ITEM 1. BUSINESS
GENERAL
Broughton was incorporated under the laws of the State of Ohio in 1933. On December 12, 1997, the Company completed its initial public offering (the "Offering") of 1.3 million shares of Common Stock.
The Company is a leading manufacturer and distributor of fresh milk and dairy products in Ohio, West Virginia, Kentucky, Tennessee, Michigan and parts of the eastern United States. The Company has grown primarily through internal growth and strategic acquisitions. Through such growth, the Company has realized regional economies of scale and operational efficiencies. The Company operates through four (4) divisions -- the Dairy Division (based in Marietta, Ohio), the Southern Belle Division (based in Somerset, Kentucky), the London's Farm Division (based in Port Huron, Michigan) and the Foods Division (based in Charleston, West Virginia). The Dairy Division, with its raw milk processing plant based in Marietta, Ohio, manufactures and distributes a full line of fresh milk and related products and also distributes brand name dairy and non-dairy foods. The Dairy Division processes whole milk, reduced-fat milk, low-fat milk, and fat-free milk and manufactures buttermilk, cottage cheese, chocolate milk, eggnog, iced tea, ice cream mix, fruit drink, yogurt mix and ice cream under its own Broughton or Dairylane label and under various private labels. The Southern Belle Division is primarily a fluid milk producer with a raw milk processing plant based in Somerset, Kentucky. Other product lines produced at the Southern Belle Division include orange juice and flavored drinks. Products are manufactured by the Company under the Southern Belle brand name and other private labels. The London's Farm Division, with its raw milk processing plant in Port Huron, Michigan, manufactures and distributes a full line of fresh milk and other products, while its Burton, Michigan plant produces a variety of ice cream products. The Foods Division, with a UHT plant based in Charleston, West Virginia, manufactures a variety of extended life products, including half-and-half, sour cream, dips, dressings, aerosol toppings, whipped cream, coffee cream, table cream, non-dairy creamers and whipped toppings. The Foods Division also distributes various lines of branded refrigerated food products manufactured by third parties. The Company also operates one dairy store, which is managed by the Dairy Division.
The Company acquired Johnson's All-Star Dairy ("Johnson") in May 1997. Johnson sold dairy products in West Virginia, eastern Kentucky and southeastern Ohio. Since its acquisition of Johnson, the Company has consolidated all of Johnson's production into existing facilities, has reduced costs associated with Johnson's former manufacturing facility and has eliminated duplicative delivery and administrative expenses.
On December 12, 1997, the Company merged with Southern Belle Dairy Company, with the Company as the surviving entity, and paid the shareholders of Southern Belle a combined total of $5.0 million in cash and shares of Common Stock of the Company. The transaction was completed concurrent with the closing of the Offering. Although not a separate corporate entity from the Company, the former Southern Belle Dairy Company is maintained as a separate division of the Company (collectively referred to as the "Southern Belle Division" or "Southern Belle").
The Company completed an acquisition of LFD Holding Corp. and its wholly owned subsidiary, London's Farm Dairy, Inc. (collectively referred to as "London's", "London's Farm Division" or "London's Farm Dairy"), on May 29, 1998, pursuant to which LFD Holding Corp. became a subsidiary of the Company. The London's Farm Division operates an ice cream plant in Burton, Michigan and a raw milk processing facility in Port Huron, Michigan.
On September 11, 1998, the Company announced that it had executed an Agreement and Plan of Merger with Suiza Foods Corporation ("Suiza") a Delaware corporation and Suiza Foods Acquisition Corp. ("Merger Sub"), an Ohio corporation and wholly owned subsidiary of Suiza dated September 10, 1998 (the "Agreement"), providing for the merger of the Company with Merger Sub, with each Company share being exchanged for the sum of Nineteen Dollars ($19.00) cash. Consummation of the merger is conditioned upon satisfaction of all conditions contained in the Agreement. If the merger is consummated, the Company will become a wholly-owned subsidiary of Suiza. On September 10, 1998, 5,774,335 shares of Company common stock were issued
and outstanding. The Agreement was approved by Company shareholders at a special meeting held on December 4, 1998.
On January 18, 1999 the Company announced that Suiza and the Company had executed an amendment to the Agreement.
The amended Agreement, dated January 18, 1999, extends from December 31, 1998 to April 15, 1999 the date on which either party may terminate the amended Agreement if the merger has not been completed on such date. A related Stock Purchase Agreement dated January 18, 1999 between Suiza, the Company and eight shareholders of the Company provides that at completion of the merger, those shareholders will sell Two Million (2,000,000) Company shares to Suiza, and will receive, in lieu of the $19.00 per share cash merger consideration, the cash sum of $10.00 per Company share, without interest, plus the right to receive up to an additional $9.00 per share if certain earnings and performance goals are met between the date of the merger and March 31, 2000.
Subject to satisfaction of all conditions contained in the Agreement and Plan of Merger, as amended, and the Stock Purchase Agreement, the parties agreed to complete the merger on March 31, 1999.
On March 18, 1999 the United States District court for the Eastern District of Kentucky, London Division, entered a temporary restraining order enjoining Suiza, the Company and all persons acting on their behalf from consummating, directly or indirectly, their proposed merger, or implementing any other plan or agreement by which Suiza and the Company, or any part of them would combine under common ownership or control. Earlier the same day, the United States Department of Justice Antitrust Division ("DOJ") filed a Motion for Temporary Restraining Order ("TRO"), Motion for Preliminary Injunction and a Complaint in seeking to enjoin the proposed acquisition of the Company by Suiza. The DOJ alleged that competition in the production and sale of school milk in South Central Kentucky school districts would be substantially lessened as a result of the proposed transaction.
By terms of the Court's order, the TRO shall remain in effect until such time as the Court addresses the DOJ's Motion for Preliminary Injunction. Suiza and the Company independently concluded and agreed not to contest the motion for TRO. Suiza and the Company continue to review their options for responding to the DOJ's action.
The final outcome of the proposed merger with Suiza may impact the Company's future plans regarding business strategy and may have a material adverse effect on the Company's financial position and results of operations.
The complete mailing address for the Company's principal executive office is 210 North Seventh Street, P.O. Box 656, Marietta, Ohio 45750. The Company's telephone number is (740) 373-4121.
INDUSTRY OVERVIEW
Management believes that the dairy industry has matured, has excess capacity, is highly fragmented and has been in the process of consolidation for many years. Consolidation has resulted from the development of more efficient manufacturing techniques, new and modern packaging machinery and equipment, the establishment of captive dairy manufacturing operations by large grocery retailers and relatively little growth in the demand for fresh milk products. According to published industry statistics, approximately $23.2 billion of fluid milk products were sold in 1997 at the wholesale level in the United States compared to $20.6 billion sold in 1987. As the industry has consolidated, many smaller dairy processors have been eliminated and several large regional dairy processors have emerged. According to published industry statistics, in 1996 the number of U.S. fluid milk companies was estimated to be 441, down 4.8% from 1995. Meanwhile, the number of fluid milk plants declined 17% to 622 from the 749 plants operating in 1992. The number of plants with 20 or more manufacturing employees declined from 507 to 427 over the same period. Management believes that this consolidation trend will continue for the foreseeable future.
The ice cream industry also has excess capacity and has been in the process of consolidation for many years. Consolidation has resulted from the development of more efficient manufacturing techniques, high-speed freezing, filling and hardening equipment. The ice cream industry traditionally has experienced slow and steady
growth. As the industry has grown, many smaller ice cream manufacturers have been eliminated and several large, regional ice cream manufacturers have emerged, producing a mix of regional and national brands and a proliferation of ice cream and related frozen products. According to published statistics, there were 458 ice cream manufacturing facilities in the United States in 1997, compared to 483 in 1994. Management believes that this consolidation trend will continue for the foreseeable future.
BUSINESS STRATEGY
The following discussion is wholly premised upon the Company not entering into its strategic alliance with Suiza.
The Company's business strategy is to continue to expand primarily through consolidating acquisitions within the markets it currently serves and through strategic acquisitions of regional dairies and related businesses in new geographic markets. The Company's objective is to become a leading national provider of dairy and related products. In addition, the Company will seek to expand its existing operations by adding new customers, extending its product lines and securing distribution rights for additional branded product lines.
Consolidating and Strategic Acquisitions. The Company's objective is to expand through a combination of consolidating acquisitions in its existing markets as well as strategic acquisitions in new markets. The focus of the Company's acquisition program at present is to capitalize on opportunities within its existing operating regions that will create synergies and efficiencies, as well as to selectively enter new markets in surrounding regions. The Company may also selectively consider acquisition or consolidation opportunities involving public companies or large privately held companies.
The Southern Belle acquisition has provided the Company with a dependable source of certain raw materials and manufacturing capabilities. In addition, the acquisition has helped the Company to seek to expand its existing operations by adding new customers, extending its product lines and securing distribution rights for additional branded product lines.
The acquisition of London's helped expand the Company's customer base, manufacturing capacity and geographic diversity.
In addition to the Southern Belle and London's Acquisition, the Company implemented its consolidation strategy in 1997 by acquiring and integrating Johnson's All-Star Dairy ("Johnson") into the Company and obtaining a distributorship for Hagan-Crowley Ice Cream ("Hagan Ice Cream"). Johnson, which was acquired by the Company in May 1997, sells dairy products in West Virginia, eastern Kentucky and southeastern Ohio. Since the acquisition of Johnson, the Company has consolidated all of Johnson's production into existing facilities, has reduced costs associated with Johnson's former manufacturing facility and has eliminated duplicative delivery and administrative expenses.
Internal Growth. The Company's strategy for improving internal growth includes consolidating and integrating operations, improving operating efficiencies, providing high levels of customer service, marketing to new customers and maintaining strict cost controls. The Company intends to continue its efforts to add new customers, increase market share and extend its own branded product lines, such as Broughton Premium ice cream, milk and dairy products. With respect to its dairy and food distribution business, the Company will seek to secure distribution rights for additional branded product lines and will continue its efforts to increase distribution of Broughton products in conjunction with strategies to expand its customer base.
Expand Customer Base and Brand Recognition. The Company plans to increase its business by taking advantage of demand for new and additional products from existing customers, by increasing its customer base in each of the markets in which it operates and by expanding its business nationally.
As part of its strategy to continue to develop and sell new and additional products to existing customers and to expand the number of customers in each of the markets in which the Company operates, the Company tailors its sales and marketing techniques to each of its local markets. These techniques are designed to develop local brand loyalty by promoting the Company's reputation for competitively priced, premium products. The Company's promotional techniques target the retail trade to induce the trade to display and carry the Company's
products and target the consumer to promote purchases and further increase local brand name loyalty and recognition. Such promotional techniques may utilize local broadcast media and employ or integrate portions of the image created through the Company's general advertising campaigns, but will typically be more "directed" to the point of purchase, employing techniques such as couponing, sampling, incentives, private labeling, merchandising and licensing and similar efforts.
The Company's strategy of establishing and expanding its share of the national market for dairy products and building its brand name recognition nationally is a long-term objective and is tied to the Company's acquisition strategy discussed above. The Company believes that as it expands into new markets, its growing national presence and brand name recognition will enhance its ability to attract larger customers. In addition, the Company eventually plans to promote its products on an Internet website, television, radio, print and other forms of communication designed to generate national brand recognition and product awareness among consumers.
RAW MATERIALS AND SUPPLY
Dairy, Southern Belle and London's Farm Divisions
The Company's Marietta facility receives approximately 70,000 gallons of raw Grade A milk daily from over 170 dairy farms in Ohio and West Virginia; the Southern Belle facility receives approximately 66,000 gallons of raw milk daily, principally from Southeastern Graded Milk Producers Association ("SEGMPA"), representing approximately 280 dairy farms in Kentucky; and the London's Farm Division receives approximately 53,500 gallons of raw milk daily, principally from Michigan Milk Producers Association.
To ensure a constant supply of raw milk meeting Company standards, a full-time field department is maintained at the Company's Southern Belle and Dairy Divisions. Inspectors visit each dairy farm and work with farmers on product quality assurance. Over 450 farmers in Ohio, West Virginia and Kentucky and the farmers of Michigan Milk Producers Association produce Grade A milk for the Company. Contract haulers check the quality of raw milk and transport the milk from the farms to the plant. Fresh, raw milk is received and processed (pasteurized) every day of the year. In order to monitor product quality, the Company maintains its own laboratories. The laboratories are staffed by trained technicians who are certified by state authorities at the Company's Dairy and Southern Belle Divisions. The supply of raw milk in the United States is influenced by many factors, including seasonality and government regulation, and is therefore variable.
Certain other raw materials used by the Company, including milk powder, cocoa powder, sugar, flavorings, fruits, nuts and packaging supplies are generally available from numerous third party sources. The Company's Dairy, Southern Belle and London's Farm Divisions are not dependent upon any single supplier for these materials, and management believes that any supplier could be replaced in the ordinary course of business.
Foods Division
The Foods Division receives its primary supply of pasteurized milk and butterfat from the Company's Dairy and Southern Belle Divisions, and it is anticipated that the London's Farm Division will provide additional butterfat during certain peak periods of the year. Additional cream is purchased from numerous other suppliers. The Southern Belle Division provides the Company with a stable source of butterfat, an integral raw material required in the production of the Foods Division products.
Other raw materials used in the Foods Division's production processes, including sugar, flavorings, seasonings and packaging supplies, are generally available from various third party sources. The Foods Division is not dependent upon any single supplier for these materials and management believes that any supplier could be replaced in the ordinary course of business.
