UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
---------------------------
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the quarterly period ended March 27, 2005.
[ ] 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 001-11777
MONTEREY GOURMET FOODS, INC.
Delaware 77-0227341
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
1528 Moffett Street
Salinas, California 93905
(Address of principal executive offices)
Telephone : (831) 753-6262
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
At May 13, 2005, 14,459,051 shares of common stock, $.001 par value, of the
registrant were outstanding.
MONTEREY GOURMET FOODS, INC
FORM 10-Q
Table of Contents
PART 1. FINANCIAL INFORMATION Page
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
March 27, 2005 (unaudited) and December 26, 2004 ...... 3
Condensed Consolidated Statements of Operations
(unaudited) for the three months ended
March 27, 2005 and March 28, 2004 ..................... 4
Condensed Consolidated Statements of Cash Flows
(unaudited) for the three months ended
March 27, 2005 and March 28, 2004 ..................... 5
Notes to the Unaudited Condensed Consolidated
Financial Statements .................................. 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ................... 12
Item 3. Quantitative and Qualitative Disclosures About
Market Risk ........................................... 20
Item 4. Controls and Procedures ................................. 21
PART II. OTHER INFORMATION
Item 5. Other Information ........................................ 21
Item 6. Exhibits ................................................. 21
Signature Page ................................................... 22
Exhibits ......................................................... 23
302 Certification of Chief Executive Officer - Exhibit 31.1 ...... 26
302 Certification of Chief Financial Officer - Exhibit 31.2 ...... 27
906 Certification of Chief Executive Officer - Exhibit 32.1 ...... 28
906 Certification of Chief Financial Officer - Exhibit 32.2 ...... 29
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MONTEREY GOURMET FOODS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands of dollars)
March 27, 2005 December 26, 2004
-------------- -----------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 1,277 $ 569
Accounts receivable, net 5,746 6,212
Inventories 4,731 4,325
Deferred tax assets 1,128 1,126
Prepaid expenses and other 815 957
------------- -------------
Total current assets 13,697 13,189
Property and equipment, net 14,645 14,768
Deferred tax assets 2,032 3,952
Deposit and other 179 126
Intangible assets, net 10,442 6,114
Goodwill 11,027 8,143
------------- -------------
Total assets $ 52,022 $ 46,292
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,224 $ 2,298
Accrued liabilities 2,097 2,370
Current portion of long-term debt 845 757
------------- -------------
Total current liabilities 6,166 5,425
Long-term debt 6,610 1,651
Stockholders' equity:
Common stock 14 14
Additional paid-in capital 45,116 45,103
Accumulated deficit (5,884) (5,901)
------------- -------------
Total stockholders' equity 39,246 39,216
------------- -------------
Total liabilities and stockholders' equity $ 52,022 $ 46,292
============= =============
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
MONTEREY GOURMET FOODS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands of dollars except per share data)
(unaudited)
Three Months Ended
--------------------------------
March 27, 2005 March 28, 2004
-------------- --------------
Net revenues $ 17,663 $ 16,385
Cost of sales 12,715 11,903
-------------- --------------
Gross profit 4,948 4,482
Selling, general and administrative 4,846 5,180
-------------- --------------
Operating income (loss) 102 (698)
Other income, net 5 12
Interest expense, net (79) (26)
-------------- --------------
Income (loss) before provision for income taxes 28 (712)
Income tax benefit (provision) (11) 231
-------------- --------------
Net income (loss) $ 17 $ (481)
============== ==============
Net income (loss) per common share:
Basic income (loss) per common share $ 0.00 $ (0.03)
============== ==============
Diluted income (loss) per common share $ 0.00 $ (0.03)
============== ==============
Basic shares outstanding 14,394,016 14,218,835
Diluted shares outstanding 14,516,283 14,396,331
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
MONTEREY GOURMET FOODS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of dollars)
(unaudited)
Three Months Ended
--------------------------------
March 27, 2005 March 28, 2004
-------------- --------------
Cash flows from operating activities:
Net income (loss) ................................................... $ 17 $ (481)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Deferred income taxes ......................................... (2) (244)
Depreciation and amortization ................................. 713 614
Provisions for allowances for bad debts, returns,
adjustments and spoils ..................................... (76) (38)
Tax benefit of disqualifying dispositions ..................... - 4
Changes in assets and liabilities, net of acquisitions:
Accounts receivable ....................................... 1,451 634
Inventories ............................................... (72) (352)
Prepaid expenses and other ................................ 135 221
Accounts payable .......................................... 679 683
Accrued liabilities ....................................... (1,097) (70)
-------------- --------------
Net cash provided by operating activities .............. 1,748 971
-------------- --------------
Cash flows from investing activities:
Purchase of property and equipment ............................ (192) (161)
Acquisition of business net of cash and minority interest ..... (5,654) (7,229)
-------------- --------------
Net cash used in investing activities ............................ (5,846) (7,390)
-------------- --------------
Cash flows from financing activities:
Proceeds from bank borrowing .................................. 5,000 2,000
Repayment of bank borrowing ................................... (207) (63)
Repayment of capital lease obligations ........................ - (1)
Proceeds from issuance of common stock ........................ 13 55
-------------- --------------
Net cash provided by financing activities ........................ 4,806 1,991
-------------- --------------
Net decrease in cash and cash equivalents ........................... 708 (4,428)
Cash and cash equivalents, beginning of period ...................... 569 5,285
-------------- --------------
Cash and cash equivalents, end of period ............................ $ 1,277 $ 857
============== ==============
Cash payments: March 27, 2005 March 28, 2004
-------------- --------------
Interest $ 71 $ 24
Income Taxes 13 19
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
MONTEREY GOURMET FOODS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The condensed consolidated financial statements have been prepared by
Monterey Gourmet Foods, Inc. (the "Company") and are unaudited. The financial
statements have been prepared in accordance with the instructions for Form 10-Q
and, therefore, do not necessarily include all information and footnotes
required by generally accepted accounting principles, and should be read in
conjunction with the Company's 2004 Annual Report on Form 10-K. In the opinion
of the Company, all adjustments necessary to present fairly the Company's
consolidated financial position, results of operations and cash flows as of
March 27, 2005 have been recorded. A description of the Company's accounting
policies and other financial information is included in the audited consolidated
financial statements as filed with the Securities and Exchange Commission in the
Company's Form 10-K for the year ended December 26, 2004. The consolidated
results of operations for the interim quarterly periods are not necessarily
indicative of the results expected for the full year.
For quarterly reporting purposes the Company employs a 4-week, 4-week,
5-week reporting period. The fiscal year ends on the last Sunday of each
calendar year (52/53-week year). The 2004 fiscal year contained 52 weeks and
ended on December 26. The current fiscal year contains 52 weeks and will end on
December 25, 2005.
Certain reclassifications have been made to 2004 balances to conform to
2005 presentation.
2. Business Acquisition and Statement of Cash Flows
On January 11, 2005, Monterey Gourmet Foods, Inc. ("Monterey"), Casual
Gourmet Foods, Inc. ("Casual"), and the shareholders of Casual ("Shareholders")
entered into a definitive agreement (the "Stock Purchase Agreement") for the
purchase by Monterey of 100% of Casual's outstanding shares. The acquisition was
structured to provide that Monterey acquired 60% of Casual's outstanding shares
immediately and the remaining 40% over the next three years. Casual, which
produces branded gourmet sausages, prepared soups and other food products, is a
Florida corporation with headquarters in Clearwater, Florida. Prior to entry
into the Stock Purchase Agreement, there were no existing material relationships
between or among Monterey and Casual or its Shareholders. Monterey acquired
Casual in order to expand and diversify its product line in the specialty foods
category in which it competes.
For its initial acquisition, Monterey paid $6.1 million in cash. Purchase
of the remaining shares over the next three years will be at a price derived
from a predetermined calculation based upon a multiple of earnings before taxes,
interest, depreciation and amortization during the interim periods. However,
Monterey is entitled to 100% of Casual's profits and is the sole source of any
financing needed by Casual in the interim period. Purchase accounting reflects
the transaction as if Monterey purchased 100% of Casual. No liability has been
established for the remaining payments to Casual's shareholders because the
liability is not quantifiable. When Monterey pays for the remaining shares of
Casual, the Company's goodwill will increase by the corresponding amount.
Casual will remain a separate entity until the acquisition is completed
and, under additional agreement between Monterey, Casual and the Shareholders,
Casual's day-to-day operations until the acquisition is completed will be
managed by Casual's existing management under the direction of the board of
directors; Monterey will control a majority of the Board of Directors.
Casual markets a wide range of refrigerated branded specialty items,
including chicken sausages, chicken burgers, and gourmet soups. Their products
are sold in club stores and retail food stores in 38 states. Some of their most
popular sausage items include red bell pepper with basil, and spinach with
Asiago cheese. Their lobster bisque soup is also a strong seller. Additional
information about Casual Gourmet Foods, Inc. and its products can be found on
its website at www.cgfoods.com.
