Item 1. Business
Overview
We are one of the largest vertically integrated providers of pork products in the United States, producing consistent, high-quality pork products for the retail, wholesale, foodservice, further processor and export markets. We have become a recognized leader in the pork industry through our vertically integrated business model that combines modern, efficient production and processing facilities, sophisticated genetics, and strict control over the variables of health, diet and environment. We are the sixth largest pork processor in the United States, with processing facilities in Missouri and North Carolina that have the capacity to process approximately 4.6 million hogs per year. Operating in concert with our processing facilities, we are the second largest owner of sows in the United States, currently producing approximately 4.5 million hogs per year in operations located on approximately 100,000 acres in Missouri, Texas and North Carolina.
We are able to leverage our vertically integrated operations to produce premium and specialty products, which typically command higher prices. We tailor our production process to target discriminating customers willing to pay for high-quality products. We lower our production costs by controlling hog procurement and streamlining logistics, transportation and production schedules.
For the fiscal year ended March 26, 2005, our business generated total net sales of approximately $927.6 million and net income of approximately $67.7 million. Fiscal year 2005 results reflected historically high pork and hog prices. The Company believes it is unlikely that the current favorable price environment will be sustained over time. Consequently, the Company believes that its net sales and net income for fiscal year 2006 will be substantially lower than in fiscal year 2005.
Recent Developments
Reorganization. On May 2, 2005, PSF Group Holdings merged with and into its wholly owned subsidiary, Premium Standard Farms, Inc., with Premium Standard Farms being the surviving corporation.
Contemplated Initial Public Offering. On March 11, 2005, we filed a registration statement with the Securities and Exchange Commission (the “SEC”) relating to an initial public offering of shares of common stock by certain shareholders. It is not contemplated that any shares will be sold by us in the initial public offering.
Debt Tender. On May 9, 2005, we completed a tender offer and consent solicitation (the “Tender Offer”) with respect to the 9 1/4% senior notes due 2011 (the “9 1/4% Notes”) pursuant to which we purchased $173,000,000 principal amount of the aggregate $175,000,000 of the 9 1/4% Notes previously outstanding and eliminated substantially all of the restrictive covenants relating to the remaining 9 1/4% Notes. The purchase price and related consent payment was $197.2 million based on a price determined generally by discounting the redemption price of the 9 1/4% Notes when they may be first called on June 15, 2006 (i.e., $1,046.25 per $1,000 9 1/4% Note) to present value using the market yield of a comparable U.S. treasury note as of April 19, 2005 plus 0.50%, including accrued interest of $6.4 million. The Tender Offer was financed through borrowings under the existing bank credit agreement (as amended through May 9, 2005) and available cash and will result in a charge of approximately $21.8 million to be recognized in the first quarter of fiscal year 2006. Giving effect to the completion of the Tender Offer, we had as of May 9, 2005 outstanding borrowings under our credit agreement of approximately $156.9 million and outstanding letters of credit of approximately $11.2 million, and approximately $51.9 million available for borrowing.
Industry Overview
Pork products are the largest source of meat protein in the world and the third largest source in the United States. According to the USDA, pork processors in the United States processed approximately 103.4 million hogs in 2004, representing approximately 20.5 billion pounds of pork. US exports of pork products have grown substantially in recent years. From 1995 through 2004, exports increased at an 11% compound annual growth rate, with total exports increasing from 0.8 billion pounds to 2.2 billion pounds. The USDA estimates that pork exports increased by 27% in 2004, a substantially higher growth rate, primarily as a result of increased levels of foreign demand due to a ban by certain foreign countries on the import of U.S. beef related to BSE, the outbreak of avian influenza affecting the poultry industry, favorable exchange rates and the continuing development of export markets for U.S. pork. Countries showing substantial increases include Mexico, China, Russia and Taiwan.