PRODUCTS
The following table shows the Company's breakdown by product, as an approximate percentage of revenues, for the years ended December 31, 1996, 1997 and 1998:
The Company's cultured products include cottage cheese, sour cream, imitation sour cream and non-dairy dips.
COMPETITION
The Company's business is highly competitive. The Company has a number of competitors in each of its major product, service and geographic markets, and many of these competitors are larger, more established and better capitalized than the Company.
Dairy Division, Southern Belle Division and London's Farm Division
Due to the perishability concerns and costs associated with transporting fresh milk, competition in the fluid dairy business tends to be regional rather than national, with strong brand identity, flexibility of service, price, breadth of product line and quality as the primary competitive factors. The Company competes primarily on the basis of quality, service, brand recognition, breadth of product line and price. Because of its size, the quality of its manufacturing facilities, the efficiency of its work force, the strength of its distribution network and the strength of its brand name, management believes the Company can continue to compete effectively within the regions currently served by the Company's dairy business.
The Dairy, Southern Belle and London's Farm Divisions' competitors include other large, independent dairy processing companies and dairy processors owned by grocery chains, many of which are larger and better capitalized than the Company.
In the manufacturing and distribution of ice cream, the Company competes with large integrated dairy and ice cream manufacturing companies and independent distributors of national ice cream brands. Because the Company offers brands manufactured by third parties as well as its own brand of ice cream products, it is able to compete effectively in this market by offering convenience stores and other small retailers a broad line of ice cream products and frozen novelties. The addition of the Hagan Ice Cream distributorship allows the Company to offer an extensive line of popular national and other ice cream brands, generating sales volume from retail sites that single line or other more limited distributors may find uneconomical to service.
Foods Division
Although a pioneer in UHT processing, the Company now competes against larger, integrated dairies and UHT manufacturing companies which are better capitalized. Consequently, the Company only has a small percentage of the market share in the eastern United States.
TRADEMARKS
The Company currently holds four registered trademarks, primarily used by the Company's Dairy and Foods Divisions: the Company's corporate logo, Broughton B Kitchen Guild (plus logo)(R), Kitchen Guild(R), Keepwell(R) and Sokreem(R), and also uses other trademarks that have been licensed or sublicensed from Marbo, Inc., a food
company. The Company has trademarks for: Southern Belle(R), Ultra Skim(R), Southern Belle's corporate logo and for SBD Good For You! (and design)(R). The Company has applications pending for X.Y. Zoo's(TM), Grape Gorilla(TM), Lemon Lion(TM), Punch A Rama(TM), Orangeopus(TM), Carablue(TM), Lemonsaur(TM) and Chocodile(TM). The Company's London's Farm Dairy Division has the following registered trademarks: Corporate logo, "Your Natural Choice" and "Michigan's Natural Choice", as well as a licensing agreement to use the tradename "Ryba's Mackinaw Island Fudge" and "Mackinaw Island Fudge".
GOVERNMENT REGULATION
The Company is extensively regulated under both federal and state law. The following information summarizes certain aspects of that regulation applicable to the Company and is qualified in its entirety by reference to all particular statutory or regulatory provisions.
Regulation at the federal, state and local levels is subject to change. To date, compliance with governmental regulations has not had a material impact on the Company's level of capital expenditures, earnings or competitive position, but, because of the evolving nature of such regulations, management is unable to predict the impact such regulation may have in the foreseeable future.
Public Health
As a manufacturer and distributor of food products, the Company is subject to the Federal Food, Drug and Cosmetic Act and regulations promulgated thereunder by the Food and Drug Administration (the "FDA"). This comprehensive regulatory scheme governs the manufacture (including composition and ingredients), labeling, packaging and safety of food. The FDA regulates manufacturing practices, including quality assurance programs, for foods through its current good manufacturing practices regulations, specifies the standards of identity for certain foods, including many of the products sold by the Company, prescribes the format and content of certain nutrition information required to appear on food product labels and approves and regulates claims of health benefits of food products.
In addition, the FDA enforces the Public Health Service Act and regulations issued thereunder, which authorize regulatory activity necessary to prevent the introduction, transmission or spread of communicable diseases. These regulations require, for example, pasteurization of milk and milk products. The Company and its products are also subject to state and local regulation through such measures as the licensing of dairy manufacturing facilities, enforcement by state and local health agencies of state standards for the Company's products, inspection of the Company's facilities and regulation of the Company's trade practices in connection with the sale of dairy products.
The Company maintains quality control laboratories at each of its dairy manufacturing facilities to test milk, other ingredients and finished products. Product quality and freshness are essential to the successful retail distribution of dairy and refrigerated dairy products. To monitor product quality at its facilities, the Company maintains quality control programs to test products during various processing and packaging stages. Each dairy manufacturing facility has its own staff of technicians who monitor products to maintain high quality formulations and to protect against contamination.
Employee Safety Regulations
The Company is subject to certain health and safety regulations, including regulations issued pursuant to the Occupational Safety and Health Act. These regulations require the Company to comply with certain manufacturing, health and safety standards.
Environmental Regulations
The Company is subject to certain federal, state and local environmental regulations. These laws include, but are not limited to, the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended; the Resource Conservation and Recovery Act, as amended; the Federal Water Pollution Control Act, as amended; the Toxic Substances Control Act; the Clean Air Act; the Safe Drinking Water Act; the Oil Pollution
Act of 1990; the Occupational Safety and Health Act of 1970, as amended; and their state and local counterparts and equivalents.
The Company's facilities discharge biodegradable wastewater into municipal waste treatment facilities at levels that require the Company to pay monthly wastewater surcharges to municipal water treatment authorities. These authorities may, however, require the Company to limit the level of discharges and construct pre-treatment facilities or take other action to reduce effluent discharge in the future.
The Company maintains aboveground or underground petroleum storage tanks at several of its facilities. These tanks are periodically inspected to determine compliance with applicable regulations. The Company may be required to make expenditures from time to time in order to remain in compliance with such regulations.
U.S. Dairy Support Program
The minimum price paid to producers for Grade-A milk in the United States is established by federal milk marketing orders promulgated under the Agriculture Marketing and Agreement Act of 1937. In federal milk marketing orders, a Marketing Administrator regulates minimum prices for milk based on how it is used. Each month the Market Administrator audits the books of all processors and ensures that farmers receive minimum prices. In reality, fluid processors often pay more than the minimum price. Dairy cooperatives have antitrust immunity under the Capper Volstead Act of 1922 to organize and bargain for higher prices. Further, the prices paid for milk by processors are higher than these minimums due to handling charges or other administrative fees charged by suppliers and shippers. Congress has recently passed legislation designed to phase out support prices over a specified period. See "Risk Factors -- Government Regulations; Regulatory Uncertainty."
On January 23, 1998, the United States Department of Agriculture (the "USDA") announced proposed changes to the federal milk marketing order program. This was in relation to the 1996 Farm Bill which required that federal milk marketing orders be consolidated by April 1999. The USDA proposal would reduce the number of federal orders from 31 to 11 and implement a replacement for the basic formula price. The USDA held hearings on these and other changes which commenced on February 17, 1998 with the commencement of a public comment period. The USDA has not announced a definitive effective date for the changes as required by the 1996 Farm Bill.
In 1998, the State of West Virginia passed legislation which would allow West Virginia dairy farmers to join the Southern Dairy Compact. This legislation would allow the state to establish a regional over-order price for members among other provisions and mechanisms to achieve its statement of purpose as defined in the legislation.
The Company is unable to evaluate the impact, if any, of proposed federal and state changes, described above, based on the information available at this time.
EMPLOYEES
As of December 31, 1998, the Company had 832 full-time employees and 51 part-time employees. Of this number, 293 were employed by the Dairy Division and the General Office, 108 worked in the Foods Division, 247 in the Southern Belle Division and 235 in the London's Farm Division. Broughton also employs additional employees during its peak summer season and has not experienced difficulty in meeting its seasonal employment needs. Management believes that the Company's relations with its employees are good.
The Company is party to several collective bargaining agreements with approximately 331 of its employees.
RISK FACTORS
The following risk factors are applicable to the Company's business and operations and should be considered carefully. The applicability of certain of these risk factors, such as Risks Related to an Acquisition Strategy; Management of Growth, Risks Related to Acquisition and Other Financing, Dependence on Certain Customers, Dependence on Key Personnel and Control by Principal Shareholders are dependent upon whether or not the Company's merger with Suiza is consummated.
Risks Related to Operating and Internal Growth
The Company's ability to increase the net sales of its existing operations and any acquired businesses would be affected by various factors, including demand for its products, the cost of expanding and upgrading its facilities, the Company's ability to expand the range of products offered to customers, its success in implementing strategies necessary to attract new customers and attract and retain necessary personnel and its ability to obtain necessary financing. Many of these factors are beyond the Company's control, and there can be no assurance that operating and internal growth would be successful or that the Company would be able to generate cash flow adequate for its operations and to support internal growth.
Risks Related to an Acquisition Strategy; Management of Growth
There can be no assurance that the Company would be able to identify, acquire or profitably manage additional businesses or successfully integrate acquired businesses into the Company without substantial costs, delays or other operational or financial problems. In addition, increased competition for acquisition candidates may develop, in which event there may be fewer acquisition opportunities available to the Company as well as higher acquisition prices. Further, acquisitions involve a number of special risks, including possible adverse effects on the Company's operating results, diversion of management's attention, risks related to having adequate corporate and financial controls and procedures to manage and monitor the Company's operations as they expand, risks associated with unanticipated events or liabilities and amortization of acquired intangible assets, some or all of which could have a material adverse effect on the Company's business, financial condition and results of operations, particularly in the fiscal quarters immediately following the consummation of such transactions. Customer dissatisfaction or performance problems at a single acquired Company could also have an adverse effect on the reputation of the Company. There also can be no assurance that a business acquired in the future would achieve anticipated revenues and earnings.
In addition, growth also could impose significant added responsibilities on members of senior management, resulting in the need to identify, recruit and integrate new senior level managers and executives. There can be no
assurance that such additional management could be identified and retained by the Company. To the extent that the Company would be unable to manage its growth efficiently and effectively, or would be unable to attract and retain additional qualified management, the Company's business, financial condition and results of operations and the market price of the Common Stock could be materially adversely affected.
Risks Related to Acquisition and Other Financing
The timing, size and success of any acquisition efforts and the associated capital commitments cannot be readily predicted. The Company would finance future acquisitions by using shares of its Common Stock for all or a significant portion of the consideration to be paid. If the Common Stock did not maintain a sufficient market value, or if potential acquisition candidates would be unwilling to accept Common Stock as part of the consideration for the sale of their businesses, the Company would be required to utilize more of its cash resources, if available, in order to initiate and maintain an acquisition program. If the Company did not have sufficient cash resources, its growth could be limited unless it is able to obtain additional capital through debt or equity financings.
In the future, the Company would require significant amounts of additional capital to fund the internal expansion of its operations, the acquisition of businesses and its working capital. The exact amount of the Company's future capital requirements, however, would depend upon many factors, including the cost, timing and extent of any upgrade or expansion of its operations, the Company's ability to penetrate new markets, regulatory changes, the status of competing businesses, the magnitude of potential acquisitions and the Company's results of operations. Individually or collectively, variances in these and other factors could cause material changes in the Company's actual capital requirements.
New sources of capital could include public and private equity and debt financings by the Company. The incurrence of additional indebtedness could subject the Company to expanded or more restrictive financial covenants. There can be no assurance that additional financing would be available on acceptable terms or at all. To the extent unplanned expenditures arise or the Company's estimates of its capital requirements prove to be inaccurate, the Company could require such additional financing sooner than anticipated and in amounts greater than current expectations. If such funds were not available or were available on terms that the Company viewed as unfavorable, the Company would be required to limit or abandon certain of its expansion strategies. The delay or abandonment of some or all of the Company's development and expansion plans or the incurrence by the Company of additional debt could have a material adverse effect on the business, financial condition and results of operations of the Company and on the market price of the Common Stock.
Risks Associated with Perishable Food Production
The food manufacturing and distribution industry is subject to varying degrees of risk. In particular, dairy products are highly perishable and must be transported timely and efficiently within a precise temperature range. As a result, the Company is always subject to risk of spoilage or contamination of its dairy products. In addition, food producers, such as the Company, may be subject to claims for damages if contaminated food causes injury to consumers.
The food products sold by the Company include dairy products and other perishable goods with a limited shelf life. Because it is not practicable to hold excess inventory of perishable products, the Company's results of operations are partly dependent on its ability to accurately forecast its near-term sales in order to adjust its supply of perishable items accordingly. Historically, forecasting product demand has been difficult and the Company expects it to be an ongoing challenge. Failure to accurately forecast product demand could result in the Company either being unable to meet higher than anticipated demand or producing excess inventory that cannot be profitably sold. In addition, certain of the Company's trade customers have the right to return any products that are not sold by their expiration date. The inability of the Company to meet higher than anticipated demand, excess production or significant amounts of product returns could have a material adverse effect on the Company's business, financial condition and results of operations and on the market price of the Common Stock.
