(Mark One)/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 27, 2003
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______ to _______
Commission File Number 0-24620
DARLING INTERNATIONAL INC.(Exact name of registrant as specified in its charter)
251 O'CONNOR RIDGE BLVD., SUITE 300, IRVING, TEXAS 75038(Address of principal executive offices)(972) 717-0300(Registrant's telephone number)
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/
There were 63,306,244 shares of common stock, $0.01 par value, outstanding at November 10, 2003.
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DARLING INTERNATIONAL INC. AND SUBSIDIARIESFORM 10-Q FOR THE THREE MONTHS ENDED SEPTEMBER 27, 2003
TABLE OF CONTENTS
PART I: FINANCIAL INFORMATION
PART II: OTHER INFORMATION
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DARLING INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETSSeptember 27, 2003 and December 28, 2002(in thousands, except shares and per share data)
September 27, December 28, 2003 2002 ------------- ------------ ASSETS (unaudited) - ------ Current assets: Cash and cash equivalents ........................................ $ 15,775 $ 15,537 Accounts receivable .............................................. 29,497 24,099 Inventories ...................................................... 7,560 7,006 Prepaid expenses ................................................. 6,116 4,975 Deferred income taxes ............................................ 3,447 3,659 Assets held for sale (note 10) ................................... 968 968 Other ............................................................ 25 63 --------- --------- Total current assets ......................................... 63,388 56,307 Property, plant and equipment, less accumulated depreciation of $158,753 at September 27, 2003 and $153,029 at December 28, 2002 73,460 72,954 Collection routes and contracts, less accumulated amortization of $27,044 at September 27, 2003 and $23,956 at December 28, 2002 ..... 20,591 23,088 Goodwill, less accumulated amortization of $1,077 at September 27, 2003 and December 28, 2002 .............................................. 4,429 4,429 Deferred loan costs ................................................... 3,076 3,822 Other noncurrent assets ............................................... 2,520 2,312 --------- --------- $ 167,464 $ 162,912 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY - ------------------------------------ Current liabilities: Current portion of long-term debt (note 6) ....................... $ 8,656 $ 8,372 Accounts payable, principally trade .............................. 10,327 9,902 Accrued expenses ................................................. 29,727 28,567 Accrued interest ................................................. 264 314 --------- --------- Total current liabilities .................................... 48,974 47,155 Long-term debt, less current portion (note 6) ......................... 51,993 60,067 Other non-current liabilities ......................................... 7,106 7,518 Deferred income taxes ................................................. 3,447 3,659 Redeemable Preferred Stock, $0.01 par value, 1,000,000 shares authorized, 100,000 shares outstanding (notes 2, 6 and 12) ......... 8,952 - --------- --------- Total liabilities ............................................ 120,472 118,399 --------- --------- Redeemable Preferred Stock, $0.01 par value, 1,000,000 shares authorized, 100,000 shares outstanding (notes 2, 6 and 12) ......... - 8,599 Stockholders' equity (note 6): Common stock, $0.01 par value; 100,000,000 shares authorized; 63,021,304 and 62,302,448 shares issued at September 27, 2003 and at December 28, 2002, respectively ........................ 630 623 Additional paid-in capital ....................................... 76,491 74,747 Treasury stock, at cost; 21,000 shares at September 27, 2003 and December 28, 2002 ........................................... (172) (172) Accumulated comprehensive loss ................................... (3,907) (3,907) Accumulated deficit .............................................. (26,050) (35,377) --------- --------- Total stockholders' equity ................................... 46,992 35,914 --------- --------- Contingencies (note 3) $ 167,464 $ 162,912 ========= ========= The accompanying notes are an integral part of these consolidated financial statements.