Historically, the United States pork industry has been highly cyclical in nature due to the natural inverse relationship of prices and production and the tendency of independent hog producers to increase production levels in response to higher hog prices. A typical cycle begins with higher hog prices, which leads to incremental production. This, in turn, leads to overproduction, which drives market prices lower. Eventually, lower market prices will generally cause production to moderate or decline which generally leads to higher market prices. Because of the length of the production cycle, there is relatively little ability of hog producers to adjust their production in the short-term, although some changes in supply may occur through net increases or decreases of pork products held in freezers.
The prices for all of these commodities are volatile and the spreads between these prices vary substantially. High prices for hogs normally hurt the profitability of processing operations unless pork prices increase sufficiently to offset these cost increases. On the other hand, hog producers tend to record better results when prices for hogs are high, especially in relation to grain prices. Therefore, results of our processing segment in certain periods may be better or worse than results for our production segment, and vice versa.
The following graphs set forth various hog, pork and grain price data for recent periods and illustrate the volatility in market prices.
Pork Production, Hog Prices and Pork Prices
(1)
Based on USDA statistics published by Informa Economics.
(2)
Average annual price based on the market price of lean hogs, as published by the Chicago Mercantile Exchange.
(3)
Average annual price based on the 185# cutout pricing method, a standard measure for determining current market prices of pork primal cuts that is published by the USDA.
The costs of pork processors are highly dependent on the cost of hogs, and net sales are determined in large part by the prices they receive for pork products. Conversely, net sales from hog production are highly dependent on the prices the producer receives for hogs while the cost of goods sold is determined in large part by the cost of feed. High feed prices can negatively impact production results since these increases can raise the costs to the producer. The graphs below demonstrate how prices for corn and soybean meal, which are the primary components of our feed costs, have fluctuated over the last 10 years ended December 31, 2004.
Corn $/Bushel
(1)
Average annual price, based on the monthly average of daily close prices of the Nearby Corn Futures quoted by the Chicago Board of Trade.
Soybean Meal $/Ton
(1)
Average annual price, based on the monthly average of daily close prices of the Nearby Soybean Futures quoted by the Chicago Board of Trade.
Historically, the United States pork industry has been divided into two segments: pork processing and hog production. As a vertically integrated supplier of pork products, we operate in both industry segments.
Pork Processing
The U.S. pork processing industry is highly concentrated, with the top ten processors representing over 90% of total federally inspected industry capacity as of March 2005, and the industry is highly competitive. Although customers in the retail, wholesale, foodservice, further processor and export markets have different product specifications and service requirements, processors generally compete on the basis of the price and quality of their product. We believe that this consolidation has been driven by a number of factors, including the desire to achieve economies of scale in purchasing, processing and regulatory compliance and the increased concentration among grocery retailers and other customers.
The processing industry is geographically concentrated in the hog producing regions of the U.S., particularly the Midwest and portions of the Southeast. Due to the substantial degree of fragmentation of the hog production industry, processing operations typically are extremely large relative to the producers that supply them. As a result, non-integrated processors must acquire each day’s supply of hogs from a large number of suppliers, many of whom use varying genetics, feeding programs and growing environments. We believe that this dichotomy between the hog requirements of processors and the fragmentation and variation of hog production makes it relatively difficult for non-integrated pork processors to produce consistent, high-quality products.
Hog Production
The hog production industry, although consolidating, remains substantially fragmented and can be characterized by large variations in costs of production and quality of hogs produced. As a result, a large portion of the industry is generally characterized by fewer hogs per sow per year, higher feed-to-gain conversion ratios, higher costs of production, lower quality and less consistent hogs brought to market. Breeding and farrowing are more efficient in the Spring and Fall, resulting in fluctuating seasonal production and prices.
