nominal amount.
TRANSACTIONS WITH DLJMB AND ITS AFFILIATES
DLJMB and certain other entities affiliated with DLJMB and CSFB are the owners of 351,428 shares of common stock and warrants to purchase 4,514,928 shares of Doane Pet Care Enterprises, Inc. CSFB and its affiliates have received certain payments of fees, including fees for various investment banking and commercial banking services provided to us and to Doane Pet Care Enterprises, Inc. There are currently no agreements to make any such payments.
DLJMB and certain other entities affiliated with DLJMB and CSFB are parties to the investors' agreement. In accordance with the investors' agreement, DLJMB has designated Mr. Finney to the board of directors of Doane and Doane Pet Care Enterprises, Inc.
TRANSACTIONS WITH SCI
SCI and the other former partners of Summit/DPC Partners, L.P. are the owners of 5,382,272 shares of common stock of Doane Pet Care Enterprises, Inc. SCI has received certain payments of fees and reimbursements for out-of-pocket expenses. There are currently no agreements to make any such payments.
SCI and the other former partners of Summit/DPC Partners, L.P. are parties to the investors' agreement. In accordance with the investors' agreement, SCI has designated Mr. Kelly to the boards of directors of Doane and Doane Pet Care Enterprises, Inc.
TRANSACTIONS WITH JPMP AND AFFILIATES
JPMP is an affiliate of JPMorgan Chase Bank ("Chase"). JPMP and an affiliate of JPMP own:
- 200,000 shares of our preferred stock;
- 428,000 shares of Class A Common Stock of Doane Pet Care Enterprises, Inc. and 2,560,093 shares of Class B (non-voting) Common Stock of Doane Pet Care Enterprises, Inc.; and
- warrants to purchase 6,694,153 shares of common stock of Doane Pet Care Enterprises, Inc.
Chase and its affiliates perform various investment banking and commercial banking services from time to time for Doane and its affiliates. Chase serves as an agent bank and a lender to Doane under the senior credit facility. Since the beginning of fiscal 2001 through March 28, 2002, Chase and its affiliates have received a total of $1.0 million for acting in the foregoing capacities, excluding interest and other charges earned by all lenders under our senior credit facility.
JPMP is a party to the investors' agreement. In accordance with the investors' agreement, JPMP has designated Messrs. Walker and Lori to the boards of directors of Doane and Doane Pet Care Enterprises, Inc.
ITEM 14
ITEM 14 -- EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
(1) Financial Statements
(3) Exhibits
The following exhibits are filed as part of this report:
- ----------
* Filed herewith
+ Management contracts or compensatory plans or arrangements.
(b) Reports on Form 8-K
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
DOANE PET CARE COMPANY
By: /s/ PHILIP K. WOODLIEF ----------------------------------- Philip K. Woodlief Vice President, Finance and Chief Financial Officer
By: /s/ STEPHEN P. HAVALA ----------------------------------- Stephen P. Havala Corporate Controller and Principal Accounting Officer
Date: March 29, 2002
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on behalf of the registrant and in the capacities and on the dates indicated.
DOANE PET CARE COMPANY AND SUBSIDIARIES
FINANCIAL INFORMATION
INDEPENDENT AUDITORS' REPORT
Board of Directors Doane Pet Care Company
We have audited the accompanying consolidated balance sheets of Doane Pet Care Company and subsidiaries as of December 30, 2000 and December 29, 2001 and the related consolidated statements of income, stockholder's equity and comprehensive income and cash flows for the years ended January 1, 2000, December 30, 2000 and December 29, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Doane Pet Care Company and subsidiaries at December 30, 2000 and December 29, 2001 and the results of its operations and its cash flows for the years ended January 1, 2000, December 30, 2000 and December 29, 2001 in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 2 to the consolidated financial statements, effective January 1, 1999, the Company adopted Statement on Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities."
/s/ KPMG LLP
Houston, Texas March 22, 2002
DOANE PET CARE COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PAR VALUE AMOUNTS)
See accompanying notes to consolidated financial statements.
DOANE PET CARE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
See accompanying notes to consolidated financial statements.
DOANE PET CARE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY AND COMPREHENSIVE INCOME (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
See accompanying notes to consolidated financial statements.
DOANE PET CARE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
See accompanying notes to consolidated financial statements.
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
Doane Pet Care Company ("Company" or "Doane") is a wholly-owned subsidiary of Doane Pet Care Enterprises, Inc. ("Parent" or "Enterprises"). The Company is a leading global provider of pet food, primarily private label, with 31 combined manufacturing and distribution facilities in the United States and Europe. The Company manufactures pet food products primarily for dogs and cats, including dry, wet, semi-moist, soft dry, soft treats and biscuits, to retailers of all types. The Company also operates a machine shop and a structural steel fabrication plant that sells to third parties and supports the Company's facilities.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated. The Company's 50% joint venture investments are accounted for under the equity method. Equity from the joint venture investments is recorded in other income, net in the accompanying consolidated statements of income.
52-53 Week Fiscal Year
Effective January 1, 1999, the Company changed its fiscal year so that it ends on the Saturday nearest to the end of December; and therefore, fiscal 1999, 2000 and 2001 ended on January 1, 2000, December 30, 2000 and December 29, 2001, respectively.
Reclassifications
Certain fiscal 1999 and 2000 amounts have been reclassified to conform with fiscal 2001 presentation.
Use of Estimates
In conformity with accounting principles generally accepted in the United States of America, preparation of the Company's financial statements requires management to make estimates and assumptions that affect the reported amounts and disclosures in the financial statements; and therefore, actual results could ultimately differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents include all liquid investments with original maturities of three months or less. The Company reduces cash and cash equivalents for outstanding checks when the Company's net cash balance with the same bank is positive at the end of the period and classifies outstanding checks, net of cash, in accounts payable when the Company's net cash balance with the same bank is negative at the end of the period.
Accounts Receivable
Accounts receivable are stated at net realizable value through recording allowances for deductions, doubtful accounts and cash discounts. The Company had accounts receivable allowances of $6.4 million and $8.6 million at December 30, 2000 and December 29, 2001, respectively.
The Company extends unsecured credit in the form of accounts receivable, principally to retailers and national branded companies throughout the United States and Europe, with credit extended to one customer approximating 47% and 45% of accounts receivable, net, at December 30, 2000 and December 29, 2001, respectively.