Product Liability Risks
The Company may be subject to significant liability should the consumption of any of its products cause injury, illness or death. There can be no assurance that product liability claims will not be asserted against the Company or that the Company will not be obligated to recall its products. The Company has an umbrella insurance policy and carries product liability insurance and product withdrawal expense insurance. The Company's umbrella insurance policy supplements the underlying general liability and product liability and withdrawal expense insurance. There can be no assurance that this insurance would be adequate to protect the Company against product liability claims, or that such insurance will continue to be available to the Company on reasonable terms. A product recall or a product liability judgment against the Company (regardless of whether covered by insurance) could have a material adverse effect on the Company's business, financial condition and results of operations and on the market price of the Common Stock.
Government Regulation; Regulatory Uncertainty
The manufacturing, processing, packaging, storage, distribution, licensing and labeling of food products are subject to extensive federal, state and local regulations. The Company's business is subject to regulation through inspection by the FDA, the USDA, and local and state health agencies. This comprehensive regulatory program establishes, among other things, the manufacturing, composition and ingredients (the "standards of identity"), labeling, packaging and safety of food and pricing of certain raw materials. For example, the FDA regulates manufacturing practices for foods through its "current good manufacturing practices" regulations, and specifies the standards of identity for certain foods. In addition, the Nutrition Labeling and Education Act of 1990, as amended, prescribes the format and content of certain nutrient information required to appear on the labels of and in health claims regarding food products. The FDA has proposed rules to amend the regulations that govern the standards of identity and the labeling of certain products eventually manufactured by the Company. No assurance can be made that such proposed FDA rules, in the form adopted, would not impose additional costs on the production of the Company's products which could have a material adverse effect on the Company's business, financial condition and results of operations and on the market price of the Common Stock.
Enforcement actions for violations of federal, state and local regulations may include condemnation of violative products following product seizures, cease and desist orders, injunctions precluding the manufacture and shipment of products and/or monetary penalties and criminal sanctions. Noncompliance in manufacturing processes can result in warning letters from regulatory agencies and requests that the Company voluntarily recall violative products. In addition, federal and other regulators may issue adverse publicity or other product advisories against consumption of the Company's products if they believe that public health risks exist. Any of these regulatory actions could have a material adverse effect on the Company's business, financial condition and results of operations and on the market price of the Common Stock. There can be no assurance that the Company's facilities and practices are sufficient to maintain compliance with applicable government regulations.
Like many other businesses, the Company is subject to a full range of federal, state and local laws and regulations pertaining to the environment, including the discharge of materials into the environment and the handling and disposal of wastes (including solid and hazardous wastes). No assurance can be made that the Company is in compliance with all applicable environmental laws and regulations governing its business or that the Company's costs of compliance with, or any liability under, such environmental laws and regulations would not have a material adverse effect on its business, financial condition and results of operations and on the market price of the Common Stock.
Dependence on Certain Customers
Direct sales of products to the ten largest customers represented approximately 24.8% of the Company's total net sales in 1998. A loss of any of these customers or any significant reduction in sales to them could adversely affect the Company's business, financial condition and results of operations and the market price of the Common Stock.
A number of the Company's customers, such as public schools and penitentiaries, are acquired pursuant to government bid contracts. Such public sector customers have considerable ability to force the renegotiation of the
terms of a contract upon the Company and frequently are significantly slower in paying outstanding accounts than are private sector entities. Termination or forced renegotiation of contracts with the Company's public sector customers or delays in payments from public sector entities could have a material adverse effect on the Company's business, financial condition and results of operations and on the market price of the Common Stock.
Risks of Government Contracting
The Company faces the risks associated with government contracting, which may include substantial administrative, civil and criminal fines and penalties for, among other matters, non-compliance with federal procurement laws and regulations, employing improper billing practices, receiving or paying kickbacks or filing false claims. Government contracting requirements are complex, highly technical and subject to varying interpretation and changing government enforcement priorities and practices. As a result of its government contracts, the Company has been, is and expects in the future to be the subject of audits and investigations by government agencies. In addition to potential damage to the Company's business reputation, the failure to comply with the terms of one or more of its government contracts could also result in the Company's suspension or debarment from future government contracting and subcontracting for a significant period of time. The fines and penalties that could result from noncompliance with applicable laws and regulations, as well as the Company's suspension or debarment, could have a material adverse effect on the Company's business, financial condition and results of operations and the market price of the Common Stock. See "Legal Proceedings".
Risks Relating to Antitrust Laws
The dairy industry is subject to various federal and state antitrust laws which prohibit anticompetitive conduct, including price fixing, bidrigging, concerted refusals to deal and divisions of markets. The dairy industry has been in the past, and may be in the future, subject to government investigation and/or enforcement action with respect to such antitrust laws.
The Company and certain other dairy companies were the subject of civil litigation initiated by the State of Ohio relating to the pricing of contracts to supply school milk. On September 12, 1997, the Company settled the civil litigation initiated by the State of Ohio by agreeing to supply approximately $30,000 of the Company's product to certain school systems and paying approximately $20,000.
The Southern Belle Division and the Company are currently the subject of suspension and debarment proceedings proposed by the U.S. Department of Agriculture ("USDA"). See "Legal Proceedings".
Additionally, the DOJ has filed suit in U.S. District Court for the Eastern District of Kentucky seeking to enjoin Suiza's proposed acquisition of the Company See "Legal Proceedings".
Dependence on Certain Suppliers
Raw milk is the primary raw material of the Company. The Dairy Division purchases some of its raw milk from dairy cooperatives but buys substantially all of its raw milk, on a noncontractual, non-exclusive basis, from dairy farms throughout Ohio and West Virginia. Substantially all of the Southern Belle Division's raw milk is supplied, on a contractual, exclusive basis, by SEGMPA, a milk farm cooperative based in Somerset, Kentucky. Substantially all of the London's Farm Division's raw milk is supplied by the Michigan Milk Producers Association. If for any reason SEGMPA was unable or unwilling to continue supplying the operations of the Southern Belle Division, or the Michigan Milk Producers Association was unable or unwilling to continue supplying the operations of the London's Farm Division, the Company could incur substantial costs and delays in the growth and expansion of its business. See "Business -- Raw Materials and Supply."
Possible Volatility of Raw Material and Transportation Costs
U.S. dairy policy since the mid-1980s has focused on gradually reducing federal government involvement in the dairy industry and moving the industry in a more market oriented direction. In order to accomplish these goals, the federal government has targeted the federal milk marketing order system and the milk price support
program for reform. These reforms have resulted in the potential for greater price volatility relative to past periods, as prices are more responsive to the fundamental supply and demand of the market.
Changes in U.S. dairy policy could increase the risk for price volatility in the dairy industry. There can be no assurance that a material volatility in milk prices will not occur or that any such volatility would not have a material adverse effect on the Company's business, financial condition and results of operations and the market price of the Common Stock.
Independent of changes in U.S. dairy policy, the Company has experienced increased costs in raw milk and in butterfat, a raw material required in the production of many items by the Foods Division and in ice cream production. See "Business -- Raw Materials and Supply."
The Company's earnings are especially sensitive to transportation costs, an important component of which is the cost of diesel fuel. Petroleum product prices continue to be subject to unpredictable economic, political and market factors. Accordingly, the price and availability of diesel fuel continue to be unpredictable. Increases in the price of diesel fuel translate into increases in the Company's annual transportation costs. Because transportation costs constitute a major expenditure for the Company, significant increases in diesel fuel costs could have a material adverse effect on the Company's business, financial condition and results of operations and the market price of the Common Stock.
Dependence on Key Personnel
The future success of the Company's business operations is dependent in part on the efforts and skills of certain key members of management, including Marshall T. Reynolds, Chairman of the Company's Board of Directors, and Philip E. Cline, President and Chief Executive Officer. The loss of any of its key members of management could have an adverse effect on the Company.
Risks Related to Changing Industry Environment
The dairy industry is undergoing accelerated change and consolidation as producers, manufacturers, distributors and retailers seek to lower costs and increase services in an increasingly competitive environment of relatively static overall demand. The Company believes that these changes have led to reduced sales, reduced margins and lower profitability throughout the industry. Failure to develop a successful response to such changed market conditions, including relatively little growth in demand over the long term and reduced profitability, could have a material adverse effect on the Company's business, financial condition and results of operations and on the market price of the Common Stock.
Seasonality and Quarterly Fluctuations
The Company's results have been subject to quarterly fluctuations caused primarily by the seasonal variations in demand for its milk and dairy products. For example, the Company experiences a decrease in sales to schools during months when schools close for vacation during the third quarter of each fiscal year. In addition, the Company traditionally experiences peak demand for its ice cream products during the summer months. Because the Company's results of operations from its ice cream business depend significantly on sales generated during its peak season, adverse weather during this season (such as an unusually mild or rainy period) could have a disproportionate impact on the Company's results of operations for the full year. Unexpected variations in quarterly results could have a material adverse effect on the Company's business, financial condition and results of operations and on the market price of the Common Stock.
Risks Related to Labor Disputes
The Company is party to various collective bargaining agreements with local unions representing a significant amount of its respective employees. Typical agreements are three to five years in duration, and as such agreements expire, the Company expects to negotiate with the unions and to enter into new collective bargaining agreements. There can be no assurance, however, that agreements will be reached without work stoppages or other labor disputes. A prolonged work stoppage or other labor dispute could have a material adverse effect on
the Company's business, results of operations and financial condition and on the market price of the Common Stock.
Control by Principal Shareholders
The Company's executive officers and directors beneficially own an aggregate of 43.4% of the Company's outstanding shares of Common Stock. Such shareholders, if voting together, would likely have sufficient voting power to elect a majority of the Board of Directors, exercise control over the business, policies and affairs of the Company and, in general, determine the outcome of any corporate transaction or other matter submitted to the shareholders for approval, such as (i) any amendment to the Company's Articles of Incorporation, (ii) any merger, consolidation, sale of all or substantially all of the assets of the Company and (iii) any "going private" transaction, and, in general, prevent or cause a change of control of the Company, all of which may adversely affect the Company and its shareholders.
Risk Related to Failure to Complete the Merger with Suiza
Since the announcement of the proposed merger with Suiza, the Company has devoted significant effort and resources towards completing that transaction. In anticipation of such merger, the Company has also forgone certain planned expenditures and operational and structural changes. Failure to complete the transaction may adversely affect the Company's financial position and results of operations, at least on a short-term basis.
ITEM 2.
ITEM 2. PROPERTIES
The Company's executive offices are located in leased premises at 210 North Seventh Street, Marietta, Ohio. The Company has manufacturing facilities in Marietta, Ohio; Charleston, West Virginia; Somerset, Kentucky; Port Huron, Michigan and Burton, Michigan. There are twenty dairy distribution centers: two in Marietta (in one location) and one in each of (i) Old Washington, Ohio; (ii) Charleston, Ripley and Clarksburg, West Virginia; (iii) Coleman and Bay City, Michigan; (iv) Ashland, Danville, Lexington, London, Morehead, Louisville and Russell Springs, Kentucky; and (v) Cookeville, Nashville, Knoxville, Chattanooga and Johnson City, Tennessee. In addition, the Company's Hagan Ice Cream distributorship is located in Dunbar, West Virginia. In March 1999, the Company consolidated its Bay City, Michigan operations into the Coleman facility.
Dairy Division
The Dairy Division conducts its manufacturing and distribution operations from its Marietta, Ohio, plant and from seven distribution centers, two of which are owned and five of which are leased.
Foods Division
The Foods Division conducts its manufacturing and distribution operations from its Charleston, West Virginia plant.
Southern Belle Division
The Southern Belle Division conducts its manufacturing and distribution operations from its Somerset, Kentucky plant and from eleven distribution centers, three of which are owned and eight of which are leased.
London's Farm Division
The London's Farm Division conducts manufacturing and distribution operations from its Port Huron and Burton, Michigan facilities. In addition, it performs distribution operations at an owned facility in Coleman, Michigan and a leased facility in Bay City, Michigan. The Division's Port Huron operation manufactures a full line of fresh milk and other products, while its Burton plant produces a variety of ice cream products. In March 1999, the Company consolidated its Bay City operations into the Coleman facility.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The former Southern Belle Dairy Company received a Notice of Proposed Debarment dated June 1, 1994, from the USDA, in which the USDA proposed to debar the former Southern Belle Dairy Company from engaging in contracts and other transactions involving all federal agency procurement and nonprocurement programs for up to three years as a result of previously settled antitrust violations by such entity. On April 18, 1995, the former Southern Belle Dairy Company entered into a Compliance Agreement in Lieu of Debarment with the USDA (the "Southern Belle Compliance Agreement"). This agreement was for a three-year period and required the former Southern Belle Dairy Company to establish and maintain a compliance program which included, among other things, the establishment of an ethics committee and formal ethics and education training for all employees. Although the Southern Belle Compliance Agreement expired on April 18, 1998, the Southern Belle Division is still operating under its terms.
By notice dated December 31, 1997, the USDA suspended the Southern Belle Division from federal procurement and nonprocurement programs and proposed to debar such division for a period that by regulation would not exceed three years, based on alleged breaches of the Southern Belle Compliance Agreement by the former Southern Belle Dairy Company, prior to its merger with the Company in early December 1997. The Company has challenged the USDA action in an administrative proceeding. The USDA had proposed that the Southern Belle Division and the Company enter into a new Compliance Agreement in Lieu of Debarment as a means of resolving this matter and has indicated that Southern Belle could be subject to debarment and the Company subject to suspension and debarment if they fail to enter into such proposed agreement. The Company is currently engaged in discussions with USDA with respect to this matter.