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CONSOLIDATED STATEMENTS OF OPERATIONSThree Months and Nine Months ended September 27, 2003 and September 28, 2002(in thousands, except per share data)(unaudited)
Three Months Ended Nine Months Ended ---------------------------- ---------------------------- September 27, September 28, September 27, September 28, 2002 2003 2002 2003 ------------- ------------ ------------- ------------ Net sales .................................................. $ 80,723 $ 72,969 $ 227,910 $ 191,837 --------- --------- --------- --------- Costs and expenses: Cost of sales and operating expenses .................. 62,839 54,308 173,922 142,676 Selling, general and administrative expenses .......... 8,570 7,333 25,969 22,776 Depreciation and amortization ......................... 3,678 4,246 10,958 12,271 --------- --------- --------- --------- Total costs and expenses ........................... 75,087 65,887 210,849 177,723 --------- --------- --------- --------- Operating income ................................... 5,636 7,082 17,061 14,114 --------- --------- --------- --------- Other income (expense): Interest expense ...................................... (716) (700) (1,627) (5,971) Other, net ............................................ (140) (233) (10) 1,261 --------- --------- --------- --------- Total other expense ............................... (856) (933) (1,637) (4,710) --------- --------- --------- --------- Income from continuing operations before income taxes ...... 4,780 6,149 15,424 9,404 Income taxes ............................................... (2,052) (2,362) (6,097) (3,733) --------- --------- --------- --------- Income from continuing operations ..................... 2,728 3,787 9,327 5,671 Discontinued operations Loss from discontinued operations, net of tax (note 11) - (334) - (386) --------- --------- --------- --------- Net income ................................................. 2,728 3,453 9,327 5,285 Preferred dividends and accretion (note 2) ............ - (375) (697) (630) --------- --------- --------- --------- Net income applicable to common shareholders .......... $ 2,728 $ 3,078 $ 8,630 $ 4,655 ========= ========= ========= ========= Basic income per share (note 2): Continuing operations ................................. $ 0.04 $ 0.06 $ 0.14 $ 0.13 Discontinued operations ............................... - (0.01) - (0.01) --------- --------- --------- --------- Total ............................................. $ 0.04 $ 0.05 $ 0.14 $ 0.12 ========= ========= ========= ========= Diluted income per share (note 2): Continuing operations ................................. $ 0.04 $ 0.06 $ 0.14 $ 0.13 Discontinued operations ............................... - (0.01) - (0.01) --------- --------- --------- --------- Total ............................................. $ 0.04 $ 0.05 $ 0.14 $ 0.12 ========= ========= ========= ========= The accompanying notes are an integral part of these consolidated financial statements.
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CONSOLIDATED STATEMENTS OF CASH FLOWSNine Months ended September 27, 2003 and September 28, 2002(in thousands)(unaudited)
Nine Months Ended --------------------------- September 27, September 28, 2003 2002 ------------ ------------- Cash flows from operating activities: Income from continuing operations ................................ $ 9,327 $ 5,671 Adjustments to reconcile net income to net cash provided by continuing operating activities: Depreciation and amortization ................................. 10,958 12,271 Gain on disposal of property, plant, equipment and other assets (52) (1,558) Gain on early extinguishment of debt .......................... (555) - Preferred stock dividend and discount accretion ............... 252 - Changes in operating assets and liabilities: Accounts receivable .......................................... (5,398) 1,253 Inventories and prepaid expenses ............................. (1,695) (1,720) Accounts payable and accrued expenses ........................ 1,762 4,594 Accrued interest ............................................. (50) 2,310 Other ........................................................ 493 779 --------- --------- Net cash provided by continuing operations ............................ 15,042 23,600 Net cash provided by discontinued operations .......................... - 954 --------- --------- Net cash provided by operating activities ................ 15,042 24,554 --------- --------- Cash flows from investing activities: Capital expenditures ............................................. (7,823) (9,807) Business acquisitions ............................................ (1,131) - Gross proceeds from disposal of property, plant and equipment and other assets .............................................. 75 1,622 --------- --------- Net cash used by investing activities ................... (8,879) (8,185) --------- --------- Cash flows from financing activities: Proceeds from debt ............................................... 157,486 141,665 Payments on debt ................................................. (164,459) (147,676) Common and preferred stock issuance costs ........................ - (4,043) Proceeds from common stock issued ................................ 1,316 - Contract payments ................................................ (268) (289) --------- --------- Net cash used by financing activities ................... (5,925) (10,343) --------- --------- Net increase in cash and cash equivalents ............................. 238 6,026 Cash and cash equivalents at beginning of period ...................... 15,537 3,668 --------- --------- Cash and cash equivalents at end of period ............................ $ 15,775 $ 9,694 ========= ========= Supplemental disclosure of cash flow information: Cash paid during the period for: Interest ..................................................... $ 2,846 $ 3,661 ========= ========= Income taxes, net of refunds ................................. $ 5,000 $ 619 ========= ========= The accompanying notes are an integral part of these consolidated financial statements.