As part of the acquisition, Monterey Gourmet Foods commissioned a valuation
study to determine the components that represent the intangible assets and
goodwill purchased as part of the purchase price. Under the purchase method of
accounting, the total estimated purchase price is allocated to Casual's tangible
and intangible assets based upon their estimated fair value as of the date of
completion of the acquisition. Based upon the purchase price, the preliminary
valuation, and the financial information at the time of the acquisition, which
is subject to change as more information becomes available, the preliminary
purchase price allocation is as follows (in thousands of dollars):
6
Cash paid directly to owners of Casual $ 6,000
Acquisition costs incurred 128
----------
Total cost of acquisition 6,128
----------
Liabilities assumed 1,322
Deferred tax liability created at time of acquisition 1,920
Cash acquired at time of acquisition (474)
Inventory valuation adjustment to market (30)
Tangible assets acquired (1,444)
Computed interest on non-interest bearing notes 2
Intangible assets acquired (4,540)
----------
Goodwill acquired in transaction $ 2,884
==========
The following unaudited pro forma financial information presents a summary
of our consolidated results of operations for the three month period ended March
27, 2005 and March 28, 2004, assuming the CIBO Naturals (see the Company's
current reports on Forms 8-K and 8-K/A dated January 28, 2004 and April 12,
2004, respectively) and Casual Gourmet Foods acquisitions (see the Company's
current reports on Form 8-K and 8-K/A dated January 18 and march 28, 2005,
respectively) had taken place as of January 1, 2005 and January 1, 2004
respectively (in thousands except per share data).
Three Months Ended
--------------------------------
March 27, 2005 March 28, 2004
-------------- --------------
Net revenues $ 17,866 $ 19,153
Net income (loss) $ (10) $ (486)
============== ==============
Net income (loss) per common share:
Basic income (loss) per common share $ (0.00) $ (0.03)
============== ==============
Diluted income (loss) per common share $ (0.00) $ (0.03)
============== ==============
Basic shares outstanding 14,394,016 14,218,835
Diluted shares outstanding 14,516,283 14,396,331
The unaudited condensed pro forma financial information has been prepared
for comparative purposes only and reflects the historical unaudited results of
Casual Gourmet Foods, Inc and CIBO Naturals LLC. The pro forma financial
information includes adjustments to reflect interest expense generated from cash
that was used for the acquisitions and related income tax adjustments. The pro
forma information also includes an estimate of amortization of identifiable
tangible assets. The pro forma information does not purport to be indicative of
operating results that would have been achieved had the acquisition taken place
on the dates indicated or the results that may be obtained in the future.
7
3. Inventories
Inventories consisted of the following (in thousands):
March 27, 2005 December 26, 2004
-------------- -----------------
Production - Ingredients $ 2,468 $ 1,971
Production - Finished goods 1,063 1,341
Paper goods and packaging materials 1,518 1,190
Operating supplies 43 36
-------------- --------------
5,092 4,538
Allowances for spoils and obsolescence (361) (213)
-------------- --------------
$ 4,731 $ 4,325
============== ==============
4. Property and Equipment
Property, plant and equipment consisted of the following (in thousands):
March 27, 2005 December 26, 2004
-------------- -----------------
Leasehold improvements $ 5,099 $ 5,084
Machinery and equipment 19,385 19,317
Computers, office furniture and equipment 1,234 1,195
Vehicles 443 298
-------------- --------------
26,161 25,894
Less accumulated depreciation and amortization (11,664) (11,163)
-------------- --------------
14,497 14,731
Construction in progress 148 37
-------------- --------------
$ 14,645 $ 14,768
============== ==============
The majority of construction in progress is related to projects started in
the previous year including plant improvements at plants acquired through
acquisitions and process improvement projects. Other construction in progress
spending is associated with typical annual projects involving replacement,
regulatory, food safety and efficiency projects.
5. Credit Facility
Comerica Bank provides a multi-year credit facility to the Company. The
credit facility includes a $2.0 million dollar working capital line of credit
and a non-revolving term loan. A letter of Credit in the amount of $1.0 million
is issued in favor of an insurance company to support a self-funded worker's
compensation program initiated by the Company which reduces the amount of the
line of credit available to the Company. The $2.0 million working capital
portion of the facility is priced at LIBOR, plus 200 basis points. The working
capital commitment expires October 31, 2005.
The non-revolving term loan is priced at either prime rate or LIBOR plus a
premium of 225 basis points over LIBOR. The term loan is subject to annual
review and bank approvals must be obtained before funding. On January 11, 2005,
the Company borrowed an additional $5 million from Comerica Bank under this loan
agreement in order to fund the acquisition of Casual Gourmet Foods. No principal
payments are required for the first year on this additional borrowing.
On April 7, 2005, Monterey Gourmet Foods, Inc. ("Monterey"), Sonoma Foods,
Inc. ("Sonoma"), and the shareholders of Sonoma entered into a definitive
agreement for the purchase by Monterey of 80% of Sonoma's outstanding shares
("Sonoma Stock Purchase Agreement").
8
For its initial acquisition, Monterey paid $3.5 million in cash and stock.
This acquisition was funded in part with $2.5 million in financing provided by
Comerica Bank under the non-revolving term loan agreement. The Bank loan carries
a floating interest rate which is the lower of Comerica Bank's prime rate or
LIBOR plus 2.75% and the principal is payable in equal monthly installments of
$41,666 plus interest over the next five years. The bank requires as collateral
a blanket lien on all existing assets of Monterey Gourmet Foods, Inc., including
equipment, accounts receivable, inventory, trademarks and the stock acquired in
Sonoma Foods, Inc. The bank also requires the company to meet certain financial
covenants which will be reported to the bank on a monthly basis.
The terms of the Credit Facility prohibit the payment of cash dividends
(except with written approval) on the Company's capital stock and restrict
payments for, among other things, repurchasing shares of the Company's capital
stock. Other terms of the Credit Facility limit the Company with respect to,
among other things, (i) incurring additional indebtedness, (ii) adversely
changing the capital structure, and (iii) acquiring assets other than in the
normal course of business including specific limits on annual capital
expenditures. The credit facility is also subject to certain covenants including
meeting certain financial ratios. The Company was in compliance with these
covenants as of March 27, 2005.
6. Income Taxes
Deferred tax assets, principally related to the expected benefit from
utilization of net operating loss carryforwards ("NOLs"), offset most of the
estimated book tax expense, with actual cash tax payments of $14,000 made during
the first three months of 2005. Deferred tax assets remaining on the balance
sheet at the end of the first quarter to offset future income tax liabilities,
are $1,128,000 short term and $2,032,000 long term. Casual Gourmet will not be
consolidated for income tax reporting for calendar years 2005 and 2006. Under
purchase accounting intangible assets were recorded for financial reporting
purposes creating a basis difference between financial reporting and tax
reporting for Casual Gourmet. In order to properly account for this basis
difference, the Company established an estimated deferred tax liability of
$1,920,000 which is included in the Company's net long-term deferred tax assets
of $2,032,000. This deferred tax liability is subject to change based on the
finalization of intangible asset values and further assessment of the income tax
effects of the acquisition.
7. Litigation
Commitments and contingencies
There are no material legal proceedings pending to which the Company is a
party or to which any of its property is subject. The Company is a party to
ordinary routine litigation incidental to the Company's business.
The lease at the main processing facility and corporate offices expired on
October 4, 2004. The Company and the landlord agreed to a ten year extension of
the current lease at current fair-market value. The fair-market value was
determined by a real estate appraiser in the area. The fair market value from
the appraiser increased the rent for the Moffett Street facility by 32%. The
Landlord is currently disputing the amount of office square footage and
therefore the determined fair-market value. The City of Salinas has also issued
a notice of violation regarding lack of a conditional use permit for certain
outside storage containers. The Company is negotiating with the landlord and the
City of Salinas and intends to clear the notice of violation and to resolve
outstanding lease issues with the landlord in the near future. No liability has
been established because the Company's believes that a liability is neither
probable or estimatable.
Guarantees
The Company adopted FASB Interpretation No. 45, Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others ("FIN 45") effective for financial statements of interim
or annual periods ending after December 15, 2002. FIN 45 requires a guarantor to
recognize, at the inception of a qualified guarantee, a liability for the fair
value of the obligation undertaken in issuing the guarantee.
Pursuant to its bylaws, the Company has agreed to indemnify its officers
and directors for certain events or occurrences arising as a result of the
officer or director serving in such capacity. The term of the indemnification
period is for the officer's or director's lifetime. To date, the Company has not
incurred any costs as there have been no lawsuits or claims that would invoke
these indemnification agreements. Accordingly, the Company has no liabilities
recorded for these agreements as of March 27, 2005.