On September 23, 1998, the USDA agreed to the Company's request that it separate the suspension and debarment proceedings against the Southern Belle Division and such similar threatened proceedings against the Company, and advised that it will pursue suspension and proposed debarment against the Southern Belle Division and the Company's settlement of civil antitrust litigation independent of each other. Accordingly, the USDA withdrew its offer to the Company of the newly proposed Compliance Agreement in Lieu of Debarment. The USDA advised that a decision on Southern Belle's suspension and debarment would be rendered by October 15, 1998, unless good cause exists to extend the determination period. Since that date, the USDA has extended that decision in successive 45-day periods with the latest notification stating the USDA's decision on Southern Belle's suspension and debarment will be rendered by April 14, 1999, unless good cause exists to extend the determination period.
Management is unable at this time to predict the outcome of this USDA proceeding; however, if unfavorably resolved, this USDA proceeding could have a material adverse effect on the Company's financial position and results of operations.
On September 11, 1998, the Company announced that it had executed an Agreement and Plan of Merger with Suiza Foods Corporation ("Suiza") a Delaware corporation and Suiza Foods Acquisition Corp. ("Merger Sub"), an Ohio corporation and wholly owned subsidiary of Suiza dated September 10, 1998 (the "Agreement"), providing for the merger of the Company with Merger Sub, with each Company share being exchanged for the sum of Nineteen Dollars ($19.00) cash. Consummation of the merger is conditioned upon satisfaction of all conditions contained in the Agreement. If the merger is consummated, the Company will become a wholly-owned subsidiary of Suiza. On September 10, 1998, 5,774,335 shares of Company common stock were issued and outstanding. The Agreement was approved by the Company shareholders at a special meeting held on December 4, 1998.
On January 18, 1999 the Company announced that Suiza and the Company had executed an amendment to the Agreement.
The amended Agreement, dated January 18, 1999, extends from December 31, 1998 to April 15, 1999 the date on which either party may terminate the amended Agreement if the merger has not been completed on such date. A related Stock Purchase Agreement dated January 18, 1999 between Suiza, the Company and eight shareholders of the Company provides that at completion of the merger, those shareholders will sell Two Million (2,000,000) Company shares to Suiza, and will receive, in lieu of the $19.00 per share cash merger consideration,
the cash sum of $10.00 per Company share, without interest, plus the right to receive up to an additional $9.00 per share if certain earnings and performance goals are met between the date of the merger and March 31, 2000.
Subject to satisfaction of all conditions contained in the Agreement and Plan of Merger, as amended, and the Stock Purchase Agreement, the parties agreed to complete the merger on March 31, 1999.
On March 18, 1999 the United States District court for the Eastern District of Kentucky, London Division, entered a temporary restraining order enjoining Suiza, the Company and all persons acting on their behalf from consummating, directly or indirectly, their proposed merger, or implementing any other plan or agreement by which Suiza and the Company, or any part of them would combine under common ownership or control. Earlier the same day, the United States Department of Justice Antitrust Division ("DOJ") filed a Motion for Temporary Restraining Order ("TRO"), Motion for Preliminary Injunction and a Complaint in seeking to enjoin the proposed acquisition of the Company by Suiza. The DOJ alleged that competition in the production and sale of school milk in South Central Kentucky school districts would be substantially lessened as a result of the proposed transaction.
By terms of the Court's order, the TRO shall remain in effect until such time as the Court addresses the DOJ's Motion for Preliminary Injunction. Suiza and the Company independently concluded and agreed not to contest the motion for TRO. Suiza and the Company continue to review their options for responding to the DOJ's action.
The Company is involved in or subject to certain other legal proceedings, including with respect to regulatory matters, which arise in the ordinary course of the Company's business. Although the Company cannot predict the outcomes of these legal proceedings, the Company's management does not believe that these actions will have a material adverse effect on the Company's financial position, results of operations or liquidity.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS
On December 4, 1998 the Company held a special meeting of shareholders to vote upon a proposal to approve and adopt an Agreement and Plan of Merger dated September 10, 1998 among Suiza Foods Corporation, the Company and a wholly-owned subsidiary of Suiza providing for the merger of the Company with the Suiza subsidiary in exchange for receipt of $19.00 cash per Company share, without interest.
At the date of the meeting, the company had outstanding 5,774,335 shares of common stock. Each share was entitled to one vote. There were 4,968,253 votes cast for the merger, 7,892 votes against the merger, 5,235 abstentions and 715,914 broker non-votes.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Broughton Common Stock has traded on the NASDAQ National Market System since the Offering on December 9, 1997, under the symbol "MILK". The high and low prices for the period of trading commencing on December 9, 1997 through the year end of December 31, 1997 were a high of $17.50 and a low of $16.00.
The following table sets forth the high and low prices for Broughton common stock for the period indicated. The range of high and low prices are based on data from NASDAQ.
The approximate number of holders of record of the Company's Common Stock on March 17, 1999, was 307.
The following table sets forth the quarterly dividends per share declared on Broughton Common Stock.
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(1) On August 17, 1997, the Company's Board of Directors approved a 30-for-1 stock split in the form of a stock dividend. Retroactive restatement has been made to all share and per share amounts to reflect the stock split.
DIVIDEND POLICY
The Company has in the past declared cash dividends on its Common Stock. Pursuant to the Agreement of Merger between the Company and Suiza, the Company agreed to not pay a dividend pending consummation or termination of the Agreement. If the alliance with Suiza is terminated, the Board of Directors presently anticipates paying a cash dividend but the declaration of cash dividends will be at the discretion of the Board of Directors based on the Company's earnings, financial condition, capital requirements and other relevant factors, including applicable law and any restrictions set forth in credit facilities entered into by the Company.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data of the Company as of and for the five years ended December 31, 1998. Such data as of and for the five years ended December 31, 1998, are derived from the Company's financial statements, which have been audited by PricewaterhouseCoopers LLP, independent public accountants.
The selected historical financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's Financial Statements and the related Notes thereto.
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(1) Other income for the year ended December 31, 1996 includes a $3.0 million pre-tax gain on the sale of an investment. In 1998 interest income was approximately $448,000 resulting primarily from funds invested from the Company's initial public offering.
(2) On August 27, 1997, the Company's Board of Directors approved a 30-for-1 stock split in the form of a stock dividend. Retroactive restatement has been made to all share amounts to reflect the stock split.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company is a leading manufacturer and distributor of fresh milk and related dairy products in Ohio, West Virginia, Kentucky, Tennessee, Michigan and parts of the eastern United States. The Company has grown primarily through internal growth and strategic acquisitions. Through such growth, the Company has realized regional economies of scale and operational efficiencies. The Company operates through four major divisions -- the Dairy Division based in Marietta, Ohio; the Foods Division based in Charleston, West Virginia; the Southern Belle Division based in Somerset, Kentucky; and the London's Farm Division based in Port Huron, Michigan.
The Company completed an acquisition of Southern Belle Dairy Company of Somerset, Kentucky in December 1997. The Company has had an increase in sales, cost of sales and operating expenses for the year ended December 31, 1998 compared with the year ended December 31, 1997 due primarily to the Southern Belle and London's acquisitions. As a result of the Southern Belle acquisition, the Company has taken and expects to take a number of actions intended to integrate the operations of Southern Belle with the Company's existing operations and to reduce certain product costs and overall, selling, general and administrative expenses. The Company has successfully implemented synergy savings involving the utilization of butterfat, a raw material required in the production of many items within the Foods Division, including heavy whipping cream, table cream, aerosol whipped toppings and half-and-half. Southern Belle does not manufacture non-fluid dairy products and, therefore, does not utilize butterfat, a by-product of its fluid milk manufacturing processes and an integral raw material required in the production of non-fluid dairy products. Accordingly, as a result of the Southern Belle acquisition, the Company has received cost savings from less dependence on the "spot" market for its butterfat requirements. Southern Belle is also supplying the Dairy Division with orange juice and buttermilk, items which the Dairy Division previously manufactured. The Dairy Division is currently successfully manufacturing for the Southern Belle Division both plastic pints and soft-serve mixes. Southern Belle previously purchased soft-serve mixes from an outside supplier and had not initiated a plastic pint product within its market segment. In addition to the products that have been successfully integrated into the Company, additional cost savings are anticipated to be achieved through the further integration of ice cream, sour cream and cottage cheese production, all products that Southern Belle has historically purchased from outside suppliers and which will now be supplied by the Company. The Company's Foods Division is currently manufacturing for the Southern Belle Division a full complement of UHT products including heavy whipping cream, half-and-half and non-dairy creamers. The Company has been successful in integrating many of the cost saving synergies identified in the Southern Belle acquisition, however, there can be no assurance that the Company will be successful in integrating the remaining operations of Southern Belle and realizing additional cost savings in the future.
The Company completed the acquisition of London's Farm Dairy on May 29, 1998. As a result of the London's acquisition, the Company had an increase in sales, cost of sales and operating expenses for the second, third and fourth quarters of 1998. As a result of the acquisition of London's, the Company expected to take a number of actions intended to integrate the operations of London's with the Company's existing operations and to reduce overall selling, general and administrative expenses. London's previously purchased certain products from outside suppliers, including UHT products, cottage cheese and plastic pints, each of which can be supplied by the Company at an anticipated savings. The acquisition is expected to provide the Company with an additional source of butterfat for the Company's Foods Division during certain peak periods of the year. London's operates an ice cream plant in Burton, Michigan, and it is anticipated that additional internal ice cream production needs will be converted to this plant for the Company as a whole, thereby better utilizing internal equipment and production capacity. There can be no assurance that the Company will be successful in integrating the operations of London's and realizing the anticipated cost savings. Among the factors that might affect the Company's ability to integrate the operations of London's and realize anticipated cost savings include the Company's ability to distribute London's products to other Company divisions in a cost-effective manner, London's ability to realize an increase in plastic pint sales and the Company's ability to develop uniform standards for ice cream production across its plants.
The Company began discussions with Suiza in May 1998 regarding a possible business combination and as a result of the proposed merger with Suiza Foods, announced on September 11, 1998, the Company has been delayed in integrating the operations of London's and completing the integration of Southern Belle.
Approximately $1.7 million of the purchase price for the Southern Belle acquisition has been recorded by the Company as goodwill. Goodwill will be amortized as a non-cash charge to the income statement over a period of 40 years. The impact of this amortization will result in a charge to earnings of approximately $43,400 annually. Approximately $11.9 million of the purchase price of the London's acquisition has been recorded by the Company as intangible assets to be amortized as a non-cash charge to the income statement over periods ranging from 23 to 40 years. The impact of this amortization will result in a charge to earnings of approximately $311,000 annually for the first 23 years of charges.
The Company's net sales consist primarily of sales of products derived from raw milk, including fluid milk, frozen desserts, cultured products and UHT products. Revenues are recognized by the Company when the Company's products are received by the customer. The Company's revenues are subject to quarterly fluctuations caused by seasonal variations in the demand for milk and dairy products.
The Company's cost of sales consists primarily of raw materials, including milk and items procured from outside parties, such as packaging material, and manufacturing costs, including direct labor and overhead. Significant factors affecting the Company's cost of sales include the costs of raw materials and labor and benefit rates.
The Company's operating costs consist of selling, distribution, general and administrative components. These costs include salaries for sales and marketing personnel, certain administrative personnel and executive salaries as well as salary and related costs for transportation and distribution.
The former Southern Belle Dairy Company received a Notice of Proposed Debarment dated June 1, 1994, from the USDA, in which the USDA proposed to debar the former Southern Belle Dairy Company from engaging in contracts and other transactions involving all federal agency procurement and nonprocurement programs for up to three years as a result of previously settled antitrust violations by such entity. On April 18, 1995, the former Southern Belle Dairy Company entered into a Compliance Agreement in Lieu of Debarment with the USDA (the "Southern Belle Compliance Agreement"). This agreement was for a three-year period and required the former Southern Belle Dairy Company to establish and maintain a compliance program which included, among other things, the establishment of an ethics committee and formal ethics and education training for all employees. Although the Southern Belle Compliance Agreement expired on April 18, 1998, the Southern Belle Division is still operating under its terms.
By notice dated December 31, 1997, the USDA suspended the Southern Belle Division from federal procurement and nonprocurement programs and proposed to debar such division for a period that by regulation would not exceed three years, based on alleged breaches of the Southern Belle Compliance Agreement by the former Southern Belle Dairy Company, prior to its merger with the Company in early December 1997. The Company has challenged the USDA action in an administrative proceeding. The USDA had proposed that the Southern Belle Division and the Company enter into a new Compliance Agreement in Lieu of Debarment as a means of resolving this matter and has indicated that Southern Belle could be subject to debarment and the Company subject to suspension and debarment if they fail to enter into such proposed agreement. The Company is currently engaged in discussions with USDA with respect to this matter.
On September 23, 1998, the USDA agreed to the Company's request that it separate the suspension and debarment proceedings against the Southern Belle Division and such similar threatened proceedings against the Company, and advised that it will pursue suspension and proposed debarment against the Southern Belle Division and the Company's settlement of civil antitrust litigation independent of each other. Accordingly, the USDA withdrew its offer to the Company of the newly proposed Compliance Agreement in Lieu of Debarment. The USDA advised that a decision on Southern Belle's suspension and debarment would be rendered by October 15, 1998, unless good cause exists to extend the determination period. Since that date, the USDA has extended that decision in successive 45-day periods with the latest notification stating the USDA's decision on Southern Belle's suspension and debarment will be rendered by April 14, 1999, unless good cause exists to extend the determination period.
