UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

ý		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended  December 31, 2004
OR
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-9145

 

ML MACADAMIA ORCHARDS, L.P.

(Exact Name of registrant as specified in its charter)

 

DELAWARE		99-0248088
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
26-238 Hawaii Belt Drive HILO, HAWAII		96720
(Address of principal executive offices)		(Zip Code)

 

	Registrant’s telephone number, including area code:	(808) 969-8057
	Registrant’s website:	www.mlmacadamia.com

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

 

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE

 

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 twelve 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  ý  No  o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this 10-K or any amendment to this 10-K.  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).   Yes  o  No  ý

 

As of March 14, 2005, 7,500,000 shares of the registrant’s Class A Units were outstanding, and the aggregate market value of such Units held by non-affiliates was $45,600,000 (based on the closing price on that date of $6.08 per Unit).

 

 

PART I

 

ITEM 1.  BUSINESS OF THE PARTNERSHIP

 

(a) General Description of the Business

 

ML Macadamia Orchards, L.P. (the “Partnership”) is a publicly traded partnership, organized under the laws of the State of Delaware, and engaged in the business of growing and farming macadamia nuts in Hawaii.  The Partnership believes that it is one of the world’s largest growers of macadamia nuts.  The Partnership owns or leases approximately 4,169 tree acres of macadamia nut orchards in three locations within a 50-mile radius on the island of Hawaii.  (“Tree acres” are acres of the Partnership’s owned or leased lands utilized for macadamia nut orchards.  “Gross acres” includes areas not utilized for orchards.)  The Partnership sells all of its macadamia nut production to Mauna Loa Macadamia Nut Corporation (“Mauna Loa”) under long-term nut purchase contracts.  The Partnership farms its own orchards and approximately 2,505 additional acres of macadamia orchards for other orchard owners.  The Partnership is managed by its general partner, ML Resources, Inc. (“MLR” or the “Managing Partner”).  On August 1, 2001, all of the stock of the Managing Partner was purchased by D. Buyers Enterprises, LLC (“DBE”).  J.W.A. Buyers is the majority owner and Member of DBE and the Chairman of the Board of CBCL. . On January 6, 2005, the stock of ML Resources, Inc. was purchased from DBE by the Partnership for $750,000. Approximately $425,000 of the purchase price will be capitalized to record the General Partner’s 1% interest in the Partnership and the remainder, attributable to the management contract and fees is expected to be expensed in the first quarter of 2005.

 

Ownership of Class A Units confers no direct or indirect interest in CBCL, DBE or any of their affiliated entities, or in Mauna Loa.

 

The Partnership commenced operations in June 1986, following its acquisition of interests in approximately 2,423 tree acres of macadamia nut orchards from subsidiaries of CBCL.  In December 1986 and October 1989, respectively, the Partnership acquired from subsidiaries of CBCL interests in approximately 266 and 1,260 additional tree acres of macadamia orchards.  In September 1991 the Partnership acquired approximately 78 tree acres of producing macadamia orchards.

 

On May 1, 2000, the Partnership purchased 142 acres of macadamia orchards and the macadamia farming operations from subsidiaries of CBCL.  The farming operations consist of farming contracts, farming equipment, vehicles, a husking plant, irrigation well, office buildings, garages and warehouses, office furniture and equipment and material inventories related to macadamia farming.  All the assets and operations are located on the island of Hawaii.

 

(b) Financial Information about Industry Segments

 

The response to this section of Item 1 incorporates by reference Note 4 of the Notes to the Financial Statements.

 

(c) Narrative Description of the Business

 

Owned-orchard Segment

 

The Partnership currently sells all of the macadamia nuts from its orchards to Mauna Loa under long-term nut purchase contracts.  Mauna Loa processes and markets the nuts under the Mauna Loaâ brand name and is believed to be one of the largest processors and marketers of macadamia nuts in the world.  The Partnership is Mauna Loa’s largest single supplier of macadamia nuts.  Mauna Loa was a subsidiary of CBCL until its sale in September 2000 to The Shansby Group.  In December 2004 Mauna Loa was purchased by Hershey Food Corporation.  On May 1, 2000, the Partnership began farming its own macadamia orchards.  Prior to that date, subsidiaries of CBCL performed the farming activities for the Partnership under long-term farming contracts.

 

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Nut Purchase Contracts.  The Partnership is a party to five nut purchase contracts with Mauna Loa.  They cover all nuts produced by the orchards acquired in June 1986, December 1986, October 1989, September 1991 and May 2000, respectively.  The 1986 contracts expire in 2006, while the 1989 contract expires in 2019 and also provides for the exclusion of unusable nuts from those purchased by Mauna Loa.  The first three contracts are identical in all other material respects.  The fourth contract was acquired by assignment with the orchard purchase in September 1991 and expired on June 30, 2003. Effective July 1, 2003 the fourth contract was renegotiated with an expiration date of December 31, 2006. The fourth contract is a set price contract ($0.60 cents per pound at WIS 25%) with an adjustment for trash and spoilage outside the range of 10% to 13%.  The first three contracts use a pricing formula based 50% on a two-year trailing average of the macadamia nut price published annually by the United States Department of Agriculture and 50% on Mauna Loa’s “netback component.”  The netback component is calculated by subtracting Mauna Loa’s processing and marketing costs per pound and a “capital charge” of 20% from its nut revenues per pound.  The fifth contract expires in 2006.  Its pricing formula is based 100% on the two-year trailing average of USDA reported prices.  The first three nut purchase contracts may be terminated by Mauna Loa upon thirty days’ notice if the Managing Partner is involuntarily removed as the managing general partner and replaced by a person or entity not affiliated with Mauna Loa.  The fifth contract may be terminated at any time by mutual agreement in writing.  On December 16, 2004, a new nut purchase contract was signed with Hamakua Macadamia Nut Company (“Hamakua”) for the delivery of six million WIS pounds, effective January 1, 2007. The contract provides for a minimum price of 79 cents per pounds and a maximum price of 99 cents per pound. The pricing formula includes a fixed component of 85 cents and a second component based on Hamakua’s average selling price for bulk kernel.  Refer to Exhibit 10.52 on page 57.

 

Competition.  Because the Partnership’s revenues from nut sales are tied to a formula dependent in large part upon Mauna Loa’s market performance, the Partnership bears certain risks associated with Mauna Loa’s marketing of the nuts, including the possibility of increased future competition. Subsequent to the sale of Mauna Loa to The Shansby Group in September 2000, the Partnership no longer has access to the operational and marketing strategies and financial results of Mauna Loa, as it is no longer a related entity.

 

Mauna Loa considers its primary competition to be other premium nut products, except in Hawaii where its products compete with those of other macadamia nut producers and other food and non-food tourist items.  As a premium nut, macadamia nuts compete with cashews, almonds and pistachios.

 

Mauna Loa sells macadamia nuts as “retail” nuts and “commercial” nuts and produces and sells various macadamia nut products. These include pristine salted and unsalted roasted macadamia nuts, packages of diced macadamia nuts and macadamia oil (for cooking and baking), value-added products such as candy-glazed macadamia nuts, chocolate-covered macadamia nuts, chocolate macadamia nut candy bars, honey-roasted macadamia nuts and macadamia nut brittle.

 

Macadamia nuts comprise less than 5% of the sales of branded premium nuts sold through mass merchandisers, drug and grocery stores on the U.S. mainland.  Cashews and mixed nuts represent the bulk of the dollar sales in this segment, followed by pistachios.  Macadamia nuts are the highest priced of all premium nuts, and, therefore, they may be sensitive to price competition from other nuts.

 

The primary market for the Mauna Loaâ brand is the U.S. mainland, where Mauna Loa sells its products through brokers to food stores, club stores, drug store chains, mass merchandisers and commercial customers.

