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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the period ended: July 2, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number: 001-13403
American Italian Pasta Company
(Exact name of Registrant as specified in its charter)
Delaware 84-1032638
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4100 N. Mulberry Drive, Suite 200, Kansas City, Missouri 64116
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (816) 584-5000
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if
changed since last report)
Indicate by check mark whether the Registrant has (1) filed all documents
and reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the Registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
The number of shares outstanding as of July 30, 2004 of the Registrant's
Class A Convertible Common Stock was 18,053,466 and there were no shares
outstanding of the Class B Common Stock.
Page 1
American Italian Pasta Company
Form 10-Q
Quarter Ended July 2, 2004
Table of Contents
Part I - Financial Information Page
Item 1. Consolidated Financial Statements (unaudited)
Consolidated Balance Sheets at July 2, 2004 and
October 3, 2003. 3
Consolidated Statements of Operations for the three
months ended July 2, 2004 and July 4, 2003. 4
Consolidated Statements of Operations for the nine
months ended July 2, 2004 and July 4, 2003. 5
Consolidated Statements of Stockholders' Equity
for the nine months ended July 2, 2004. 6
Consolidated Statements of Comprehensive Income
for the three months ended July 2, 2004 and
July 4, 2003. 7
Consolidated Statements of Comprehensive Income
for the nine months ended July 2, 2004 and
July 4, 2003. 8
Consolidated Statements of Cash Flows for the
nine months ended July 2, 2004 and July 4, 2003. 9
Notes to Consolidated Financial Statements 10
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 23
Item 4. Controls and Procedures 24
Part II - Other Information
Item 1. Legal Proceedings 24
Item 2. Changes in Securities and Use of Proceeds 24
Item 3. Defaults Upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 5. Other Information 24
Item 6. Exhibits and Reports on Form 8-K 25
Signature Page 26
Page 2
PART I - FINANCIAL INFORMATION
Item 1 - Consolidated Financial Statements (Unaudited)
AMERICAN ITALIAN PASTA COMPANY
Consolidated Balance Sheets
July 2, October 3,
2004 2003
(In thousands)
(Unaudited)
Assets
Current assets:
Cash and temporary investments $10,570 $6,465
Trade and other receivables 49,040 51,730
Prepaid expenses and deposits 13,813 12,692
Inventory 84,058 78,760
Deferred income taxes 2,435 2,435
-------- --------
Total current assets 159,916 152,082
Property, plant and equipment:
Land and improvements 15,004 14,867
Buildings 133,307 132,035
Plant and mill equipment 383,306 355,767
Furniture, fixtures and equipment 29,122 25,266
-------- --------
560,739 527,935
Accumulated depreciation (140,885) (122,811)
-------- --------
419,854 405,124
Construction in progress 5,875 18,996
-------- --------
Total property, plant and equipment 425,729 424,120
Brands and trademarks 190,139 186,147
Other assets 8,904 8,146
-------- --------
Total assets $ 784,688 $ 770,495
========= =========
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 31,206 $ 42,416
Accrued expenses 19,821 18,480
Income tax payable -- 1,096
Current maturities of long-term debt 2,037 2,554
-------- --------
Total current liabilities 53,064 64,546
Long-term debt 307,308 300,778
Deferred income taxes 70,890 61,666
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value: -- --
Authorized shares - 10,000,000
Issued and outstanding shares - none
Class A common stock, $.001 par value:
Authorized shares - 75,000,000
Issued and outstanding shares - 20,174,206 and 18,050,745, 20 20
respectively at July 2, 2004, and 20,063,827 and 18,040,709,
respectively at October 3, 2003
Class B common stock, $.001 par value:
Authorized shares - 25,000,000
Issued and outstanding shares - none -- --
Additional paid-in capital 230,520 227,234
Treasury stock, at cost (51,598) (46,585)
Unearned compensation (1,193) (891)
Retained earnings 172,893 164,495
Accumulated other comprehensive income (loss) 2,784 (768)
-------- --------
Total stockholders' equity 353,426 343,505
-------- --------
Total liabilities and stockholders' equity $784,688 $770,495
======== ========
See accompanying notes to consolidated financial statements.
Page 3
AMERICAN ITALIAN PASTA COMPANY
Consolidated Statements of Operations
Three Months Ended
July 2, July 4,
2004 2003
---- ----
(In thousands, except per share data)
(Unaudited)
Revenues $103,184 $104,302
Cost of goods sold (Notes 3 & 4) 80,475 67,861
New product development and start up costs 1,279 --
-------- --------
Gross profit 21,430 36,441
Selling and marketing expense 14,538 12,217
General and administrative expense 3,755 3,484
Provision for restructuring expense 945 --
-------- --------
Operating profit 2,192 20,740
Interest expense, net 2,989 2,764
-------- --------
Income (loss) before income tax expense (benefit) (797) 17,976
Income tax expense (benefit) (271) 5,942
-------- --------
Net income (loss) $(526) $ 12,034
======== ========
Earnings Per Common Share:
Net income (loss) per common share $ (0.03) $ 0.67
======== ======
Weighted-average common shares outstanding 18,040 17,838
======== ======
Earnings Per Common Share - Assuming Dilution:
Net income (loss) per common share assuming dilution $ (0.03) $ 0.65
======== ======
Adjusted weighted-average common shares outstanding 18,040 18,594
======== ======
Cash Dividend Declared Per Common Share $ 0.1875 $ --
======== ======
See accompanying notes to consolidated financial statements.
Page 4
AMERICAN ITALIAN PASTA COMPANY
Consolidated Statements of Operations
Nine Months Ended
July 2, July 4,
2004 2003
---- ----
(In thousands, except per share data)
(Unaudited)
Revenues $318,130 $321,990
Cost of goods sold (Notes 3 & 4) 228,762 216,691
New product development and start-up costs 3,906 --
-------- --------
Gross profit 85,462 105,299
Selling and marketing expense 42,500 38,553
General and administrative expense 10,925 9,841
Acquisition-related and plant start-up expenses -- 4,939
Provision for restructuring expense 945 --
-------- --------
Operating profit 31,092 51,966
Interest expense, net 8,475 7,440
-------- --------
Income before income tax expense 22,617 44,526
Income tax expense 7,455 14,699
-------- --------
Net income $ 15,162 $ 29,827
======== ========
Earnings Per Common Share:
Net income per common share $ 0.84 $ 1.68
====== ======
Weighted-average common shares outstanding 18,039 17,800
====== ======
Earnings Per Common Share - Assuming Dilution:
Net income per common share assuming dilution $ 0.82 $ 1.61
====== ======
Weighted-average common shares outstanding 18,578 18,474
====== ======
Cash Dividend Declared Per Common Share $0.375 $ --
====== ====
See accompanying notes to consolidated financial statements.