Management is unable at this time to predict the outcome of this USDA proceeding; however, if unfavorably resolved, this USDA proceeding could have a material adverse effect on the Company's financial position and results of operations.
On September 11, 1998, the Company announced that it had executed an Agreement and Plan of Merger with Suiza Foods Corporation ("Suiza") a Delaware corporation and Suiza Foods Acquisition Corp. ("Merger Sub"), an Ohio corporation and wholly owned subsidiary of Suiza dated September 10, 1998 (the "Agreement"), providing for the merger of the Company with Merger Sub, with each Company share being exchanged for the sum of Nineteen Dollars ($19.00) cash. Consummation of the merger is conditioned upon satisfaction of all conditions contained in the Agreement. If the merger is consummated, the Company will become a wholly-
owned subsidiary of Suiza. On September 10, 1998, 5,774,335 shares of Company common stock were issued and outstanding. The Agreement was approved by Company shareholders at a special meeting held on December 4, 1998.
On January 18, 1999 the Company announced that Suiza and the Company had executed an amendment to the Agreement.
The amended Agreement, dated January 18, 1999, extends from December 31, 1998 to April 15, 1999 the date on which either party may terminate the amended Agreement if the merger has not been completed on such date. A related Stock Purchase Agreement dated January 18, 1999 between Suiza, the Company and eight shareholders of the Company provides that at completion of the merger, those shareholders will sell Two Million (2,000,000) Company shares to Suiza, and will receive, in lieu of the $19.00 per share cash merger consideration, the cash sum of $10.00 per Company share, without interest, plus the right to receive up to an additional $9.00 per share if certain earnings and performance goals are met between the date of the merger and March 31, 2000.
Subject to satisfaction of all conditions contained in the Agreement and Plan of Merger, as amended, and the Stock Purchase Agreement, the parties agreed to complete the merger on March 31, 1999.
On March 18, 1999 the United States District court for the Eastern District of Kentucky, London Division, entered a temporary restraining order enjoining Suiza, the Company and all persons acting on their behalf from consummating, directly or indirectly, their proposed merger, or implementing any other plan or agreement by which Suiza and the Company, or any part of them would combine under common ownership or control. Earlier the same day, the United States Department of Justice Antitrust Division ("DOJ") filed a Motion for Temporary Restraining Order ("TRO"), Motion for Preliminary Injunction and a Complaint in seeking to enjoin the proposed acquisition of the Company by Suiza. The DOJ alleged that competition in the production and sale of school milk in South Central Kentucky school districts would be substantially lessened as a result of the proposed transaction.
By terms of the Court's order, the TRO shall remain in effect until such time as the Court addresses the DOJ's Motion for Preliminary Injunction. Suiza and the Company independently concluded and agreed not to contest the motion for TRO. Suiza and the Company continue to review their options for responding to the DOJ's action.
RESULTS OF OPERATIONS
The following table presents certain information concerning the Company's results of operations, including certain information presented as a percentage of net sales.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
Net Sales
Net sales for 1998 increased $92.3 million, or 105.8%, to $179.4 million from $87.2 million for 1997. Net sales increased primarily due to (i) the acquisition of Southern Belle for a full year in 1998 compared to 20 days' sales in 1997 and (ii) the acquisition of London's in May 1998.
Cost of Sales
Cost of sales for 1998 increased $73.1 million, or 105.4%, to $142.3 million from $69.3 million in 1997. Cost of sales as a percentage of net sales was 79.3% in 1998 compared to 79.5% in 1997. The Company's cost of sales in 1998 have been impacted by the following factors: (i) a significant change in customer mix resulting from the Southern Belle and London's acquisitions, (ii) less dependence on the spot market for the Company's internal butterfat requirements, (iii) the production of certain products by the Company which were previously purchased from outside suppliers, (iv) a change in customer mix toward customers requiring additional delivery service with such sales typically having a lower cost basis as a percentage of net sales, and (v) an overall increase in butterfat and raw milk costs and increased price competition.
Operating Expenses
Operating expenses for 1998 increased $17.7 million, or 110.2%, to $33.7 million from $16.0 million in 1997. Operating expenses as a percentage of net sales increased to 18.8% in 1998 from 18.4% in 1997. This percentage increase was primarily due to increased general and administrative expenses as a result of direct merger costs associated with the proposed merger with Suiza Foods of approximately $420,000.
Other Income (Expense)
Other income (expense), net for 1998 changed by $328,000 to an expense of ($241,000) from income of $87,000 in 1997. This was primarily due to increased interest expense resulting from the purchase of London's.
Net Income
For reasons set forth above, net income for 1998 increased $746,000 to $1.9 million, or $0.33 per share on a diluted basis, from $1.2 million for 1997, or $0.28 per share on a diluted basis.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Net Sales
Net sales for 1997 increased $3.3 million or 3.9%, to 87.2 million from 83.9 million for 1996. The increase in net sales was primarily due to (i) favorable market conditions, (ii) the Company's pricing strategies with its current customers, (iii) a sales expansion into the northeast and (iv) the acquisition of Southern Belle for 20 days of 1997 and the acquisition of Johnson Dairy in May 1997. The increase in net sales for 1997 compared to 1996 would have been greater except for a one-time net sales increase in 1996 resulting from the Company entering into a co-packing arrangement with another dairy for the production of a nationally known brand product and the Company receiving certain one-time net sales from another dairy which had ceased operations due to a labor related work stoppage in the third quarter of 1996.
Cost of Sales
Cost of sales for 1997 increased $624,000, or 0.9%, to $69.3 million from $68.7 million in 1996. Cost of sales as a percentage of net sales, however, decreased to 79.5% in 1997 from 81.8% in 1996 primarily as a result of (i) reductions in raw material prices and changes in customer mix for certain sales in 1996 related to the Company entering into a co-packing arrangement with another dairy for the production of a nationally known brand product and (ii) the Company receiving certain one-time sales from another dairy which had ceased
operations due to a labor related work stoppage in the third quarter of 1996, which sales had a higher cost basis as a percentage of sales.
Operating Expenses
Operating expenses for 1997 increased $1.5 million, or 10.4%, to $16.0 million from $14.5 million in 1996. Operating expenses as a percentage of net sales were 18.4% in 1997 compared to 17.3% in 1996. Operating expenses as a percentage of net sales increased primarily due to a shift in customer mix from customers who utilized the Company's dock pickup program in 1996 to customers requiring additional delivery services.
Other Income
Other income for 1997 was $87,000 compared to $3.0 million in 1996. The decrease in other income was due primarily to a pre-tax gain of $3.0 million on the sale of the Company's investment in the nonmarketable common stock of a privately held entity which was sold by the Company to enhance cash flow, which resulted in cash proceeds of $3.1 million in 1996. The decrease was also impacted by the additional income earned on life insurance proceeds in 1996 upon the death of the former Chairman.
Net Income
For the reasons set forth above, net income for 1997 decreased $1.2 million to $1.2 million, or $0.28 per share on a diluted basis, from $2.3 million, or $0.57 per share on a diluted basis in 1996. The 1996 net income per share was favorably impacted by a pre-tax gain of $3.0 million on the sale of an investment in the non-marketable common stock of a privately held entity.
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically financed its capital expenditures and working capital requirements through cash generated from operating activities. The Company's working capital position increased to $16.9 million at December 31, 1998 from $16.7 million at December 31, 1997.
Cash Flows Provided by (Used in) Operating Activities.
Cash flows provided by (used in) operating activities for fiscal years 1996, 1997, and 1998 were $126,000; ($1,073,000) and ($129,000), respectively.
Cash Flows Provided by (Used in) Investing Activities.
Cash flows provided by (used in) investing activities for fiscal years 1996, 1997, and 1998 were $3.0 million; ($4.1) million and ($23.3) million, respectively.
Cash flows used in investing activities have historically consisted of capital expenditures. The Company's capital expenditures for 1998 were $5.1 million, compared to $2.0 million for 1997. The Company's capital expenditures in 1998 consisted primarily of the addition of a water pre-treatment facility at the Southern Belle Division, computer and software upgrades and additions for the Company's corporate offices and Dairy Division and design, engineering, construction and equipment costs at the Dairy Division's plant in Marietta, Ohio.
In May 1998, the Company expended $19.0 million for the cash consideration and related acquisition costs for the purchase of London's, net of cash acquired.
In December 1997, the Company expended $2.2 million for the cash consideration and related acquisition costs for the purchase of Southern Belle, net of cash acquired.
In May 1997, the Company acquired substantially all of the operating assets of Johnson's All-Star Dairy ("Johnson") for approximately $565,000 in cash. Johnson sells dairy products in West Virginia, eastern Kentucky and southeastern Ohio.
In November 1996, the Company received approximately $3.1 million from the sale of an investment in the nonmarketable common stock of a privately held entity. The Company recorded a gain on the sale of such stock in the amount of $3.0 million.
Cash Flows (Used in) Provided by Financing Activities.
Cash flows (used in) provided by financing activities for fiscal years 1996, 1997 and 1998 were ($989,000), $12.5 million, and $18.0 million respectively. In 1997 as a result of an initial public offering, the Company received net proceeds in the aggregate amount of $19.7 million. As a result of the Offering, all debt was paid down, as of December 31, 1997 in the aggregate amount of $7.5 million with the exception of a capital lease obligation with an outstanding balance of $58,297 at December 31, 1997.
On March 30, 1998, the Company finalized a loan commitment agreement with a bank that was entered into on February 16, 1998. The agreement provides for two additional credit facilities, in addition to the Company's $4.0 million line of credit agreement with another bank. The first facility provides for a $15.0 million line of credit with interest at either the bank's prime rate or LIBOR plus a margin. The borrowings under this agreement are uncollateralized and the Company pays a commitment fee on unused borrowings ranging from .20% to .35%. The second facility is a $5.0 million uncollateralized capital expenditure line of credit at either the bank's prime rate or LIBOR plus a margin. The borrowings under this commitment are uncollateralized and provide for monthly interest-only payments for one year, converting to term debt to be paid over seven years. As a result of the Company's acquisition of London's, approximately $19.3 million was drawn from the Company's available credit facility in May 1998 to finance the acquisition.
The most restrictive covenants under these agreements are the maintenance of a maximum funded debt to Earnings Before Interest Expense, Taxes, Depreciation and Amortization (EBITDA) ratio, a minimum tangible net worth, a minimum Earnings Before Interest and Taxes (EBIT) to interest expense ratio, a cashflow coverage ratio as well as other restrictive covenants which are included in the credit agreement dated March 30, 1998.
The Company believes that current cash positions, expected cash flows from operating activities and cash flows from financing activities will be sufficient to fund the Company's capital requirements for at least the next 12 months. To the extent that the Company is successful in consummating acquisitions and/or implementing its expansion plans, it may be necessary to finance such acquisitions and/or expansion plans through the issuance of additional equity securities, incurrence of indebtedness or both.
YEAR 2000
The Year 2000 problem can affect all software programs and physical devices with embedded computer chips or processors. The Company has been concerned with this problem and committed to limiting its exposure. The Company and its subsidiaries have put in place a plan to analyze all software and systems in order to isolate where Year 2000 problems will occur. This project is divided into two major sections; General Offices and Plants, and is being reviewed on a divisional basis.
The analysis of the General Offices includes all systems and software, including, but not limited to, major business software and hardware; personal computers; telephone systems; and security systems. The Company's General Offices review is near completion. The major business application hardware and software for the Company's London's Farm Dairy Division, a commercial software package, is Year 2000 compliant; however, the software vendor is continuing its testing program. The Company's Dairy division hardware is compliant and a compliant software version of its business applications is to be supplied by the vendor in the second quarter of 1999. The Company's Foods division hardware is compliant and will commence conversion to the Company's Dairy division's commercial software package in the second quarter of 1999. The Company's Southern Belle division hardware and software is currently non-compliant. This division will commence conversion to the software utilized by the Company's Dairy division in the second quarter of 1999.
The analysis of the Company Plants includes all systems and software, including, but not limited to, process control equipment (PLC) and software; personal computers; safety systems; telephone systems; and security systems. The Company Plants have been contacting their vendors to ensure Year 2000 compliance. A substantial
portion of this section of the project has been completed. The analysis phase will be completed by the second quarter of 1999. All Company Plant systems are expected to be compliant by the third quarter of 1999.
The Company is committed to remediate or replace any software or system that has been identified as being non-Year 2000 compliant. The review of the majority of software and systems is completed. As Year 2000 compliance issues are identified, they have been eliminated. For the past several years, all software and system purchases and/or upgrades were made with the understanding of Year 2000 compliance. An ownership change in November 1996 was a primary driver in the replacement of major business hardware and software. Although Year 2000 compliance was a consideration, it did not accelerate the conversion to the new systems. The remaining costs associated with Year 2000 compliance are not expected to significantly affect the operating cash flow, although such costs have not been completely quantified at this time.
Contingency plans have been created in order for the Company to produce and distribute products in the event of non-compliance. The impact of these contingencies would not adversely affect the operation or financial condition of the Company.
The Company is also concerned with the readiness of its suppliers and vendors with a material relationship to the Company. They are being contacted on the Company's behalf to verify that their systems also will be Year 2000 compliant and, if not, whether such non-compliance will have a material impact on the operations of the Company. The Company intends to develop, if needed, contingency plans to facilitate a supply of products to its customers and the receipt of products from suppliers and vendors if problems are discovered.