 

A strong secondary market for the Mauna Loaâ brand is the state of Hawaii, where Mauna Loa sells through its own direct sales force primarily to retailers. Substantial portions of the macadamia nut products sold in Hawaii are purchased by visitors as gifts and souvenirs. Mauna Loa believes that it is one of the largest sellers of macadamia products in the State of Hawaii.

 

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Mauna Loa also sells macadamia products as ingredient nuts, through its visitor centers and mail order sales.

 

In addition to the State of Hawaii, mature macadamia nut orchards are located in Australia, Africa, and Central America.  For the 2005 crop, Hawaii was expected to supply 25% of the world crop, and Australia, the world’s largest producer, was expected to supply 40%.

 

A general decline in nut prices would adversely affect the prices which Mauna Loa could charge for its macadamia nut products and could have a negative effect on its profitability.  Since the purchase price for the Partnership’s nuts under all but one of its nut purchase contracts is based in part on nut prices reported by the industry and in part on the marketing success of Mauna Loa, a general decline in macadamia nut prices could also adversely affect the Partnership’s revenues.

 

Macadamia Farming Segment

 

Since the May 2000 purchase of the macadamia farming operations, the Partnership farms its own 4,169 acres of macadamia orchards and approximately 2,505 additional acres of macadamia orchards owned by other growers.

 

All the orchards are located in three separate regions on the island of Hawaii (“Keaau”, “Ka’u” and “Mauna Kea”).  Because each region has different terrain and weather conditions, farming methods vary somewhat among the three locations.

 

Farming Contracts.  The Partnership was a party to four farming contracts with two affiliates of CBCL, Ka’u Agribusiness Company, Inc. (“KACI”) and Mauna Kea Agribusiness Company, Inc. (“MKACI”).  Services under these contracts included cultivation, weed and pest control, fertilization, pruning and hedging, replanting, harvesting, husking and related services for the Partnership’s orchards.  In return, the Partnership reimbursed KACI and MKACI for direct and indirect costs incurred in providing such services, including an equipment utilization charge and an annual farming fee.  The contracts were terminated May 1, 2000 when the Partnership acquired all the farming assets from KACI and MKACI.

 

The Partnership currently services approximately twenty additional farming contracts which were assigned to the Partnership with the May 2000 acquisition.  Services under these contracts include cultivation, weed and pest control, fertilization, pruning and hedging, replanting, harvesting, and husking.  These contracts also provide a management fee to the Partnership, which is based as either a fixed fee per acre farmed, or as a percent of reimbursed costs, ranging from 5% to 20%.

 

Orchard Maintenance.  Maintenance of an orchard is essential to macadamia nut farming.  Pruning and hedging of trees is necessary to allow space for mechanical harvesting and cultivating equipment to operate safely and efficiently and to remove dead branches.  Where mechanical equipment is used, the orchard floor must be maintained in a condition that will permit its operation.  Soil and gravel are used to repair mud holes and other surface irregularities caused by soil erosion from heavy rain and by farming equipment.  Pruning and surface maintenance are usually performed between harvest seasons.

 

Orchard management also requires the proper selection and application of fertilizers, pesticides (to control rodents, insects and fungi) and herbicides (to control weeds).  Insects, rodents and fungi, as well as wild pigs, if not controlled, can cause losses to nut production.

 

Harvesting.  The harvest period begins in the late summer and runs through the following spring.  Mature nuts fall from the trees and are harvested using mechanized harvest equipment when the orchard floor is level enough to permit its use.  Nuts are harvested by hand when the orchard floor is too uneven to permit mechanical harvesting, when the nut drop is very light and when nuts remain after harvesting.  At Keaau, Ka’u and Mauna Kea, seasonal labor for hand harvesting and other operations is generally available from nearby Hilo and adjacent communities.

 

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Mechanical harvesting is less costly than hand harvesting, but mechanical harvesting is possible only where the orchard floor is relatively flat.  Approximately 70% of the orchards in Ka’u, 59% in Keaau and 94% in Mauna Kea are currently mechanically harvested.  The remaining acres are too uneven for mechanical harvesting and must be harvested by hand.

 

During the harvest season, the nuts are collected every six to ten weeks.  Nuts suffer loss in quality if they remain on the ground too long.  The harvested nuts are then transported to the husking facilities, which are located in Ka’u and Keaau.  The Keaau husking facility is owned by Mauna Loa, and the Ka’u husking facility is owned by the Partnership.  Nuts harvested in the Mauna Kea region are transported to the husking facility in Keaau.  At the husking facility, the outer husk is removed and the nuts, still in their shell, are weighed and sampled to determine moisture content and kernel quality.  Title to the nuts husked in Keaau passes to Mauna Loa after weighing.  Title to the nuts husked at Ka’u pass to Mauna Loa after delivery to the Mauna Loa processing plant in Keaau.  The nuts are then moved to a drying facility.

 

Processing.  The nuts purchased by Mauna Loa from the Partnership and from the other orchards farmed by the Partnership are primarily processed at Mauna Loa’s processing plant located adjacent to the orchards located in the Keaau area.  The plant was built in 1966 and is presently capable of handling approximately 210,000 pounds of dry-in-shell (commonly abbreviated “DIS”) nuts per day.  Processing at the plant includes drying, cracking, roasting, inspecting and limited packaging.  The plant also includes separate warehouses, a machine shop, storage facilities, husking facilities, nut drying facilities, a generator and a 10,000 square foot chocolate processing plant.  None of these processing facilities are owned by the Partnership.

 

At Mauna Loa’s plant in Keaau, the harvested nuts pass by conveyors over metal screens, blowers and rock separators that remove extraneous material from the in-husk nuts. The husks are then split and removed by pressing the nuts between steel roller bars and a rubber pad.  At this stage, the nut kernels are still encased in their hard round shells and roughly 20% of their weight is attributable to moisture content.  At this point, the nuts are referred to as wet-in-shell (commonly abbreviated “WIS”).  The WIS weight of the nuts is used to determine payments to be made by Mauna Loa under the Nut Purchase Contracts.  Approximately 20% of the WIS weight of the nuts will become dry salable kernels when all further processing is completed.

 

After the nuts are weighed, the moisture content of the nuts is reduced by blowing warm air over them, which produces DIS nuts. Metal rollers are used to crack the nuts and remove the shell.  Mechanical and optical equipment, as well as hand sorting, are used to separate the salable kernels from unusable nuts and pieces of broken shell.

 

The dry nut kernels are roasted and then sorted into retail and commercial grades.  At this stage, some of the nuts are bulk-packed and sent to various co-packers on the U.S. mainland for packaging.  At Mauna Loa’s plant in Keaau the nuts may be salted, or covered with chocolate or one of several coatings, and finally packaged, labeled and readied for shipment.

 

Stabilization Payments

 

In December 1986, the Partnership acquired a 266-acre orchard that was several years younger than other orchards of the Partnership.  Because of the relative immaturity of the newer orchard, its productivity (and therefore its cash flow) was expected to be correspondingly lower for the first several years than for the other older orchards.

 

Accordingly, the seller of this orchard (KACI) agreed to make cash stabilization payments to the Partnership for each year through 1993 in which the cash flow (as defined) from this orchard fell short of the target cash flow level, which equaled $507,000.  Stabilization payments for any given year were limited to the lesser of the amount of the shortfall or a maximum payment amount.  For the years from

 

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1987 through 1993, inclusive, the Partnership received a total of $1,628,000 (including a 4% Hawaii general excise tax) in stabilization payments under this agreement.

 

The Partnership accounted for stabilization payments (net of the 4% Hawaii general excise tax) as a reduction in the cost basis of the orchard.  As such, these payments are being reflected in the Partnership’s net income ratably through 2019 as a reduction to the depreciation expense reported for this orchard.