According to the USDA, the number of U.S. hog producers has declined by more than 85% over the last 20 years while the average size of production facilities has increased dramatically. We believe that as the hog production industry moves to more sophisticated production techniques, the pressures on marginal producers will intensify. In the last several years, a number of operations have emerged which are based on large-scale, scientific and management-intensive production of hogs. These operations have grown rapidly. We expect that the hog production industry will see continued consolidation and integration in the future. We believe that this consolidation is being driven by a number of factors, including (1) the substantial investments in equipment, improved breeding herds and process improvements required to achieve economies of scale, meet customers’ demand for product quality and consistency and comply with animal welfare and environmental regulation, and (2) the increasing concentration among processors.
Competitive Strengths
We believe the following competitive strengths position us to enhance our growth and profitability:
• Vertically Integrated, Efficient Operations. We believe that we are one of the most vertically integrated pork processors in the United States, owning and operating each of the key steps of production. In fiscal 2005, 99% of the hogs used by our Milan, Missouri processing plant were sourced from our Missouri hog production operation. During the same period, approximately 75% of hogs used by our Clinton, North Carolina processing plant were supplied by our owned and contracted North Carolina hog production operations, with the remaining 25% supplied through long-term contracts with independent producers. Vertical integration gives us strict control over our process, from a hog’s initial genetic makeup to the pork product ultimately produced and shipped. This process allows us to produce high-quality pork and pork products efficiently by combining cost-effective, high-volume hog production in close proximity to modern and technically advanced pork processing facilities. We believe this vertical integration gives us powerful competitive advantages as compared to non-integrated competitors, such as:
- A dependable supply of high-quality hogs that lead to high meat quality, processing efficiencies and improved sales margins;
- Streamlined logistics, feed manufacturing, transportation and production schedules; and
- Control over key factors (genetics, nutrition and environment) that affect cost of hogs and meat quality, enabling us to market the value, safety, traceability, and quality of our products to our customers.
• Strong Market Position with Strategically Located, Efficient Operations. We are the sixth largest pork processor in the United States and the second largest hog producer in the United States. Our large-scale integrated operations, geographic diversification and strong market position allow us to serve a broad range of customers, while maintaining economies of scale in production and marketing. We are also one of the few national pork processors with an East Coast processing plant and distribution center. Coupled with our Midwest plant location, we are able to provide cost-effective overnight delivery of fresh pork to many of the most populous regions in the United States. Our hog production operations incorporate advanced breeding, farrowing and finishing methods. We believe our processing plants are two of the most modern and technically advanced facilities of their kind in the United States.
• Premium Product Offerings Focused on Discriminating Customers. By leveraging our modern, efficient processing operations and our high-quality production capabilities, we are able to produce products for discriminating customers who demand and expect high-quality pork on a consistent basis. In the retail sector we target high-end independent grocers rather than large national supermarket chains. Our premium products enable these retail customers to differentiate their product offerings from those generally available in large supermarkets. Our premium retail and export products include “Fresh and Tender” moisture-enhanced pork, KenKo-Ton “healthy pork” for the Japanese market and “Natural Excellence” antibiotic-free pork. Also, our integrated business model allows us to target specific product characteristics required by specialty branded processed-meat customers. PSF pork was awarded the Best Taste Award by the American Culinary Institute (“ACI”) in 2004 and the Gold Medal Taste Award from the American Tasting Institute (“ATI”) in 2002. Judged by a panel of professional chefs, our products were recognized for the best tasting, highest quality food and culinary product by ACI, and for appearance, freshness and taste by ATI, with taste being the most important attribute.
• Process Verified Certification. We believe we were the first pork company to receive “Process Verified” certification from the USDA for our entire production and processing supply chain. The Process Verified certification program is modeled after ISO-9000 quality management and quality assurance standards. Process Verified certification helps ensure our customers that food safety, meat quality, traceability, animal handling and environmental management standards, among other standards, have been met and benchmarked for continual improvement. While others in the industry have the certification for parts of their system, we believe we are the only company that has currently received the certification for the entire production and processing supply chain. Our marketing strategy capitalizes on these attributes and the consistency and quality of the pork we produce.