Despite the Company's efforts in regards to this issue, there can be no assurance that partial or total systems interruptions, or the costs necessary to update hardware and software, would not have a material adverse effect upon the Company. The foregoing assessments of the impact on the Year 2000 compliance problem on the Company are based on management's best estimates at the present time and could change substantially. The Company's readiness program is an ongoing process and the estimated completion dates for various software and systems described above are subject to change.
INFLATION
The impact of inflation on the Company's business has been insignificant to date and the Company believes that it will continue to be insignificant for the foreseeable future.
NEW ACCOUNTING PRONOUNCEMENTS
In March 1998, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." The SOP requires that certain external costs and internal payroll and payroll-related costs be capitalized during the application development and implementation stages of a software development project and amortized over the software's useful life. The SOP is effective in the first quarter of 1999 and the Company does not anticipate that this SOP will have an adverse effect on the Company's results of operations.
Additionally, SOP 98-5, "Reporting on the Costs of Start-Up Activities", was issued in April 1998. The SOP requires that entities expense start-up costs and organization costs as they are incurred. The SOP is effective in the first quarter of 1999 and the Company does not anticipate that this SOP will have an adverse effect on the Company's results of operations.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and other information required by this item are contained in the financial statements and footnotes thereto listed in the index on page on this report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There were none.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS:
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(1) Director of the West Virginia Dairy Products Association
(2) Director of SBR, Inc., Peoples Banking & Trust Company and Peoples Bancorp., Inc.
(3) Director of McCorkle Machine and Engineering Company, Banc One West Virginia Corporation, Champion Industries, Inc. and Logan Corporation.
(4) Director of the First National Bank of Southeastern Ohio, Marmac Corporation and Ohio Banks Association, and the Chairman of the Board of Directors of Russell Federal Savings Bank.
(5) Director of Banc One West Virginia Corporation and Banc One Charleston.
(6) Chairman of the Board of the Radisson Hotel in Huntington, West Virginia, Chairman of McCorkle Machine and Engineering Company, Director of the Abigail Adams National Bancorp, Inc., Chairman of the Board of First Guaranty Bank, and Chairman of the Board of Premier Financial Bancorp.
(7) Director of Banc One West Virginia Corporation, Champion Industries, Inc. and Logan Corporation.
(8) Director, Innovative Screen Technology, Inc. and American Centrifuge, Inc.
(9) Director, Thomas Bradford Shirt Company; former Director, and executive officer of AxisTech Warehouse, Inc., and former Chief Executive Officer of Mid-American Spring Air, Inc. (each of which filed for protection under the federal bankruptcy laws in February 1998 and March 1998, respectively.)
(10) Director of Peoples Bancorp, Inc., The Peoples Banking and Trust Company and First National Bank of Southeastern Ohio.
(11) Director, Thomas Bradford Shirt Company; former Chairman of the Board of Directors, Mid-American Spring Air, Inc. (see note 9 above).
MEETINGS AND COMMITTEES OF THE BOARD
During the calendar year ended December 31, 1998, the Board of Directors held 13 meetings. During their term, all of the then incumbent directors, were present for at least seventy-five percent of the meetings of the Board and the committees of the Board on which they serve.
The Compensation Committee of the Board of Directors presently consists of Messrs. Evans, Reynolds, Scaggs and Theisen. The Compensation Committee is responsible for the determination of the compensation for the Company's directors and officers and recommends policies relating to the Company's benefits plans. The compensation committee held one meeting in 1998.
The Audit Committee of the Board of Directors has certain duties relating to the year-end audit, the Company's internal accounting controls and the Company's relationship with its independent auditors. Messrs. Hooten, Shell and Taylor are the current members of the Audit Committee. There was one Audit Committee meeting held in 1998.
The Board of Directors does not have a nominating committee or committee performing similar functions. The Board of Directors will consider stockholder nominations for directors timely given in writing to the secretary of the Company prior to the meeting.
COMPENSATION OF DIRECTORS
Each of the Company's directors received, during 1998, $500 for each meeting of the Board personally attended by him. Directors of the Company are reimbursed for their expenses in attending meetings of the Board of Directors.
EXECUTIVE OFFICERS OF THE REGISTRANT:
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
During 1998, to the knowledge of the Company, each of the Company's directors, executive officers and 10% shareholders filed all reports relating to the Common shares required under Section 16(a) of the Exchange Act.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth information as to compensation paid for services rendered to the Company by the President and Chief Executive Officer for each of the three calendar years ended December 31, 1998. No other executive officer of the Company received a total annual salary and bonus in excess of $100,000 with respect to such, except Martin P. Shearer for services rendered in 1998.
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(1) Mr. Cline began serving as President and Chief Executive Officer of the Company as of November 18, 1996.
(2) This represents fees paid to Mr. Cline for serving on the Company's Board of Directors.
(3) This represents fees paid to Mr. Shearer for serving on the Company's Board of Directors, life insurance premiums and matching contributions by the Company to its 401(k) Plan.
(4) Mr. Shearer began serving as vice-president, general manager, Southern Belle Division in December 1997.
EMPLOYMENT AND SEVERANCE AGREEMENTS
During 1997, the Company entered into an employment agreement (the "Employment Agreement") with Martin P. Shearer in connection with the Company's acquisition (the "Acquisition") of the Southern Belle Dairy Company ("Southern Belle") on December 12, 1997. Under the Employment Agreement, which is terminable at the will of either party after 30 days' written notice, Mr. Shearer is entitled to an annual base salary of approximately $80,000, an annual bonus of 4% of the net pre-tax profits of the Southern Belle division of the Company and certain customary benefits. Under the Employment Agreement, Mr. Shearer is subject to certain customary non-compete conditions for a period of two years after a termination of his employment with the Company.
REPORT ON COMPENSATION OF EXECUTIVE OFFICERS
Messrs. Evans, Reynolds, Scaggs and Theisen currently serve as the members of the Compensation Committee. The Compensation Committee establishes salaries, incentives and other forms of compensation for the Company's directors and officers and recommends policies relating to the Company's benefit plans.
The Company makes an effort to offer competitive compensation packages that allow the Company to attract and retain highly qualified individuals. The Compensation Committee believes the long-term strategic goals of the Company can be accomplished only if the Company employs management with experience and skills relevant to the changing nature of the Company's products, sales and marketing efforts. A not insubstantial portion of each executive officer's total compensation is incentive-based in order to motivate the Company's executive officers in the performance of their duties and to encourage a continued focus on Company profitability. For those executive officers responsible for particular production divisions of the Company, the financial and non-financial results of their divisions are also considered. The Compensation Committee believes that by emphasizing performance based compensation, it will encourage the Company's management to act in concert with the interests of the Company's shareholders. The Company currently does not maintain any long-term incentive plans and does not grant stock appreciation rights, stock options or restricted stock awards, but is presently considering the implementation of an incentive stock plan.
Compensation packages offered to the Company's senior management are thought to be competitive within the dairy food industry. The Compensation Committee believes the compensation packages for its senior management are competitive with compensation packages for executives of other public domestic dairy food companies based on the size and current structure of the organization and are based on the discretion of the committee. The Compensation Committee meets with the President to evaluate the performance of the other executive officers and meets in the absence of the President to evaluate his performance. The Compensation Committee reports its executive evaluations to the other outside members of the Board.
Mr. Cline's $80,004 salary for fiscal 1998 was established by the Compensation Committee to be an acceptable base salary and is not tied to any objective standards of the Company's stock performance or earnings in fiscal 1998. Mr. Cline may also be eligible for a bonus from time to time based on various objective and subjective standards as may be established by the Compensation Committee. In 1998 Mr. Cline received a bonus of $20,000.
The overall compensation of each of the Company's executive officers (other than Mr. Cline) consists of two principal elements:
Base Salary
Executive officers' base salaries are reviewed annually by the Compensation Committee. In the case of all executive officers, their base salary is their principal element of compensation. In an effort to ensure that the Company can obtain the talent it needs to effectuate its long-term strategies, the base salary of all executive officers has been set at a level that is thought to be competitive within the group of public businesses identified as similar to the Company and adjusted accordingly based on the current size and structure of the Company. Factors
considered in establishing base salaries include the requisite skill and experience required in a particular position, the range of duties and responsibilities attributable to that position, the individual's prior experience and compensation, the compensation similarly situated individuals in the dairy food industry and the overall past and expected future contributions of the individual. Generally, in establishing such salaries, the greatest weight is given to ensuring that a competitive salary level is established. Overall, the process is subjective, with no precise, mathematical weight given to the enumerated factors.
Annual Bonus
The Company operates an annual bonus plan. As of September 1, 1997, the general managers of the Southern Belle Division, the Dairy Division and the Foods Division are entitled to an annual bonus of 4% of the net pre-tax profits of their respective divisions. The bonus element of each executive officer's compensation is set at a level that the Compensation Committee believes is necessary to compensate executive officers for the achievement of short-term goals forming part of the Company's overall strategic objectives. Short-term sales, profit and performance goals for each division and for the Company as a whole are developed annually and in advance by the Company's management and then reviewed by the Company's Board of Directors. Performance is monitored against established goals throughout the year.
Performance Graph
The following graph compares the cumulative total return of the Company's Common Stock during the period commencing December 9, 1997, to December 31, 1998, with the Standard & Poor's 500 Stock Index (the "S & P 500 Index"), Russell 2000 Index and a peer group index (the "Peer Group Index") of United States companies within Standard Industrial Codes 2020 to 2029 (dairy products). The graph depicts the results of investing $100 in the Common Shares, the S & P 500 Index, the Russell 2000 Index and the Peer Group Index at closing prices on December 31, 1998.
COMPARISON OF 13 MONTH CUMULATIVE TOTAL RETURN* AMONG BROUGHTON FOODS COMPANY, THE S & P 500 INDEX, THE RUSSELL 2000 AND A PEER GROUP
[GRAPH]
*$100 invested on 12/9/97 in stock or on 11/30/97 in index - including reinvestment of dividends. Fiscal year ending December 31.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Set forth below is a table showing certain information with respect to those persons known to the Company to be the beneficial owners of more than 5% of the outstanding shares of Common Stock, the Named Executives, each director of the Company and all executive officers and directors of the Company as a group as of March 17, 1999.
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* Indicates beneficial ownership of less than 1% of the issued and outstanding shares of Common Stock.
(1) Calculated pursuant to Rule 13d-3(d) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Under Rule 13d-3(d), shares not outstanding which are subject to options, warrants, rights or conversion privileges exercisable within 60 days are deemed outstanding for the purpose of calculating the number and percentage owned by such person, but not deemed outstanding for the purpose of calculating the percentage owned by each other person listed. As of March 17, 1999, the Company had 5,774,335 shares of Common Stock issued and outstanding.
(2) Includes 435,000 shares held by Mr. Reynolds' wife and children, 4,050 shares held by ADJ Corporation (an entity controlled by certain immediate family members of Mr. Marshall Reynolds), 6,150 shares held by Champion Leasing Corporation (an entity which holds shares over which Mr. Marshall Reynolds effectively exercises sole voting and investment power) and 78,440 shares held by Harrah & Reynolds Corporation (an entity which holds shares over which Mr. Marshall Reynolds effectively exercises sole voting and investment power). Mr. Reynolds' address is 2450 First Ave., Huntington, West Virginia 25701.
(3) Does not include 12,000 shares held in trust over which Mr. Cline disclaims beneficial ownership.
(4) Includes 29,250 shares held by Mr. Broughton's children.
(5) Includes 12,000 shares held by Mr. Hooten's children and 12,000 shares held in trust or in other forms of indirect ownership over which shares Mr. Hooten effectively exercises sole voting and investment power.
(6) Includes 27,000 shares held by Mr. Scaggs' family members and 12,000 shares held in trust over which shares Mr. Scaggs effectively exercises sole voting and investment power.
(7) Includes 450 shares held by Mr. Taylor's children.
(8) Includes 300,000 shares held in trust over which shares Mr. Wright effectively exercises sole voting and investment power. Mr. Wright's address is 500 Scott Street, Hangar A, Worthington, Kentucky 41183.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company's distribution center in Ashland, Kentucky is leased from the ADJ Corporation for $9,350 a month, subject to adjustment after April 1, 2002, based on a specified consumer price index. The lease expires on April 30, 2007. The ADJ Corporation is controlled by certain immediate family members of Mr. Marshall T. Reynolds, Chairman of the Company's Board of Directors. Lease expense for 1998 was $112,200.
The Company purchased office supplies and printing services, from certain divisions of Champion Industries, a company controlled by Mr. Marshall T. Reynolds, Chairman of the Company's Board of Directors. Such purchases totaled $130,000 in 1998.
The Company purchased equipment for plant and building repairs from Hooten Equipment. Mr. Charles R. Hooten, Jr., a member of the Company's Board of Directors, serves as President of Hooten Equipment Company. Such purchases totaled $108,100 in 1998.
PART IV.
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)
(1) Financial Statements
The consolidated balance sheets at December 31, 1998 and 1997, the related consolidated statements of operations, of shareholders' equity and of cash flows for each of the three fiscal years in the period ended December 31, 1998, and the notes thereto, together with the report from PricewaterhouseCoopers LLP, dated March 19, 1999, are filed in Section of this report.
(2) Schedules other than those listed on page, are omitted because of the absence of conditions under which they are required or because the information required is included in the consolidated financial statements and notes thereto.