9
The Company enters into indemnification provisions under (i) its agreements
with other companies in its ordinary course of business, typically with business
partners, contractors and customers and its sublandlord and (ii) its agreements
with investors. Under these provisions the Company has agreed to generally
indemnify and hold harmless the indemnified party for losses suffered or
incurred by the indemnified party as a result of the Company's activities or, in
some cases, as a result of the indemnified party's activities under the
agreement. These indemnification provisions often include indemnifications
relating to representations made by the Company with regard to intellectual
property rights. These indemnification provisions generally survive termination
of the underlying agreement. The maximum potential amount of future payments the
Company could be required to make under these indemnification provisions is
unlimited. To date, the Company has not incurred any costs as there have been no
lawsuits or claims related to these indemnification agreements. Accordingly, the
Company has no liabilities recorded for these agreements as of March 27, 2005.
8. Stockholders' Equity
During the first three months of 2005, 4,327 employee stock purchase plan
shares were issued with proceeds to the Company of $13,000. No other shares of
common stock were issued during the quarter.
As permitted under the provisions of SFAS 123, Accounting for Stock-Based
Compensation, the Company continues to account for employee stock-based
transactions under Accounting Principles Board Opinion ("APB") No. 25,
Accounting for Stock Issued to Employees. However, SFAS 123 requires the Company
to disclose pro forma net income and earnings per share as if the fair value
method had been adopted. Under the fair value method, compensation cost is
measured at the grant date based on the fair value of the award and is
recognized over the service period, which is usually the vesting period. For
non-employees, cost is also measured at the grant date, using the fair value
method, but is actually recognized in the financial statements over the vesting
period, or immediately if no further services are required.
If the Company had elected the fair value method of accounting for
stock-based compensation, compensation cost would be accrued at the estimated
fair value of stock option grants over the service period, regardless of later
changes in stock prices and price volatility. The fair values at date of grant
for options granted have been estimated based on a modified Black-Scholes
pricing model.
The table below shows net income per share as if the Company had elected
the fair value method of accounting for stock options (dollars except per share
data stated in thousands).
March 27, 2005 March 28, 2004
-------------- --------------
(in thousands)
Net income (loss) as reported $ 17 $ (481)
Deduct: total stock-based employee compensation
determined under fair value method for all awards,
net of related tax effects (115) (176)
Proforma net income (loss), as adjusted (98) (657)
Earnings per share:
Basic, as reported $ 0.00 $ (0.03)
Basic, as adjusted $ (0.01) $ (0.05)
Diluted, as reported $ 0.00 $ (0.03)
Diluted, as adjusted $ (0.01) $ (0.05)
9. New Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment".
SFAS No. 123R is a revision of SFAS No. 123, "Accounting for Stock Based
Compensation", and supersedes APB 25. Among other items, SFAS 123R eliminates
the use of APB 25 and the intrinsic value method of accounting, and requires
companies to recognize the cost of employee services received in exchange for
awards of equity instruments, based on the grant date fair value of those
awards, in the financial statements.
10
The effective date of SFAS 123R is the first fiscal year beginning after
June 15, 2005, which is the first quarter 2006 for calendar year companies,
although early adoption is allowed. SFAS 123R permits companies to adopt its
requirements using either a "modified prospective" method, or a "modified
retrospective" method. Under the "modified prospective" method, compensation
cost is recognized in the financial statements beginning with the effective
date, based on the requirements of SFAS 123R for all share-based payments
granted after that date, and based on the requirements of SFAS 123 for all
unvested awards granted prior to the effective date of SFAS 123R. Under the
"modified retrospective" method, the requirements are the same as under the
"modified prospective" method, but also permits entities to restate financial
statements of previous periods based on proforma disclosures made in accordance
with SFAS 123.
The Company currently utilizes a standard option pricing model (i.e.,
Black-Scholes) to measure the fair value of stock options granted to Employees.
While SFAS 123R permits entities to continue to use such a model, the standard
also permits the use of a "lattice" model. The Company has not yet determined
which model it will use to measure the fair value of employee stock options upon
the adoption of SFAS 123R. See Note entitled "Stock Based Compensation" for
further information. SFAS 123R also requires that the benefits associated with
the tax deductions in excess of recognized compensation cost be reported as a
financing cash flow, rather than as an operating cash flow as required under
current literature. This requirement will reduce net operating cash flows and
increase net financing cash flows in periods after the effective date. These
future amounts cannot be estimated, because they depend on, among other things,
when employees exercise stock options.
The Company currently expects to adopt SFAS 123R effective January 1, 2006;
however, the Company has not yet determined which of the aforementioned adoption
methods it will use.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs: an
amendment of ARB No. 43, Chapter 4" to clarify the accounting of abnormal
amounts of idle facility expense, freight, handling costs and wasted material.
SFAS No. 151 is effective for inventory costs incurred during fiscal years
beginning after June 15, 2005. At this time, management is in the process of
reviewing this statement for its impact on the Company's cost of goods sold and
inventory valuation. Management has not determined if this statement will impact
its statement of operations in the future.
10. Subsequent Events
On April 7, 2005, Monterey Gourmet Foods, Inc. ("Monterey"), Sonoma Foods,
Inc. ("Sonoma"), and the shareholders of Sonoma ("Shareholders") entered into a
definitive agreement for the purchase by Monterey of 80% of Sonoma's outstanding
shares ("Stock Purchase Agreement"). The Stock Purchase Agreement provides
options for Sonoma's two other shareholders to sell their remaining 20% interest
after four years and, if that option is not exercised, for Monterey to acquire
the interest after seven years. Sonoma will continue to operate under its
current management with its board of directors augmented by representatives of
Monterey..
Sonoma markets a variety of refrigerated branded specialty cheese items,
including their flagship products, Sonoma Jack Cheeses in a variety of flavors.
Sonoma's products are sold in retail supermarkets, club stores, and specialty
food stores across the US with the greatest penetration in the Western US
markets. Sonoma maintains its headquarters in Sonoma, CA.
For its initial acquisition, Monterey paid $3.3 million in cash and $200
thousand in value of Monterey common stock. Purchase of the remaining shares
will be at a price derived from a predetermined calculation based upon a
percentage of earnings before taxes, interest, bonuses, depreciation and
amortization during the interim periods. Sonoma will remain a separate entity
and, under additional agreement between Monterey, Sonoma and the Shareholders,
Sonoma's day-to-day operations until the acquisition is completed will be
managed by Sonoma's existing management; Monterey will control a majority of the
Board of Directors.
The initial acquisition was funded in part with $2.5 million in financing
provided by Comerica Bank, Monterey's principal bank. The Bank loan carries a
floating interest rate which is the lower of Comerica Bank's prime rate or LIBOR
plus 2.75% and the principal is payable in equal monthly installments of $41,666
plus interest over the next five years. The bank requires as collateral a
blanket lien on all existing assets of Monterey Gourmet Foods, Inc., including
equipment, accounts receivable, inventory, trademarks and the stock acquired in
Sonoma Foods, Inc. The bank also requires the company to meet certain financial
covenants which will be reported to the bank on a monthly basis.
11
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
General
The following discussion should be read in conjunction with the financial
statements and related notes and other information included in this report. The
financial results reported herein do not indicate the financial results that may
be achieved by the Company in any future period.
Other than the historical facts contained herein, this Quarterly Report
contains forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995, particularly statements relating to our
expectations relating to, among other things, the Company's results of
operations, future plans and growth strategies. The Company's actual results
regarding such matters may vary materially as a result of certain risks and
uncertainties. For a discussion of such risks and uncertainties, please see the
Company's Annual Report on Form 10-K for the year ended December 26, 2004. In
addition to the risks and uncertainties discussed in the Annual Report, the
risks set forth herein, including the risks associated with any reduction of
sales to two major customers currently comprising a majority of total revenues,
the Company's ability to expand distribution of food products to new and
existing customers, attract and retain qualified management, integrate newly
acquired businesses and compete in the competitive food products industry,
should be considered.
Background
Monterey Gourmet Foods, Inc. ("Monterey Gourmet" or the "Company") was
incorporated in June 1989 as a producer and wholesaler of refrigerated gourmet
pasta and sauces to restaurants and grocery stores in the Monterey, California
area. The Company has since expanded its operations to provide a variety of
gourmet refrigerated food products to grocery and club stores throughout the
United States, selected regions in Canada, the Caribbean, Latin America and Asia
Pacific. The Company's overall strategic plan is to enhance the value of the
Monterey Gourmet Foods brands by distributing its gourmet products through
multiple channels of distribution.
The Company's product distribution to grocery and club stores increased
from approximately 25 stores as of December 1989, to approximately 9,600 stores
by December 26, 2004. During recent years the Company added retail and club
distribution through internal growth and through the Frescala Foods, Nate's,
Emerald Valley, CIBO, and Casual Gourmet acquisitions. Additional distribution
was obtained when the Company introduced CarbSmart products, a full line of
low-carbohydrate pastas and sauces and also whole wheat pastas. Also in 2004,
the Board of Directors unanimously approved a resolution to change the name of
the Company to Monterey Gourmet Foods, Inc. The name change was made to define
the Company's strategic direction more accurately. The name change also
announces to the investor community, our customers and consumers, our strategic
direction to become more than just a pasta company.