 

In return, the Partnership is obligated to pay the seller 100% of any year’s cash flow from this orchard in excess of the target cash flow as additional percentage rent until the aggregate amount of the additional percentage rent paid equals 150% of the total amount of stabilization payments previously received. Thereafter, the Partnership is obligated to pay the seller 50% of this orchard’s cash flow in excess of the target cash flow as additional incentive rent.  No additional rent was due in 2002, 2003, or 2004.

 

Risks Involved in Operating Macadamia Orchards

 

Macadamia nut trees are subject to damage or destruction from diseases, pests, floods, droughts, windstorms, hurricanes, volcanic activity and other natural causes. Partnership tree replacements for all orchards from all causes were 0.9% in 2002, 0.6% in 2003, and 0.6% in 2004. Both crop and tree insurance are in place to protect the Partnership against material losses.

 

Diseases and Pests.  The Partnership’s Keaau orchards experienced tree replacements of 1.5% in 2002, 1.3% in 2003, and 1.4% in 2004.  Other macadamia growers in the vicinity have also experienced losses due to a problem known as “Macadamia Quick Decline” (“MQD”).  Based upon research by the University of Hawaii and other experts, it is believed that the situation is due to fungi associated with high moisture conditions.  It is also believed that a particular variety of macadamia nut tree (variety 333) is most susceptible to MQD.  Another tree variety (variety 344) has also been identified as being more susceptible to MQD than other varieties.  Approximately 9% of the Partnership’s orchards are variety 333 and 45% are variety 344.  Both the Keaau and Mauna Kea orchards are areas with high moisture conditions, and may be more susceptible to the MQD problem.  MQD is present in the Ka’u orchards, but tree losses to date have been less than 1% in the Ka’u area.

 

There are also two types of fungal diseases, which can affect nut production but are not fatal to the trees themselves.  One of these is Phytophthora, which affects the macadamia flowers and nutlets, and the other is Botrytis cinerea.  These types of fungal disease are generally controllable with fungicides.  Historically, these fungi have attacked the orchards located in Keaau during periods of persistent inclement weather.  A light infestation of Phytophthora occurred in late January-early February 2001.

 

Rainstorms and Floods.  The Partnership’s orchards are located in areas on the island of Hawaii that are susceptible to heavy rainstorms.  In November 2000 the Ka’u region was affected by flooding.  This flooding resulted in expected 2000 harvesting being done in 2001.  Since the flood in 2000 heavy rain in the Ka’u region has not produced flooding of any consequence.

 

Windstorms.  The Partnership’s orchards are located in areas on the island of Hawaii that are susceptible to windstorms.  Twenty-four major windstorms have occurred on the island of Hawaii since 1961, and four of those caused material losses to Partnership orchards.  Several of the Partnership’s orchards are surrounded by windbreak trees, which provide limited protection.  Younger trees that have not developed extensive root systems are particularly vulnerable to windstorms.

 

Insurance.  The Partnership secures tree insurance each year under a federally subsidized program.  The tree insurance for 2004 provides coverage up to a maximum of approximately $23.7 million against loss of trees due to wind, fire or volcanic activity. Crop insurance was purchased for the 2004-2005 crop year and provides coverage up to a maximum of approximately $9.1 million against loss of nuts due to wind, fire, volcanic activity, earthquake, adverse weather, wildlife damage and failure of irrigation water supplies.

 

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Volcanoes.  The orchards are located on the island of Hawaii, where there are two active volcanoes.  To date, no lava flows from either volcano have affected or threatened the orchards.

 

Rainfall.  The productivity of orchards depends in large part on moisture conditions.  Inadequate rainfall can reduce nut yields significantly, while excessive rain without adequate drainage can foster disease and hamper harvesting operations.  While rainfall at the orchards located in the Keaau and Mauna Kea areas has generally been adequate, the orchards located in the Ka’u area generally receive less rainfall and, as a result, a portion of the Ka’u orchards is presently irrigated.  Irrigation can mitigate the effects of a drought, but it cannot completely protect a macadamia nut crop from the effect of a drought.  Recorded rainfall at each of the three locations of the Partnership’s orchards for the past five years is shown below:

 

Year		Ka’u		Keaau		Mauna Kea
2000		47.1”		147.9”		158.0”
2001		46.0”		124.0”		133.4”
2002		58.5”		139.4”		156.1”
2003		22.8”		94.8”		117.4”
2004		54.9”		142.7”		151.5”

 

During 2004 the Ka’u, Keaau and Mauna Kea areas recorded 127%, 106% and 102% of the normal average annual rainfall in their area of the island, respectively.

 

Water Supply for Irrigation

 

With the May 2000 acquisition, the Partnership acquired an irrigation well (the “Sisal Well”), which supplies water to the Partnership’s orchards in Ka’u which were purchased in June 1986 and 1989.  The Sisal Well is situated on land owned by MKACI.  On May 1, 2000 the Partnership entered into a license agreement with MKACI, which allows the Partnership necessary access to maintain and operate the Sisal Well, as well as the use of roads to access, maintain and operate the Partnership’s macadamia orchards.  Annual rent for the license agreement is one dollar.  The license agreement terminates on the earlier of June 30, 2045, or at the termination of the May 1, 2000 lease between Partnership and KACI.

 

Prior to the May 2000 acquisition, the Partnership and KACI were parties to a water agreement to which KACI agreed to supply water to those portions of the June 1986 Orchards and October 1986 Orchards located at Ka’u and which had been irrigated historically.

 

If the amount of water provided by the Sisal Well becomes insufficient to irrigate the above named orchards, the Partnership may consider increasing the capacity of the Sisal Well, drilling an alternative well into the historical source which provides water to the Sisal Well or obtaining water from other sources.

 

On a historical basis, the quantity of water available from the Sisal Well has been generally sufficient to irrigate these orchards in accordance with prudent farming practices.  The irrigated portion of the Ka’u II Orchards is expected to need greater quantities of water as the orchards mature.  The Managing Partner anticipates that the amount of water available from the Sisal well will be generally sufficient, assuming average levels of rainfall, to irrigate the irrigated orchards in accordance with prudent farming practices for the next several years.  If no irrigation water is available to the Irrigated Orchards, then, based on historical average rainfall levels, diminished yields of macadamia nut production can be expected.

 

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Employees

 

As of December 31, 2004, the Partnership employed 259 people, of which 176 were seasonal employees.  Of the total, 21 are in farming supervision and management, 226 in production, maintenance and agricultural operations, and 12 in accounting and administration.

 

With the May 2000 acquisition, the Partnership agreed to the assumption of three bargaining agreements with the ILWU Local 142.  These agreements cover all production, maintenance and agricultural employees of the Ka’u Orchard Division, of the Keaau Orchard Division and of the Mauna Kea Orchard Division.  These labor contracts became effective May 1, 1997 and expired on April 30, 2002.  The parties have recently agreed to a new three-year contract, which will expire on April 30, 2005. The Partnership believes that relations with its employees and the ILWU are generally very good.

 

Available Information.  The Partnership files annual, quarterly and current reports and other information with the Commission.  These filings are available free of charge through its Internet website at www.mlmacadamia.com as soon as reasonably practicable after the Partnership electronically files such material with, or furnishes it to, the Commission.  Any Unit holder, who so requests may obtain a printed copy of these documents from the Partnership, by contacting the Partnership at 808-969-8057, or in writing at 26-238 Hawaii Belt Road, Hilo, Hawaii 96720.

 

ITEM 2.  PROPERTIES

 

Location.  The Partnership owns or leases approximately 4,169 tree acres of macadamia orchards on the island of Hawaii.  The orchards are located in three areas: Ka’u, Keaau and Mauna Kea.  The Ka’u area is located in the south part of the island about fifty miles from Hilo.  The Keaau area is located six miles south of Hilo on the east side of the island, and the Mauna Kea area is located three miles north of Hilo on the east side of the island.