Page 5
AMERICAN ITALIAN PASTA COMPANY
Consolidated Statements of Stockholders' Equity
Nine Months Ended July 2,
2004
---------------------------
(In thousands)
(unaudited)
Class A Common Shares
Balance, beginning of period 20,064
Issuance of shares of Class A Common stock through option exercises & other issuances 110
------
Balance, end of period 20,174
======
Class A Common Stock
Balance, beginning and end of period $ 20
====
Additional Paid-in Capital
Balance, beginning of period $227,234
Issuance of shares of Class A Common stock through option exercises & other issuances, net 2,855
Tax benefit from stock compensation 431
--------
Balance, end of period $230,520
========
Treasury Stock
Balance, beginning of period $(46,585)
Purchase of treasury stock (5,013)
--------
Balance, end of period $(51,598)
========
Unearned Compensation
Balance, beginning of period $ (891)
Earned compensation 438
Issuance of common stock (740)
--------
Balance, end of period $ (1,193)
========
Other Comprehensive Income (Loss)
Foreign currency translation adjustment
Balance, beginning of period $1,751
Change during the period 2,152
--------
Balance, end of period $3,903
--------
Interest rate swaps fair value adjustment
Balance, beginning of period $ (2,519)
Change during the period 1,400
--------
Balance, end of period $ (1,119)
--------
Total accumulated other comprehensive income $2,784
========
Retained Earnings
Balance, beginning of period $164,495
Net income 15,162
Dividends declared (6,764)
--------
Balance, end of period $172,893
========
Total Stockholders' Equity $353,426
========
See accompanying notes to consolidated financial statements.
Page 6
AMERICAN ITALIAN PASTA COMPANY
Consolidated Statements of Comprehensive Income
Three months ended
July 2, July 4,
2004 2003
---- ----
(In thousands)
(unaudited)
Net income (loss) $ (526) $ 12,034
Other comprehensive income
Net unrealized gains (losses) on qualifying cash flow hedges (net of income
tax benefit (expense) of $(593) and $514,
respectively) 1,152 (1,043)
Foreign currency translation adjustment (net of income tax
benefit (expense) of $123 and $(935), respectively) (241) 1,900
---- -----
Total other comprehensive income 911 857
---- --------
Comprehensive income $385 $ 12,891
==== ========
See accompanying notes to consolidated financial statements.
Page 7
AMERICAN ITALIAN PASTA COMPANY
Consolidated Statements of Comprehensive Income
Nine months ended
July 2, July 4,
2004 2003
---- ----
(In thousands)
(unaudited)
Net income $15,162 $29,827
Other comprehensive income
Net unrealized gains (losses) on qualifying cash flow hedges (net of
income tax benefit (expense)of $(715) and $1,204, respectively) 1,400 (2,444)
Foreign currency translation adjustment (net of income tax
expense of $(1,056) and $(1,932), respectively) 2,152 3,923
----- -----
Total other comprehensive income 3,552 1,479
----- -----
Comprehensive income $18,714 $31,306
======= =======
See accompanying notes to consolidated financial statements.
Page 8
AMERICAN ITALIAN PASTA COMPANY
Consolidated Statements of Cash Flows
Nine Months Ended
July 2, July 4,
2004 2003
---- ----
(In thousands)
(Unaudited)
Operating activities:
Net income $ 15,162 $ 29,827
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization 19,479 18,164
Deferred income tax expense 7,918 12,885
Changes in operating assets and liabilities:
Trade and other receivables 2,968 2,670
Prepaid expenses and deposits (1,221) (264)
Inventory (5,385) (20,771)
Accounts payable and accrued expenses (10,251) 14,510
Income tax payable 646 3
Other (1,656) (1,690)
-------- --------
Net cash provided by operating activities 27,660 55,334
Investing activities:
Purchase of pasta brands (4,276) (57,583)
Additions to property, plant and equipment (18,451) (35,752)
-------- --------
Net cash used in investing activities (22,727) (93,335)
Financing activities:
Additions to deferred debt issuance costs (847) (1,106)
Proceeds from issuance of debt 21,900 78,968
Principal payments on debt and capital lease
obligations (19,691) (32,972)
Proceeds from issuance of common stock, net of
issuance costs 2,162 2,756
Dividends Paid (3,379) --
Purchase of treasury stock (1,013) (12,119)
-------- --------
Net cash provided (used) by financing activities (868) 35,527
Effect of exchange rate changes on cash 40 851
-------- --------
Net increase (decrease) in cash
and temporary investments 4,105 (1,623)
Cash and temporary investments at beginning of period 6,465 8,247
-------- --------
Cash and temporary investments at end of period $ 10,570 $ 6,624
======== ========
Supplemental disclosure of cash flow information:
Note payable exchanged for treasury stock $ 4,000 $ --
======== ========
Pasta brands acquired in exchange for common stock $ -- $ 5,000
======== ========
See accompanying notes to consolidated financial statements.
Page 9
AMERICAN ITALIAN PASTA COMPANY
Notes to Consolidated Financial Statements
(In thousands, except share and per share data)
July 2, 2004
1. Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the nine-month period ended July 2, 2004
are not necessarily indicative of the results that may be expected for the year
ending October 1, 2004. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's Annual
Report on Form 10-K for the year ended October 3, 2003.
American Italian Pasta Company (the "Company" or "AIPC") uses a 52/53 week
financial reporting cycle with a fiscal year which ends on the last Friday of
September or the first Friday of October. The Company's first three fiscal
quarters end on the Friday last preceding December 31, March 31, and June 30 or
the first Friday of the following month. For purposes of this Form 10-Q, the
first fiscal quarter of fiscal year 2004 included thirteen weeks of activity and
fiscal 2003 included fourteen weeks of activity and are included in the
nine-month periods ended July 2, 2004 and July 4, 2003, respectively.
Inventories
Inventories are stated using product specific standard costs which approximate
the lower of cost determined on a first-in, first-out (FIFO) basis, or market.
Inventories consist of the following:
July 2, October 3,
2004 2003
-------- --------
(In thousands)
Finished goods $ 70,581 $ 65,024
Raw materials, packaging materials and work-in-process 13,477 13,736
------ ------
$ 84,058 $ 78,760
======== ========
2. Stock Options/Earnings Per Share
A summary of the Company's stock option activity:
Number of Shares
----------------
Outstanding at October 3, 2003 2,793,593
Exercised (79,530)
Granted 131,792
Canceled/Expired (223,441)
--------
Outstanding at July, 2004 2,622,414
=========
Dilutive securities, consisting of options to purchase the Company's Class A
common stock, included in the calculation of diluted weighted average common
shares were 539,000 shares for the nine-month period ended July 2, 2004, and
756,000 and 674,000 shares for the three-month and nine-month periods ended July
4, 2003, respectively. Otherwise dilutive securities consisting of options to
purchase the Company's Class A common stock amounting to 430,000 shares for the
three-month period ended July 2, 2004, were excluded from the calculation of
diluted weighted average common shares as the effect would have been
anti-dilutive.
Page 10
Pro forma information regarding net income and earnings per share has been
determined as if the Company had accounted for its employee stock options under
the fair value method of Statement of Financial Accounting Standards (SFAS) No.
123, "Accounting for Stock-Based Compensation".