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Inventories
Inventories are valued at the lower of cost or market. Cost is determined using the first-in, first-out method. Inventories are stated net of a valuation allowance for obsolescence of $2.5 million and $7.6 million at December 30, 2000 and December 29, 2001, respectively, primarily for packaging inventories. The Company estimates its obsolescence reserve based on specific identification of obsolete SKUs or potential SKUs to be rationalized with the estimate taking into account both the probability and timing of rationalization.
Property, Plant and Equipment
Property, plant and equipment are depreciated using the straight-line method over the estimated useful lives of 20 to 40 years for buildings and improvements and 3 to 12 years for machinery and equipment.
Goodwill and Other Intangible Assets
Goodwill has been recorded under the purchase accounting method to represent the excess of the purchase price over the fair value of the assets acquired and liabilities assumed. Other intangible assets consist of trademarks. Through December 29, 2001, the Company amortized goodwill over 20 and 40 years and trademarks over 30 years using the straight-line method. The recovery of the carrying value of goodwill and other intangible assets is periodically evaluated for impairment in relation to the operating performance and expected future operating cash flows of the Company on an undiscounted basis. If the carrying value of such assets exceeds the expected undiscounted future operating cash flows, an impairment loss is recognized to the extent the carrying amount of the acquired net assets exceeds the fair value, which is calculated using expected discounted future operating cash flows. See "Recently Issued Accounting Pronouncements."
Financial Instruments
The fair value of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximates book value. The fair value of long-term debt is based upon market value, if traded, or discounted at the estimated rate the Company would currently incur on similar debt. See Note 10 -- "Fair Value of Financial Instruments."
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are determined based upon differences between the financial reporting and tax basis of assets and liabilities. The differences are measured by applying enacted tax rates and laws to taxable years in which such differences are expected to reverse.
Revenue Recognition
Revenue is recognized at the time the product is shipped. Sales are recorded net of discounts, volume-based rebates, returns and allowances.
In fiscal 2001, the Company adopted Financial Accounting Standards Board's Emerging Issues Task Force Issue No. 01-9, Accounting for Consideration Given by a Vendor to a Customer, ("EITF 01-9") which provides guidance on when to record certain sales incentives as well as the classification of certain sales incentives in the statement of income. As a result of adopting EITF 01-9, the Company records volume-based rebates and certain sales incentives as a component of net sales and free-goods promotions as a component of cost of goods sold. Prior to adopting EITF 01-9, the Company recorded these costs as a component of promotion and distribution expense. All prior periods presented in the statements of income have been reclassified for consistency with the fiscal 2001 presentation. See Note 25 -- "Quarterly Financial Data and Promotional Accounting Reclassification (Unaudited)."
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Promotion and Distribution
Promotion and distribution expenses are primarily promotions, freight, brokerage fees, and warehousing expenses. Distribution expenses were $24.0 million, $31.2 million and $34.7 million in fiscal 1999, 2000 and 2001, respectively.
Commodity Derivative Instruments
The Company manages its commodity price risk associated with market fluctuations by using derivative instruments for portions of its corn, soybean meal, alternative proteins and natural gas purchases, principally through exchange traded futures and options contracts. The terms of these contracts are generally less than one year. During the term of the contract, the Company balances positions daily with cash payments to or from the exchanges. At the termination of a contract, the Company has the ability to settle financially or by exchange for the physical commodity, in which case, the Company exchanges the contract against the acquisition of the physical commodity. The Company's policy does not permit speculative commodity trading. All changes in the fair value of the Company's commodity derivative instruments are included in cost of goods sold in the accompanying consolidated statements of income.
Interest Rate Swap and Cap Contracts
The Company periodically uses interest rate swap and cap contracts to limit its exposure to the interest rate risk associated with its floating rate debt. The Company's policy does not permit speculative trading related to its debt. Changes in market values of these financial instruments are highly correlated with changes in market values of the hedged item both at inception and over the life of the contracts. Since adoption of SFAS 133 on January 1, 1999, the Company's interest rate swap contracts have been designated as cash flow hedges with changes in fair value recognized in accumulated other comprehensive income (loss) in the accompanying consolidated financial statements. Amounts received or paid under interest rate swap contracts and gains and losses on interest rate cap contracts are recorded as interest income (expense) in the accompanying consolidated statements of income.
Foreign Currency Derivative Instruments
The Company has entered into various foreign currency forward contracts to manage its exposure to exchange rate fluctuations on foreign currency transactions. Changes in market values of these financial instruments are highly correlated with changes in market values of the hedged item both at inception and over the life of the contracts. In accordance with SFAS 133, gains and losses on foreign currency forward contracts are recorded in accumulated other comprehensive income (loss) in the accompanying consolidated financial statements.
Comprehensive Income (Loss)
Comprehensive income (loss) consists of (1) net income (loss); (2) foreign currency translation adjustment, including changes in the fair value of the Company's Euro-denominated debt designated as a hedge of the Company's net investment in Arovit; and (3) unrealized holding gains and losses on interest rate swap contracts and foreign currency derivative instruments designated as hedges. Comprehensive income (loss) is presented in the accompanying consolidated statements of stockholder's equity and comprehensive income.
Foreign Currency Gains and Losses
The Company's foreign-owned assets and liabilities have been translated to U.S. dollars using the exchange rates in effect at the balance sheet dates. Results of foreign operations have been translated using the average exchange rate during the periods of operation presented in the accompanying consolidated statements of income. The translation adjustment for the Company's net investment in foreign operations has been recognized as a component of accumulated other comprehensive income (loss) in the accompanying consolidated financial statements. Foreign currency transaction gains and losses are recognized in the accompanying consolidated statements of income as they occur.
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Net Income (Loss) Per Common Share
Basic net income (loss) per common share is calculated using the weighted average number of shares of common stock outstanding during the period after adjusting net income (loss) for unpaid cumulative preferred stock dividends and the accretion of the preferred stock. Diluted net income (loss) per common share is the same as basic net income (loss) per common share as no common stock equivalents exist.
Recently Issued Accounting Pronouncements
In July 2001, the FASB issued Statement on Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, ("SFAS 142") which became effective for the Company as of the beginning of fiscal 2002. SFAS 142 requires that goodwill and other intangible assets with indefinite lives no longer be amortized. SFAS 142 further requires that the fair value of goodwill and other intangible assets with indefinite lives be tested for impairment upon adoption of this statement, annually and upon the occurrence of certain events, and be written down to fair value if considered impaired. SFAS 142 will result in the elimination of annual amortization expense related to goodwill of approximately $10.0 million, or $7.5 million net of income tax benefit; however, the impact of related impairment, if any, on the Company's financial position or results of operations has not yet been determined.