 

The majority of macadamia nut trees grown in the State of Hawaii are grown on the island of Hawaii in volcanic soil that permits drainage during heavy rainfall.  While the orchards are located approximately within a 50-mile radius, the climate and other conditions that affect the growing of macadamia nuts are different.  These differences are the result of prevailing wind patterns and island topography, which produce a variety of microclimates throughout the island.

 

Age and Density.  The productivity of macadamia nut orchards depends on several factors including, among others, the age of the trees, the number of trees planted per acre, soil condition, climate, rainfall and/or irrigation.  The most significant characteristic affecting yields is maturity.  The trees in a macadamia nut orchard generally begin to produce nuts at a commercially acceptable level at around nine years of age.  Thereafter, nut yields increase gradually until the trees reach maturity, after which the nut yield remains relatively constant except for variances produced by rainfall, cultivation practices, pest infestation and disease.

 

Macadamia orchards normally reach peak production after fifteen to eighteen years of age.  All of the 4,169 tree acres of macadamia orchards owned or leased by the Partnership are over nineteen years of age.  About 2% of trees are lost to various causes each year and are replaced.

 

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Rainfall.  Macadamia trees grow best in climates with substantial and evenly distributed rainfall (or equivalent irrigation) and in soil that provides good drainage.  Inadequate rainfall can significantly reduce nut yields, while excessive rain without adequate drainage can impede healthy tree growth, promote the growth of harmful fungal diseases and produce mud holes that require repair of the orchard floor.

 

At Keaau, normal rainfall is adequate without irrigation, and the volcanic soil provides good drainage.  However, short droughts and occasional flooding have occurred.  At Mauna Kea, normal rainfall is adequate without irrigation and the volcanic soil provides adequate drainage.  In the event of a very long drought, production at Keaau and Mauna Kea might be affected.  At Ka’u, located on the drier side of the island, the rainfall averages are substantially less than at Keaau, particularly at the lower elevations.  Approximately 652 acres at the lower elevations of Ka’u are irrigated to provide for additional water when required.  Under extremely dry conditions at Ka’u, such as a prolonged drought, irrigation is not sufficient, and production will be adversely affected.

 

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Orchards.  The following table lists each of the orchards, the year acquired, tree acres, tenure, and lease rents:

 

Orchard		Acquired		Tree Acres		Tenure		Lease Expiration		Min. Rent per Annum
Keaau I		June 1986		1467		Fee simple
Ka’u I		June 1986		456		Fee simple
“		June 1986		500		Leasehold (1)		2019		$	25,000
Ka’u Green Shoe I		Dec. 1986		266		Leasehold (1)		2019		$	5,586
Keaau II		Oct. 1989		220		Fee simple
Ka’u II		Oct. 1989		327		Leasehold (2)		2034		$	23,544
“		Oct. 1989		175		Leasehold (1)		2028		$	17,314
“		Oct. 1989		26		Leasehold (3)		2029		$	2,041
“		Oct. 1989		186		Leasehold (1)		2031		$	18,585
Mauna Kea		Oct. 1989		326		Leasehold (2)		2034		$	23,508
Keaau Lot 10		Sept. 1991		78		Fee simple
Ka’u O		May 2000		142		Leasehold (1)		2045		$	10,224
Total acres				4169

 

(1)                                  Lease of land only; trees may be removed at termination of lease.

(2)                                  Lease of land only; lessor may purchase trees from lessee at any time after June 30, 2019.

(3)                                  Lease of land; trees revert to lessor upon termination of lease.

 

For certain additional information concerning farming leases, see Item 13, page 47.

 

In addition to the minimum annual lease payment amount, all the leases require the Partnership to pay various expenses with respect to the leased premises as well as an additional rental payment based on the market price per pound of macadamia nuts sold in Hawaii.

 

With respect to the Ka’u Green Shoe I Orchard, the lease requires the Partnership to pay KACI, the seller and lessor, additional rent equal to 100% of any year’s cash flow generated by such orchard in excess of a target level of $507,000 until the aggregate amount paid equals 150% of the aggregate amount of the stabilization payments previously received by the Partnership.  Thereafter, the Partnership is required, with respect to any year prior to the expiration of the lease, to pay as additional rent, 50% of the cash flow generated by such orchard for such year in excess of a target level of $507,000 of cash flow.  For additional information, see “Stabilization Payments” on page 5.

 

ITEM 3.  LEGAL PROCEEDINGS AND SETTLEMENT

 

As reported on August 13, 2004, in the Quarterly Report on Form 10-Q of ML Macadamia Orchards, L.P. (the “Partnership”) for its fiscal quarter ended June 30, 2004, the Partnership and several independent growers filed suit against Mauna Loa Macadamia Nut Corporation in the Circuit Court of the Third Judicial Circuit of the State of Hawaii in Hilo, alleging that the proposed acquisition by Mauna Loa Macadamia Nut Corporation (“Mauna Loa”) of the assets of Mauna Loa’s major competitor, MacFarms of Hawaii, LLC (“MacFarms”), would give Mauna Loa a monopoly over the supply and processing of wet-in-shell macadamia nuts on the Island of Hawaii, which in turn would give Mauna Loa monopoly power over the growers and other processors on the Island of Hawaii and consumers of macadamia nuts in Hawaii and on the mainland United States. Hamakua Macadamia Nut Company, Inc.  (“Hamakua”)

 

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subsequently filed its own lawsuit against Mauna Loa, which was then consolidated with the Partnership’s case.

 

On October 1, 2004, the Partnership, the independent growers and Hamakua entered into an agreement with Mauna Loa whereby Mauna Loa terminated its agreement to acquire the assets of MacFarms and the Partnership, the independent growers and Hamakua caused their lawsuits to be dismissed.

 

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

No matters were submitted during the fourth quarter of the fiscal year covered by this report to a vote of security holders.

 

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PART II

 

ITEM 5.               MARKET FOR REGISTRANT’S CLASS A UNITS AND RELATED UNITHOLDER MATTERS

 

The Partnership’s Class A Depositary Units are listed for trading on the New York Stock Exchange (symbol = NUT).  There were 1,170 registered holders of Class A Depositary Units on December 31, 2004.

 

Distributions declared and high and low sales prices of the Class A Depositary Units, based on New York Stock Exchange daily composite transactions, are shown in the table below:

 

				Distribution			High		Low
2004:		4th Quarter		$	0.050		6.00		3.80
		3rd Quarter		0.050			4.39		3.80
		2nd Quarter		0.050			4.77		3.85
		1st Quarter		0.050			4.75		3.51
2003:		4th Quarter		$	0.030		3.70		3.28
		3rd Quarter		0.030			3.75		3.39
		2nd Quarter		0.050			3.50		3.16
		1st Quarter		0.050			3.52		3.20

 

Restrictions on Cash Distributions

 

In connection with the Partnership’s Credit Agreement with American AgCredit Capital Markets, cash distributions to partners are restricted unless the Partnership is in compliance with specified terms and conditions of the Credit Agreement, including restrictions on further indebtedness, sales of assets, and maintenance of certain financial ratios.  The Partnership was in compliance with the terms and conditions of the Credit Agreement at December 31, 2004 except for its debt coverage ratio. The lender has provided a waiver to the loan covenants for this ratio for the fourth quarter 2004.  Had the lender not waived the restriction the Partnership would have been restricted in its ability to pay distributions to the limited partners.