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information follows (in thousands except for earnings per share
information):
Three months ended Nine months ended
July 2, July 4, July 2, July 4,
2004 2003 2004 2003
---- ---- ---- ----
Net income (loss), as reported $(526) $12,034 $15,162 $29,827
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects (985) (1,193) (2,971) (4,443)
---- ------ ------ ------
Pro forma net income (loss) $(1,511) $10,841 $12,191 $25,384
======== ======= ======= =======
Earnings (loss) per share:
Basic - as reported $ (0.03) $0.67 $0.84 $1.68
======== ===== ===== =====
Basic - pro forma $ (0.08) $0.61 $0.68 $1.43
======== ===== ===== =====
Diluted - as reported $ (0.03) $0.65 $0.82 $1.61
======== ===== ===== =====
Diluted - pro forma $ (0.08) $0.58 $0.66 $1.37
======== ===== ===== =====
3. Restructuring and Rightsizing Program
During the third fiscal quarter of 2004, the Company announced a restructuring
and rightsizing program to better align its production capacity and cost
structure with the Company's current business and operating profile and the
current pasta industry environment. The restructuring program responds to
industry-wide reductions in demand related to recent changes in consumer diet
trends and to manufacturing overcapacity in the pasta industry. The key
strategic elements of the restructuring program include reductions in the
Company's workforce, manufacturing capacity and inventory levels and the related
reconfiguration of its distribution network. In that regard, in July 2004, the
Company indefinitely suspended operations at one of its manufacturing
facilities; temporarily halted production at two of its four domestic
manufacturing facilities; and began preparing to exit eight of its leased
domestic distribution centers. As a result of the restructuring and rightsizing,
production capacity and output will more effectively match anticipated sales
demand, significant cost savings are expected to be generated and lower
inventory levels will be achieved.
During the third fiscal quarter of 2004, the Company recorded $945,000 of
restructuring expenses. These expenses include employee severance and
termination benefits and lease costs. The severance and benefit costs relate to
the termination of approximately 14% of the Company's workforce, a majority of
whom were employed at manufacturing locations. Lease costs relate to the
commitments and termination costs for certain leased warehouses that will no
longer be required due to the distribution network restructuring facilitated by
reduced inventory levels. The table below sets forth the significant cost
components and related activity in the restructuring program during the third
Page 11
fiscal quarter (such costs are reflected in the accompanying consolidated
statement of income (loss) in the line item entitled "Provision for
restructuring expense"):
Restructuring- Non-Cash Cash Balance at
Related Charges Charges Payments July 2, 2004
--------------- ------- -------- ------------
(in 000's)
Employee severance and termination
benefits $ 683 $-- $ -- $ 683
Lease costs 117 -- -- 117
Other 145 -- (57) 88
----- ----- ----- -----
Total $ 945 $-- $(57) $ 888
===== ===== ===== =====
As of July 2, 2004, the remaining liability related to the accrual of the
restructuring costs during the third fiscal quarter was $888,000 and is included
in "Accrued expenses" on the accompanying consolidated balance sheet.
4. Cost of Goods Sold
As discussed in Note 3, a key strategic element of the Company's restructuring
and rightsizing program is the reduction of inventory levels through decreasing
manufacturing capacity, resulting in reductions of manufacturing output from
previous levels. This strategic objective will be accomplished through the
suspension of one plant's operations, the temporary shutdown of two other plants
and by reducing slow moving inventory. The Company recognized $5.5 million of
expenses in the third fiscal quarter of 2004 related to this strategic
objective. Such expenses are included in "Cost of goods sold" in the
accompanying consolidated statement of income (loss).
These costs include $3.5 million of manufacturing costs that have been incurred
during the fiscal year which were expected to be absorbed as production costs
during the year. The Company sets inventory cost standards based upon expected
annual production levels. As a result of the actions taken to implement the
restructuring and rightsizing program, including the suspension of production at
the Kenosha facility and the other temporary shutdowns, the Company determined
that these costs would not be absorbed through production as product costs and
were recognized as cost of goods sold. In addition, approximately $2.0 million
was recognized as a provision for slower moving and discontinued inventory.
5. Continued Dumping and Subsidy Offset Act of 2000
On October 28, 2000, the U.S. government enacted the "Continued Dumping and
Subsidy Offset Act of 2000" (the "Act"), commonly known as the Byrd Amendment,
which provides that assessed anti-dumping and subsidy duties liquidated by the
Department of Commerce on Italian and Turkish imported pasta after October 1,
2000 will be distributed to affected domestic producers. The legislation
creating the dumping and subsidy offset payment provides for annual payments
from the U.S. government.
In the first quarter of fiscal 2003, the Company received $2.4 million under the
Act and recognized the revenue income ratably in each quarter over the fiscal
year. Beginning with the current fiscal year, the Company is recognizing the
entire Byrd Amendment payment as revenue in the quarter in which the amount and
the right to receive the payment can be reasonably determined. As such, $1.5
million related to fiscal 2004 was recognized as revenue in the three months
ended April 2, 2004. Payment in the amount of $769,000 was received in the
quarter ended July 2, 2004. The remaining $731,000 is expected to be received in
the fourth quarter of fiscal 2004 or in the first quarter of fiscal 2005.
It is not possible to reasonably estimate the potential amount, if any, to be
received in future periods beyond fiscal 2004.
Page 12
6. Brand Acquisitions
On January 5, 2004, the Company repurchased for $5.0 million, the shares issued
pursuant to the Mrs. Leeper's Specialty Pasta acquisition and paid $3.0 million
in lieu of the scheduled cash earn out tied to sales and profit growth over the
next two years.
7. Dividend Plan
On June 25, 2004, the Company announced that the Board of Directors authorized
the payment of a quarterly dividend of 18.75 cents per share, payable to
shareholders of record as of July 6, 2004, to be paid on July 20, 2004. The
aggregate amount of the dividend, totaling $3,385,000, is recorded in accrued
expenses in the accompanying July 2, 2004 consolidated balance sheet. In
addition, the Company paid in the third quarter an aggregate dividend of $3,379
million (18.75 cents per share) which was declared in the second quarter.
8. Amendment to Credit Facility
Effective June 29, 2004, the Company's revolving credit agreement was amended to
change the definitions of "Consolidated EBITDA" and "Fixed Charge Coverage
Ratio" and increase the Maximum Leverage Ratio and decrease the Minimum
Consolidated EBITDA allowed under the credit agreement. The original terms of
the facility, other than those addressed above, remain generally the same.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The discussion set forth below, as well as other portions of this Quarterly
Report, contains statements concerning potential future events. Such
forward-looking statements are based upon assumptions by our management, as of
the date of this Quarterly Report, including assumptions about risks and
uncertainties faced by AIPC. Readers can identify these forward-looking
statements by their use of such verbs as expects, anticipates, believes or
similar verbs or conjugations of such verbs. If any of our assumptions prove
incorrect or should unanticipated circumstances arise, our actual results could
materially differ from those anticipated by such forward-looking statements. The
differences could be caused by a number of factors or combination of factors
including, but not limited to, those factors identified in our 8-K dated July
28, 2004. That report has been filed with the Securities and Exchange Commission
(the "SEC" or the "Commission") in Washington, D.C. and can be obtained by
contacting the SEC's public reference operations or obtaining it through the
SEC's web site on the World Wide Web at http://www.sec.gov. Readers are strongly
encouraged to consider those factors when evaluating any such forward-looking
statement. We will not update any forward-looking statements in this Quarterly
Report to reflect future events or developments.
In this report, we have identified certain expenses, either shown separately on
our income (loss) statement, or included within other broader expense categories
and has provided net income, gross operating margin, and earnings per share
amounts on a basis as adjusted for these expenses. We have also provided
information about its "free cash flow". The adjusted net income, gross operating
margin, and earnings per share amounts and free cash flow are non-GAAP financial
measures which management believes provide useful information about our
operating results and cash generation. These amounts should be read in
conjunction with our GAAP financial statements included in the report.