(3) EXHIBITS
(b) The Company filed no reports on Form 8-K during the last quarter of the period covered by this report.
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.
BROUGHTON FOODS COMPANY
/s/ PHILIP E. CLINE By: --------------------------------------
Philip E. Cline President and Chief Executive Officer
March 30, 1999
INDEX TO FINANCIAL STATEMENTS -- COMPANY
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders Broughton Foods Company and Subsidiaries
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, shareholders' equity and cash flows present fairly, in all material respects, the financial position of Broughton Foods Company and Subsidiaries (the "Company") at December 31, 1997 and December 31, 1998 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. 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 of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
PRICEWATERHOUSECOOPERS LLP
Columbus, Ohio March 19, 1999
BROUGHTON FOODS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of the consolidated financial statements.
BROUGHTON FOODS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS -- (CONTINUED)
The accompanying notes are an integral part of the consolidated financial statements.
BROUGHTON FOODS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of the consolidated financial statements.
BROUGHTON FOODS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
The accompanying notes are an integral part of the consolidated financial statements.
BROUGHTON FOODS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of the consolidated financial statements.
BROUGHTON FOODS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS -- (CONTINUED)
The accompanying notes are an integral part of the consolidated financial statements.
BROUGHTON FOODS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF ACCOUNTING POLICIES:
A. BUSINESS AND PRINCIPLES OF CONSOLIDATION: Broughton Foods Company and its wholly owned subsidiaries (collectively referred to as the "Company") was organized in April 1933 under the laws of the state of Ohio. The Company is engaged primarily in the business of producing dairy and dairy-related food products for wholesale and retail distribution in Ohio, West Virginia, Kentucky, Tennessee, Michigan and parts of the eastern United States. The Company also operates one limited service restaurant under the name "Broughton's." The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Somerset Computer Services, which became a subsidiary of the Company on December 12, 1997, concurrent with the Southern Belle merger and LFD Holding Corp and its wholly-owned subsidiary, London's Farm Dairy, Inc. All significant inter-company accounts and transactions have been eliminated.
B. INVENTORIES: In connection with the Company's initial public offering, a new method for accounting for cost was adopted to make the Company's inventory values comparable to the predominate method used by public companies in its industry. Inventories are valued at the lower of cost or market with cost determined on the first-in, first-out ("FIFO") method using standard costs which approximate actual. The financial statements of all prior years have been restated to apply the new method retroactively. Before January 1, 1997, inventory had been valued with cost determined on the last-in, first-out method. For income tax purposes, the FIFO method has been adopted as of January 1, 1998.
The major components of inventory at December 31, 1997 and 1998 were as follows:
C. PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment are stated at cost. The Company provides for depreciation and amortization principally on the straight-line method in amounts adequate to amortize costs over the estimated useful lives of the assets. Useful lives for major classes of property, plant and equipment are as follows:
Upon sale or retirement, the Company removes the asset cost and related accumulated depreciation from the appropriate accounts and reflects any gain or loss in current operations. Depreciation expense was approximately $890,000 in 1996, $1,013,000 in 1997 and $2,266,000 in 1998 and has been recorded in the statements of operations.
D. INVESTMENTS: The Company previously held various nonmarketable securities which were carried at cost. These investments were held as noncurrent assets in other assets. During 1996, the Company sold the shares of a privately held entity for $3,056,196. A pre-tax gain of $2,976,453 was recorded on this sale. At December 31, 1997 and 1998, the Company had no investments in nonmarketable securities.
E. NET INCOME PER SHARE OF COMMON STOCK: Basic earnings per share were computed by dividing net income available to common shareholders (the numerator) by the weighted average number of
BROUGHTON FOODS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
common shares outstanding (the denominator). Diluted earnings per share were computed by dividing the net income available to common shareholders (the numerator) by the sum of the weighted average number of shares outstanding and the dilutive effect of outstanding options as determined by the application of the treasury stock method (the denominator).
F. CASH AND CASH EQUIVALENTS: For purposes of the consolidated statements of cash flows, the Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. The Company maintains its cash balances primarily with one financial institution.
G. REVENUE RECOGNITION: The Company recognizes revenue when products are received by the customer.
The allowance for doubtful accounts approximated $140,000, $243,000, $465,000, and $652,000 at December 31, 1995, 1996, 1997 and 1998, respectively. As a result of the Southern Belle acquisition, approximately $251,000 was recorded as an addition to the allowance for doubtful accounts in December 1997. As a result of the London's acquisition, approximately $261,000 was recorded as an addition to the allowance for doubtful accounts in May 1998.
H. INCOME TAXES: The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes", which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of the assets and liabilities using enacted tax rates.
I. USE OF ESTIMATES: The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates.
J. FAIR VALUE OF FINANCIAL INSTRUMENTS: Fair value of long-term debt is based on the interest rate available to the Company on similar debt agreements. As the interest rates on the Company's long-term debt obligations are primarily variable rates for approximately $19.3 million of debt obligations, fair value approximates the carrying value.
K. RECLASSIFICATIONS: Certain prior-year amounts have been reclassified to conform to the current-year financial statement presentation.
L. SEGMENT INFORMATION: In 1998, the Company adopted SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. SFAS 131 supersedes SFAS 14, Financial Reporting for Segments of a Business Enterprise, replacing the "industry segment" approach with the "management" approach. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Company's reportable segments. SFAS 131 also requires disclosures about products and services, geographic areas, and major customers. The adoption of SFAS 131 did not affect results of operations or financial position but did affect the disclosure of segment information (see "Segment Information" note).
M. PENSION PLAN: In 1998, the Company adopted SFAS No. 132, "Employers' Disclosures About Pensions and Other Post-Retirement Benefits", which requires revisions of employers' disclosures about pension and other post-retirement plans. The adoption of SFAS No. 132 did not change the measurement or recognition of the Plan.
N. REPORTING COMPREHENSIVE INCOME: In 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive Income". SFAS No. 130 established standards for reporting and display of comprehensive
BROUGHTON FOODS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. The adoption of this standard did not affect the Company's financial statements.
O. NEW ACCOUNTING PRONOUNCEMENTS: In March 1998, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use". The SOP requires that certain external costs and internal payroll and payroll-related costs be capitalized during the application development and implementation stages of a software development project and amortized over the software's useful life. The SOP is effective in the first quarter of 1999 and the Company does not anticipate that this SOP will have an adverse effect on the Company's results of operations.
Additionally, SOP 98-5, "Reporting on the Costs of Start-Up Activities, was issued in April 1998. The SOP requires that entities expense start-up costs and organization costs as they are incurred. The SOP is effective in the first quarter of 1999 and the Company does not anticipate that this SOP will have an adverse effect on the Company's results of operations.
2. NOTE PAYABLE -- BANK:
The Company has an uncollateralized line of credit of $4.0 million with a Bank. Interest on this line of credit is .25 percentage points under the highest prime rate as published by the Wall Street Journal.
On March 30, 1998, the Company finalized an agreement with a Bank to provide for two additional credit facilities, in addition to the Company's $4.0 million line of credit agreement with another bank. The first facility provides for a $15.0 million line of credit with interest at either the Bank's prime rate or LIBOR plus a margin. The borrowings under this agreement are uncollateralized and the Company pays a commitment fee on unused borrowings ranging from .20% to .35%. The principal is payable in full on March 30, 2000, with monthly interest-only payments. The second facility is a $5.0 million uncollateralized capital expenditure line of credit at either the Bank's prime rate or LIBOR plus a margin. The borrowings under this commitment provide for monthly interest-only payments for one year, converting to term debt to be paid over seven years.
The most restrictive covenants under these agreements are the maintenance of a maximum funded debt to Earnings Before Interest Expense, Taxes, Depreciation and Amortization (EBITDA) ratio, a minimum tangible net worth, a minimum Earnings Before Interest and Taxes (EBIT) to interest expense ratio and a cashflow coverage ratio.
The Company had $19,336,230 outstanding under its revolving credit facilities at December 31, 1998.
BROUGHTON FOODS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. TERM DEBT:
Term debt as of December 31, 1997 and 1998 consisted of the following:
4. LEASE COMMITMENTS:
The Company leases certain property, plant and equipment (primarily delivery vehicles) under noncancellable operating lease agreements expiring through 2007. Certain of the leases include renewal options at terms similar to the initial lease terms. Minimum rentals in connection with these leases are as follows:
Total rental expense for cancelable and noncancelable lease agreements approximated $2,238,600 in 1996, $2,800,200 in 1997 and $6,499,000 in 1998, of which $393,000 in 1996, $546,000 in 1997, and $1,630,000 in 1998 were contingent rentals. Contingent rentals are based primarily on mileage.
5. PENSION PLAN:
The Company has a noncontributory pension plan for all nonmanagement hourly employees not subject to a collective bargaining agreement and substantially all salaried employees for two of the Company's divisions. Benefits under the plan are based upon a social security offset formula. Total pension expense (benefit) was $132,600 in 1996, $64,492 in 1997 and ($60,138) in 1998. The Company funds contributions based upon normal cost under the projected unit credit method subject to Internal Revenue Service minimum and maximum limitations. The following table sets forth the plan's funded status and amount included in the Company's financial statements at December 31, 1997 and 1998.
BROUGHTON FOODS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Plan assets include investments in stock and bond common trust funds and U.S. Government and corporate bonds.
Net periodic pension expense for the Company for 1996, 1997 and 1998 included the following:
RECONCILIATION OF PROJECTED BENEFIT OBLIGATION
BROUGHTON FOODS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
RECONCILIATION OF MARKET VALUE OF ASSETS
The following assumptions were used in the calculation of the actuarial present value of benefit obligations at December 31, 1996, 1997 and 1998:
In addition, the Company participates in three multi-employer plans that provide defined benefits to substantially all the Company's unionized employees. Amounts charged to pension expense and contributed to the plans were $387,453 in 1996, $419,365 in 1997 and $493,202 in 1998.
6. DEFERRED SAVINGS PLAN:
Salaried, nonunion, and certain union hourly employees are eligible to participate in a deferred savings plan and trust (401(k) plan) for two divisions. Under the plan, the Company is required to make contributions based on a percentage of the employee's payroll contribution, limited to a maximum of 1.5% of the employee's total compensation. The Company contributed $43,600 in 1996, $41,900 in 1997 and $46,175 in 1998.
The Company has a defined contribution profit-sharing plan covering substantially all employees not covered in the plan discussed above, except for those covered by a collective bargaining agreement which requires the Company to contribute to a multiemployer pension retirement fund. This plan was carried forward from the Southern Belle acquisition. The plan allows eligible employees to contribute up to 15% of their compensation. The Company contributes 25% of the amount of each participant's contribution for the plan year, up to 1% of the participant's salary. For the years ended December 31, 1997 and 1998, $2,300 and $26,400 has been recorded, respectively, as pension expense under this defined contribution profit-sharing plan.
The Company sponsors a defined contribution plan for employees not covered in the plans discussed above who meet certain eligibility requirements. This plan was carried forward from the London's acquisition. The Company may make discretionary contributions to the plan at the option of the Board of Directors. In addition, the Company may match employee contributions equal to a percentage of the participant's contribution to the plan. In 1998, the Company matched 100% of employee contributions, up to a maximum of 6% of the participant's annual compensation. The Company contributed $185,017 to the plan during the year ended December 31, 1998.
7. SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN:
The Company had a nonqualified benefit plan for certain key management employees. The plan provided for 50% of annual pay reduced for years less than 15 years, less benefits paid under the Company's qualified pension plan and social security. The Supplemental Executive Retirement Plan ("SERP") was terminated on
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
December 31, 1996, at which time the assets of the plan were distributed. The Company recognized a termination cost of approximately $232,700 associated with this transaction.
The following details the net pension expense under SFAS No. 87 and SFAS No. 88 recorded in 1996. There was no pension expense in 1997 and 1998 as the plan had been terminated.
The following table sets forth the SERP's funded status of the plan and amounts included in the Company's financial statements at December 31, 1996:
8. STOCK OPTIONS:
Certain shares of common stock were reserved for sale to certain officers and employees under an incentive stock option plan. There were no outstanding options at December 31, 1997 and 1998.
9. INCOME TAXES:
A reconciliation of the federal corporate income tax rate and the effective tax rate on income taxes is summarized below for the years ended December 31, 1996, 1997 and 1998:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Components of the provision for income taxes are as follows:
Deferred income taxes reflect the impact of "temporary differences" between the amounts of the assets and liabilities for financial reporting purposes and such amounts as determined by tax regulations. These temporary differences are determined in accordance with SFAS No. 109.
The components of the net deferred tax liability at December 31, 1997 and 1998 are as follows:
The Company had certain state net operating loss carryforwards of approximately $432,000 at December 31, 1997, as a result of the Southern Belle acquisition. These net operating losses were utilized in 1998.
The Company had certain federal net operating loss carryforwards of approximately $811,000 at December 31, 1998 as a result of the London's acquisition. This net operating loss expires in 2018. The alternative minimum tax credit carryforwards have no expiration dates.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. EARNINGS PER SHARE OF COMMON STOCK:
The Company adopted SFAS No. 128, "Earnings per Share" in the fourth quarter 1997. In accordance with the provisions of this statement, the following table sets forth the computation of earnings per share and earnings per share, assuming dilution.