 

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ITEM 6.               SELECTED FINANCIAL DATA
(In thousands, except per pound and per unit data)

 

		2004			2003			2002			2001			2000
Financial:
Total revenue		$	13,665		$	15,426		$	14,556		$	16,893		$	13,758
Net cash provided by operating activities (1)		368			2,262			2,166			2,237			2,507
Income (loss) before taxes		(1,644		)	111			(447		)	1,112			(360		)
Net income (loss)		(1,649		)	69			(480		)	1,010			(398		)
Distributions declared		1,515			1,212			1,515			1,515			3,523
Total working capital		2,931			4,165			3,220			3,183			1,599
Total assets		58,438			60,069			61,803			65,329			65,625
Long-term debt		2,034			2,468			2,920			3,402			3,716
Total partners’ capital		50,542			53,706			54,849			56,844			57,349
Class A limited partners’ capital		50,037			53,169			54,300			56,275			56,775
Net cash flow (2)		466			2,157			1,592			3,093			1,824
Operations:
Acres harvested		4,169			4,169			4,169			4,169			4,169
Macadamia nuts harvested (lbs.) (3)		18,933			21,196			21,404			23,013			19,255
Net price $/lb. (3)(4)		$	0.4972		$	0.4857		$	0.4748		$	0.4830		$	0.5125
Per Class A Unit (5):
Income (loss) before taxes		$	(0.22	)	$	0.01		$	(0.06	)	$	0.15		$	(0.05	)
Net income (loss)		(0.22		)	0.01			(0.06		)	0.13			(0.05		)
Net cash flow (2)		0.06			0.28			0.21			0.41			0.24
Distributions		0.20			0.16			0.20			0.20			0.465
Partners’ capital		6.67			7.09			7.24			7.50			7.57

 

(1)          See “Statements of Cash Flows” in the financial statements for method of calculation.

(2)          See Footnote 5 in the notes to financial statements for method of calculation.

(3)          Wet-in-shell at 25% moisture.

(4)          Weighted average for all orchards.

(5)          7,500,000 Class A Units were issued and outstanding for all periods presented.

 

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Contractual obligations for the Partnership are detailed in the following:

 

Contractual Obligations		Total		Payments Less Than 1 Year		Due by 1-3 Years		Period 3-5 Years		More Than 5 Years
Long-Term Debt		2,400,000		400,000		800,000		800,000		400,000
Capital Lease Obligations		69,000		35,000		34,000		—		—
Operating Leases		4,102,000		348,000		682,000		443,000		2,629,000
Purchase Obligations		—		—		—		—		—
Other Long-Term Liabilities off The Registrant’s Balance Sheet under GAAP		—		—		—		—		—
Total		6,571,000		703,000		1,516,000		1,243,000		3,029,000

 

ITEM 7.            MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

This discussion should be read in conjunction with the financial statements and the related notes included elsewhere in this report.

 

Results of operations – 2004, 2003, 2002

 

Owned-Orchard Segment - Production and Yields

 

Production and yield data for the eight orchards are summarized below (expressed in wet-in-shell pounds at 25% moisture):

 

						2004		Average Yield per Acre
Orchard		Acquired		Acreage		Production		2004		2003		2002
Keaau I		June 1986		1,467		5,692,221		3,880		4,271		4,272
Keaau II		Oct. 1989		220		600,381		2,729		2,862		2,966
Keaau Lot 10		Sept. 1991		78		251,215		3,221		3,255		3,850
Ka’u I		June 1986		956		5,117,852		5,353		5,886		6,933
Ka’u Green Shoe I		Dec. 1986		266		1,764,237		6,632		7,619		6,659
Ka’u II		Oct. 1989		714		3,617,893		5,067		5,504		5,214
Ka’u O		May 2000		142		633,871		4,464		5,252		5,880
Mauna Kea		Oct. 1989		326		1,255,571		3,851		5,271		3,762
Totals (except yields which are averages)				4,169		18,933,241		4,541		5,084		5,134

 

Production for the orchards purchased in 1989 and 2000 is net of unusable nuts, as stated in their respective nut purchase agreements.  Production for the orchards purchased in 1986 and 1991 includes all nuts delivered.  The nut purchase contracts for the 1986 orchards require the purchaser, Mauna Loa Macadamia Nut Corporation (“Mauna Loa”), to purchase all of the nuts delivered from these orchards.  The 1991 contract, renegotiated this year, allows for a set price within a range of unusable of 10% to 13%.  The Partnership reports on a calendar year basis, though the natural crop year generally begins in August and runs through April.

 

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Production in 2004 was 10.7% lower than 2003 and 11.5% lower than 2002. Production in 2003 was 1.0% lower than 2002 and 7.9% lower than 2001. Significant factors affecting the crop were as follows:

 

1.  The drought in the Ka’u orchards in 2003 affected the nut set, development and production for the spring of 2004.

 

2.  The above average rainfall in the Keaau and Mauna Kea orchards negatively impacted the pollination and nut set in 2004.

 

3.  The Ka’u region recorded above average rainfall in 2004.  The rainfall replenished the soil moisture and is expected to improve yields in the region for the spring of 2005.

 

4.  The maturation of the crop was delayed by the weather conditions which resulted in less production in the fall of 2004 and is expected to improve yields in the spring of 2005.

 

The Ka’u Green Shoe I orchard and the Mauna Kea orchard are fully mature.  As a result, the yields from these orchards are expected to produce on average with the Partnership’s mature orchards.  At full maturity under favorable growing conditions, a macadamia orchard can produce between 5,500 and 7,500 WIS pounds of macadamia nuts per acre each year at Ka’u and between 4,000 and 6,000 WIS pounds of macadamia nuts per acre each year at Keaau.  All the trees have reached full maturity in the Mauna Kea area and it is expected that production will approximate Keaau levels.

 

Owned-Orchard Segment - Nut Revenue

 

Macadamia nut revenues depend on the number of producing acres, yields per acre and the nut purchase price.  The impact of these factors is summarized in the following table:

 

		2004		2003		2002		2004 vs 2003		2003 vs 2002
Trees acres harvested		4,169		4,169		4,169		—		—
Average yield (WIS lbs./acre)		4,541		5,084		5,134		-11	%	-1	%
Nuts harvested (000’s WIS lbs.)		18,933		21,196		21,404		-11	%	-1	%
Nut price ($/WIS lbs. @ 25%)		0.4972		0.4857		0.4748		+2	%	+2	%
Gross nut sales ($000)		9,414		10,295		10,162		-9	%	+1	%
2001 nut price settlement		—		—		174
2002 nut price settlement		—		14		—
2003 early harvest agreement		—		150		—
Recorded nut sales ($000s)		9,414		10,459		10,336

 

Under three of the nut purchase contracts with Mauna Loa, the price for nuts delivered is based 50% on the two-year trailing average of USDA published macadamia nut prices and 50% on a “netback component”.  The netback component is determined by subtracting from Mauna Loa’s gross revenues from the sale of macadamia products (i) allocable processing, packaging, marketing, selling and advertising costs and (ii) a 20% capital charge on the difference between those aggregate gross revenues and aggregate allocable costs.

 

In mid December, Mauna Loa notified the Partnership that it would be unable to accept deliveries over a five-day period during the height of the harvest season. The Partnership advised Mauna Loa that this was

 

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unacceptable for both financial and operational reasons and arrangements would be made to deliver the nuts to another processor. After alternative deliveries had been committed to, Mauna Loa notified the Partnership that it was willing to accept delivery. As a result of the alternative commitment, the Partnership delivered approximately 240,000 pounds of nuts to Mac Farms of Hawaii at a price of 93 cents per pound over a two-day period. In late December, Mauna Loa notified the Partnership that it intended to deduct $118,000 from future nut payments as damages. The Partnership notified Mauna Loa that the deduction was a violation of our various contracts and the Partnership would consider termination of the contracts if such deduction were made. Mauna Loa has since withdrawn their notice of deduction, but the Partnership has reserved $118,000 for this unresolved dispute.