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Notes to Consolidated Financial StatementsSeptember 27, 2003(unaudited)
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DARLING INTERNATIONAL INC. AND SUBSIDIARIESFORM 10-Q FOR THE THREE MONTHSENDED SEPTEMBER 27, 2003
PART I
The following discussion summarizes factors affecting the Company’s results of operations for the three and nine months ended September 27, 2003 and September 28, 2002, and information with respect to the liquidity and capital resources of the Company at September 27, 2003.
The following discussion contains forward-looking statements that involve risks and uncertainties. The Company’s actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth below under the heading “Forward Looking Statements” and elsewhere in this report, and under the heading “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 28, 2002, and in the Company’s other public filings with the SEC.
The following discussion should be read in conjunction with the Company’s historical consolidated financial statements and notes thereto.
RESULTS OF OPERATIONS
Three Months Ended September 27, 2003 Compared to Three Months Ended September 28, 2002
GENERAL
The Company recorded income from continuing operations of $2.7 million for the third quarter of the fiscal year ending January 3, 2004 (“Fiscal 2003”), as compared to income from continuing operations of $3.8 million for the third quarter of the fiscal year ended December 28, 2002 (“Fiscal 2002”), a reduction of $1.1 million. Principal factors affecting these comparative results, which are discussed further in the following section were higher raw material prices, higher energy and fleet fuel expenses, and payroll and related benefit expenses, which offset higher sales prices, inage and collection fees, and lower depreciation and income tax expenses.
NET SALES
The Company collects and processes animal by-products (fat, bones and offal) and used restaurant cooking oil to produce finished products of tallow, protein, and yellow grease. Sales are significantly affected by finished goods prices, quality of raw material, and volume of raw material. Net sales include the sales of produced finished goods, collection fees, grease trap services, and finished goods purchased for resale, which constitutes approximately 8.9% of total sales for the third quarter of Fiscal 2003 and approximately 15.3% of total sales for the third quarter of Fiscal 2002.
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During the third quarter of Fiscal 2003, net sales increased by $7.7 million (10.6%), to $80.7 million, as compared to $73.0 million during the third quarter of Fiscal 2002, primarily due to the following: 1) Increases in aggregate finished goods prices resulted in a $6.5 million increase in sales in the third quarter of Fiscal 2003, compared to the third quarter of Fiscal 2002 (the Company’s finished product prices increased 12.4% in the third quarter of Fiscal 2003 compared to the third quarter of Fiscal 2002); 2) Inage increased $0.9 million; 3) Recovery of collection expenses increased $0.7 million; and 4) Other net decreases of $0.4 million.
COST OF SALES AND OPERATING EXPENSES
Cost of sales and operating expenses include prices paid to raw material suppliers, the cost of product purchased for resale, and the cost to collect and process raw material. The Company utilizes both fixed and formula pricing methods for the purchase of raw materials. Fixed prices are adjusted where possible for changes in competition and significant changes in market conditions. Raw materials purchased under formula prices are correlated with specific finished goods prices.
During the third quarter of Fiscal 2003, cost of sales and operating expenses increased $8.5 million (15.7%) to $62.8 million as compared to $54.3 million during the third quarter of Fiscal 2002 primarily as a result of: 1) Higher raw material prices of $4.6 million, which are due in part to higher finished product prices, which increase formula raw material pricing arrangements with raw material suppliers; 2) Higher energy prices, $1.9 million; 3) Higher factory and collection payroll and related benefits of $1.1 million; 4) Higher finished products purchased for resale of $0.3 million; 5) Higher fleet fuel expense, $0.3 million; and 6) Other expense increased $0.3 million.