In 2004 the Company launched two new product lines outside its core
pasta/sauce business, including Gourmet Refrigerated Entrees, such as Seafood
Lasagna and Pasta Primavera, and Grilled Wrap Sandwiches, featuring a Garlic
Chicken Wrap and a Chicken Ranchero Burrito which have helped increase sales
during the first quarter of 2005. Over the past two years, the Company also
completed three acquisitions outside its pasta business: Emerald Valley Kitchen
(September 2002), a Eugene, Oregon based manufacturer of organic dips and
salsas, CIBO Naturals (January 2004), a maker of sauces, dips and spreads, and
Casual Gourmet Foods, Inc. (January 2005) a marketer of flavorful lower fat,
low-calorie sausages and burgers. The Company believes that the gourmet food
segment is growing rapidly as time-starved consumers seek high quality
quick-meal solutions and Monterey Gourmet Foods, with its staff of senior chefs
and its flexible manufacturing facilities, is well positioned to bring new
products to these consumers.
The success of the Company's efforts to increase revenue will depend on
four key factors: (1) whether grocery and club store chains will continue to
increase the number of their stores offering the Company's products, (2) whether
the Company can continue to increase the number of grocery and club store chains
offering its products, (3) continued introduction of new products that meet
consumer acceptance, (4) whether the Company, by diversifying into other
complementary businesses through new product offerings or acquisitions can
leverage its strengths and continue to grow revenues at levels attractive to its
investors, and (5) whether the Company can maintain the number of items it is
selling into its two largest customers. Grocery and club store chains
continually re-evaluate the products carried in their stores, and no assurances
can be given that the chains currently offering the Company's products will
continue to do so in the future or that such chains will not reduce the number
of stores carrying the Company's products. During 2003, Costco chose to reduce
the number of items it carries, which caused a reduction of sales from the
Company to Costco. In late 2004, Sam's Club has began an SKU (Stock Keeping
Unit) reduction project which has impacted the Company's sales in the first
quarter of 2005.
12
The Company believes that access to substantially greater capital
resources, increased sales to offset higher fixed overhead, coupled with
continued reduction of its administrative and production costs as a percent of
sales revenue, will be key requirements in the Company's efforts to enhance its
competitive position and increase its market penetration. In order to support
its expansion program, the Company continues to develop new products for
consumers and revised advertising and promotional activities for its retail
grocery and club store accounts. There can be no assurance that the Company will
be able to increase its net revenues from grocery and club stores. Because the
Company will continue to make expenditures associated with the expansion of its
business, the Company's results of operations may be affected.
Monterey Gourmet's overall objective is to become a leading national
supplier of refrigerated gourmet food products through distribution of its
products to grocery and club stores. The key elements of the Company's strategy
include the following targeted goals:
o Expand market share through same-store revenue growth, addition of new
grocery and club stores, geographic diversification, and product line
expansion, including creation of additional meal solutions using
Monterey Gourmet products.
o Introduce new products on a timely basis to maintain customer interest
and to respond to changing consumer tastes. In order to maximize its
margins, the Company will focus its efforts on those new products that
can be manufactured and distributed out of its Salinas, California or
Eugene, Oregon, Seattle, WA facilities, and will supplement and
compliment its existing product lines.
o Reduce operating costs as a percentage of sales through continual
evaluation of administrative and production staffing and procedures.
The Company will consider additional capital improvements at its
manufacturing facilities in order to increase production efficiencies
and capacities, and to reduce the Company's cost of goods on a per
unit basis.
o Create brand awareness by communicating to the consumer that Monterey
Gourmet Foods provides a healthful and nutritious line of products,
and promote repeat business by reinforcing positive experiences with
the Company's products.
o Introduce new products at the Company's two largest customers in order
to replace sales reductions from these customers.
o Consider the acquisition of other compatible companies or product
lines to expand retail distribution, or the range of product
offerings, or to accomplish other synergies where the acquisition
could create long-term stockholder value, and be accretive to earnings
in the first year.
The Company will continue to direct its advertising and promotional
activities to specific programs customized to suit its retail grocery and club
store accounts as well as to reach target consumers. These will include in-store
demonstrations, coupon programs, temporary price reduction promotions, and other
related activities. There can be no assurance that the Company will be able to
increase its net revenues from grocery and club stores. Because the Company will
continue to make expenditures associated with the expansion of its business, the
Company's results of operations may be affected.
The success of the Company's acquisition strategy will depend upon its
ability to generate cash from current operations, attract new capital, find
suitable acquisition candidates, and successfully integrate new businesses and
operations. There is no assurance that acquisitions can be financed from current
cash flow, and, if not, that outside sources of capital will be available to
supplement internally-generated funds. There is no assurance that management can
successfully select suitable acquisition candidates and that these new
businesses can be successfully integrated to create long term stockholder value.
Results of Operations
Net revenues from operations were as follows (in thousands):
Quarter Ended
--------------------------------
March 27, 2005 March 28, 2004
-------------- --------------
Net Revenues $ 17,663 $ 16,385
Percent Change in Net Revenues
from prior year 8% 2%
13
The quarterly increase is due to the volume generated from the acquisition
of CIBO, Emerald Valley and Casual Gourmet Foods, some of which had sales in the
previous year. Excluding sales generated from these three acquisitions, net
sales declined 16%. Sales of pasta to Costco and Sam's Club continue to be
impacted by these customers' decisions to reduce the number of SKUs they choose
to purchase from the Company. These customers have also reduced the shelf space
allotted to pasta. Pasta sales to these two customers declined 23% in the first
quarter of 2005 compared to the same quarter in 2004. The Company's Monterey
Pasta brand retail business, which has been a focus for the Company, is up 11%
when compared to the same quarter one year ago.
Gross profit and gross margin were as follows:
Quarter Ended
--------------------------------
March 27, 2005 March 28, 2004
-------------- --------------
Gross profit $ 4,948 $ 4,482
Gross margin percent 28.0% 27.4%
Gross profit for the year ended December 26, 2004 was 26.4%. The gross
margin improvement compared with first quarter 2004 was a function of reduced
fixed costs, reduced labor costs and changes in product mix. Gross margin
percent compared to prior year is a function of cost savings obtained by running
more efficiently and also an improvement in product mix especially from recent
acquisitions offset by less volume through the Salinas plants, higher utility
costs, higher raw material costs especially in dairy and cheese products. The
Company has not been able to pass along these higher costs to its customers.
Management has continued to reorganize its workforce in Salinas where the number
of employees has been reduced by approximately 30%. This was done in an effort
to reduce processing costs and increase margins. The impact of this change on
the Company's gross profit is difficult to quantify because of its sensitivity
to volume through the plant
Selling, general and administrative expenses or SG&A were as follows (in
thousands):
Quarter Ended
--------------------------------
March 27, 2005 March 28, 2004
-------------- --------------
SG&A Expense $ 4,846 $ 5,180
SG&A Expense as a percent of net
revenues 27.4% 31.6%
SG&A expenses decreased when compared to the same quarter last year. SG&A
as a percent of sales also decreased for the first quarter 2005 compared to the
first quarter 2004. For fiscal year ended December 26, 2004, SG&A expenses were
29.2% of sales. The quarterly decreases compared to 2004 are related to a
reduction in legal fees, lower selling and demonstrating costs, and lower fixed
payroll costs. These cost reductions are partially offset by increased freight
cost due to fuel surcharges and less efficient loads related to increased retail
sales distribution and also by adding the SG&A costs associated with Casual
Gourmet's overhead.
Depreciation and amortization expense, included in cost of sales and SG&A,
was $713,000 or 4.0% of net revenues for the quarter ended March 27, 2005,
compared to $614,000 or 3.7% of net revenues for the quarter ended March 28,
2004. The increase is associated with the amortization of intangible assets
acquired in the Casual Gourmet acquisition.
Net interest expense was $79,000 for the quarter ended March 27, 2005,
compared to net interest expense of $26,000 for the same quarter in 2004. The
change in interest reflects the borrowings that came about from the acquisitions
of CIBO and Casual.
Income taxes for the first quarter of 2005 reflect a tax expense of $11,000
or approximately 39.3% of pretax income, as compared to a tax benefit of
$231,000 for the same period in 2004. The tax rate for the calendar year of 2004
was 27%.
14
Liquidity and Capital Resources
During the three month period ended March 27, 2005, $1,748,000 of cash was
provided by the Company's operations, compared to $971,000 cash provided in the
first three months of 2004. The increase in cash from operations reflects an
increase in net income of $498,000, reduction of accounts receivable and higher
depreciation and amortization expense and partially offset by lower accounts
payable balances. Capital expenditures were $192,000 in the first three months
of 2005 compared to $161,000 for the first quarter of 2004. Capital spending in
2005 reflects projects associated with acquired facilities. The Company will
spend capital dollars when appropriate either to support sales initiatives or to
reduce operating costs.