 

The following table sets forth the manner in which the nut purchase price per pound was determined for 2004, 2003 and 2002 ($/lb.):

 

		2004		2003		2002
USDA price - two years prior (a)		0.5666		0.5601		0.6227
USDA price - one year prior (a)		0.5391		0.5666		0.5601
USDA price - two year trailing average		0.5528		0.5634		0.5914
Gross revenues		1.3929		1.4346		1.5049
Less allocable processing, packaging, marketing, sales and advertising costs		0.8515		0.9400		1.0868
Less 20% capital charge		0.1083		0.0996		0.0828
Net-back component		0.4331		0.3950		0.3353
USDA price - two year trailing average		0.5528		0.5634		0.5914
Net-back component		0.4331		0.3950		0.3353
Average of USDA two year trailing average price and net-back component		0.4929		0.4792		0.4634
Plus Hawaii general excise tax (0.5%)		0.0025		0.0024		0.0019
Net purchase price (b) (c) (d) (e)		0.4954		0.4816		0.4653

 

(a)          Mauna Loa’s own purchases comprise a substantial portion of nut purchases reported to the USDA.  Therefore, the USDA price component of the purchase price is, to a substantial degree, the average price that Mauna Loa has paid to purchase macadamia nuts from the Partnership and from third parties during the previous two years.

 

(b)         The nut purchase price for the 1986 and 1989 orchards was the same for 1999 and all previous years.  With the change of ownership of Mauna Loa in 2000, a quality conversion factor in the nut purchase contracts was initiated.  The effect was to cause a slightly different price of $0.4644 for the 1989 orchards in 2002, $0.4808 in 2003 and $0.4951 in 2004.  An early harvest round was requested by Mauna Loa in 2003 resulting in a payment of $150,000 over the contract price.  With this payment the 2003 price was $0.4883.

 

(c)          The nut purchase contract covering nut production from the 78 acre Keaau Lot 10 orchard acquired in September 1991 defines the “two-year trailing average” provision slightly differently from the 1986 and 1989 nut purchase contracts, and thus, results in a different nut price.  This was in affect for the first six months of 2003.  A new contract was negotiated with a fixed price for all nuts with unusables

 

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in a range of 10% to 13%.  The nut price for this orchard was $0.6000 in 2004, $0.5923 in 2003, and $0.4920 in 2002.  This orchard accounts for less than 2% of the Partnership’s macadamia nut production.

 

(d)         The nut purchase contract for the Ka’u O orchards purchased in May 2000 uses only the two-year trailing USDA average to determine its nut price, which was $0.5560 in 2004, $0.5660 in 2003 and $0.5940 in 2002.

 

(e)          Mauna Loa has not yet provided the final 2004 audited nut price to the Partnership. The price reflected above and in the financial statements is described by Mauna Loa as a “very preliminary” estimate, which when finalized, will be subject to audit and review by the Partnership

 

The 2004 average nut price from all orchards increased 3% from 2003.  The 2003 average nut price from all orchards increased 2% from 2002.  The USDA portion decreased 2% in 2004, 5% in 2003 and 4% in 2002. The netback increased 10% in 2004 compared to 2003 and increased 18% in 2003 compared to 2002. The current netback price reflects the operating performance of Mauna Loa.

 

The USDA published price for the 2003-2004 crop year was $0.5769 per pound (WIS at 25% moisture), which is 7% higher than the 2002-03 crop year of $0.5391, and 2% higher than the 2001-2002 price of $0.5666.  The USDA two-year trailing average, which affects the Partnership’s 2004 nut price, will be $0.5580, a 1% increase over the 2003 two-year average.

 

Owned-Orchard Segment - Cost of Goods Sold

 

Agricultural unit costs depend on the operating expenses required to maintain the orchards and to harvest the crop as well as on the quantity of nuts actually harvested.

 

The Partnership’s unit costs (expressed in dollars per wet-in-shell pound at 25% moisture) are calculated by dividing all agricultural costs for each orchard (including lease rent, property tax, tree insurance and depreciation) by the number of pounds of macadamia nuts produced by that orchard and are summarized below ($/lb.):

 

				Cost per pound
Orchard		Acquired		2004		2003		2002
Keaau I		June 1986		0.5767		0.5453		0.5097
Keaau II		Oct. 1989		0.5545		0.6179		0.5601
Keaau Lot 10		Sept. 1991		0.4491		0.3461		0.3745
Ka’u I		June 1986		0.5211		0.4611		0.4397
Ka’u Green Shoe I		Dec. 1986		0.3409		0.2533		0.2817
Ka’u II		Oct. 1989		0.3938		0.3822		0.3915
Ka’u O		May 2000		0.4226		0.3403		0.3344
Mauna Kea		Oct. 1989		0.7119		0.4976		0.7601
All Orchards				0.5062		0.4582		0.4559

 

Cost of goods sold was $704,000 lower in 2004 than in 2003, and $612,000 higher in 2003 than in 2002, but the cost per pound was 10.4% higher in 2004 than 2003 and was the same in 2003 compared to 2002.  The lower production costs in 2004 were a result of lower harvesting and husking costs because of fewer

 

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pounds handled.  The lower production costs in 2003 were the result of lower production costs in Ka’u and Mauna Kea.  The lower costs in 2002 were the result of lower production.

 

Farming Segment - Farming Service Revenue

 

As a result of the acquisition of the farming operation in 2000, the Partnership acquired approximately 20 farming contracts to farm macadamia orchards owned by other growers. These contracts cover macadamia orchards in the same three locations on the island of Hawaii where the Partnership owns orchards.  The farming contracts provide the Partnership to be reimbursed for all direct farming costs (cultivation, irrigation and harvesting), collect a pro-rata share of indirect costs and overheads, and charge a management fee.  The management fee is based on the number of acres farmed or on a percentage of total costs billed.  Revenues from farming services were $4.3 million in 2004, $5.0 million in 2003, and $4.2 million for 2002. The 2004 farming service revenues were less that expected because of the late drop of nuts in the fall crop.  The 2003 farming service revenues were greater than anticipated because of the timing of harvesting. The 2002 farming service revenues were less than anticipated because of the termination of farming contracts related to 155 tree acres to third parties.  Also, in 2002 one of the major farming contracts requested longer harvest intervals for their orchards.

 

Farming Segment - Cost of Services Sold

 

The cost of services sold relating to the farming contracts was $3.9 million in 2004, $4.5 million in 2003 and $3.8 million for 2002.  These costs were all reimbursed to the Partnership.

 

General and Administrative Costs

 

General and administrative expenses are comprised of accounting and reporting costs, reimbursements to the Managing Partner for directors’ fees, office expenses and liability insurance, and the management fee.  In addition, general and administrative costs are also incurred in connection with the farming operations.  Previous to the May 2000 acquisition, general and administration costs relating to the Partnership’s orchards were included in the Partnership’s farming expenses.

 

Total general and administrative costs for 2004 were $482,000 higher than 2003, which is attributed to higher legal costs.  Legal costs of $464,000 related to the lawsuit, initiated and settled, to prevent Mauna Loa from acquiring MacFarms of Hawaii, LLC.  General and administrative costs for 2003 were $85,000 lower than in 2002 which was attributed to lower service costs and orchard management costs.

 

A management fee based on Partnership cash flow is payable annually to the Managing Partner.  The amount paid was $9,000 in 2004, $44,000 in 2003, and $32,000 for 2002.

 

Interest Income and Expense

 

The Partnership recorded interest expense of $182,000 in 2004, $203,000 in 2003, and $307,000 in 2002.  This was due to (1) the long-term loan used to acquire the farming operations, (2) the assumption of several capitalized equipment leases, and (3) interest expense on a revolving line of credit.

 

The Partnership funds its working capital needs through funds on hand and, when needed, from short-term borrowings, generating interest expense in the process.  Net interest income or expense, therefore, is partly a function of any balance carried over from the prior year, the amount and timing of cash generated and distributions paid to investors in the current year, as well as the current level of interest rates.  Interest was earned in the amount of $11,000 in 2004, $12,000 in 2003 and $46,000 in 2002 primarily from charges to Mauna Loa for late payment in 2004.