SELLING, GENERAL AND ADMINISTRATIVE COSTS
Selling, general and administrative costs were $8.6 million during the third quarter of Fiscal 2003, a $1.3 million increase from $7.3 million for the third quarter of Fiscal 2002, primarily due to increases in: 1) Payroll and related benefits of $0.7 million; 2) Legal expenses of $0.1 million; 3) Professional fees of $0.1 million; and 4) Other increases of $0.4 million.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization charges decreased $0.5 million to $3.7 million during the third quarter of Fiscal 2003 as compared to $4.2 million during the third quarter of Fiscal 2002. The decrease is primarily due to various property and equipment assets becoming fully depreciated during Fiscal 2002 and Fiscal 2003.
INTEREST EXPENSE
Interest expense was essentially unchanged at $0.7 million during both the third quarter of Fiscal 2002 and the third quarter of Fiscal 2003, primarily due to changes resulting from the effect of the provisions of SFAS 150 as it applies to the Company’s Preferred Stock outstanding issued as part of the Company’s May 13, 2002 Recapitalization Agreement (see notes 6 and 12 to the consolidated financial statements included elsewhere herein), which increased interest expense on Preferred Stock outstanding by approximately $0.3 million, essentially offset by lower interest on other debt and lower bank and letter of credit fees included in interest expense.
OTHER INCOME (EXPENSE)
Other expense decreased $0.1 million from net other expense of $0.2 million during the third quarter of Fiscal 2002 to net other expense of $0.1 million during the third quarter of Fiscal 2003, primarily due to the reduction of miscellaneous non-operating expenses.
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INCOME TAXES
The Company recorded income tax expense of $2.1 million during the third quarter of Fiscal 2003 based on its estimate of the effective tax rate for the entire year, compared to $2.4 million during the third quarter of Fiscal 2002, a decrease of $0.3 million, primarily due to differences in income before income taxes.
CAPITAL EXPENDITURES
The Company made capital expenditures of $2.9 million during the third quarter of Fiscal 2003 compared to capital expenditures of $2.4 million during the third quarter of Fiscal 2002, an increase of $0.5 million, primarily due to planned capital spending on equipment at various plant locations.
Nine Months Ended September 27, 2003 Compared to Nine Months Ended September 28, 2002
The Company recorded income from continuing operations of $9.3 million for the first nine months of the fiscal year ending January 3, 2004 (“Fiscal 2003”), as compared to income from continuing operations of $5.7 million for the first nine months of the fiscal year ended December 28, 2002 (“Fiscal 2002”), an improvement of $3.6 million. Principal factors affecting these comparative results, which are discussed further in the following section, were higher sales prices and collection fees, and lower interest expense, partially offset by higher raw material prices, energy expense, payroll and related benefit expenses, and income tax expense.
Net sales include the sales of produced finished goods, collection fees, grease trap services, and finished goods purchased for resale, which constitutes approximately 7.5% of total sales for the first nine months of Fiscal 2003 and approximately 10.9% of total sales for the first nine months of Fiscal 2002.
During the first nine months of Fiscal 2003, net sales increased by $36.1 million (18.8%), to $227.9 million, as compared to $191.8 million during the first nine months of Fiscal 2002, primarily due to the following: 1) Increases in aggregate finished goods prices resulted in a $29.0 million increase in sales in the first nine months of Fiscal 2003, compared to the first nine months of Fiscal 2002 (the Company’s finished product prices increased 22.2% during the first nine months of Fiscal 2003 compared to the first nine months of 2002); 2) Finished products purchased for resale increased $5.6 million; 3) Recovery of collection expenses increased $2.1 million; and 4) Other net decreases of $0.6 million.