(2) CHANGE IN ACCOUNTING PRINCIPLE
Effective January 1, 1999, the Company adopted SFAS 133, which establishes new accounting and reporting guidelines for derivatives and hedging transactions. At the date of adoption, the Company had commodity derivative losses that had been properly deferred as required by previous accounting guidance. Since adoption of SFAS 133, the Company does not defer gains or losses associated with its commodity derivative transactions. As a result, the Company recorded a cumulative effect of a change in accounting principle related to commodity derivative instruments of $2.3 million, net of income tax benefit of $1.4 million, at adoption on January 1, 1999.
(3) ACQUISITIONS
Larkshall Acquisition
On October 14, 1999, the Company acquired all of the assets of the Larkshall Extrusions ("Larkshall") division of Buxted Chicken Limited for approximately $5.0 million in cash. Larkshall is a manufacturer of a complete range of dry pet foods located in the United Kingdom. This acquisition was accounted for as a purchase with the purchase price and direct acquisition costs allocated based on the fair value of assets acquired. The results of operations for Larkshall have been included in the accompanying consolidated statements of income since October 14, 1999.
Arovit Acquisition
On May 10, 2000, the Company acquired A/S Arovit Petfood ("Arovit"), headquartered in Esbjerg, Denmark, for approximately $144.4 million and assumed indebtedness, net of cash, of approximately $11.8 million. Arovit manufactures and sells throughout Europe a full range of pet food products for dogs and cats, including wet, dry and treats, primarily through private label programs. This acquisition was accounted for as a purchase with the purchase price and direct acquisition costs allocated based on the fair value of assets acquired and liabilities assumed. In connection with the purchase of Arovit, the Company recorded $72.7 million of goodwill and trademarks that were amortized over 40 years through December 29, 2001 and $9.4 million of other identifiable assets that are being amortized over 5 to 30 years. Additionally, the Company is depreciating acquired property, plant and equipment of $69.2 million over the remaining useful lives ranging from 5 to 30 years. The Company financed this acquisition through an amendment to its existing credit facilities that included Euro 82.0 million ($73.7 million) of new Euro Tranche A loans with the remainder being an incremental Tranche B loan. The Euro-denominated debt has been designated as a hedge of the foreign currency exposure inherent in the Company's net investment in Arovit. Changes in the fair value of this Euro-denominated debt due to fluctuations in the Euro to U.S. dollar exchange rate have been recognized in accumulated other comprehensive income (loss) in the accompanying consolidated financial statements.
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Set forth below is certain unaudited pro forma consolidated financial information of the Company for the year ended December 30, 2000 that has been adjusted to reflect the Company's acquisition of Arovit as if such transaction occurred at January 2, 2000 (in thousands, except per share amounts):
The pro forma financial data above is based on certain assumptions and estimates; and therefore, does not purport to be indicative of the results that would actually have been obtained had the acquisition of Arovit been completed as of such dates or indicative of future financial position and results of operations.
(4) DIVESTITURES
On April 27, 2001, the Company sold its Perham, Minnesota dry dog and cat food facility and related assets, including the Tuffy's brand, for $7.0 million. On May 3, 2001, the Company sold its Deep Run domestic wet pet food business and related assets, other than real estate, for $13.9 million (collectively, the "Divestitures.") The Company recognized a $4.7 million net loss on the sale of these businesses. In addition, the Company recognized $2.0 million of severance costs for the elimination of certain corporate positions following the Divestitures. These charges are recorded in fiscal 2001 non-recurring expenses in the accompanying consolidated statements of income. See Note 16 -- "Non-Recurring and Project Focus Implementation Expenses."
(5) INVENTORIES
A summary of inventories, net of valuation allowance, follows (in thousands):
(6) PROPERTY, PLANT AND EQUIPMENT
A summary of property, plant and equipment follows (in thousands):
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(7) GOODWILL AND OTHER INTANGIBLE ASSETS
A summary of goodwill and other intangible assets follows (in thousands):
(8) ACCRUED LIABILITIES
A summary of accrued liabilities follows (in thousands):
(9) LONG-TERM DEBT
A summary of long-term debt follows (in thousands):
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Bank Loans
In May 2000, the Company entered into a new senior credit facility with a syndicate of banks and other institutional investors, as lenders, and JPMorgan Chase Bank, as administrative agent, as amended in March 2001 and 2002 (the "Amended Credit Facility"). The Amended Credit Facility provides for total commitments of a Euro 75.4 million term loan facility (the "Euro Term Loan Facility") and $361.0 million, consisting of a $286.0 million term loan facility (the "USD Term Loan Facility") and a $75.0 million revolving credit facility (the "Revolving Credit Facility"), with a $20.0 million sub-limit for issuance of letters of credit of which $2.0 million and $2.6 million was outstanding at December 30, 2000 and December 29, 2001, respectively. In March 2001, the commitments under the Revolving Credit Facility were reduced to $60.0 million until certain financial performance tests are achieved. Such tests were not met in fiscal 2001 and the Company does not believe they will be met in fiscal 2002. Until March 25, 2002, the loans under the Amended Credit Facility bear interest at (i) the prime rate of the administrative agent or, if higher, the secondary market rate for certificates of deposit plus 1% (or the federal funds rate plus 0.5%) plus a specified margin based on the type of loan and the current ratio of senior debt (total consolidated debt excluding senior subordinated notes) to EBITDA (the "Applicable Margin"); or (ii) the Euro dollar rate plus the Applicable Margin. The Company also pays certain fees with respect to the Amended Credit Facility. The Euro Term Loan Facility bore interest at 7.48% and 7.65%, the USD Term Loan Facility bore interest at 9.51% and 8.91% and the Revolving Credit Facility bore interest at 9.71% and 8.66% at December 30, 2000 and December 29, 2001, respectively. Effective March 31, 2002, all loans will bear interest at the Euro dollar rate plus 4.75%, or the prime rate plus 3.75% until maturity in 2006. The principal amounts due under the Euro Term Loan Facility are as follows: (i) approximately Euro 8.7 million in the years 2002 and 2003; (ii) approximately Euro 11.0 million in the year 2004; and (iii) approximately Euro 47.0 million in the year 2005. The USD Term Loan Facility consists of three tranches with terms between five and one-half years and six and one-half years, unless terminated sooner upon an event of default. The principal amounts due under the USD Term Loan Facility are as follows: (i) approximately $15.0 million in the years 2002, 2003 and 2004; (ii) approximately $162.0 million in the year 2005; and (iii) approximately $79.1 million in the year 2006. The Revolving Credit Facility has an initial term of six and one-half years. At December 29, 2001, the Company had approximately $19.4 million of additional borrowings available under the Revolving Credit Facility.