Page 13
Results of Operations
Overview
We believe we are the largest producer of dry pasta in North America. We began
operations in 1988. We believe our singular focus on pasta, our
vertically-integrated facilities and highly efficient production facilities
focused primarily on specific market segments and our highly skilled workforce
make us a more efficient company and enable us to produce high-quality pasta at
very competitive costs. We believe that the combination of our low cost
structure, the addition of several new brands to our portfolio of brands, our
scalable production facilities and our key customer relationships create
opportunity for continued growth.
We generate revenues in two customer markets: retail and institutional. Retail
market revenues include the revenues from sales of our pasta products to
customers who resell the pasta in retail channels. These revenues represented
73.5% and 74.9% of our total revenue for the nine months ended July 2, 2004 and
July 4, 2003, respectively, and include sales to club stores and grocery
retailers, and encompass sales of our private label and branded products.
Institutional market revenues include revenues from product sales to customers
who use our pasta as an ingredient in food products or who resell our pasta in
the foodservice market. It also includes revenues from opportunistic sales to
government agencies and other customers that we pursue periodically when
capacity is available to increase production volumes and thereby lower average
unit costs. The institutional market represented 26.5% and 25.1% of our total
revenue for the nine months ended July 2, 2004 and July 4, 2003, respectively.
During the quarter, the dry pasta category in the United States experienced
year-over-year declines in consumption in excess of 5%. In our view this
category decline, which had significant impact on the Company's results for the
quarter versus the year ago quarter, is attributable to dietary concerns by the
American consumer related to carbohydrates. As discussed more fully below, these
consumption declines have resulted in significant revenue declines for the
Company, which in turn were the genesis of the restructuring and rightsizing
program initiated in the current quarter. Looking forward over the balance of
fiscal year 2004, we do not anticipate a change in current consumer trends. As a
result, we may further adjust or reduce certain production schedules and incur
other costs to reduce inventories and other elements of our cost structure.
Average sales prices for our non-branded products vary depending on
customer-specific packaging and raw material requirements, product manufacturing
complexity and other service requirements. Average prices for our branded
products are also based on competitive market factors. Average retail and
institutional prices will also vary due to changes in the relative share of
customer revenues and item specific sales volumes (i.e., product sales mix).
Generally, average retail sales prices are higher than institutional sales
prices. Selling prices of our branded products are significantly higher than
selling prices in our other business units, including private label. This
results in higher revenues, gross profits, and gross margin percentages than our
non-branded businesses. Our new reduced carb product line generates
significantly higher per unit revenue than our other products. Revenues are
reported net of cash discounts, product returns, and certain promotional
allowances.
We seek to develop strategic customer relationships with food industry leaders
that have substantial pasta requirements. We have a long-term supply agreement
through December 31, 2006 with Sysco, and other similar arrangements with food
industry leaders, such as Sam's Club, that provide for the "pass-through" of
direct material cost changes as pricing adjustments. The pass-throughs are
generally limited to actual changes in cost and, as a result, impact percentage
profitability in periods of changing costs and prices. The pass-throughs are
generally effective 30 to 90 days following such cost changes and thereby
significantly reduce the long-term exposure of our operating results to the
volatility of raw material costs. These pass-through arrangements also require
us to pass on the benefits of any price decrease in raw material costs.
Page 14
Our cost of goods sold consists primarily of raw materials, packaging,
manufacturing (including depreciation) and distribution costs. A significant
portion of our cost of goods sold is durum wheat. We purchase durum wheat on the
open market and, consequently, those purchases are subject to fluctuations in
cost. We manage our durum wheat cost risk through durum wheat cost
"pass-through" agreements in long-term contracts and other non-contractual
arrangements with our customers as mentioned above and advance purchase
contracts for durum wheat which are generally less than twelve months' duration.
Our new reduced carb product line includes significantly higher costs for raw
materials and manufacturing than our other pasta products.
We introduced a portfolio of new reduced carb and low carb products in early
fiscal 2004, designed to help mitigate the impact of general pasta consumption
declines. With the introduction of our reduced carb product line, we have
incurred $3.9 million of new product development and start-up costs ($2.6
million in the second quarter, and an additional $1.3 million in the current
quarter). These costs represent the upfront "investment" in a portfolio of new
products expected to address carbohydrate awareness among consumers. These costs
included formulation development and product testing of a portfolio of low and
reduced carb products; incremental manufacturing and logistics costs including
unplanned downtime on dedicated lines, efficiency losses, and excess product
waste; overcoming limited short-term raw material availability and sourcing
issues (blending, transportation, etc.); and quality assurance, outside testing
and other direct product development costs. Consumer feedback received on the
quality of our products has been favorable and while the early demand was
relatively strong, more recent sales trends have not met our expectations. This
segment has not yet grown to become a significant component of the pasta market
and while we believe reduced carb products will fulfill a relevant role in the
diets of some consumers, the product line will not be a significant driver of
our sales in the short-term and will not compensate for volume declines and
associated profits of traditional pasta.
Our capital asset strategy is to achieve low-cost production through vertical
integration and investment in the most current pasta-making assets and
technologies. The manufacturing- and distribution-related capital assets that
have been or will be acquired to support this strategy are depreciated over
their respective economic lives. Because of the capital-intensive nature of our
business, we believe our depreciation expense for production and distribution
assets may be higher than that of many of our competitors. Depreciation expense
is a component of inventory cost and cost of goods sold.
Selling and marketing costs constituted 13.4% and 12.0% of revenues for the nine
months ended July 2, 2004 and July 4, 2003, respectively. We expect these costs
to remain higher than a year ago during the fourth quarter of fiscal 2004,
primarily due to the continued support of reduced carb pasta and as a result of
increased price competition.
Critical Accounting Policies
This discussion and analysis discusses our results of operations and financial
condition as reflected in our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. As discussed in Note 1 to our October 3, 2003 consolidated
financial statements, the preparation of financial statements in conformity with
accounting principles generally accepted in the United States requires our
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 reported amounts of revenues and
expenses during the reporting periods. On an ongoing basis, our management
evaluates its estimates and judgments, including those related to the impairment
of long-lived and intangible assets, the method of accounting for stock options,
and the estimates used to record allowances for doubtful accounts, slow-moving
and discontinued inventory and derivatives. Our management bases its estimates
and judgments on its substantial historical experience and other relevant
factors, the results of which form the basis for making judgments about the
carrying values of assets and liabilities that are not readily apparent from
other sources. See Note 1 to our October 3, 2003
Page 15
consolidated financial statements for a complete listing of our significant
accounting policies. Our most critical accounting policies are described below.
Long Lived Assets. In accordance with Statement of Financial Accounting
Standards (SFAS) No. 144, "Accounting For Impairment or Disposal of Long-lived
Assets," we review long-lived assets for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. We evaluate recoverability of assets to be held and used by
comparing the carrying amount of an asset to future net cash flows expected to
be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets. Assets to be disposed
of are reported at the lower of the carrying amount or fair value less costs to
sell.
In conjunction with our restructuring and rightsizing program, we indefinitely
suspended operations at our Kenosha, Wisconsin manufacturing facility. We have
reviewed this facility for impairment and have determined that none exists at
this time.
Impairment Testing of Intangible Assets. In accordance with Statement of
Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible
Assets," we do not amortize the cost of intangible assets with indefinite lives.