During the first three months of 2005, proceeds from the Employee Stock
Purchase Plan share purchase of 4,327 shares were $13,000. This compares to the
first three months of 2004 in which $25,000 was generated from 8,484 shared
issued under the Employee Stock Purchase Plan and $33,000 from the exercise of
17,666 equivalent shares from the Company's employee stock option plan.
The Company finances its operations and growth primarily with cash flows
generated from operations. The Company has a $2.0 million dollar working capital
line of credit against which a letter of Credit in the amount of $1,000,000 is
issued in favor of an insurance company to support a self-funded worker's
compensation program initiated by the Company on January 1, 2003 and continuing
into 2005. The Company borrowed $2.0 million in 2004 to partially fund the CIBO
acquisition. The Company also borrowed $5.0 million in 2005 to partially fund
the Casual Gourmet acquisition. On April 11, 2005 the Company announced the 80%
purchase of Sonoma Foods, Inc. also known as Sonoma Cheese Company. As part of
this acquisition the Company borrowed an additional $2.5 million.
The Company believes that its existing credit facilities, together with
cash flow from operations, are sufficient to meet its cash needs for normal
operations including all capital expenditures for the next twelve months. The
Company also believes that the integrations of acquisitions will not require
significant usages of cash.
Contractual Obligations
The Company has no raw material contracts exceeding one year in duration.
However, it does have one long-term contract with its liquid nitrogen provider,
which expires November 30, 2007. In addition, the Company leases production,
warehouse and corporate office space as well as certain equipment under both a
month-to-month and non-cancelable operating lease agreement. All building leases
have renewal options and all include cost of living adjustments. The following
table summarizes the estimated annual obligations.
Payments due by period
-------------------------------------------------------------------
Contractual Obligations Less than More than 5
(in Thousands) Total 1 year 1 - 3 years 3 -5 years years
----------- ----------- ----------- ----------- -----------
Long-term debt $ 7,332 $ 828 $ 3,710 $ 2,175 $ 619
Capital lease obligations 123 28 73 22 -
Operating leases 7,639 1,182 2,112 1,151 3,194
Purchase obligations 2,302 695 1,607 - -
----------- ----------- ----------- ----------- -----------
Total $ 17,396 $ 2,733 $ 7,502 $ 3,348 $ 3,813
=========== =========== =========== =========== ===========
The Company has a standby letter of credit in favor of an insurance company
for $1,000,000 for Workers Compensation insurance which expires on December 31,
2005.
15
Critical Accounting Policies and Management Judgments
Accounts Receivable and Allowances
The Company provides allowances for estimated credit losses, product
returns, spoilage, and adjustments at a level deemed appropriate to adequately
provide for known and inherent risks related to such amounts. The allowances are
based on reviews of the history of losses, returns, spoilage, contractual
relationships with customers, current economic conditions, and other factors
that warrant consideration in estimating potential losses. While management uses
the best information available in making its determination, the ultimate
recovery of recorded accounts, notes, and other receivables is also dependent on
future economic and other conditions that may be beyond management's control.
Income Taxes
The Company accounts for corporate income taxes in accordance with SFAS 109,
"Accounting for Income Taxes", which requires an asset and liability approach.
This approach results in the recognition of deferred tax assets (future tax
benefits) and liabilities for the expected future tax consequences of temporary
timing differences between the book carrying amounts and the tax basis of assets
and liabilities. Future tax benefits are subject to a valuation allowance to the
extent of the likelihood that the deferred tax assets may not be realized. The
Company's deferred tax assets include significant amounts of NOLs. During 2004,
the valuation allowance was increased due to consideration of the impact of the
2004 losses and the Company's assessment of the realization of such NOLs. The
amount of the valuation allowance is significantly dependent on management's
assumptions regarding future taxable income and the availability of these NOLs
to offset future taxable income. The effect on the Company's net income is
significant whenever the estimate of realizability changes. The Company expects
to utilize most of the remaining NOLs in future years. Casual Gourmet will not
be consolidated for income tax reporting for calendar years 2005 and 2006. Under
purchase accounting, intangible assets were recorded creating a basis
difference between financial reporting and tax reporting for Casual Gourmet. In
order to properly account for this basis difference, the Company established an
estimated deferred tax liability of $1,920,000 which is included in the
Company's net long-term deferred tax assets of $2,032,000. This deferred tax
liability is subject to change based on the finalization of intangible asset
values and further assessment of the income tax effects of the acquisition.
Inventory Valuation
Inventories are stated at the lower of cost (using the first-in, first-out
method) or market and consist principally of component ingredients to the
Company's refrigerated pasta and sauces, finished goods, and packaging
materials. Many of the ingredients used in the Company's products are short
shelf-lived products and if not used in a certain amount of time may spoil.
Management estimates that the raw material will be used in a timely manner;
however, management has established certain reserves for the potential of
inventory obsolescence, especially for slow moving inventory. In addition, the
Company purchased certain packaging materials for its products that are intended
to be used in the future. As of March 27, 2005, the Company reduced the carrying
value of its inventory by $361,000. This write-down was made to cover certain
refrigerated raw material inventory that is nearing its shelf-life, certain
packaging labels for products that may be rotated out of the Club Store accounts
and for products that have already been rotated out of the Club Store accounts
that may or may not be rotated back into the Club Store accounts. The allowance
is established based on management's estimate of alternative usage or salvage
value of obsolete inventory. Management believes its estimates for spoiled and
obsolete inventory is adequate given the current volume of business to its
current customers.
Workers Compensation Reserve
The Company entered into a partially self-insured worker's compensation
program for fiscal year 2003 and will continue the program into 2005. This
program features a fixed annual payment, with a deductible on a per occurrence
basis. The annual expense consists of a base fee paid to an insurance company to
administer the program, direct cash expenses to pay for injuries, an estimate
for potential injuries that may have occurred but have not been reported, an
estimate by the insurance company of costs to close out each injury and an
estimate for injury development. The Company has been on this partially
self-insured program for just over two years and therefore has limited history
of claim resolution available to support the Company's specific actuarial
projections. Therefore the Company is using published industry actuarial data
from an insurance carrier and reviewing each claim individually to determine the
amount of reserves that should be established. Management believes that its
16
current safety program and its safety record will provide the foundation to
enable the Company to realize the premium savings partially self-insured
programs are designed to achieve, however, estimated reserves may vary from
future cash outlays.
Revenue Recognition
The Company recognizes revenues through sales of its products primarily to
grocery and club store chains. Revenues are recognized once there is evidence of
an arrangement (such as a customer purchase order), product either has been
shipped to the customer or has been delivered to the customer, the price and
terms are fixed, and collectibility is reasonably assured. Accordingly, sales
are recorded when goods are shipped or for one customer, when the product is
delivered, at which time title and risk of loss have passed to the customer,
consistent with the freight terms for most customers. Title and risk of loss
pass upon delivery to retail locations for the Direct Store Delivery program, as
that product is transported in the Company's own vehicles. Potential returns,
adjustments and spoilage allowances are provided for in accounts receivable
allowances and accruals.
The Company records shipping cost for product delivered to customers in
selling expense. Any amounts charged to customers for freight and deliveries are
included in revenues. Certain incentives granted to customers such as
promotions, trade ads, slotting fees, and coupons are recorded as offsets to
revenues.
Goodwill and Intangible Assets
Effective January 1, 2002 under SFAS 142, "Goodwill and Other Intangible
Assets" goodwill and intangible assets with indefinite useful lives are to be
tested for impairment at least annually. Intangible assets with definite useful
lives continue to be amortized over their respective estimated useful lives. The
primary identifiable intangible assets of the Company's reporting units are
trademarks, tradenames and customer relationships acquired in business
acquisitions. Identifiable intangibles with finite lives are amortized and those
with indefinite lives are not amortized. The estimated useful life of an
identifiable intangible asset to the reporting unit is based upon a number of
factors, including the effects of demand, competition, and future cash flows. As
of March 27, 2005, the net book value of trademarks and other identifiable
intangible assets was $10.4 million.
Identifiable intangible assets that are subject to amortization are
evaluated for impairment using a process similar to that used to evaluate
elements of property. Identifiable intangible assets not subject to amortization
are assessed for impairment at least as often as annually and as triggering
events may occur. The impairment test for identifiable intangible assets not
subject to amortization consists of a comparison of the fair value of the
intangible asset with its carrying amount. An impairment loss is recognized for
the amount by which the carrying value exceeds the fair value of the asset. In
making this assessment, management relies on a number of factors to discount
anticipated future cash flows including operating results, business plans and
present value techniques. Rates used to discount cash flows are dependent upon
interest rates and the cost of capital at a point in time. There are inherent
uncertainties related to these factors and management's judgment in applying
them to the analysis of intangible asset impairment. It is possible that
assumptions underlying the impairment analysis will change in such a manner that
impairment in value may occur in the future.