The Company and certain restricted subsidiaries are required to guarantee amounts outstanding under the Amended Credit Facility. The indebtedness incurred pursuant to the Amended Credit Facility is secured by a first priority lien on substantially all of the material assets of the Company and its restricted domestic subsidiaries. The Amended Credit Facility contains certain financial and other covenants usual and customary for a secured credit agreement.
The Amended Credit Facility entered into in March 2002, provided, among other things, for: 1) a limit on the amount of future capital expenditures up to a total of $25.0 million for 2002 and $7.0 million for the first quarter of 2003; 2) a limit on other investing activities; 3) restrictions on repayments under the Sponsor Facility; and 4) a new minimum EBITDA covenant. In addition, an Excess Leverage Fee will accrue if the "senior leverage" ratio exceeds 3.25 to 1.00 as of March 31, 2003, at a rate equal to 2.5% of the sum of the daily average of the aggregate unpaid principal amount of the loans from March 25, 2002 to March 31, 2003. If the fee is earned, it will be payable only from any future asset sales and debt and equity offerings, but in any event not later than March 31, 2005.
The Amended Credit Facility in 2001 and 2002 also waived certain financial covenant requirements for the years ended December 30, 2000 and December 29, 2001 and reduced the financial covenant requirements through March 31, 2003. Without such waivers, the Company would not have been in compliance with the covenants at December 30, 2000 or December 29, 2001.
The Company is required to keep a certain percentage of its outstanding debt at a fixed interest rate. In connection with this requirement, the Company may enter into interest rate swap and cap agreements from time to time to manage its interest rate risk exposure under the Amended Credit Facility. At December 29, 2001, the Company had interest rate swap contracts with a total notional amount of $115.0 million for which the Company pays fixed rates and receives floating rate LIBOR and had an interest rate cap contract with a notional amount of $50.0 million for which the Company would receive payments if floating rate LIBOR exceeds the cap rate.
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Sponsor Facility
The Sponsor Facility is a senior unsecured loan bearing interest at 15.0%. Principal and accrued interest under the loan is due on March 15, 2007. The Amended Credit Facility restricts the payment of any interest or principal on the Sponsor Facility until the ratio of the Company's Average Senior Debt to EBITDA, as defined in the Amendment, calculated on a pro forma basis giving effect to any such principal or interest payments, is no greater than 2.75 to 1.00 and the Company maintains at least $35.0 million of credit availability (the "Payment Test"). The Sponsor Facility requires that all unpaid interest and principal be paid at the end of each quarter in which the Payment Test is achieved, to the extent allowed by the Amended Credit Facility. The Company has not made any payments in fiscal 2001 and does not believe any payments will be made on the Sponsor Facility in fiscal 2002. The Company's Parent issued warrants in connection with the Sponsor Facility that gave the warrantholders the right to purchase 30.0% of the outstanding stock of the Company's Parent for a nominal amount. The cash proceeds of $25.0 million were allocated between the warrants and the Sponsor Facility, based on their relative fair values. As a result, $8.4 million has been allocated to the warrants and recognized as a capital contribution from the Company's Parent in the accompanying consolidated statement of stockholder's equity and comprehensive income. The Sponsor Facility is being accreted to its $25.0 million face value as a charge to interest expense in the accompanying consolidated statements of income to reflect an effective interest rate over the life of the Sponsor Facility.
Senior Subordinated Notes
On November 12, 1998, the Company issued $150.0 million in aggregate principal amount of its 9 3/4% Senior Subordinated Notes due May 15, 2007 with interest payable semi-annually. The senior subordinated notes were issued at a discount that is being amortized as interest expense on a straight-line basis over the term of the notes. The senior subordinated notes are general unsecured obligations and are subordinated in right of payment to all senior indebtedness and senior in right of payment to any current or future indebtedness of the Company that, by its terms, is subordinated to the senior subordinated notes. The payment of obligations of each subsidiary guarantor are subordinated to the payment of senior indebtedness of such subsidiary guarantor.
The Company may redeem the senior subordinated notes at any time on or after May 15, 2002, in whole or in part, at the option of the Company, at the redemption prices set forth below, plus accrued and unpaid interest, if any, to the redemption date:
At any time prior to May 15, 2002, the senior subordinated notes may also be redeemed in whole, but not in part, at the option of the Company upon the occurrence of a Change in Control (as defined in the Note Indenture) at a redemption price equal to 100% of the principal amount thereof plus the Applicable Premium (as defined in the Note Indenture) and the unpaid accrued interest, if any, to the date of redemption. Upon a Change in Control, holders of the senior subordinated notes may require the Company to purchase all or a portion of the senior subordinated notes at a purchase price equal to 101% of their principal amount plus accrued interest, if any. The senior subordinated notes have certain covenants that have restrictions on dividends, distributions, indebtedness, affiliate transactions and lines of business.
Industrial Development Revenue Bonds
On March 12, 1997, the Company issued $6.0 million of 7.25% Ottawa County Finance Authority Industrial Development Revenue Bonds (the "Miami Bonds"). The Miami Bonds are subject to mandatory redemption prior to maturity, in part, at a redemption price of 100% of the principal amount thereof, plus accrued interest to the redemption date, in varying principal amounts on June 1 of each year from 2007 through 2017. The Miami Bonds are general secured obligations of the Company and rank on a parity in right of payment with all other senior indebtedness of the Company.