SFAS No. 142 requires that we perform certain fair value based tests of the
carrying value of indefinite lived intangible assets at least annually and more
frequently should events or changes in circumstances indicate that the carrying
amount of an asset may not be fully recoverable. Our impairment testing is in
progress, and is expected to be completed during the fourth quarter of this
fiscal year. These impairment tests are impacted by judgments as to future cash
flows and other considerations. If such assets are considered to be impaired,
the impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets. Assets to be disposed
of are reported at the lower of the carrying amount or fair value less costs to
sell. Future events could cause our management to conclude that impairment
indicators exist and that the value of intangible assets is impaired.
Stock Options. We have elected to follow Accounting Principles Board Opinion
(APB) No. 25, "Accounting for Stock Issued to Employees," and related
Interpretations in accounting for our employee stock options and have adopted
the pro forma disclosure requirements under SFAS No. 123 "Accounting for
Stock-Based Compensation." Under APB No. 25, because the exercise price of our
employee stock options is equal to the market price of the underlying stock on
the date of grant, no compensation expense is recognized.
Pro forma information regarding net income and earnings per share is required by
SFAS No. 123 and has been determined as if we had accounted for our employee
stock options under the fair value method of SFAS No. 123. The fair value for
these options was estimated at the date of grant using a Black-Scholes option
pricing model with the following weighted-average assumptions: risk-free
interest rate of 1.33% for fiscal 2003 and 2004; dividend yield of zero for
fiscal 2003 and 2% for fiscal 2004; a volatility factor of the expected market
price of our common stock of .354 for fiscal 2003 and fiscal 2004; and a
weighted-average expected life of the options of five years.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
our employee stock options have characteristics significantly different from
those traded options, and because changes in the subjective input assumptions
can materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the fair
value of our employee stock options.
Page 16
Accounts Receivable - Significant Customers. We generate approximately 25% of
our revenues and corresponding accounts receivable from sales to two
multi-national customers. If our primary customers experience significant
adverse conditions in their industry or operations, our customers may not be
able to meet their ongoing financial obligations to us for prior sales or
complete the purchase of additional products from us under the terms of our
existing purchase and sale commitments.
Allowance for Doubtful Accounts - Methodology. We evaluate the collectibility of
our accounts receivable based on a combination of factors. In circumstances
where we are aware of a specific customer's inability to meet its financial
obligations to us (e.g. bankruptcy filings, substantial down-grading of credit
scores), we record a specific reserve for bad debts against amounts due to
reduce the net recognized receivable to the amount we reasonably believe will be
collected. For all other customers, we recognize reserves for bad debts based on
the length of time the receivables are past due, and our historical experience.
If circumstances change (i.e., higher than expected defaults or an unexpected
material adverse change in a major customer's ability to meet its financial
obligations to us), our estimates of the recoverability of amounts due us could
be reduced by a material amount.
Derivatives. We hold derivative financial instruments to hedge a variety of risk
exposures including interest rate risks associated with variable rate long-term
debt and foreign currency risks associated with our Italy operations. These
derivatives qualify for hedge accounting as discussed in detail in Note 1 to our
October 3, 2003 consolidated financial statements. We do not participate in
speculative derivatives trading. Hedge accounting results when we designate and
document the hedging relationships involving these derivative instruments. While
we intend to continue to meet the conditions for hedge accounting, if hedges did
not qualify as highly effective or if we did not believe that forecasted
transactions would occur, the changes in the fair value of the derivatives used
as hedges would be reflected in earnings.
To hedge foreign currency risks, we use futures contracts. The fair values of
these instruments are determined from market quotes. These forward contracts are
valued in a manner similar to that used by the market to value exchange-traded
contracts; that is, using standard valuation formulas with assumptions about
future foreign currency exchange rates derived from existing exchange rates, and
interest rates observed in the market. To hedge interest rate risks, an interest
rate swap is used to effectively convert a portion of variable rate debt to
fixed rate. This instrument is valued using the market standard methodology of
netting the discounted future fixed cash receipts and the discounted expected
variable cash payments. The variable cash payments are based on an expectation
of future interest rates derived from observed market interest rate curves. We
have not changed our methods of calculating these fair values or developing the
underlying assumptions. The values of these derivatives will change over time as
cash receipts and payments are made and as market conditions change. Our
derivative instruments are not subject to multiples or leverage on the
underlying commodity or price index. Information about the fair values, notional
amounts, and contractual terms of these instruments can be found in Note 1 to
our October 3, 2003 consolidated financial statements and the section titled
"Quantitative and Qualitative Disclosures About Market Risk."
We consider our budgets and forecasts in determining the amounts of our foreign
currency to hedge. We combine the forecasts with historical observations to
establish the percentage of our forecast we are assuming to be probable of
occurring, and therefore eligible to be hedged. The purchases are hedged for
exposures to fluctuations in foreign currency exchange rates.
We do not believe we are exposed to more than a nominal amount of credit risk in
our interest rate and foreign currency hedges as the counter parties are
established, well-capitalized financial institutions. Our exposure is in liquid
currency (Euros), so there is minimal risk that appropriate derivatives to
maintain our hedging program would not be available in the future.
Page 17
Restructuring and Rightsizing Program
The pasta industry continues to experience the significant changes that have
been seen over the last 12-14 months, with U.S. pasta consumption continuing to
decrease as a result of recent changes in consumer diet trends. During this
period, we estimate the decline in industry-wide consumption to be over 100
million annualized pounds. Retail consumption of dry pasta (as measured by AC
Nielsen) declined by 5% in volume for the 13 weeks ended July 10, 2004. The
production overcapacity that exists within the pasta industry, combined with
decreasing consumer demand, has resulted in a highly competitive market share
battle with pricing levels and operating margins coming under increasing
pressure.
During the third fiscal quarter of 2004, we announced a restructuring and
rightsizing program to better align our production capacity and cost structure
with our current business and operating profile and the current pasta industry
environment. The restructuring and rightsizing program responds to industry-wide
reductions in demand related to recent changes in consumer diet trends and to
manufacturing overcapacity in the pasta industry.
The key strategic elements of the restructuring and rightsizing program include
reductions in our workforce, manufacturing capacity and inventory levels and the
related reconfiguration of our distribution network. In that regard, in July
2004 we indefinitely suspended operations at one of our manufacturing facilities
(Kenosha, Wisconsin); temporarily halted production at two of our four domestic
manufacturing facilities (Excelsior Springs, Missouri and Columbia, South
Carolina); and began preparing to exit eight of our leased domestic distribution
centers. As a result of the restructuring and rightsizing, our production
capacity and output will more effectively match our anticipated sales demand and
we expect to generate significant cost savings and lower our inventory levels.
We are recognizing restructuring expenses relating to this program in the third
and fourth quarters of fiscal year 2004.
A key strategic element of our restructuring and rightsizing program is the
reduction of inventory levels. As noted above, this will be accomplished through
the suspension of one plant's operations and the temporary shutdowns of two
other plants, as well as reducing our slow moving and discontinued inventory.
Related to this element of the strategy, we will recognize certain expenses in
the third and fourth quarters of fiscal year 2004. These expenses will include
manufacturing costs that have been incurred during the fiscal year which were
expected to be absorbed as production costs during the year. We set inventory
cost standards based upon our expected annual production levels. As a result of
the actions taken to implement the restructuring and rightsizing program,
including the suspension of production at the Kenosha facility and the other
temporary shutdowns, we have determined that these costs will not be absorbed
through production as inventory costs and we are recognizing these costs in the
third and fourth quarters of fiscal 2004. In addition, we recorded a provision
for slower moving and discontinued inventory in the third quarter.