• Experienced Management Team. Our senior management has an average of 19 years of industry experience. We believe we have one of the most experienced management teams in the pork industry in operating fully-integrated systems with an average of 23 years of industry experience in production, 31 years in processing, 16 years in technical and food safety and 19 years in sales. Our experienced and motivated management team is focused on expanding our position as one of the premier producer/ processors of high-quality pork and pork products.
Business Strategy
We are pursuing a strategy designed to increase our sales margins and returns on invested capital. Key elements of our strategy include:
• Focus on High Quality and Value-Added Products. We are seeking to move more of our products up the value-added chain to improve sales margins, develop a stronger brand, enhance relationships with key customers and drive new product development. We intend to continue to focus on producing high-quality and value-added products, such as boneless products, marinated pork, moisture-enhanced pork, sliced bacon,
microwave cooked bacon, smoked hams, sausage and other processed meats. We plan to continue our focus on marketing these products to discriminating customers in the retail, wholesale, foodservice, further processor and export markets in order to further differentiate our products from those of our more commodity-oriented competitors.
• Expand Processing Capacity. We continue to seek additional expansion opportunities with the potential to generate attractive returns on investment. As an example, through modernization and efficiency efforts in fiscal year 2003, we completed expansion of processing capacity at our North Carolina processing plant from 6,500 hogs per day to up to approximately 10,000 hogs per day on a single shift. At this North Carolina facility, we are now evaluating the further expansion of our value-added processing capacity.
• Continue Expansion into International Markets. We believe that international markets offer significant growth opportunities and we intend to continue our efforts to develop sales outside the United States. Over the past ten years, we have expanded our efforts to increase export sales. Sales to Japan, Mexico, Canada and other export markets accounted for 10% of our net sales for the fiscal year ended March 26, 2005. We believe that our presence in these markets allows us to achieve higher prices for certain pork products than could be obtained domestically. In particular, we intend to increase our export volumes to Japan using available capacity at our North Carolina plant, as the Japanese market ascribes significant value to premium, process-controlled, traceable products. We also intend to actively expand sales in other Asian and Latin American markets, as well as other international regions.
• Pursue Strategic Acquisition, Disposition and Partnership Opportunities. As a key part of our growth strategy, we evaluate on an ongoing basis potential industry-related acquisitions, dispositions and joint ventures. We will continue to evaluate those opportunities that fit strategically with our objective of producing more processed meats and other high quality, value-added products.
• Further Improve Cost Structure. We strive to produce high-quality pork products at a low cost by combining modern and efficient pork processing with efficient, high volume hog production. We continually measure our processing and production activities in an effort to improve our processing yields, develop new value-added products, lower our costs and increase our hog production efficiencies.
Our History
Our hog production business was originally founded in 1988. In 1994, we completed construction of our Missouri processing plant. Due primarily to start-up costs at the Missouri farms and plant, combined with a decline in hog prices at the same time feed prices increased, our predecessor filed for bankruptcy reorganization under Chapter 11 on July 2, 1996. In September 1996, the reorganization became effective and our business emerged from Chapter 11.
Since emerging from bankruptcy, we have expanded our business in two significant ways. On May 13, 1998, we expanded our Missouri operations in a series of transactions with ContiGroup. In these transactions, ContiGroup purchased a 51.0% ownership interest in our outstanding common stock for $182.3 million. In exchange, we purchased the North Missouri farms hog production operations then owned by ContiGroup for $75.0 million. These transactions allowed us to operate the Milan, Missouri plant at full capacity.
In fiscal year 2001, we expanded our operations through two acquisitions in North Carolina. On August 25, 2000, we acquired The Lundy Packing Company and its subsidiaries, which consisted of hog production and pork processing operations. On September 22, 2000, we acquired Premium Standard Farms of North Carolina from ContiGroup. In the latter transaction, ContiGroup received cash and additional shares of our common stock, bringing its overall ownership to 53.1% of our outstanding common stock.