Goodwill is not amortized but is subject to periodic assessments of
impairment. At March 27, 2005, the Company had $11.0 million of goodwill on its
books. Goodwill is assessed for impairment at least as often as annually and as
triggering events may occur. The corporation performs its annual review in the
fourth quarter of each year. Recoverability of goodwill is evaluated using a
comparison of the fair value of a reporting unit with its carrying value. If the
carrying value of the goodwill of a reporting unit exceeds the fair value of
that goodwill, an impairment loss is recognized in an amount equal to the
excess. Reporting units are business components one level below the operating
segment level for which discrete financial information is available and reviewed
by segment management.
In evaluating the recoverability of goodwill, it is necessary to estimate
the fair value of the reporting units. In making this assessment, management
relies on a number of factors to discount anticipated future cash flows
including operating results, business plans and present value techniques. Rates
used to discount cash flows are dependent upon interest rates and the cost of
capital at a point in time. There are inherent uncertainties related to these
factors and management's judgment in applying them to the analysis of goodwill
impairment. It is possible that assumptions underlying the impairment analysis
will change in such a manner that impairment in value may occur in the future.
17
Sales and Marketing
The Company's sales and marketing strategy is twofold and emphasizes
sustainable growth in distribution of its products and introduction of
innovative new products to keep the Company positioned as the category leader in
the marketplace.
Pasta is a staple of the North American diet. It is widely recognized that
pasta is a convenient and nutritious food. The USDA places pasta on the
foundation level of its pyramid of recommended food groups and pasta supports
consumers' lifestyle demands for convenient at-home meals.
The Company offers its customers distinctive packaging that uses a sleeve
to wrap the inner package, and incorporates color graphics and product
photography in a contemporary new look. The packaging is created to communicate
to the consumer (1) higher product quality, (2) ease and swiftness of
preparation, and (3) appetite appeal to encourage point of sale purchase and to
show a variety in product choice. The Company continues to improve its product
to enhance the dining experience. This new package is designed to both
strengthen the Monterey Gourmet Foods brand recognition and reinforce its
positioning as a premium quality product.
The Company employees two full time chefs and continues to introduce new
products. Recent introductions include CARBSMART, a line of reduced carbohydrate
fresh pastas, sauces and prepared entrees with about half the carbohydrates of
regular pasta. The Company also has introduced a full line of whole wheat pastas
into the market place. The Company is the first to introduce whole wheat in the
refrigerated pasta category. Sales of these items have helped grow the retail
branded category by 11% over the same quarter one year ago.
The Company is also combining efforts with its recently acquired companies
to maximize selling and marketing efforts. The Company has a dedicated sales
force that focuses solely on the natural and organic foods category, a category
which is growing throughout the United States. This sales force along with the
Company's retail sales and club store sales forces have the ability to sell
products nationwide. With the recent acquisitions, the sales personnel have more
products in their offering and more opportunities to place themselves in front
of strategic buyers.
Major Customers
Two of the Company's customers, Costco and Sam's Club Stores, accounted for
44% and 18%, respectively, of the Company's net revenues for the three months
ended March 27, 2005. No other customer accounted for greater than 10% of net
revenues for the period.
Business Risks
Certain characteristics and dynamics of the Company's business and of
financial markets generally create risks to the Company's long-term success and
to predictable quarterly results. These risks include:
o No Assurance of Profitability. Refrigerated pasta sales have declined over
the past two years, generating losses from this product line. The Company
reported a loss for the entire year of 2004. At March 27, 2005 the Company
had an accumulated deficit of $5,884,000. There can be no assurance that
the Company will generate profits in the short or long term.
o Liquidity: Need for Additional Capital. Management believes that its
current cash balances, operations, and existing bank lines of credit will
provide adequate liquidity to meet the Company's planned capital and
operating requirements for normal operations and capital expenditures for
the next twelve months. See Notes to the financial statements for a
description of the credit facility. If the Company's operations do not
provide cash sufficient to fund its operations, and the Company seeks
outside financing, there can be no assurance that the Company will be able
to obtain such financing when needed, on acceptable terms, or at all. In
addition, any future equity financing or convertible debt financing could
cause the Company's stockholders to incur dilution in net tangible book
value per share of the Company's Common Stock.
18
o Hiring and Retention of Key Personnel. The success of the Company depends
on its ability to retain key executives, and to motivate and retain other
key employees and officers. CEO James Williams joined the Company in
October 2002 and Mr. Scott Wheeler became CFO in October 2003. The Company
currently has a key man insurance policy with a face amount of $500,000 for
Mr. Williams. Part of the Company's acquisition strategy is to maintain the
current management of each acquisition and motivate them appropriately to
help garner synergies and grow their respective Companies. The management
of CIBO, Casual Gourmet, and Sonoma Foods have employment contracts to help
insure the growth of these acquisitions. There can be no assurance that key
management will remain stable; significant management turnover could
disrupt the Company's operations with consequent adverse effect on the
business.
o Moffett Street Lease. The lease at the main processing facility and
corporate offices expired on October 4, 2004. The Company and the landlord
agreed to a ten year extension of the current lease at current fair-market
value. The fair-market value was determined by a real estate appraiser in
the area. The fair market value from the appraiser increased the rent for
the Moffett Street facility by 32%. The Landlord is currently disputing the
amount of office square footage and therefore the determined fair-market
value. The City of Salinas has also issued a violation regarding lack of a
conditional use permit for certain outside storage containers. The Company
is negotiating with the landlord and the City of Salinas and intends to
clear the notice of violation and to resolve outstanding lease issues with
the landlord in the near future.
o Impact of Inflation. The increased cost of dairy ingredients had a material
inflationary impact on the Company's operations during the first quarter of
2005. Protein items such as chicken have decreased since December but are
still higher than the same quarter one year ago. Freight rate increases
related to fuel surcharges impacted the quarter. Medical benefits continued
to increase at rates higher than the consumer price index. Potential
increases in labor, employee benefits, freight, ingredients and packaging,
rents and other operating expenses, as well as increases in dairy
ingredients have adversely affected the Company's profitability and may
continue to impact the Company in future periods. The Company cannot
predict whether such increases will occur in the future or their magnitude
if they do.
o Risks Inherent in Food Production. The Company faces all of the risks
inherent in the production and distribution of refrigerated food products,
including contamination, adulteration, spoilage, and the associated risks
of product liability litigation, which may occur even with an isolated
event. Although the Company has modern production facilities, and has
obtained USDA approval for them, and employs what it believes are the
necessary processes and equipment in order to insure food safety, there can
be no assurance that the Company's procedures will be adequate to prevent
the occurrence of such events.
o Dependence on Major Customers. During the first quarter of 2005, two of the
Company's customers, Costco and Wal-Mart, Inc including its subsidiary,
Sam's Club, accounted for 48% and 18%, respectively, of the Company's total
revenues. The Company currently sells its products to eight separate US
Costco regions and its international regions which currently make
purchasing decisions independently of one another. These regions
re-evaluate, on a regular basis, the products carried in their stores.
There can be no assurance that these Costco regions will continue to offer
the Company's products in the future or continue to allocate Monterey
Gourmet the same amount of shelf space. In addition, there can be no
assurance that Sam's Club will continue to carry the Company's products.
Loss of either of these customers, Costco or Sam's Club, or a significant
further reduction in sales to either, would have a material adverse effect
on the Company. Additionally, liberalized pricing or allowance terms would
create downward pressure on gross margins.
o Changing Consumer Preferences. Consumer preferences change, sometimes
quickly, and the success of the company's food products depends on the
company's ability to identify the tastes and dietary habits of consumers
and offer products that appeal to their preferences. The Company introduces
new products and improved products, and incurs development and marketing
costs associated with new products. If the Company's products fail to meet
consumer preferences, then the Company's strategy to grow sales and profits
with new products will be less successful. Recent attention to low
carbohydrate diets by certain segments of the U.S. population has affected
the consumption of pasta, and pasta sales have decline as a percentage of
grocery sales in the U.S. As American consumers seek new ways to reduce
their intake of carbohydrates, Monterey Gourmet Foods has developed
products to address these changing preferences. Towards the end of 2004,
the low-carbohydrate diet trend decreased and the trend has been towards
whole grains and less refined products. The Company has spent resources to
develop whole wheat pasta products that meet this new trend. However, there
can be no assurance that these new products will meet the changing demands
of the consumer.
o Seasonality and Other Variable Factors. The Company's grocery and club
store accounts are expected to experience seasonal fluctuations to some
extent. The Company's business in general may also be affected by a variety
of other factors, including but not limited to general economic trends,
competition, marketing programs, and special or unusual events.