Third quarter fiscal 2004 compared to third quarter fiscal 2003.
Revenues. Total revenues decreased $1.1 million, or 1.1%, to $103.2 million for
the three-month period ended July 2, 2004, from $104.3 million for the
three-month period ended July 4, 2003. Revenues increased $0.7 million, or 0.7%
due to higher volumes and decreased $1.8 million or 1.8%, due to lower average
selling prices in part due to competitive pricing pressures, and the reduction
of revenue recognized from the Continued Dumping and Subsidy Offset Act of 2000
(CDSOA). We did not recognize revenue under the CDSOA in the third current
fiscal quarter versus $0.6 million in revenue in the year ago quarter.
Revenues from the Retail market decreased $3.2 million, or 4.1%, to $73.8
million for the three-month period ended July 2, 2004, from $77.0 million for
the three-month period ended July 4, 2003. Revenues decreased $0.8 million or
1.0%, due to volume declines and decreased $2.4 million, or 3.1% due to lower
average selling prices in part due to competitive pricing pressures, and the
reduction of revenue recognized from the CDSOA.
Page 18
Revenues for the Institutional market increased $2.1 million, or 7.6%, to $29.4
million for the three-month period ended July 2, 2004, from $27.3 million for
the three-month period ended July 4, 2003. Revenues increased $1.1 million or
3.9%, due to higher volumes, and increased $1.0 million, or 3.7% due to higher
average selling prices and changes in sales mix.
Cost of Goods Sold. Per unit manufacturing cost increases were due primarily to
lower actual production volumes than expected in original operating plans. The
lower utilization of production capacity, combined with a manufacturing and
logistics cost structure that includes proportionately higher levels of fixed
costs, resulted in the substantial increase in cost of goods sold and lower
gross profit. In addition, inflationary factors including higher utilities and
freight costs, negatively impacted cost of goods sold.
The costs of our inventory reduction strategy, a key component of our
Restructuring and Rightsizing Program, totaled $5.5 million during the third
quarter of 2004. These costs, included in cost of goods sold, include $3.5
million of manufacturing costs that have been incurred during the fiscal year
which were expected to be absorbed as production costs during the year. We set
inventory cost standards based upon expected annual production levels. As a
result of the actions taken to implement the restructuring and rightsizing
program, including the suspension of production at the Kenosha facility and the
other temporary shutdowns, it was determined that these costs will not be
absorbed as product costs and were recognized as cost of goods sold. It is
anticipated that an additional $3.5 - $4.0 million of such costs will be
recognized in the fourth quarter of 2004. In addition, approximately $2.0
million is being recognized as a provision for slower moving and discontinued
inventory.
New Product Development and Start-up Costs. The new product development and
start-up costs of $1.3 million for the quarter ended July 2, 2004 related to our
reduced carb products. These costs included formulation development and product
testing of a portfolio of low and reduced carb products; incremental
manufacturing and logistics costs including unplanned downtime on dedicated
lines, efficiency losses, and excess product waste; overcoming limited
short-term raw material availability and sourcing issues (blending,
transportation, etc.); and quality assurance, outside testing and other direct
product development costs.
Gross Profit. Gross profit decreased $15.0 million, or 41.2% to $21.4 million
for the three-month period ended July 2, 2004, from $36.4 million for the
three-month period ended July 4, 2003. Gross profit was impacted by a number of
factors as compared to the prior year's third quarter; including revenue
decreases of $1.1 million (as discussed above), higher per unit manufacturing
costs and the costs of our inventory reduction strategy (as discussed above).
Also included in the 2004 quarter gross profit is the impact of the $1.3 million
charge for incremental costs associated with the new product development.
Gross profit as a percentage of revenues decreased to 20.8% for the three-month
period ended July 2, 2004 from 34.9% for the three month period ended July 4,
2003, principally due to the $1.3 million of incremental costs incurred and
higher costs discussed above, and the decrease in the revenue associated with
the CDSOA. Excluding the impacts of the inventory reduction charge of $5.5
million and the new product development and start-up expenses of $1.3 million,
gross margins were 27.4% for the quarter.
Selling and Marketing Expense. Selling and marketing expense increased $2.3
million, or 19.0%, to $14.5 million for the three-month period ended July 2,
2004, from $12.2 million for the three-month period ended July 4, 2003 primarily
due to introductory marketing support for the new reduced carb product line of
$2.2 million. Selling and marketing expense as a percentage of revenues
increased to 14.1% for the three-month period ended July 2, 2004, from 11.7% for
the comparable prior year period.
General and Administrative Expense. General and administrative expenses
increased $0.3 million, or 7.8%, to $3.8 million for the three-month period
Page 19
ended July 2, 2004 from $3.5 million for the three-month period ended July 4,
2003 primarily due to increased investments in information technology and the
cost of regulatory compliance. General and administrative expense as a
percentage of revenues increased to 3.6% for the three-month period ended July
2, 2004 from 3.3% for the comparable prior year period.
Provision for Restructuring Expense. During the three-month period ended July 2,
2004, $0.9 million of restructuring expenses were recorded relating to the
restructuring and rightsizing program announced in the third quarter of 2004.
These costs included employee severance and termination benefits and lease
costs. The severance and benefit costs relate to the termination of 14% of our
workforce, a majority of whom were employed at manufacturing locations. Lease
costs relate to the commitments and termination costs for certain leased
warehouses that will no longer be required due to the distribution network
restructuring facilitated by reduced inventory levels. It is anticipated that an
additional $2.0 - $2.5 million of restructuring expenses will be recorded in the
fourth fiscal quarter of 2004.
Operating Profit. Operating profit for the three-month period ended July 2,
2004, was $2.2 million, a decrease of $18.5 million or 89.4% from the $20.7
million reported for the three-month period ended July 4, 2003. Operating profit
decreased as a percentage of revenues to 2.1% for the three-month period ended
July 2, 2004, from 19.9% for the three-month period ended July 4, 2003 as a
result of the factors discussed above.
Interest Expense. Interest expense for the three-month period ended July 2,
2004, was $3.0 million, increasing $0.2 million or 8.1% from the $2.8 million
reported for the three-month period ended July 4, 2003. The increase in interest
is attributable to higher interest rates in the current quarter versus a year
ago, offset partially by the impact of lower debt levels than a year ago.
Income Tax. Income tax expense (benefit) for the three-month period ended July
2, 2004, was ($0.3) million, compared to $5.9 million reported for the
three-month period ended July 4, 2003, and reflects effective income tax rates
of approximately 34.0% and 33.0% respectively.
Net Income (Loss). Net income (loss) for the three-month period ended July 2,
2004, was ($0.5) million, decreasing $12.6 million or 104.4% from the $12.0
million reported for the three-month period ended July 4, 2003. Diluted earnings
(loss) per common share were ($0.03) per share for the three-month period ended
July 2, 2004 compared to $0.65 per share for the three-month period ended July
4, 2003, primarily due to the factors above.
Excluding certain expenses totaling $9.9 million before tax ($6.5 million after
tax, or $0.35 per diluted share), net income would have been $6.0 million, or
$0.32 per diluted share. Such excluded expenses are comprised of $0.9 million in
restructuring expenses, $5.5 million of costs related to inventory reduction
strategy (included in cost of goods sold) and $3.5 million of expenses related
to new product introduction (comprised of new product development and start-up
expenses of $1.3 million and related marketing expenses of $2.2 million).