During the first nine months of Fiscal 2003, cost of sales and operating expenses increased $31.2 million (21.9%) to $173.9 million as compared to $142.7 million during the first nine months of Fiscal 2002 primarily as a result of: 1) Higher raw material prices of $14.0 million, which are due in part to higher finished product prices, which increase formula raw material pricing arrangements with raw material suppliers; 2) Higher finished products purchased for resale increased cost of sales $5.6 million; 3) Higher energy prices, $5.3 million; 4) Higher factory and collection payroll and related benefits of $3.2 million; 5) Higher fleet fuel expense, $1.1 million; 6) Higher insurance expense of $0.9 million; and 7) Other expense increased $1.1 million.
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Selling, general and administrative costs were $26.0 million during the first nine months of Fiscal 2003, a $3.2 million increase from $22.8 million for the first nine months of Fiscal 2002, primarily due to: 1) Increases in payroll and employee benefits of $1.2 million; 2) Increased legal expense of $0.6 million; 3) Increased professional fees of $0.4 million; 4) Higher information technology expenses of $0.2 million; 5) Higher insurance expense of $0.2 million; 6) Higher board of director fees of $0.2 million; and 7) Other increases of $0.4 million.
Depreciation and amortization charges decreased $1.3 million to $11.0 million during the first nine months of Fiscal 2003 as compared to $12.3 million during the first nine months of Fiscal 2002. The decrease is primarily due to various property and equipment assets becoming fully depreciated during Fiscal 2002 and Fiscal 2003.
Interest expense decreased $4.4 million from $6.0 million during the first nine months of Fiscal 2002 to $1.6 million during the first nine months of Fiscal 2003, primarily due to: 1) Changes resulting from the effect of the provisions of SFAS 15 as it applies to the Company’s May 13, 2002 Recapitalization Agreement (see notes 6 and 12 to the consolidated financial statements included elsewhere herein), which reduced interest expense in Fiscal 2003 on bank debt by approximately $3.1 million; 2) Forbearance fees accrued in the first nine months of Fiscal 2002 of approximately $1.7 million; and 3) Other decreases in bank fees of $0.2 million; partially offset by 4) Higher amortization of deferred loan costs of $0.3 million; and 5) Interest expense of $0.3 million resulting from SFAS 150 as it applies to the Company’s Preferred Stock outstanding issued as part of the Company’s May 13, 2002 Recapitalization Agreement.
Other income (expense) decreased $1.3 million from net other income of $1.3 million during the first nine months of Fiscal 2002 to net other expense of less than $0.1 million during the first nine months of Fiscal 2003, primarily due to inclusion of a gain on extinguishment of debt of $0.6 million during the first nine months of Fiscal 2003, which resulted from retirement of debt with a carrying value, net of related unamortized debt issuance costs, of $4.7 million and a cash payment of $4.1 million, due to SFAS 15 accounting, and other net expense of $0.6 million. Included in net other income in the first nine months of Fiscal 2002 was a gain of $1.7 million resulting from insurance proceeds received in excess of net book value of assets destroyed by fire at the Company’s Norfolk, Nebraska facility, and other net expense of $0.4 million.
The Company recorded income tax expense of $6.1 million during the first nine months of Fiscal 2003 based on its estimate of the effective tax rate for the entire year, compared to $3.7 million during the first nine months of Fiscal 2002, an increase of $2.4 million, primarily due to difference in income before income taxes.
The Company made capital expenditures of $7.8 million and acquired rendering and grease businesses for a net investment of approximately $1.1 million, which included machinery, equipment and routes during the first nine months of Fiscal 2003 compared to capital expenditures of $9.8 million during the first nine months of Fiscal 2002, a decrease of $0.9 million, primarily due to capital investment in the expansion of the Company’s Sioux City, Iowa plant location incurred in Fiscal 2002.