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
On July 24, 1998, the Company issued $9.0 million of 6.25% Oklahoma Development Finance Authority Industrial Development Revenue Bonds, Series 1998 (the "Clinton Bonds") through the Oklahoma Development Finance Authority. The Clinton Bonds are subject to mandatory redemption prior to maturity, in part, at a redemption price of 100% of the principal amount thereof, plus accrued interest to the redemption date, in varying principal amounts on July 15 of each year from 2018 through 2023. The Clinton Bonds are general obligations of the Company and rank on a parity in right of payment with all other senior indebtedness of the Company. On July 24, 1998, the Clinton Bonds were purchased by the Company's wholly-owned subsidiary, Doane/Windy Hill Joint Venture Corporation, which sold the bonds on May 6, 1999 at a net price of $8.7 million.
Debt of Foreign Subsidiaries
Debt of foreign subsidiaries consists of peseta denominated borrowings for which the HSBC Branch in Spain is the facility agent. At December 29, 2001, the borrowings are comprised of Tranche A of $5.7 million (1,069 million pesetas) outstanding and amortizing semi-annually until maturity in April 2005 and Tranche B of $3.0 million (554 million pesetas) outstanding and payable in full in April 2006. The interest rates were 6.29% and 5.78% on Tranche A and 7.48% and 6.78% on Tranche B at December 30, 2000 and December 29, 2001, respectively, and will adjust with changes in MIBOR (Madrid Inter-Bank Offer Rate).
In February 2002, the peseta denominated loan was refinanced. The new loan is with FIH (Finansierings Instituttet for Industri og Handvaerk A/S), a Danish lender, in the amount of Euro 11.0 million. The loan amortizes evenly on a quarterly basis until the final maturity in 2008. The interest rate is fixed at 5.37% until the end of the third year, at which point it resets to the then current three year rate plus interest margin. At December 29, 2001, the loan has been classified between long term debt and current maturities of long term debt based on the terms of the new loan.
Debt of foreign subsidiaries also consists of DKK denominated borrowings from various financial institutions totaling DKK 49.5 million ($5.9 million) at December 29, 2001. These borrowings are comprised of both fixed and variable rate loans with maturity dates ranging from 2003 to 2014 and interest rates ranging from 5.84% to 7.80%.
Annual Maturities of Long-Term Debt
A summary of the aggregate annual maturities of long-term debt at December 29, 2001 follows (in thousands):
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(10) FAIR VALUE OF FINANCIAL INSTRUMENTS
A summary of the estimated fair value of financial instruments, other than current assets and liabilities, follows (in thousands):
The fair value of debt is, where available, based on the traded market price on the date closest to the Company's year end. The Company considers the the Revolving Credit Facility and other long-term debt, as recorded in the accompanying consolidated balance sheets, to approximate fair value.
The Company periodically uses interest rate swap and cap contracts to limit its exposure to the interest rate risk associated with its floating rate debt, which totaled $403.2 million and $402.6 million at December 30, 2000 and December 29, 2001, respectively. At December 30, 2000 and December 29, 2001, $126.6 million and $165.0 million, respectively, of the Company's floating rate debt was hedged by interest rate swap and cap contracts. The Company had a cumulative deferred loss of $0.2 million, net of deferred tax benefit of $0.2 million, at December 30, 2000 and a cumulative deferred loss of $2.7 million, net of deferred tax benefit of $1.7 million, at December 29, 2001. The maturity dates of the Company's outstanding interest rate swap and cap contracts at December 29, 2001 extend through November 2003.
At December 29, 2001, the Company had a cumulative deferred gain on foreign currency forward contracts of $1.5 million, net of deferred tax expense of $0.6 million. At December 29, 2001, the Company had open foreign currency forward contracts that mature within the next 12 months with a notional value of $7.4 million and a fair value loss of $0.7 million.
(11) SENIOR PREFERRED STOCK (REDEEMABLE)
The Senior Preferred Stock has an initial liquidation preference of $25 per share (aggregate initial liquidation preference is $30.0 million). The Senior Preferred Stock was recorded at the net proceeds of $17.1 million at October 5, 1995 after deducting $12.9 million paid to the Company for 1,354,478 warrants of Parent, which were issued in conjunction with the Senior Preferred Stock. The excess of the liquidation preference over the carrying value is being accreted quarterly by a direct reduction to retained earnings over a 12 year period that ends September 30, 2007.
Dividends on the Senior Preferred Stock are payable quarterly at the rate of 14.25% per annum per share. Dividends on the Senior Preferred Stock accrete to the liquidation value of the Senior Preferred Stock. The Company has not paid dividends in cash or additional shares of Senior Preferred Stock since the initial issuance of the Senior Preferred Stock. Cumulative dividends on Senior Preferred Stock that have not been paid at December 30, 2000 and December 29, 2001 are $32.5 million and $41.9 million, respectively, and are included in the carrying amount of the Senior Preferred Stock in the accompanying consolidated balance sheets. As of December 30, 2000 and December 29, 2001, the cumulative accretion to redemption value on the Senior Preferred Stock was $5.7 million and $6.7 million, respectively.
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The Company may, at its option, redeem the Senior Preferred Stock, in whole or in part, at redemption prices per share, together with accrued and unpaid dividends as follows:
The Company is required to redeem all outstanding shares of Senior Preferred Stock on September 30, 2007 at 100% of the liquidation value at this date, together with accrued and unpaid dividends.
In the event of a Change of Control, as defined, the holders of Senior Preferred Stock have the right to require the Company to redeem such Senior Preferred Stock, in whole or in part, at a price equal to 101% of liquidation value at the Change of Control date together with any unpaid dividends.
The terms of the Senior Preferred Stock prohibit (1) the payment of dividends on securities ranking on a parity with or junior to the Senior Preferred Stock; and (2) redemption, repurchase or acquisition of any Junior Securities with certain exceptions, in each case, unless full cumulative dividends have been paid on the Senior Preferred Stock.
Holders of the Senior Preferred Stock have limited voting rights customary for preferred stock and the right to elect two additional directors to the Company's board of directors upon certain events such as the Company failing to declare and pay dividends on any six consecutive dividend payment dates.
(12) COMMON STOCK OF PARENT
The Parent's common stock consists of two classes, Class A Common Stock and Class B Common Stock. The Class A and Class B Common Stock are identical except the Class B Common Stock has no voting rights. The Class B Common Stock is convertible into shares of Class A Common Stock at any time at the option of the holder thereof. Each holder of Class A Common Stock is entitled to one vote for each share of Class A Common Stock held of record on all matters submitted to a vote of stockholders. The holders of Class A Common Stock do not have cumulative voting rights in the election of directors to the Parent's board of directors. The holders of Common Stock have no preemptive, subscription, redemptive or conversion rights, except that holders of Class B Common Stock may at their option, convert their shares into Class A Common Stock.