Nine months fiscal 2004 compared to nine months fiscal 2003.
Revenues. Revenues decreased $3.9 million, or 1.2%, to $318.1 million for the
nine-month period ended July 2, 2004, from $322.0 million for the nine-month
period ended July 4, 2003. Revenues decreased $13.6 million, or 4.2% due to
volume declines and increased $9.7 million, or 3.0% due to higher average
selling prices and the impact of revenue recognized from the CDSOA. Also
impacting the comparability of revenue is a 39-week period in fiscal 2004 versus
a 40-week period in fiscal 2003. Revenues were affected by declining category
sales due in part to current reduced carbohydrate awareness trends in the
American diet.
Revenues for the Retail market decreased $7.2 million, or 3.0%, to $234.0
million for the nine-month period ended July 2, 2004, from $241.2 million for
the nine-month period ended July 4, 2003. Revenues decreased $16.9 million, or
Page 20
7.0% due to volume declines and increased $9.7 million, or 4.0% due to higher
average selling prices and the impact of revenue recognized from the CDSOA.
Cost of Good Sold. As discussed above relating to the three-month period ended
July 2, 2004, per unit manufacturing cost increases were due primarily to lower
actual production volumes and inflationary factors including higher utilities
and freight costs. The costs related to our inventory reduction strategy totaled
$5.5 million during the nine-month period.
Revenues for the Institutional market increased $3.3 million, or 4.1%, to $84.2
million for the nine-month period ended July 2, 2004, from $80.8 million for the
nine-month period ended July 4, 2003. Revenues increased $1.0 million or 1.2%
due to volume increases and increased $2.3 million, or 2.9% due to higher
average selling prices.
New Product Development and Start-up Costs. The new product development and
start-up costs of $3.9 million for the nine-month period ended July 2, 2004
related to our reduced carb products. These costs included: formulation
development and product testing of a portfolio of low and reduced carb products;
incremental manufacturing and logistics costs including unplanned downtime on
dedicated lines, efficiency losses, and excess product waste; overcoming limited
short-term raw material availability and sourcing issues (blending,
transportation, etc.); and quality assurance, outside testing and other direct
product development costs.
Gross Profit. Gross profit decreased $19.8 million, or 18.8% to $85.5 million
for the nine-month period ended July 2, 2004, from $105.3 million for the
nine-month period ended July 4, 2003. Gross profit was impacted by a number of
factors as compared to the prior year period; including revenue decreases of
$3.9 million (as discussed above), higher per unit manufacturing costs and the
costs of our inventory reduction strategy. Also included in the 2004 nine-month
period gross profit is the impact of the $3.9 million charge for incremental
costs associated with the development and start-up of our new line of reduced
carb products.
Gross profit as a percentage of revenues decreased to 26.9% for the nine-month
period ended July 2, 2004, from 32.7% for the nine-month period ended July 4,
2003. The decrease was principally due to the revenue and cost factors noted
above. Excluding the impacts of the inventory reduction charge of $5.5 million
and the new product development and start-up expenses of $3.9 million, gross
margins were 29.8% for the nine-month period ended July 2, 2004.
Selling and Marketing Expense. Selling and marketing expense increased $3.9
million, or 10.2%, to $42.5 million for the nine-month period ended July 2,
2004, from $38.6 million for the nine-month period ended July 4, 2003, primarily
due to introductory marketing support for the new reduced carb product line of
$2.2 million and other marketing support of our brands. Selling and marketing
expense as a percentage of revenues increased to 13.4% for the nine-month period
ended July 2, 2004, from 12.0% for the comparable prior year period.
General and Administrative Expense. General and administrative expense increased
$1.1 million, or 11.0%, to $10.9 million for the nine-month period ended July 2,
2004, from $9.8 million for the comparable prior period. Certain general and
administrative expenses as a percentage of revenues increased to 3.4% for the
nine-month period ended July 2, 2004, from 3.1% for the nine-month period ended
July 4, 2003. This is attributable primarily to increased information
technology, organization-related costs, and the cost of regulatory compliance.
Acquisition-Related and Plant Start-up Expenses. The acquisition-related and
plant start-up expenses of $4.9 million for the nine-month period ended July 4,
2003 consisted of incremental costs associated with the brand acquisitions and
plant start-up costs related to the Arizona facility.
Provision for Restructuring Expense. As discussed above, during the three-month
period ended July 2, 2004, $0.9 million of restructuring expenses were
Page 21
recorded relating to the restructuring and rightsizing program announced in the
third quarter of 2004.
Operating Profit. Operating profit for the nine-month period ended July 2, 2004,
was $31.1 million, a decrease of $20.9 million or 40.2% from the $52.0 million
reported for the nine-month period ended July 4, 2003. Operating profit
decreased as a percentage of revenues to 9.8% for the nine-month period ended
July 2, 2004, from 16.1% for the nine-month period ended July 4, 2003 as a
result of the factors discussed above.
Interest Expense. Interest expense for the nine-month period ended July 2, 2004,
was $8.5 million, increasing $1.0 million or 13.9% from the $7.4 million
reported for the nine-month period ended July 4, 2003. The increase in interest
is primarily attributable to lower capitalized interest compared to a year ago
when we were completing our Tolleson, Arizona facility.
Income Tax. Income tax expense for the nine-month period ended July 2, 2004, was
$7.5 million, decreasing $7.2 million from the $14.7 million reported for the
nine-month period ended July 4, 2003, and reflects an effective income tax rate
of approximately 33.0% in both periods.
Net Income. Net income for the nine-month period ended July 2, 2004, was $15.2
million, decreasing $14.7 million or approximately 49.2% from the $29.8 million
reported for the nine months ended July 4, 2003. Diluted earnings per common
share were $0.82 per share for the nine-month period ended July 2, 2004 compared
to $1.61 per share for the nine-month period ended July 4, 2003, primarily due
to the factors described above. Net income as a percentage of net revenues was
4.8% versus 9.3% in the prior year.
Excluding certain expenses totaling $12.5 million before tax ($8.3 million
after-tax, or $0.44 per diluted share), net income would have been $23.5
million, or $1.26 per diluted share. Such excluded expenses are comprised of the
$9.9 million of expenses incurred in the three-month period ended July 2, 2004
described above and $2.6 million of new product development and start-up
expenses incurred earlier in the fiscal year.
Financial Condition and Liquidity
Our primary sources of liquidity are cash provided by operations and borrowings
under our credit facility. Cash and temporary investments totaled $10.6 million,
and working capital totaled $106.9 million at July 2, 2004.
Our net cash provided by operating activities totaled $27.7 million for the
nine-month period ended July 2, 2004 compared to $55.3 million for the
nine-month period ended July 4, 2003. This decrease of $27.7 million was
primarily due to lower net income and higher working capital requirements. Cash
provided by operating activities for the nine-month period ended July 2, 2004
was reduced by an increase in inventory of $5.4 million and a decrease in
accounts payable and accrued expenses of $11.1 million. The decrease in payables
is related to cost reduction programs and related supplier agreements. We expect
a significant benefit in cash flow during the fourth quarter from the reduction
of inventories estimated to be in a range of $10-15 million.