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FINANCING, LIQUIDITY, AND CAPITAL RESOURCES
On May 13, 2002, the Company consummated a recapitalization and executed a new amended and restated Credit Agreement with its lenders. The Credit Agreement reflects the effect of applying the provisions of Statement of Financial Accounting Standards No. 15, Accounting by Debtors and Creditors for Troubled Debt Restructurings (“SFAS 15”). SFAS 15 requires that the previously existing amount of debt owed by the Company to the lenders be reduced by the fair value of the equity interest granted and that no gain from restructuring the Company’s bank debt be recognized. As a result the carrying amount of the term loan of $60.5 million exceeds its contractual amount of $51.7 million by $8.8 million at September 27, 2003. Interest expense on the remaining carrying amount of debt reported in our financial statements is based on a new effective interest rate (0.61% at September 27, 2003) that equates the present value of the future cash payment specified by the new terms of the term loan with the carrying amount of the debt, with the result that the effective interest rate is less than the contract rate because a portion of the future cash payment is applied in accordance with SFAS 15 to reduce the carrying amount of the debt, rather than being applied to and included in interest expense.
In connection with the Company’s recapitalization and its entry into the Credit Agreement, the Company exchanged borrowings outstanding under its previous Credit Agreement, a portion of the accrued interest and commitment fees, and forbearance fees payable for 46,705,086 shares of newly issued common stock, equal to 75% of the Company’s then total outstanding common stock on a fully diluted basis (exclusive of stock options issued and outstanding), and 100,000 shares of 6% cumulative redeemable Series A Preferred Stock with a liquidation preference of $100 per share and a face value of $10.0 million, recorded at a discount of approximately $1.9 million, resulting in a yield of 10%, which approximates the market yield at the date of issue. The term loan and the revolving credit facility (under which there were no borrowings at the date of the recapitalization) mature on May 10, 2007.
The Company’s Credit Agreement consists of the following elements at September 27, 2003 (in thousands):
Substantially all assets of the Company are either pledged or mortgaged as collateral for borrowings under the Credit Agreement. The Credit Agreement contains certain terms and covenants, which, among other matters, restrict the incurrence of additional indebtedness, the payment of cash dividends, the retention of certain proceeds from sales of assets, and the annual amount of capital expenditures, and requires the maintenance of certain minimum financial ratios. As of September 27, 2003, no cash dividends could be paid to the Company’s stockholders pursuant to the Credit Agreement.
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The classification of long-term debt in the accompanying September 27, 2003 consolidated balance sheet is based on the contractual and excess cash flow repayment terms of the debt issued under the Credit Agreement pursuant to the recapitalization.
On September 27, 2003, the Company had working capital of $14.4 million and its working capital ratio was 1.29 to 1 compared to working capital of $9.2 million and a working capital ratio of 1.19 to 1 on December 28, 2002. At September 27, 2003, the Company had unrestricted cash of $15.2 million and funds available under the revolving credit facility of $6.9 million.
Net cash provided by operating activities was $15.0 million and $24.6 million for the nine months ended September 27, 2003 and September 28, 2002, respectively. Cash used by investing activities was $8.9 million for the nine months ended September 27, 2003 compared to $8.2 million in the nine months ended September 28, 2002. Net cash used by financing activities was $5.9 million in the nine months ended September 27, 2003 compared to cash used of $10.3 million in the nine months ended September 28, 2002, principally due to reductions of long-term debt.
Based upon current actuarial estimates, the Company does not expect any payments will be necessary in order to meet minimum pension funding requirements during Fiscal 2003. The minimum pension funding requirements are determined annually, based upon a third party actuarial estimate. The actuarial estimate may vary from year to year, due to fluctuations in return on investments or other factors beyond the control of management of the Company or the administrator of the Company’s pension funds. No assurance can be given that the minimum pension funding requirements will not increase in the future.
The Company’s management believes that cash flows from operating activities at the current level in Fiscal 2003, unrestricted cash, and funds available under the Credit Agreement should be sufficient to meet the Company’s working capital needs and capital expenditures for at least the next 12 months.
The current economic environment in the Company’s markets has the potential to adversely impact its liquidity in a variety of ways, including through reduced sales, potential inventory buildup, or higher operating costs.