(13) STOCK OPTION PLAN OF PARENT
Effective November 1, 1996, Parent adopted its 1996 Stock Option Plan, as amended. Certain employees of the Company are covered under this plan. Each stock option granted under this plan allows for the purchase of one share of Parent's Class A common stock. Under the 1996 Stock Option Plan, options covering 640,327 shares are outstanding as of December 29, 2001.
On July 14, 1999, Parent adopted the 1999 Stock Incentive Plan. In connection with the adoption of the 1999 Stock Incentive Plan, no new grants could be made under the 1996 Stock Option Plan.
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Effective October 31, 2001, Parent approved the "repricing" of all vested and unvested stock options under the 1996 Stock Option Plan and the 1999 Stock Incentive Plan that had an exercise price exceeding $2.50 per share. All such eligible stock options were given a new exercise price of $2.50 per share and the vesting period was re-started. The repricing involved a surrender of the eligible stock options in exchange for a grant of new stock options covering an equivalent number of shares at the new exercise price. Stock options covering a total of 1,516,300 shares were granted at the $2.50 per share exercise price, and all such grants were made under the 1999 Stock Incentive Plan and are accounted for as variable plan awards. Since the fair value of the Parent's Class A common stock was less than $2.50 per share at December 31, 2001, no compensation expense has been recorded on the variable plan awards. All of the grants have a "time vesting" schedule pursuant to which 50% of an individual's stock options will vest two years after the grant date, 25% will vest after the third year, and the remaining 25% will vest after the fourth year. Under the 1999 Stock Incentive Plan, 4,200,000 shares are authorized for issuance, and as of December 29, 2001, options covering 3,230,300 shares had been granted and remain outstanding.
The Company and its Parent have elected to continue to follow APB Opinion No. 25, Accounting for Stock Issued to Employees, ("APB Opinion No. 25") to account for fixed stock awards granted to employees; however, if the Company adopted Statement on Financial Accounting Standards No. 123, Accounting for Stock Based Compensation, ("SFAS 123") to account for fixed stock awards granted to employees, the Company's net income (loss) and basic and diluted net income (loss) per common share for fiscal 1999, 2000 and 2001 would have been reduced as follows (in thousands, except per share amounts):
In fiscal 2001, the pro forma net loss per common share is lower than net loss available to common shareholder primarily due to the reversal of compensation expense associated with unvested stock options cancelled during fiscal 2001. Pro forma information regarding net income (loss) and basic and diluted net income (loss) per common share has been determined as if the Company had accounted for its employee stock options under the minimum value method of SFAS 123 under the assumptions of a risk free rate of return of 5.67%, 6.03% and 5.02% for fiscal 1999, 2000 and 2001, respectively, and an expected life of options ranging from 5 to 10 years. The Company has no present plans to pay dividends on its common stock. The effect of applying SFAS 123, as calculated above, may not be representative of the effect on reported net income (loss) for future years.
No compensation expense was recognized in fiscal 1999, 2000 and 2001 for stock option grants.
(14) ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
A summary of the components of accumulated other comprehensive income (loss) follows (in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(15) OPERATING LEASES
The Company leases certain facilities, machinery and equipment under operating lease agreements with varying terms and conditions. A summary of the future annual minimum lease payments under these leases follows (in thousands):
Rent expense was $3.2 million, $4.9 million and $5.8 million for fiscal 1999, 2000 and 2001, respectively.
(16) NON-RECURRING AND PROJECT FOCUS IMPLEMENTATION EXPENSES
In October 2001, the Company initiated a new market and operational strategy ("Project Focus") designed to provide more focused service to its customers by simplifying and distinguishing its product offerings and associated pricing, improving its planning and marketing support services, and reducing the complexity of its operations. The Company aims to permanently reduce its cost structure by streamlining its available product offerings, optimizing its production facilities and reducing its workforce. In connection with Project Focus, the Company closed one manufacturing facility and had a corporate workforce reduction, which resulted in the termination of 45 employees in the fourth quarter of fiscal 2001. The Company recognized Project Focus related costs of $10.2 million, consisting of $2.0 million of non-recurring restructuring charges and $8.2 million of implementation expenses. The major components of these charges are included in the table below.
A summary of non-recurring and other Project Focus implementation expenses follows (in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
In fiscal 1999, the Company incurred transition expenses in connection with the merger and integration of Windy Hill. These expenses included: (1) $0.7 million of professional fees for consultants in human resources, employment, law, accounting and information systems; (2) $0.1 million of merger and relocation bonuses paid to Doane personnel; and (3) $0.2 million in travel and other miscellaneous expenses.
Fiscal 1999 transaction costs were expenses for the proposed initial public offering of Parent's common stock, which was subsequently withdrawn. Fiscal 2000 transaction costs included: (1) a loss of $4.6 million on a foreign currency purchase contract associated with the Arovit acquisition; (2) $1.5 million of costs for unconsummated acquisitions; and (3) $0.2 million of miscellaneous transaction costs.
In fiscal 2001, the Company recorded a $4.7 million net loss related to the Divestitures. See Note 4 -- "Divestitures."
Fiscal 2000 restructuring costs included: (1) severance costs of $1.5 million for the elimination of positions associated with the closure of certain inefficient manufacturing facilities, $1.6 million for the elimination of corporate positions and $0.4 million for restructuring associated with the Arovit acquisition; (2) asset impairment costs, primarily related to property, plant and equipment, associated with these facility closures; and (3) related plant shutdown expenses. Fiscal 2001 restructuring costs included: (1) severance costs of $2.0 million for the elimination of corporate positions following the Divestitures, $0.8 million for additional corporate headcount reductions in connection with Project Focus and $0.2 million for restructuring at the Company's foreign operations; (2) asset impairment costs, primarily related to property, plant and equipment, associated with the closure of a manufacturing and distribution facility in connection with Project Focus; and (3) related plant shutdown expenses of $0.4 million for this facility closure. These 2001 restructuring costs were offset by adjustments to previously accrued restructuring charges as described below. The Company terminated 330 employees in fiscal 2001 as a result of plant closings and corporate headcount reductions.