 

Other income of $32,000 was recorded in 2004 from crop insurance.  Other income of $260,000 was recorded in 2003 with $206,000 from crop insurance and $40,000 from the settlement of a written off

 

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receivable. $109,000 was recorded in 2002 primarily from the early termination of a land and garage lease with CBCL.

 

Inflation and Taxes

 

In general, prices paid to macadamia nut farmers fluctuate independently of inflation.  Macadamia nut prices are influenced strongly by prices for finished macadamia products, which depend on competition and consumer acceptance.  Farming costs, particularly labor and materials, and general and administrative costs do generally reflect inflationary trends.

 

The Partnership is subject to a gross income tax as a result of its election to continue to be taxed as a partnership rather than to be taxed as a corporation, as allowed by the Taxpayer Relief Act of 1997.  This tax is calculated at 3.5% on partnership gross income (net revenues less cost of goods sold) beginning in 1998.  The gross income tax was $5,000 in 2004, $42,000 in 2003, and $33,000 in 2002.

 

Liquidity and Capital Resources

 

Net cash provided by operation was $368,000 in 2004 a decrease of approximately $2.0 million compared to 2003.  Net cash provided by operations was $2.3 million in 2003 an increase of approximately $100,000 over 2002.  Net cash provided by operations was $2.2 million in 2002.

 

At December 31, 2004 the Partnership’s working capital was $2.9 million and it current ratio was 1.63 to 1, compared to $4.2 million and 2.55 to 1 in 2003.  In 2003 the Partnership’s working capital was $4.2 million and its current ratio was 2.55 to 1, compared to $3.2 million and 2.14 to 1 in 2002.  In 2004 the decrease in working capital compared to 2003 was a result of lower revenue and higher general and administrative costs.  In 2003 the increase in working capital compared to 2002 was a result of higher revenue, higher interest and other income, lower general and administrative costs, and lower interest costs.  In 2002 payment by Mauna Loa resulted in liabilities being paid without incurring short term debt.  The Partnership was in compliance with the terms and conditions of the Credit Agreement at December 31, 2004 except for its Debt Coverage Ratio.  The lender has provided a waiver to the loan covenants for the fourth quarter 2004.

 

Capital expenditures in 2004, 2003 and 2002 were $172,000, $20,000 and $93,000, respectively.  The increase in 2004 was the result of purchases by the Partnership of expiring leases.  Capital expenditures planned for 2005 are less than $500,000 and are expected to be financed by way of new equipment leases, either capital or operating leases.

 

Macadamia nut farming is seasonal, with production peaking late in the fall.  However, farming operations continue year round. As a result, additional working capital is required for much of the year. The Partnership meets its working capital needs with cash on hand, and when necessary, through short-term borrowings under a $5.0 million revolving line of credit. The line of credit was obtained on May 2, 2000 and expires May 1, 2008.  At December 31, 2004 the Partnership had a cash balance of $196,000 and line of credit drawings outstanding of $2,200,000.  At December 31, 2003 the Partnership had a cash balance of $36,000 and line of credit drawings outstanding of $400,000.  The cash balance was $31,000 at the end of 2002, and the line of credit drawings were $800,000 at December 31, 2002.

 

It is the opinion of management that the Partnership has adequate cash on hand and borrowing capacity available to meet anticipated working capital needs for operations as presently conducted.  However, with the September 2000 sale of Mauna Loa, the managing partner no longer has control over the timing of nut payments to the Partnership. The nut purchase contracts require Mauna Loa to make nut payments 30 days after the end of each quarter.  During certain parts of the year, if payments are not received, as the contracts require, available cash resources could be depleted.

 

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Critical Accounting Policies and Estimates

 

Management has identified the following critical accounting policies that affect the Partnership’s more significant judgments and estimates used in the preparation of the Partnership’s financial statements.  The preparation of the Partnership’s financial statements in conformity with accounting principles generally accepted in the United States of America requires the Partnership’s management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities.  On an on-going basis, management evaluates those estimates, including those related to asset impairment, accruals for self-insurance, compensation and related benefits, revenue recognition, allowance for doubtful accounts, contingencies and litigation.  The Partnership states these accounting policies in the notes to the financial statements and in relevant sections in this discussion and analysis.  These estimates are based on the information that is currently available to the Partnership and on various other assumptions that management believes to be reasonable under the circumstances.  Actual results could vary from those estimates.

 

The Partnership believes that the following critical accounting policies affect significant judgments and estimates used in the preparation of it financial statements:

 

The Partnership maintains an allowance for doubtful accounts for estimated losses resulting from the failure of its customers to make required payments, which results in bad debt expense.  Management determines the adequacy of this allowance by continually evaluating individual customer receivables, considering the customer’s financial condition, credit history and current economic conditions.  If the financial condition of customers were to deteriorate, or if a customer refuses to pay or disputes any such payment, additional allowances may be required.

 

The Partnership maintains an accrual for workers compensation claims to the extent that the Partnership’s current insurance policies will not cover such claims.  This accrual is included in other accrued liabilities in the accompanying balance sheet.  Management determines the adequacy of the accrual by periodically evaluating the historical experience and projected trends related to outstanding and potential workers compensation claims.  If such information indicates that the accrual is over or understated, the Partnership will adjust the assumptions utilized in the methodologies and reduce or provide for additional accrual as appropriate.

 

Retirement Benefits:  The Partnership sponsors a non-contributory defined benefit pension plan for union employees.  Several statistical and other factors which attempt to anticipate future events are used in calculating the expense and liabilities related to this plan.  These factors include assumptions about the discount rate, expected return on plan assets, withdrawal and mortality rates and the rate of increase in compensation levels.  The actuarial assumptions used by the Partnership may differ materially from actual results due to changing market and economic conditions, higher or lower withdrawal rates or longer or shorter mortality of participants.  These differences may impact the amount of retirement benefit expense recorded by the Partnership in future periods.

 

The Partnership reviews long-lived assets held and used, or held for sale for impairment annually or whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable.  If an evaluation is required, the estimated undiscounted future cash flows associated with the asset are compared to the asset’s carrying amount to determine if an impairment charge is required.  All long-lived assets for which management has committed to a plan of disposal are reported at the lower of carrying amount or fair value.  Changes in projected cash flows generated by an asset based on new events or circumstances may indicate a change in fair value and require a new evaluation of recoverability of the asset.

 

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Recently Issued Accounting Pronouncement

 

The Partnership has applied the revised disclosure provisions of SFAS No. 132, “Employers’ Disclosure about Pensions and other Postretirement Benefits”.  The revisions to SFAS No. 132 were issued in December 2003, and require additional disclosures about the assets, obligations, cash flows and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans.  The disclosures that are required by SFAS No. 132 are included in Note (9).

 

Legal Proceedings

 

As reported on August 13, 2004, in the Quarterly Report on Form 10-Q of ML Macadamia Orchards, L.P. (the “Partnership”) for its fiscal quarter ended June 30, 2004, the Partnership and several independent growers filed suit against Mauna Loa Macadamia Nut Corporation in the Circuit Court of the Third Judicial Circuit of the State of Hawaii in Hilo, alleging that the proposed acquisition by Mauna Loa Macadamia Nut Corporation (“Mauna Loa”) of the assets of Mauna Loa’s major competitor, MacFarms of Hawaii, LLC (“MacFarms”), would give Mauna Loa a monopoly over the supply and processing of wet-in-shell macadamia nuts on the Island of Hawaii, which in turn would give Mauna Loa monopoly power over the growers and other processors on the Island of Hawaii and consumers of macadamia nuts in Hawaii and on the mainland United States. Hamakua Macadamia Nut Company, Inc.  (“Hamakua”) subsequently filed its own lawsuit against Mauna Loa, which was then consolidated with the Partnership’s case.