19
o Competition and Dependence on Common Carriers. The Company's business
continues to be dominated by several very large competitors, who have
significantly greater resources than the Company; such competitors can
outspend the Company and negatively affect the Company's market share and
results of operations. The Company also continues to be dependent on common
carriers to distribute its products. Any disruption in its distribution
system or increase in the costs thereof could have a material adverse
impact on the Company's business.
o California Energy Supply and Pricing. Because most of the Company's
operations are in California, its operating costs are affected by increases
in electricity and natural gas prices. As a result, the Company's operating
results have been affected in some measure by the increased cost of energy.
Management cannot predict the level of future energy prices or supply with
certainty.
o Volatility of Stock Price. The market price of the Company's common stock
has fluctuated substantially since the initial public offering of the
Company's common stock in December 1993. Such volatility may, in part, be
attributable to the Company's operating results or to changes in the
direction of the Company's expansion efforts. In addition, changes in
general conditions in the economy, the financial markets or the food
industry, natural disasters or other developments affecting the Company or
its competitors could cause the market price of the Company's common stock
to fluctuate substantially. In addition, in recent years, the stock market
has experienced extreme price and volume fluctuations. This volatility has
had a significant effect on the market prices of securities issued by many
companies, including the Company, for reasons sometimes unrelated to the
operating performance of these companies. Moreover, any announced shortfall
in the Company's net sales or earnings from levels expected by securities
analysts or the market could have an immediate and significant adverse
effect on the trading price of the Company's common stock in any given
period. Additionally, the Company may not learn of such shortfalls until
late in the fiscal quarter, shortly before operating results are due to be
announced. The announcement, together or in succession, of such a shortfall
and of lower than expected quarterly operating results, could result in an
even more immediate and significant adverse impact on the trading price of
the Company's common stock upon announcement of the shortfall or quarterly
operating results.
o Marketing and Sales Risks. The future success of the Company's efforts will
depend on a number of factors, including whether grocery and club store
chains will continue to expand the number of their individual stores
offering the Company's products and whether allowances and other incentives
will expand retail distribution. Expansion into new markets increases the
risk of significant product returns resulting from the Company's supply of
slower selling items to its customers. In addition, grocery and club store
chains continually re-evaluate the products carried in their stores and no
assurances can be given that the chains currently offering the Company's
products will continue to do so in the future, either in the same measure
or at all. Should these channels choose to reduce or eliminate products,
the Company could experience a significant reduction in its product sales.
The Company remains dependent on the use of slotting allowances and other
incentives to expand retail distribution.
o Compliance with laws applicable to its business. The company's facilities
and products are subject to many laws and regulations administered by the
United States Department of Agriculture, the Federal Food and Drug
Administration, and other federal, state, local, and foreign governmental
agencies relating to the processing, packaging, storage, distribution,
advertising, labeling, quality, and safety of food products. The company's
failure to comply with applicable laws and regulations could subject it to
administrative penalties and injunctive relief, civil remedies, including
fines, injunctions and recalls of its products. Failure to comply with
these regulations can have serious consequences, including civil and
administrative penalties and negative publicity.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market Risk Disclosure
The Company does not hold market risk-sensitive trading instruments, nor
does it use financial instruments for trading purposes. All sales, operating
items and balance sheet data are denominated in U.S. dollars; therefore, the
Company has no foreign currency exchange rate risk.
In the ordinary course of its business the Company enters into commitments
to purchase raw materials over a period of time, generally six months to one
year, at contracted prices. At March 27, 2005 these future commitments were not
at prices in excess of current market, or in quantities in excess of normal
requirements. The Company does not utilize derivative contracts either to hedge
existing risks or for speculative purposes.
20
Interest Rate Risk
The Company invests excess cash in variable income investments consisting
of cash equivalents. The magnitude of the interest income generated by these
cash equivalents is affected by market interest rates. Management does not use
marketable securities or derivative financial instruments in its investment
portfolio.
The interest payable on the Company's bank line of credit is based on
variable interest rates and therefore affected by changes in market interest
rates. The Company does not believe that changes in interest rates will have a
material impact to the Company's results of operation.
Currency Risk
During the first quarter of 2005, the Company sold $50,000 of product in
currency other than US dollars. These sales have terms of net 30 days from
shipment. The Company believes that its currency exposure is not material and
has chosen not to hedge these sales.
Item 4. Controls and Procedures
Under the supervision of and with the participation of our management,
including the chief executive officer and chief financial officer, we evaluated
the effectiveness of our disclosure controls and procedures, as such term is
defined under Rule 13a-14(c) promulgated under the Securities Exchange Act of
1934, as amended. Based on this evaluation, our chief executive officer and
chief financial officer concluded that our disclosure controls and procedures
were effective to accomplish their objectives as of the end of the period
covered by this Quarterly Report.. There have been no significant changes during
the quarter ended March 27, 2005 in the Company's internal controls that have
materially affected or are reasonably likely to materially affect our internal
controls over financial reporting.
PART II. OTHER INFORMATION
Item 5. Other Information
On April 7, 2005, Monterey Gourmet Foods, Inc. ("Monterey"), Sonoma Foods,
Inc. ("Sonoma"), and the shareholders of Sonoma ("Shareholders") entered into a
definitive agreement for the purchase by Monterey of 80% of Sonoma's outstanding
shares ("Stock Purchase Agreement"). The Stock Purchase Agreement provides
options for Sonoma's two other shareholders to sell their remaining 20% interest
after four years and, if that option is not exercised, for Monterey to acquire
the interest after seven years. Sonoma will continue to operate under its
current management with its board of directors augmented by representatives of
Monterey.
Sonoma markets a variety of refrigerated branded specialty cheese items,
including their flagship products, Sonoma Jack Cheeses in a variety of flavors.
Sonoma's products are sold in retail supermarkets, club stores, and specialty
food stores across the US with the greatest penetration in the Western US
markets. Sonoma maintains its headquarters in Sonoma, CA.
For its initial acquisition, Monterey paid $3.3 million in cash and $200
thousand in value of Monterey common stock. Purchase of the remaining shares
will be at a price derived from a predetermined calculation based upon a
percentage of earnings before taxes, interest, bonuses, depreciation and
amortization during the interim periods. Sonoma will remain a separate entity
and, under additional agreement between Monterey, Sonoma and the Shareholders,
Sonoma's day-to-day operations until the acquisition is completed will be
managed by Sonoma's existing management; Monterey will control a majority of the
Board of Directors.
The initial acquisition was funded in part with $2.5 million in financing
provided by Comerica Bank, Monterey's principal bank. The Bank loan carries a
floating interest rate which is the lower of Comerica Bank's prime rate or LIBOR
plus 2.75% and the principal is payable in equal monthly installments of $41,666
plus interest over the next five years. The bank requires as collateral a
blanket lien on all existing assets of Monterey Gourmet Foods, Inc., including
equipment, accounts receivable, inventory, trademarks and the stock acquired in
Sonoma Foods, Inc. The bank also requires the company to meet certain financial
covenants which will be reported to the bank on a monthly basis.
Item 6. Exhibits
See Index of Exhibits for all exhibits filed with this report.
21
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.
MONTEREY GOURMET FOODS
Date: May 13, 2005
By: /s/ JAMES M. WILLIAMS
---------------------------
James M. Williams
Chief Executive Officer
By: /s/ SCOTT WHEELER
---------------------------
Scott Wheeler
Chief Financial Officer
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Index to Exhibits
3.1 Certificate of Incorporation dated August 1, 1996 (incorporated by
reference from Exhibit B to the Company's Definitive Proxy Statement for
its 1996 Annual Meeting of Shareholders (the "1996 Proxy").)
3.2 Delaware Certificate of Amendment filed August 2004
3.3 Bylaws of the Company (incorporated by reference from Exhibit C to the
1996 Proxy)
4.1 Form of Registration Rights Agreement dated April 1996, among the
Company, Spelman & Co., Inc. and investor (incorporated by reference
from Exhibit 10.42 filed with the Company's Original March 31, 1996
Quarterly Report on Form 10-Q on May 1, 1996 ("1996 Q1 10-Q"))
4.2 Rights Agreement dated as of May 15, 1996 between the Company and
Corporate Stock Transfer, as rights agent (incorporated by reference
from Item 2 of Form 8-A filed with the Securities and Exchange
Commission on May 28, 1996)
4.3 Amendment to Registration Rights Agreement dated as of April 20, 1997
among the Company, Spelman & Co., Inc. and investor, amending the
Registration Rights Agreement entered into as of April, 1996
(incorporated by reference from Exhibit 4.9 filed with the Company's
1996 Form 10-KA)
4.4 Registration Rights Agreement dated as of June 15,1995 with GLF
Advantage Fund Limited, as amended on October 13 and 19, 1995,
respectively (incorporated by reference from Exhibit 10.2 to the 1995
second quarter 10-Q and Exhibits 10.6 and 10.7 to the Company's S-3
Registration Statement No. 33-96684, filed on December 12, 1995 ("1995
S-3").