As of December 30, 2000, the Company had $6.5 million of accrued restructuring costs, or $4.6 million net of the accruals for the Divestitures. In fiscal 2001, the Company accrued $3.4 million of restructuring costs for severance and plant closures. In addition, the Company made cash payments of $3.2 million, consisting of $2.1 million related to severance costs and $1.1 million related to plant shutdown expenses. The Company reviews its accrued restructuring costs on a continuous basis and, as a result of its review in the fourth quarter of fiscal 2001, revised certain estimates for restructuring costs expected to be paid in
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
the future. These revised estimates resulted in a $0.2 million reduction in accrued severance costs, offset by a $0.2 million increase in accrued plant shutdown expenses. These revised estimates had no material impact on the Company's accrued restructuring costs of $4.8 million at December 29, 2001. The Company expects to pay restructuring costs of $3.3 million in fiscal 2002, $1.3 million in fiscal 2003 and the remainder in fiscal 2004.
Project Focus implementation expenses in fiscal 2001 consist of valuation allowances against packaging inventories and accounts receivable associated with estimated SKU reduction and customer mix shift. These expenses are in addition to the $2.0 million of non-recurring expenses discussed above and were classified in the accompanying consolidated statements of income as follows: (1) $0.3 million as a reduction in net sales; (2) $6.6 million as cost of goods sold; (3) $0.9 million as promotion and distribution expenses; and (4) $0.4 million as selling, general and administrative expenses.
(17) INCOME TAXES
A summary of income tax expense (benefit) follows (in thousands):
A summary of income (loss) before income taxes and cumulative effect of a change in accounting principle by domestic and foreign source follows (in thousands):
Income tax expense (benefit) differs from the amount computed by applying the U.S. federal statutory rate of 35.0% to pre-tax income (loss) as follows (in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
A summary of the income tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities follows (in thousands):
In assessing the realizable value of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which these temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based upon the historical taxable income of the Company and projections for future taxable income over the periods that the deferred tax assets are deductible, management believes it is more likely than not the Company will realize the future benefits of these deductible differences and net operating loss carryforwards at December 29, 2001.
At December 29, 2001, the Company had federal net operating loss carryforwards of $44.8 million, which resulted in a deferred tax asset of $15.7 million that is available to offset future taxable income through 2021.
(18) EMPLOYEE BENEFIT PLANS
Pension Plans
The Company had a defined benefit, non-contributory pension plan covering hourly and salaried employees of the former Hubbard Milling Company, which was frozen on May 21, 1998. As a result, future benefits no longer accumulate and the Company's service cost ceased. The Company's funding policy for this plan was to make the
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
minimum annual contribution required by applicable regulations. In addition, the Company terminated a defined benefit, non-contributory pension plan on May 31, 1998 that previously covered all non-bargaining employees. The Company's only active pension plan covers 41 union employees as of February 1, 2002 at one of its facilities.
A summary of net periodic pension income for the Company's pension plans follows (in thousands):
A summary of assumptions used by the Company in the determination of pension plan information follows:
A summary of the funded status of the pension plans reconciled with amounts recognized in other assets in the accompanying consolidated balance sheets follows (in thousands):
A reconciliation of the beginning and ending balances of the projected benefit obligation follows (in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
A reconciliation of the beginning and ending balances of plan assets at fair value follows (in thousands):
Post-Retirement Plans
The Company maintained two post-retirement healthcare plans that provided medical coverage for eligible retirees and their dependents that were merged on February 1, 2000. The Company pays benefits under the merged plan when due and does not fund its plan obligations as they accrue.
A summary of net periodic post-retirement benefit cost follows (in thousands):
A summary of the funded status of the post-retirement plans reconciled with amounts recognized in other long-term liabilities in the accompanying consolidated balance sheets follows (in thousands):
A reconciliation of the beginning and ending balances of the accumulated post-retirement benefit obligation follows (in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
For measurement purposes, per capita claims costs for participants over age 65 were assumed to increase at 6.00%, 7.90% and 9.00% annually for fiscal 1999, 2000 and 2001, respectively. The rate used to calculate the net periodic post-retirement benefit cost was assumed to decrease gradually to 2002 at the annual rate of 3.75%, 5.50% and 5.50% for fiscal 1999, 2000 and 2001, respectively. The rate used to calculate the accumulated post-retirement benefit obligation was assumed to decrease gradually to 2002 at the rates of 3.75%, 5.50% and 5.50% as of January 1, 2000, December 30, 2000 and December 29, 2001, respectively. The medical cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the assumed medical cost trend rates by one percentage point in each year would increase the accumulated post-retirement benefit obligation as of December 30, 2000 and December 29, 2001 by $347,000 and $429,000, respectively, and the aggregate of the service cost and interest cost components of net periodic post-retirement benefit cost for fiscal 2000 and 2001 by $30,000 and $32,000, respectively.
The weighted-average discount rate used in determining the net periodic post-retirement benefit cost was 6.75%, 7.90%, and 7.60% for fiscal 1999, 2000 and 2001, respectively. The weighted-average discount rate used in determining the accumulated post-retirement benefit obligation was 8.38%, 7.90% and 7.60% as of January 1, 2000, December 30, 2000 and December 29, 2001, respectively.
Defined Contribution Plans
As of January 1, 2000, the Company adopted the Doane Pet Care Retirement Savings Plan, which was formed through the merger of two predecessor plans. The merged plan was amended and restated and is intended to be a qualified plan under the Internal Revenue Code. The plan provides coverage for eligible employees and permits employee contributions from 1% to 15% of pre-tax earnings, subject to annual dollar limits set by the IRS. The Company matches 50% of the first 6% of the employee contribution with a provision for other contributions at the board of directors' discretion. Participant vesting for the employer's matching contributions are 25% per year for each full year of service. For fiscal 2000 and 2001, the Company contributed $1.3 million and $1.2 million, respectively, to the Doane Pet Care Retirement Savings Plan. In addition, the Company contributed $2.2 million to the predecessor plans during fiscal 1999.
The Company also has a plan called the Doane Pet Care Savings and Investment Plan -- Union Plan which was adopted on June 1, 1998 and covers eligible union employees at the Joplin, Missouri plant. This plan is intended to be a qualified retirement plan under the Internal Revenue Code. The plan permits employee contributions between 1% and 15% of pre-tax earnings, subject to annual dollar limits set by the IRS, and provides for a variety of investment options. Effective April 1, 2000, the union employees of the Muscatine, Iowa plant became eligible for coverage by the Doane Pet Care Savings and Investment Plan -- Union Plan under the existing terms and conditions.