 

On October 1, 2004, the Partnership, the independent growers and Hamakua entered into an agreement with Mauna Loa whereby Mauna Loa terminated its agreement to acquire the assets of MacFarms and the Partnership, the independent growers and Hamakua caused their lawsuits to be dismissed.

 

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The Partnership is exposed to market risks resulting from changes in interest rates.  The interest rates on the Partnership’s Credit Agreement, which are based on LIBOR (Farm Credit Discount Note Rate and the Farm Credit Medium Term Note Rate), are adjusted periodically based on the Partnership’s election to fix interest rates for periods ranging from between three months and five years.  As of December 31, 2004, a one percent increase or decrease in the applicable rate under the Credit agreement will result in an interest expense fluctuation of approximately $20,000.

 

ITEM 7B.  CONTROLS AND PROCEDURES

 

(a)  Under the supervision and with the participation of management, including our principal executive officer and principal financial officer, we conducted an evaluation 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 (the “Exchange Act”), within 90 days of the filing date of this report.  Based on their evaluation, our principal executive officer and principal financial officer concluded that the Partnership’s disclosure procedures are effective.

 

(b)  There have been no significant changes (including corrective actions with regard to significant deficiencies or material weaknesses) in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referenced in paragraph (a) above.

 

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ITEM 8.  FINANCIAL STATEMENTS

 

Index to Financial Statements

 

Report of Independent Registered Public Accounting Firm
Balance Sheets, December 31, 2004 and 2003
Income Statements, for the Years Ended December 31, 2004, 2003, and 2002
Statements of Partners’ Capital, for the Years Ended December 31, 2004, 2003 and 2002
Statements of Cash Flows for the Years Ended December 31, 2004, 2003 and 2002
Notes to Financial Statements

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Partners

ML Macadamia Orchards, L.P.

 

In our opinion, the accompanying balance sheets and the related income statements, statements of partners’ capital, and statements of cash flows, present fairly, in all material respects, the financial position of ML Macadamia Orchards, L.P. at December 31, 2004 and 2003, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America.  These financial statements are the responsibility of the Partnership’s management.  Our responsibility is to express an opinion on these financial statements based on our audits.  We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

 

PricewaterhouseCoopers LLP

 

Honolulu, Hawaii

March 17, 2005

 

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ML Macadamia Orchards, L.P.
Balance Sheets
(in thousands)

 

		December 31,
		2004			2003
Assets
Current assets
Cash and cash equivalents		$	196		$	36
Accounts receivable		7,092			6,526
Inventory of farming supplies		145			141
Other current assets		153			143
Total current assets		7,586			6,846
Land, orchards and equipment, net		50,810			53,201
Intangible assets, net		42			22
Total assets		$	58,438		$	60,069
Liabilities and partners’ capital
Current liabilities
Current portion of long-term debt		$	435		$	453
Short-term borrowings		2,200			400
Accounts payable		738			493
Cash distributions payable		379			227
Accrued payroll and benefits		873			847
Other current liabilities		30			261
Total current liabilities		4,655			2,681
Long-term debt		2,034			2,468
Deferred income tax liability		1,207			1,214
Total liabilities		7,896			6,363
Commitments and contingencies
Partners’ capital
General partner		505			537
Class A limited partners, no par or assigned value, 7,500 units issued and outstanding		50,037			53,169
Total partners’ capital		50,542			53,706
Total liabilities and partners’ capital		$	58,438		$	60,069

 

See accompanying notes to financial statements.

 

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ML Macadamia Orchards, L.P.
Income Statements
(in thousands, except per unit data)

 

		2004			2003			2002
Macadamia nut sales		$	9,414		$	10,459		$	10,336
Contract farming revenue		4,251			4,967			4,220
Total revenues		13,665			15,426			14,556
Cost of goods and services sold
Costs expensed for farming and services		10,956			11,660			11,048
Depreciation and amortization		2,571			2,563			2,556
Total cost of goods and services sold		13,527			14,223			13,604
Gross income		138			1,203			952
General and administrative expenses
Costs expensed under management contract with related party		177			204			217
Legal fees paid to related party		495			33			28
Other		971			924			1,002
Total general and administrative expenses		1,643			1,161			1,247
Operating income (loss)		(1,505		)	42			(295		)
Interest expense		(182		)	(203		)	(307		)
Interest income		11			12			46
Other income		32			260			109
Income (loss) before tax		(1,644		)	111			(447		)
Income tax expense		(5		)	(42		)	(33		)
Net income (loss)		$	(1,649	)	$	69		$	(480	)
Net cash flow (as defined in the Partnership Agreement)		$	466		$	2,157		$	1,592
Net income (loss) per Class A Unit		$	(0.22	)	$	0.01		$	(0.06	)
Net cash flow per Class A Unit		$	0.06		$	0.28		$	0.21
Cash distributions per Class A Unit		$	0.20		$	0.16		$	0.20
Class A Units outstanding		7,500			7,500			7,500

 

See accompanying notes to financial statements.

 

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ML Macadamia Orchards, L.P.
Statements of Partners’ Capital
(in thousands)

 

		2004			2003			2002
Partners’ capital at beginning of period:
General partner		$	537		$	549		$	569
Class A limited partners		53,169			54,300			56,275
		53,706			54,849			56,844
Allocation of net income (loss):
General partner		(17		)	1			(5		)
Class A limited partners		(1632		)	68			(475		)
		(1,649		)	69			(480		)
Cash distributions:
General partner		15			13			15
Class A limited partners		1,500			1,199			1,500
		1,515			1,212			1,515
Partners’ capital at end of period:
General partner		505			537			549
Class A limited partners		50,037			53,169			54,300
		$	50,542		$	53,706		$	54,849

 

See accompanying notes to financial statements.

 

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ML Macadamia Orchards, L.P.
Statements of Cash Flows
(in thousands)

 

		2004			2003			2002
Cash flows from operating activities:
Cash received for goods and services		$	13,947		$	15,433		$	15,841
Cash paid to suppliers and employees		(13,408		)	(12,973		)	(13,414		)
Interest received		11			5			46
Interest paid		(182		)	(203		)	(307		)
Net cash provided by operating activities		368			2,262			2,166
Cash flows from investing activities:
Capital expenditures		(172		)	(20		)	(93		)
Net cash used in investing activities		(172		)	(20		)	(93		)
Cash flows from financing activities:
Proceeds from drawings on line of credit		5,400			3,800			8,200
Repayment of long term debt		(400		)	(400		)	(400		)
Repayment of line of credit		(3,600		)	(4,200		)	(8,600		)
Loan cost		(20		)	—			—
Capital lease payments		(52		)	(73		)	(84		)
Cash distributions paid		(1,364		)	(1,364		)	(1,515		)
Net cash provided by (used in) financing activities		(36		)	(2,237		)	(2,399		)
Net increase (decrease) in cash		160			5			(326		)
Cash at beginning of period		36			31			357
Cash at end of period		$	196		$	36		$	31
Reconciliation of net income (loss) to net cash provided by operating activities:
Net income (loss)		$	(1,649	)	$	69		$	(480	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		2,571			2,563			2,556
(Increase) decrease in accounts receivable		(566		)	(869		)	830
(Increase) decrease in inventories		(4		)	17			—
(Increase) decrease in other current assets		(10		)	48			(142		)
(Increase) decrease in other assets		(7		)	—			48
Increase (decrease) in accounts payable		245			93			(66		)
Increase (decrease) in accrued payroll		26			105			(117		)
Increase (decrease) in current liabilities		(231		)	240			(465		)
Deferred income tax expense (credit)		(7		)	(4		)	2
Total adjustments		2,017			2,193			2,646
Net cash provided by operating activities		$	368		$	2,262		$	2,166

 

See accompanying notes to financial statements.

 

27