11. SEGMENT INFORMATION:
In 1998, the Company adopted SFAS No. 131. The accounting policies of the segments are the same as those described in the "Summary of Accounting Policies." Segment data includes intersegment revenues with the elimination of intercompany profit. In addition, the Company does not allocate interest or corporate general and administrative expenses to the specific operating segment. Thus, the Company evaluates the performance of its segment based on an operating profit basis prior to charges for corporate general and administrative expenses and interest. Prior to 1998, corporate general and administrative expenses were included in segment operating profit.
The Company is organized primarily on an operating division basis based on historical operations, product sales and geographic location. The Company operates through four divisions -- The Dairy Division, Foods Division, Southern Belle Division and London's Farm Dairy Division. All of the Company's four divisions are primarily engaged in the manufacture and distribution of dairy based products. Therefore, the Company reports under one segment referred to as "Dairy." (The Dairy Division is an operating division of the Dairy segment.) The Dairy Division, with its raw milk processing plant based in Marietta, Ohio manufactures and distributes a full line of fresh milk and related products and also distributes brand name dairy and non-dairy foods. The Foods Division, with an ultra high temperature ("UHT") plant based in Charleston, West Virginia, processes a variety of extended life products, including half-and-half, sour cream, dips, dressings, aerosol toppings, whipped cream, coffee cream, table cream, non-dairy creamers and whipped toppings. The Southern Belle Division with its raw milk processing plant in Somerset, Kentucky manufactures and distributes a full line of fresh milk and other products and also distributes dairy and non-dairy foods. The London's Farm Dairy Division, with its raw milk processing plant in Port Huron, Michigan manufactures and distributes a full line of fresh milk and other products, while its Burton, Michigan plant produces a variety of ice cream products.
BROUGHTON FOODS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The table below presents information about reported segments for the years ending December 31:
1998:
1997:
1996:
A reconciliation of total segment sales to total consolidated sales and of total segment operating profit to total consolidated income before income taxes, for the years ended December 31, 1996, 1997 and 1998 is as follows:
SALES:
OPERATING INCOME:
12. COMMITMENTS AND CONTINGENCIES:
The former Southern Belle Dairy Company received a Notice of Proposed Debarment dated June 1, 1994, from the USDA, in which the USDA proposed to debar the former Southern Belle Dairy Company from engaging in contracts and other transactions involving all federal agency procurement and nonprocurement programs for up
BROUGHTON FOODS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
to three years as a result of previously settled antitrust violations by such entity. On April 18, 1995, the former Southern Belle Dairy Company entered into a Compliance Agreement in Lieu of Debarment with the USDA (the "Southern Belle Compliance Agreement"). This agreement was for a three-year period and required the former Southern Belle Dairy Company to establish and maintain a compliance program which included, among other things, the establishment of an ethics committee and formal ethics and education training for all employees. Although the Southern Belle Compliance Agreement expired on April 18, 1998, the Southern Belle Division is still operating under its terms.
By notice dated December 31, 1997, the USDA suspended the Southern Belle Division from federal procurement and nonprocurement programs and proposed to debar such division for a period that by regulation would not exceed three years, based on alleged breaches of the Southern Belle Compliance Agreement by the former Southern Belle Dairy Company, prior to its merger with the Company in early December 1997. The Company has challenged the USDA action in an administrative proceeding. The USDA had proposed that the Southern Belle Division and the Company enter into a new Compliance Agreement in Lieu of Debarment as a means of resolving this matter and has indicated that Southern Belle could be subject to debarment and the Company subject to suspension and debarment if they fail to enter into such proposed agreement. The Company is currently engaged in discussions with USDA with respect to this matter.
On September 23, 1998, the USDA agreed to the Company's request that it separate the suspension and debarment proceedings against the Southern Belle Division and such similar threatened proceedings against the Company, and advised that it will pursue suspension and proposed debarment against the Southern Belle Division and the Company's settlement of civil antitrust litigation independent of each other. Accordingly, the USDA withdrew its offer to the Company of the newly proposed Compliance Agreement in Lieu of Debarment. The USDA advised that a decision on Southern Belle's suspension and debarment would be rendered by October 15, 1998, unless good cause exists to extend the determination period. Since that date, the USDA has extended that decision in successive 45-day periods with the latest notification stating the USDA's decision on Southern Belle's suspension and debarment will be rendered by April 14, 1999, unless good cause exists to extend the determination period.
Management is unable at this time to predict the outcome of this USDA proceeding; however, if unfavorably resolved, this USDA proceeding could have a material adverse effect on the Company's financial position and results of operations.
The Company is involved in or subject to certain other legal proceedings, including with respect to regulatory matters, which arise in the ordinary course of the Company's business. Although the Company cannot predict the outcomes of these legal proceedings, the Company's management does not believe that these actions will have a material adverse effect on the Company's financial position, results of operations or liquidity.
13. SIGNIFICANT ESTIMATES AND CONCENTRATIONS:
The Company maintains a self-insurance program for that portion of health care, dental and vision costs not covered by insurance. The Company is liable for claims ranging from $40,000 to $75,000 annually per employee or covered participant based on the division of employment. Self-insurance costs are accrued based upon an estimate of the liability for reported claims and for claims incurred but not reported. An accrual totaling $363,900 and $475,850 has been made at December 31, 1997 and 1998, respectively.
During 1997, the Company entered into certain agreements obligating it to purchase labels and cartons over periods ranging from two to five years. At December 31, 1998, the Company was relieved of its carton purchase commitment. Based on the Company's historical production records, these quantities do not exceed expected product requirements.
In September 1998 the Company acquired certain intangible assets of a milk distributor. As a result of this asset purchase, the Company has agreed to a contingent payment of $125,000 based on sales volume. The
BROUGHTON FOODS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
contingent payments, if earned, are due in the amounts of $50,000, $50,000 and $25,000 on May 14, 1999, January 9, 2000 and September 7, 2000, respectively.
In 1998, the Company entered into an agreement to purchase certain refrigeration equipment at a cost of $319,500. At December 31, 1998 the Company had remaining purchase commitments of $286,567.
14. RELATED PARTY TRANSACTIONS:
The Company's distribution center in Ashland, Kentucky is leased from the ADJ Corporation for $9,350 a month, subject to adjustment after April 1, 2002 based on a specified consumer price index. The lease expires on April 30, 2007. The ADJ Corporation is controlled by certain immediate family members of Mr. Marshall T. Reynolds, Chairman of the Company's Board of Directors. Lease expense was $74,800 and $112,200 for the years ended December 31, 1997 and 1998, respectively. There was no lease expense prior to May 2, 1997 for this property.
The Company purchased office supplies from Garrison Brewer, a division of Champion Industries, controlled by Mr. Marshall T. Reynolds, Chairman of the Company's Board of Directors. Such purchases totaled $50,000 and $76,900 in 1997 and 1998, respectively. There were no purchases in 1996.
The Company also purchased office supplies and printing services from Chapman Printing Company, another division of Champion Industries. Such purchases totaled $57,000 and $53,400 in 1997 and 1998, respectively. There were no purchases in 1996.
The Company purchased equipment for plant and building repairs from Hooten Equipment. Mr. Charles R. Hooten, Jr., a member of the Company's Board of Directors, serves as President of Hooten Equipment Company. Such purchases totaled $32,000 and $108,100 in 1997 and 1998, respectively. There were no purchases in 1996.
The Company received legal services from Theisen, Brock, Frye, Erb & Leeper Company. Mr. Paul Theisen, a member of the Company's Board of Directors was the President and director of the law firm prior to January 1, 1998. Mr. Theisen currently serves in an of counsel capacity. Such services totaled $23,000, $45,000 and $36,200 for the years ended December 31, 1996, 1997 and 1998, respectively.
The Company leases certain property from members of the Broughton family and related trusts established by the Broughton family. Such rental expense totaled $36,100, $50,200 and $51,700 for the years ended December 31, 1996, 1997 and 1998, respectively.
15. EVENTS AFFECTING SHAREHOLDERS' EQUITY:
The Company was authorized to issue two classes of common stock, designated nonvoting Class A and voting Class B common stock. In February 1997, the shareholders elected to convert all nonvoting common stock to one class of voting common stock. In August 1997, the Company increased the number of authorized shares of common stock to 10,000,000 shares and amended the Company's articles of incorporation to eliminate and delete all reference to and cease to authorize a class of cumulative preferred stock.
On August 27, 1997, the Company's Board of Directors authorized a thirty-share-for-one-share common stock split in the form of a common stock dividend payable to shareholders of record on September 9, 1997. The effects of the above changes in the common stock of the Company have been applied to all periods presented.
The Company had 310 shares of 6% cumulative preferred stock outstanding at December 31, 1996. These shares were subject to redemption by the Company at $110 per share. On May 28, 1997, the Company's Board of Directors authorized these shares to be redeemed at $110 per share plus accumulated dividends. All shares were redeemed by June 30, 1997.
BROUGHTON FOODS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
16. ACQUISITIONS:
In May 1997, the Company purchased substantially all of the operating assets of Johnson Dairy for $565,000. Johnson Dairy had sales of approximately $5,200,000 for the year ended December 31, 1996.
During the year ended December 31, 1997, the Company acquired Southern Belle. Total acquisition costs were $5,359,524 consisting of $3,009,399 cash and the issuance of 156,675 shares of the Company's stock valued at $2,350,125.
The acquisition was accounted for by the purchase method, and accordingly, the purchase price has been allocated to the assets and liabilities acquired based upon their fair values at the date of acquisition. The fair values of these assets are summarized as follows:
The Company is amortizing goodwill from the Southern Belle acquisition over a period of 40 years.
The purchase price includes $5,000,000 of cash and stock paid to former Southern Belle shareholders and $359,524 of related acquisition costs.
On May 29, 1998, the Company purchased LFD Holding Corp. and its wholly-owned subsidiary, London's Farm Dairy, Inc. (collectively referred to as "London's") of Port Huron, Michigan. Total acquisition costs were $19,166,519. LFD Holding Corp. is a wholly-owned subsidiary of the Company.
The acquisition was accounted for by the purchase method, and accordingly, the acquisition costs have been allocated to the assets and liabilities acquired based upon their estimated fair values at the date of acquisition. The estimated fair values of these assets are summarized as follows:
BROUGHTON FOODS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Tradename, distribution network, workforce and goodwill are being amortized over the following estimated useful lives on a straight-line basis:
The following table summarizes the unaudited consolidated pro forma results of operations and pro forma earnings per share for the years ended December 31, 1997 and 1998 assuming the Southern Belle and London's acquisition had occurred at January 1, 1997.
The consolidated pro forma results of operations and pro forma earnings per share do not represent the Company's actual results of operations, nor do they purport to predict or indicate the Company's financial position or results of operations at any future date or for any future period, and they are not necessarily indicative of the results that would have been obtained had the companies been combined during the periods indicated.
17. PROPOSED MERGER WITH SUIZA FOODS CORPORATION:
On September 11, 1998, the Company announced that it had executed an Agreement and Plan of Merger with Suiza Foods Corporation ("Suiza") a Delaware corporation and Suiza Foods Acquisition Corp. ("Merger Sub"), an Ohio corporation and wholly owned subsidiary of Suiza dated September 10, 1998 (the "Agreement"), providing for the merger of the Company with Merger Sub, with each Company share being exchanged for the sum of Nineteen Dollars ($19.00) cash. Consummation of the merger is conditioned upon satisfaction of all conditions contained in the Agreement. If the merger is consummated, the Company will become a wholly-owned subsidiary of Suiza. On September 10, 1998, 5,774,335 shares of Company common stock were issued and outstanding. The Agreement was approved by Company shareholders at a special meeting held on December 4, 1998.
On January 18, 1999 the Company announced that Suiza and the Company had executed an amendment to the Agreement.
The amended Agreement, dated January 18, 1999, extends from December 31, 1998 to April 15, 1999 the date on which either party may terminate the amended Agreement if the merger has not been completed on such date. A related Stock Purchase Agreement dated January 18, 1999 between Suiza, the Company and eight shareholders of the Company provides that at completion of the merger, those shareholders will sell Two Million (2,000,000) Company shares to Suiza, and will receive, in lieu of the $19.00 per share cash merger consideration, the cash sum of $10.00 per Company share, without interest, plus the right to receive up to an additional $9.00 per share if certain earnings and performance goals are met between the date of the merger and March 31, 2000.
Subject to satisfaction of all conditions contained in the Agreement and Plan of Merger, as amended, and the Stock Purchase Agreement, the parties agreed to complete the merger on March 31, 1999.
BROUGHTON FOODS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
On March 18, 1999 the United States District court for the Eastern District of Kentucky, London Division, entered a temporary restraining order enjoining Suiza, the Company and all persons acting on their behalf from consummating, directly or indirectly, their proposed merger, or implementing any other plan or agreement by which Suiza and the Company, or any part of them would combine under common ownership or control. Earlier the same day, the United States Department of Justice Antitrust Division ("DOJ") filed a Motion for Temporary Restraining Order ("TRO"), Motion for Preliminary Injunction and a Complaint in seeking to enjoin the proposed acquisition of the Company by Suiza. The DOJ alleged that competition in the production and sale of school milk in South Central Kentucky school districts would be substantially lessened as a result of the proposed transaction.
By terms of the Court's order, the TRO shall remain in effect until such time as the Court addresses the DOJ's Motion for Preliminary Injunction. Suiza and the Company independently concluded and agreed not to contest the motion for TRO. Suiza and the Company continue to review their options for responding to the DOJ's action.