Cash used in investing activities principally relates to the purchase of pasta
brands and investments in manufacturing, distribution, milling and management
information system assets. In September 2002, we purchased the Lensi brand, and
in October 2002, we purchased the Martha Gooch and LaRosa brands. In addition,
we purchased the Golden Grain/Mission pasta brand and the Mrs. Leeper's pasta
brand in January 2003 and February 2003, respectively, which accounted for the
$57.6 million in the period ended July 4, 2003. Additional cash payments
relative to these acquisitions were made in the period ending July 2, 2004 in
the amount of $4.3 million. Capital expenditures were $18.5 million for the
nine-month period ended July 2, 2004 compared to $35.8 million in the comparable
prior year period.
Net cash used by financing activities was $0.9 million for the nine-month period
ended July 2, 2004 compared to cash provided by financing activities of
Page 22
$35.5 million for the nine-month period ended July 4, 2003. The net borrowings
of $46.0 million in the fiscal 2003 period relates to the purchase of the Golden
Grain/Mission pasta brand and the purchase of treasury stock. We paid dividends
of $3.4 million in the nine-month period ended July 2, 2004.
We continue to use our available credit facility as well as cash from operations
to fund capital expenditures, repayments of debt, and working capital
requirements. On June 25, 2004, the Company announced that the Board of
Directors authorized the payment of a quarterly dividend of 18.75 cents per
share, payable to shareholders of record as of July 6, 2004, to be paid on July
20, 2004.
Thus, we expect that future cash provided by operating activities will
principally be used for repayments of indebtedness, working capital
requirements, capital expenditures and dividends.
Selected Contractual
Obligations at Payments Due by Period
July 2, 2004 (In thousands)
----------------------------------------------------------------------------------
Total Less than 1-3 years 4-5 years After
1 year 5 years
----------------------------------------------------------------------------------
Long term debt $309,257 $ 2,000 $307,257 $ -- $ --
obligations
Capital lease obligations 88 37 51 -- --
Raw material obligations 33,233 10,816 17,417 2,000 3,000
-------- ------- --------- ------ ------
Total contractual cash
obligations $342,578 $12,853 $324,725 $2,000 $3,000
======== ======= ======== ====== ======
Additionally, we have approximately $2.0 million in expenditures remaining under
capital programs. We expect to fund these commitments from operations and
borrowing capacity under our credit facility. At this time, the current and
projected borrowings under the credit facility do not exceed the facility's
available commitment. The facility matures on October 2, 2006. We anticipate
that any borrowing outstanding at that time will be satisfied with funds from
operations or will be refinanced. We currently have no other material
commitments.
We believe that net cash provided by operating and financing activities will be
sufficient to meet our expected capital and liquidity needs for the foreseeable
future.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our principal exposure to market risk associated with financial instruments
relates to interest rate risk associated with variable rate borrowings and
foreign currency exchange rate risk associated with borrowings denominated in
foreign currency. We occasionally utilize simple derivative instruments such as
interest rate swaps to manage our mix of fixed and floating rate debt. We had
various fixed interest rate swap agreements with an aggregate notional amount of
$110.0 million outstanding at July 2, 2004. The estimated fair value of the
interest rate swap agreements was $1.7 million and is the amount we would be
required to pay to terminate the swap agreements at July 2, 2004. If interest
rates for our long-term debt under our credit facility had averaged 10% more and
the full amount available under our credit facility had been outstanding for the
entire year, our interest expense would have increased, and income before taxes
would have decreased by $0.7 million for the quarter ended July 2, 2004.
At July 2, 2004 we had a net investment in our Italy operations of (euro)44.0
million ($52.0 million). We hedge our net investment in our foreign subsidiaries
with euro borrowings under our credit facility in the U.S. At July 2, 2004,
long-term debt includes obligations of (euro)37.5 million ($45.6 million).
Interest on our Euro debt is at variable rates and based on Euribor market
rates. Changes in the U.S.
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dollar equivalent of euro-based borrowings are recorded as a component of the
net translation adjustment in the consolidated statement of stockholder's
equity.
The functional currency for our Italy operations is the Euro. We have
transactional exposure to various other European currencies, primarily the
British pound. Our net annual transactional exposure is approximately (euro)14.0
million ($17.1 million). We frequently use forward purchase contracts to hedge
this exposure. At July 2, 2004, we have outstanding forward contracts of
(euro)6.3 million ((pound)1.2 million).
Item 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, Mr. Webster, our CEO, and
Mr. Schmidgall, our CFO, evaluated our disclosure controls and procedures and,
based on this evaluation, concluded that the Company's disclosure controls and
procedures were appropriate and effective in causing information required to be
disclosed in our reports filed under the Securities Exchange Act of 1934 to be
recorded, processed, summarized and reported within the required time periods.
There have been no changes during this fiscal quarter in our internal control
over financial reporting that has materially affected or is reasonably likely to
materially affect our internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
- -----------------------------------
Not applicable
Item 2. Changes in Securities and Use of Proceeds
- -----------------------------------
(e) The following table provides the information with respect to purchases made
by the Company of shares of its common stock during the third quarter of 2004:
Total Number of
Shares Purchased Approximate Dollar
as Part of Value of Shares that
Total Number of Average Price Publicly Announced May Yet Be Purchased
Period Shares Purchased Paid per Share Plan Under the Plan (1)
- ----------------------------------------- ----------------- ----------------- -------------------- ------------------------
April 3 to April 30 -- -- -- $7,881,000
May 1 to May 28 -- -- -- 7,881,000
May 29 to July 2 -- -- -- 7,881,000
--
Total -- -- --
===== ===== =====
(1) On October 4, 2002 the Company's Board of Directors authorized up to
$20 million to implement a common stock repurchase plan.
Item 3. Defaults Upon Senior Securities
- -------------------------------
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
- -------------------------------
Not applicable
Item 5. Other Information
- -------------------------------
Not applicable
Page 24
Item 6. Exhibits and Reports on Form 8-K
- -------------------------------
(a) Exhibits.
4.1 Third amendment, dated as of June 29, 2004 to the Credit
Agreement, dated July 16, 2001, among American Italian Pasta
Company, various financial institutions and Bank of America,
N.A. as administrative agent.
31.1 Certification of CEO Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of CFO Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32. Certification of the CEO and CFO Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K.
We furnished a report on Form 8-K on April 13, 2004,
announcing lowered guidance for 2004 and that second quarter
sales and profits will be below internal targets.
We furnished a report on Form 8-K on April 28, 2004,
announcing second quarter earnings.
We filed a report on Form 8-K on June 23, 2004, announcing a
Restructuring and Rightsizing Program.
We filed a report on Form 8-K on June 25, 2004, announcing a
quarterly dividend.
Page 25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
American Italian Pasta Company
July 30, 2004 /s/ Timothy S. Webster
- ------------------ -----------------------------------
Date Timothy S. Webster
President and Chief Executive Officer
(Principal Executive Officer)
July 30, 2004 /s/ Warren B. Schmidgall
- --------------------------- -----------------------------------
Date Warren B. Schmidgall
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
Page 26
EXHIBIT INDEX
Exhibit No. Description
----------- -----------
4.1 Third amendment, dated as of June 29, 2004, to the Credit
Amendment, dated July 16, 2001, among American Italian Pasta
. Company, various financial institutions and Bank of America, N.A
as administrative agent.
31.1 Certification of CEO Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of CFO Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32. Certification of the CEO and CFO Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
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