The principal products that the Company sells are commodities, the prices of which are quoted on established commodity markets and are subject to volatile changes. Although the current market prices of these commodities are favorable, a decline in these prices has the potential to adversely impact the Company’s liquidity. A disruption in international sales, a decline in commodities prices, or a rise in energy prices resulting from the recent war with Iraq and the subsequent political instability and uncertainty, has the potential to adversely impact the Company’s liquidity. There can be no assurance that a decline in commodities prices, a rise in energy prices, a slowdown in the U.S. or international economy, or other factors, including political instability in the Middle East or elsewhere, and the macroeconomic effects of those events, will not cause the Company to fail to meet management’s expectations, or otherwise result in liquidity concerns.
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CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS
The following table summarizes the Company’s expected material contractual payment obligations, including both on- and off-balance sheet arrangements at September 27, 2003 (in thousands):
The Company’s off-balance sheet contractual obligations and commercial commitments as of September 27, 2003 relate to operating lease obligations, letters of credit, forward purchase agreements, and employment agreements. The Company has excluded these items from the balance sheet in accordance with accounting principles generally accepted in the United States of America.
The following table summarizes the Company’s other commercial commitments, including both on- and off-balance sheet arrangements at September 27, 2003.
CRITICAL ACCOUNTING POLICIES
The Company follows certain significant accounting policies when preparing its consolidated financial statements. A complete summary of these policies is included in Note 1 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 28, 2002.
Certain of the policies require management to make significant and subjective estimates or assumptions which may deviate from actual results. In particular, management makes estimates regarding the fair value of the Company’s reporting units in assessing potential impairment of goodwill, estimates regarding future undiscounted cash flows from the future use of long-lived assets whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable, estimates regarding the net realizable value of long-lived assets held for sale, estimates regarding pension expense, estimates of bad debts and estimates regarding self insured risks including insurance, environmental and litigation contingencies.
In assessing impairment of goodwill, the Company uses estimates and assumptions in determining the estimated fair value of reporting units. In assessing the impairment of long-lived assets where there has been a change in circumstances indicating the carrying value of a long-lived asset may not be recoverable, the Company has estimated future undiscounted net cash flows from use of the asset based on actual historical results and expectations about future economic circumstances including future business volume, finished product prices and operating costs. The estimates of fair value of reporting units and of future net cash flows from use of the asset could change if actual prices and costs differ due to industry conditions or other factors affecting the level of business volume or the Company’s performance. In assessing impairment of long-lived assets held for sale, the Company has estimated the net realizable value of such assets based on information from various external sources regarding possible selling prices for such assets. The estimate of reserve for bad debts is based upon the Company’s bad debt experience, market conditions, aging of trade accounts receivable, and interest rates, among other factors. Pension expense is based upon actuarial estimates. These estimates could change based on changes in market conditions, interest rates, and other factors. In estimating liabilities for self insured risks, the Company considers information from outside consultants and experts, and past historical experience, in projecting future costs expected to be incurred. These estimates could change if future events are different than assumed by management, actual costs to settle the liabilities differ from those estimated and the circumstances associated with the self insured risks change.
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ACCOUNTING MATTERS
The Company adopted Statement of Financial Accounting Standard No. 143 (“SFAS 143”),Accounting for Asset Retirement Obligations, on December 29, 2002 (the first day of Fiscal 2003). The adoption of SFAS 143 did not have a material effect on the Company’s financial statements.
The Company adopted Statement of Financial Accounting Standard No. 146 (“SFAS 146”),Accounting for Costs Associated with Exit or Disposal Activities, on December 29, 2002. The adoption of SFAS 146 did not have a material effect on the Company’s financial statements.
In April 2003, the FASB issued Statement of Financial Accounting Standard No. 149 (“SFAS 149”), Amendment of Statement 133 on Derivative Instruments and Hedging Activities, which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133. This Statement is effective for contracts entered into or modified and for hedging relationships designated after June 20, 2003. The Company adopted SFAS 149 in the third quarter of 2003. Adoption of SFAS 149 did not have an impact on the Company’s consolidated financial statements.