(19) DEFERRED COMPENSATION AGREEMENTS AND SALARY CONTINUATION PLAN
The Company has deferred compensation agreements with two individuals that provide for annual payments upon retirement to be paid over 10 consecutive years. The recorded liability was $1.0 million and $0.7 million at December 30, 2000 and December 29, 2001, respectively.
The Company also has a salary continuation plan with 20 participants at December 29, 2001. Participants in the plan who reach age 55 and have 10 years of service with the Company begin vesting in their benefits, which are
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
payable in 10 equal annual installments after retirement. The Company recorded an expected future liability equal to the present value of future payments under this plan of $1.5 million at December 30, 2000 and December 29, 2001.
(20) SEGMENT DATA
The Company has combined manufacturing and distribution facilities in two distinct geographical markets, the United States ("Domestic") and Europe ("International"); however, its operations in both of these markets have similar manufacturing processes, as well as products and services. The Company's net sales are attributed to individual countries on the basis of where its products are manufactured and distributed. Long-lived assets of the Company are attributed to individual countries on the basis of where these assets are domiciled. A summary of net sales and long-lived assets by geographical segment follows (in thousands):
(21) MAJOR CUSTOMER
For fiscal 1999, 2000 and 2001, the same customer accounted for approximately 44%, 41% and 41%, respectively, of the Company's net sales. The Company does not have a long-term contract with this customer.
(22) ADDITIONAL CASH FLOW INFORMATION
Additional cash flow information for fiscal 1999, 2000 and 2001 follows (in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(23) RELATED PARTY TRANSACTIONS
The Company previously had a management advisory agreement with Summit Capital Inc. ("SCI") and a financial advisory agreement with Credit Suisse First Boston (USA), Inc. ("CSFB"), formerly known as Donaldson, Lufkin & Jenrette Securities Corporation, both of which are stockholders of the Company and each has a member who are directors of the Company. The Company paid SCI and CSFB an annual fee of $0.2 million and $0.1 million, respectively, for these advisory services provided. These agreements expired on October 5, 2000. In addition, an affiliate of CSFB was paid $0.4 million in fiscal 2000 for commercial banking services related to the Company's Amended Credit Facility.
J.P. Morgan Partners (BHCA), L.P. ("JPMP") and an affiliate of JPMP are shareholders of Parent and own preferred stock in the Company. JPMP is an affiliate of JPMorgan Chase Bank ("Chase"). Chase and its affiliates perform various investment banking and commercial banking services from time to time for the Company and its affiliates. Chase serves as an agent bank and a lender to the Company under the Amended Credit Facility. Chase and its affiliates received from the Company $0.4 million and $0.5 million in fiscal 2000 and 2001, respectively, for acting in the foregoing capacities, excluding interest paid and other charges earned by all lenders under the Amended Credit Facility.
In March 2001, the Company refinanced $25.0 million of indebtedness under its Amended Credit Facility with the Sponsor Facility, which is a series of loans from certain executive officers of the Company and certain shareholders of its Parent. The Sponsor Facility is a senior unsecured loan bearing interest at 15.0%. Parent issued warrants in connection with the Sponsor Facility that gives the warrantholders the right to purchase 30.0% of the outstanding stock of Parent for a nominal amount. See Note 9 -- "Long-Term Debt."
(24) COMMITMENTS AND CONTINGENCIES
The Company is party, in the ordinary course of business, to claims and litigation. In management's opinion, the resolution of such matters is not expected to have a material impact on the future financial condition, results of operations or cash flows of the Company.
(25) QUARTERLY FINANCIAL DATA AND PROMOTIONAL ACCOUNTING RECLASSIFICATION (UNAUDITED)
A summary of quarterly results follows (in thousands, except per share amounts):
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
In the fourth quarter of fiscal 2000 and 2001, the Company recognized $19.6 million of non-recurring expenses and $10.2 million of Project Focus related charges, respectively. See Note 16 -- "Non-Recurring and Project Focus Implementation Expenses."
Previously issued quarterly results of fiscal 2000 and 2001 were reclassified to reflect the change in accounting for classifying volume-based rebates and certain sales incentives as a reduction in net sales, and free-goods promotions as an increase in cost of goods sold. The reclassification results in a reduction to net sales of $5.1 million, $5.4 million and $5.3 million in the first, second and third quarters of fiscal 2001, respectively, and an increase in cost of goods sold of $0.5 million and $0.4 million in the first and second quarters of fiscal 2001, respectively. Quarterly results for fiscal 2000 have been reclassified for consistency with fiscal 2001 presentation. The reclassification results in a reduction in net sales of $4.0 million, $3.9 million, $3.8 million and $4.4 million in the first, second, third and fourth quarters of fiscal 2000, respectively, and an increase in cost of goods sold of $1.0 million, $0.8 million, $1.0 million and $1.0 million in the first, second, third and fourth quarters of fiscal 2000, respectively. The above reclassification amounts were offset by a decrease in promotion and distribution expenses in the respective quarters. See Note 1 -- "Summary of Significant Accounting Policies -- Revenue Recognition."
(26) FINANCIAL INFORMATION RELATED TO GUARANTOR SUBSIDIARIES
Consolidated financial information related to the Company and its guarantor subsidiaries and non-guarantor subsidiaries as of December 30, 2000 and December 29, 2001 and for each of the fiscal years ended January 1, 2000, December 30, 2000 and December 29, 2001 is disclosed to comply with the reporting requirements of the guarantor subsidiaries. The guarantor subsidiaries are wholly-owned domestic subsidiaries of the Company who have fully and unconditionally guaranteed the Company's 9 3/4% Senior Subordinated Notes due May 15, 2007. See Note 9 -- "Long-Term Debt." Condensed consolidated financial information follows (in thousands, except share and par value amounts):
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
CONDENSED CONSOLIDATED BALANCE SHEET
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
CONDENSED CONSOLIDATED BALANCE SHEET
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
CONDENSED CONSOLIDATED STATEMENT OF INCOME
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
CONDENSED CONSOLIDATED STATEMENT OF INCOME
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
CONDENSED CONSOLIDATED STATEMENT OF INCOME
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
DOANE PET CARE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
INDEX TO EXHIBITS
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* Filed herewith
+ Management contracts or compensatory plans or arrangements.
ii