10.1* Third Amended and Restated 1993 Stock Option Plan (as amended on August
1, 1996 and April 30, 2002) (incorporated by reference to Exhibit 10.1
filed with the Company's 1996 Form 10-K and Proposal No. 3 in the
Company's Definitive Proxy Statement for its 2002 Annual Meeting of
Shareholders)
10.2* 1995 Employee Stock Purchase Plan (incorporated by reference from
Exhibit 10.15 to the Company's 1994 Form 10-K)
10.3 Monterey County Production Facility Lease of the Company, as amended
(incorporated by reference from Exhibit 10.03 to the Company's
Registration Statement on Form SB-2 filed with the Commission (the
"SB-2))
10.4 Amendment No. 1 dated February 1, 1995 and Amendment No. 2 dated March
1, 1995 to Monterey County Production Facility Lease of the Company
(incorporated by reference from Exhibit 10.6 filed with the 1995 Form
10-K)
10.5 Amendment No. 3 dated September 12, 1997, and Amendment No. 4 dated
February 6, 1998 to Monterey County Production Facility Lease of the
Company (incorporated by reference from Exhibit 10.5 filed with the
Company's September 27, 1998 Quarterly Report on Form 10-Q dated
November 4, 1998 ("1998 Q3 10-Q"))
10.6 Trademark Registration - MONTEREY PASTA COMPANY, under Registration No.
1,664,278, registered on November 12, 1991 with the U.S. Patent and
Trademark Office (incorporated by reference from Exhibit 10.09 to the
SB-2)
10.7 Trademark Registration - MONTEREY PASTA COMPANY, under Registration No.
1,943,602, registered on December 26, 1995 with the U.S. Patent and
trademark Office (incorporated by reference from Exhibit 10.24 to the
1995 Form 10-K)
10.8 Trademark Registration - MONTEREY PASTA COMPANY and Design, under
Registration No. 1,945,131, registered on January 2, 1996 with the U.S.
Patent and trademark Office (incorporated by reference from Exhibit
10.25 to the 1995 Form 10-K)
10.9 Trademark Registration--MONTEREY PASTA COMPANY and Design, under
Registration No. 1,951,624, registered on January 23, 1996 with the U.S.
Patent and Trademark Office (incorporated by reference from Exhibit
10.26 to the 1995 Form 10-K)
10.10 Trademark Registration--MONTEREY PASTA COMPANY and Design, under
Registration No. 1,953,489, registered on January 30, 1996 with the U.S.
Patent and Trademark Office (incorporated by reference from Exhibit
10.27 to the 1995 Form 10-K)
10.11* Offer letter regarding Employment as Chief Executive Officer dated
August 20, 2002 with Mr. James M. Williams
10.12 Agreement for Handling and Storage Services between the Company and CS
Integrated LLC dated February 5, 1999 (incorporated by reference to
Exhibit 10.21 filed with the Company's 1998 Form 10-K on March 17, 1999
("1998 Form 10-K"))
10.13 Agreement for Purchase and Sale of Assets dated as of March 12, 1999, by
and among the Company and the shareholders of Frescala Foods, Inc.
(incorporated by reference from Exhibit 2.1 filed with the Company's 8-K
on March 17, 1999)
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10.14 Royalty agreement dated July 12, 1999 between Company and Chet's Gourmet
Foods, Inc. for soups (incorporated by reference to Exhibit 10.25, in
the Company's September 26, 1999 Quarterly Report on Form 10-Q filed on
November 9, 1999 ("1999 Q3 10-Q"))
10.15 Storage Agreement Manufactured Products dated August 3, 1999 between the
Company and Salinas Valley Public Warehouse for storage and handling of
Company's product in Monterey County, California storage facility
(incorporated by reference to Exhibit 10.26, filed with the Company's
1999 Q3 10-Q)
10.16 Commercial Lease dated August 10, 1999 between Company and Salinas
Valley Public Warehouse for storage space in Monterey County, California
(incorporated by reference to Exhibit 10.27, filed with the Company's
1999 Q3 10-Q)
10.17 Rental Agreement dated September 6, 1999 between Company and Porter
Family Trust for storage space in Monterey County, California
(incorporated by reference to Exhibit 10.28 filed with the Company's
1999 Q3 10-Q)
10.18 Royalty agreement dated September 15, 1999 between Company and Chet's
Gourmet Foods, Inc. for meatball and sauce item (incorporated by
reference to Exhibit 10.29, filed with the Company's 1999 Q3 10-Q)
10.19 Credit Agreement between the Company and Imperial Bank dated August 2,
1999 (incorporated by reference to Exhibit 10.30 filed with the
Company's 1999 Form 10-K on February 18, 2000 ("1999 Form 10-K"))
10.20 Commercial lease dated January 1, 2000 between the Company and PTF for
Operating Engineers, LLC for storage space in Monterey County,
California (incorporated by reference to Exhibit 10.32, in the Company's
June 25, 2000 Quarterly Report on Form 10-Q filed on August 4, 2000)
10.21 Second Amendment to Credit Agreement between the Company and Imperial
Bank dated August 2, 1999 (incorporated by reference to Exhibit 10.33 in
the Company's September 25, 2000 Quarterly Report on Form 10-Q filed on
November 6, 2000 ("2000 Q3 10-Q"))
10.22 Fourth Amendment to Credit Agreement between the Company and Imperial
Bank dated August 2, 1999 (incorporated by reference to Exhibit 10.36
filed with the Company's 2000 Form 10-K)
10.23 Fifth Amendment to Credit Agreement between the Company and Imperial
Bank dated August 2, 1999 (incorporated by reference to Exhibit 10.39 in
the Company's April 1, 2001 Quarterly Report on Form 10-Q filed on May
7, 2001)
10.24 Lease Extension and Modification Agreement between the Company and Marco
Warehouse d.b.a. Salinas Valley Public Warehouse dated September 1, 2001
(incorporated by reference to Exhibit 10.40 in the Company's September
30, 2001 Quarterly Report on Form 10-Q filed on November 7, 2001)
10.25 Royalty Agreement dated January 18, 2002 between Company and Toscana
Foods, LLC for ravioli with unique rough chopped filling (incorporated
by reference to Exhibit 10.41 in the Company's June 30, 2002 Quarterly
Report on Form 10-Q filed on August 9, 2002)
10.26 Asset Purchase Agreement dated August 23, 2002 by and among the Company
and the shareholders of Emerald Valley Kitchen, Inc. (incorporated by
reference from Exhibit 10.42 filed with the Company's 8-K on August 30,
2002)
10.27 Commercial lease dated August 23, 2002 between the Company and Mel
Bankoff for plant, warehouse and office space in Eugene, Oregon
(incorporated by reference from Exhibit 10.43 filed with the Company's
8-K on August 30, 2002)
10.28 Commercial lease dated January 3, 2003 between the Company and Conrad
Family Trust for office space in Salinas, Monterey County, California
(incorporated by reference from Exhibit 10.44 filed with the Company's
2002 Form 10-K filed on February 14, 2003)
10.29 Second Lease modification to Commercial lease dated January 1, 2000
between the Company and PTF for Operating Engineers, LLC for storage
space in Monterey County, California (incorporated by reference from
Exhibit 10.45 filed with the Company's June 29, 2003 Quarterly Report of
Form 10-Q filed on August 7, 2003)
10.30 Agreement for Purchase and Sale of Limited Liability Company Units dated
January 28, 2004 by and among the Company and the Unitholders of CIBO
Naturals, LLC. (incorporated by reference from Exhibit 2.6 filed with
the Company's 8-K on February 5, 2004 and amended on April 10, 2004)
10.31 Agreement for Purchase and Sale of OBIC, Inc.'s Limited Liability
Company Units dated May 12, 2004 by and among the Company and the
Unitholders of CIBO Naturals, LLC.
10.32 Stock Purchase Agreement by and among Monterey Gourmet Foods, Inc.,
Casual Gourmet Foods, Inc., and Certain Shareholders dated January 11,
2005. . (incorporated by reference from Exhibit 2.01 filed with the
Company's 8-K on January 18, 2005)
10.33 Stock Purchase Agreement by and among Monterey Gourmet Foods, Inc.,
Sonoma Foods, Inc., and Its Shareholders dated April 7, 2005. .
(incorporated by reference from Exhibit 2.01 filed with the Company's
8-K on April 13, 2005)
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10.34 Third Modification to Business Loan Agreement between the Company and
Comerica Bank dated January 5, 2005.(filed with the Company's 10-K on
March 25, 2005)
31.1** Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2** Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32.1** Certification of Chief Executive Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
32.2** Certification of Chief Financial Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
* Management contract or compensatory plan or arrangement covering executive
officers or directors of the Company and its former subsidiary, Upscale Food
Outlets, Inc.
** filed herewith
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