The Company adopted Statement of Financial Accounting Standard No. 150 (“SFAS 150”),Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity, on the first day of the third quarter of Fiscal 2003. The adoption of SFAS 150 affects accounting for the Company’s 100,000 shares of preferred stock outstanding, which was issued in May, 2002, has a carrying amount of $9.0 million including accumulated preferred stock dividends payable of $0.9 million at September 27, 2003, and was part of the Company’s recapitalization discussed in Note 6, and elsewhere, herein. The Company’s preferred stock contains a mandatory redemption feature which requires redemption of the preferred stock on May 10, 2007, at face value of the preferred stock of $10.0 million, plus accumulated preferred stock dividends payable. SFAS 150 requires that mandatorily redeemable financial instruments, such as the Company’s preferred stock, be reported as a liability rather than as a component of stockholders’ equity. SFAS 150 also requires that preferred stock dividends and accretion related to the preferred stock outstanding shall be included in interest expense, beginning in the third quarter of Fiscal 2003, on a prospective basis. Preferred stock dividends and accretion are estimated to be approximately $0.3 million in the fourth quarter of Fiscal 2003, and are estimated to be approximately $1.1 million in Fiscal 2004. Accumulated preferred stock dividends payable are estimated to be approximately $3.4 million on May 10, 2007, if no cash payment of dividends occurs until the redemption date. See Note 12 for information related to adoption of SFAS 150.
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FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10-Q includes “forward-looking” statements that involve risks and uncertainties. The words “believe,” “anticipate,” “expect,” “estimate,” “intend,” and similar expressions identify forward-looking statements. All statements other than statements of historical facts included in the Quarterly Report on Form 10-Q, including, without limitation, the statements under the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 3 to the consolidated financial statements, and located elsewhere herein regarding industry prospects and the Company’s financial position are forward-looking statements. Actual results could differ materially from those discussed in the forward-looking statements as a result of certain factors. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to be correct.
In addition to those factors discussed elsewhere in this report, and in other public filings with the SEC, including, without limitation, under the heading “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 28, 2002, important factors that could cause actual results to differ materially from the Company’s expectations include: the Company’s continued ability to obtain sources of supply for its rendering operations; general economic conditions in the American, European and Asian markets; and prices in the competing commodity markets which are volatile and are beyond the Company’s control. Among other things, future profitability may be affected by the Company’s ability to grow its business which faces competition from companies which may have substantially greater resources than the Company.
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Market risks affecting the Company are exposures to changes in prices of the finished products the Company sells, interest rates on debt, availability of raw material supply, and the price of natural gas used in the Company’s plants. Raw materials available to the Company are impacted by seasonal factors, including holidays, when raw material inage declines; warm weather, which can adversely affect the quality of raw material processed and finished products produced; and cold weather, which can impact the collection of raw material. Predominantly all of the Company’s finished products are commodities which are generally sold at prices prevailing at the time of sale. The Company used, through June, 2002, interest rate and, through March, 2001, natural gas swaps, to manage these related risks. The Company is not party to any interest rate swap agreements subsequent to June, 2002. Beginning in April, 2001, the Company is using natural gas forward purchase agreements with its suppliers to manage the price risk of natural gas used in its facilities.
As of September 27, 2003, the Company has forward purchase agreements in place for purchases of approximately $5.1 million of natural gas for the months of October, November and December 2003, and January, February and March 2004, which approximates 53.1% of the Company’s usage for these months.
Evaluation of Disclosure Controls and Procedures. As required by Exchange Act Rule 13a-15(b), the Company’s management, including the Chief Executive Officer and Chief Financial Officer, conducted an evaluation as of the end of the period covered by this report, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. As defined in Exchange Act Rule 13a-15(e) and 15d-15(e) under the Exchange Act, disclosure controls and procedures are controls and other procedures of the Company that are designed to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report. It should be noted that any system of controls, however well designed and operated, is based in part upon certain assumptions and can provide only reasonable, and not absolute, assurance that the objectives of the system are met.
Changes in Internal Control Over Financial Reporting. As required by Exchange Act Rule 13a-15(d), the Company’s management, including the Chief Executive Officer and Chief Financial Officer, also conducted an evaluation of the Company’s internal control over financial reporting to determine whether any change occurred during the quarter covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. Based on that evaluation, there has been no such change during the quarter covered by this report.
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PART II: Other Information
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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.
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