Products, Marketing and Customers
We market our pork products to retail, wholesale, foodservice and further processor customers in the U.S. and abroad. We focus on discriminating customers in these markets. We primarily market our products as chilled and frozen pork, sold to:
• Retailers, retail distributors and wholesalers (accounting for 46% of our total processing sales in our fiscal year 2005) primarily in the form of chilled, vacuum-packaged loins, tenderloins, hams, picnics, butts, ribs, marinated, case-ready, bacon, smoked hams and sausage;
• Foodservice customers (accounting for 3% of our total processing sales in our fiscal year 2005) primarily in the form of chilled and frozen boxed bone-in and boneless loins, ribs, picnics, butts and further processed smoked meats;
• Further processors (accounting for 40% of our total processing sales in our fiscal year 2005) primarily in the form of chilled bulk bone-in and boneless hams, bellies, trimmings, picnics and butts, variety meats and other products which are used by these customers to make processed pork products; and
• Export customers (accounting for 11% of our total processing sales in our fiscal year 2005) primarily in the form of chilled boneless loins, tenderloins, boneless picnics, fresh bone-in hams, frozen boneless hams, bellies, as well as frozen ground pork and variety meats.
We are increasingly emphasizing value-added products, such as boneless products, marinated pork, moisture-enhanced pork, sliced bacon, microwave cooked bacon, smoked hams, sausage and other processed meats. Our vertical integration and control also allows us to produce specialty products. These include our “Fresh and Tender” moisture-enhanced pork, KenKo-Ton “healthy pork” for the Japanese market and “Natural Excellence” antibiotic-free pork.
Our North Carolina plant includes further-processing facilities that produce smoked hams, sliced and microwave cooked bacon, and sausage. We continue to focus on increasing our activities in the processed meat area.
Our marketing strategy seeks to capitalize on the quality of the pork derived from our controlled supply of high-quality consistent hogs and modern processing operations allowing us to sell fresh and processed pork at prices that reflect a premium to those received by competitors selling lower quality products. Our pork processing facilities have been designed to enhance the realization of this quality by converting standard pork cuts to value-added products through boning, trimming and other further processing. Furthermore, we target specialty, export and ethnic markets, in which there is a higher demand for certain pork products. In order to capitalize on a differentiated product, we have been certified to use the USDA Process Verified seal in connection with our Missouri and North Carolina processing operations.
We sell to domestic customers directly and through regional distributors. In marketing to the retail channel, we target independent regional supermarkets seeking to differentiate themselves with “meat-case destination” premium quality pork. Our target market for further processors includes companies with established food brands that demand consistent, high quality, differentiated product.
We are increasingly targeting foodservice customers that demand consistent, high-quality product and are attracted to the traceability, food safety and animal welfare associated with the “Process Verified” certification of our product. We believe that the foodservice industry represents a growth opportunity for us.
Our international marketing efforts are directed toward a number of countries, but are predominantly focused on Japan, which ascribes significant value to our premium, process-controlled products. In our fiscal year 2005, sales to Japanese customers represented about 6% of our total sales. Sales to international markets, especially Mexico and Canada, when combined with sales to Japan, accounted for approximately 10% of our total sales in our fiscal year 2005. International sales are made both through distributors and directly to customers. Most of our Japanese exports are sold through a relationship with a Japanese trading partner, to whom we sell exclusively certain chilled pork products produced at our Milan, Missouri plant that are destined for the Japanese market. The contract with
this trading partner comes up for renewal in December 2005.
Though our sales and marketing efforts are primarily focused on sales of pork products, we also sell excess hogs from our production facilities to other pork processors. In this respect, we have contracts with two major pork processors, who purchase substantially all of the hogs produced at our Texas facilities.
The remainder of our excess hog production is sold in privately negotiated transactions. Finally, both of our facilities sell by-products primarily to the feed processing and pet food industries.
Processing and Production Operations
Overview
Our processing and production operations are organized as three separate pods located in Missouri, Texas and North Carolina. Our Missouri and North Carolina pods each combine processing plants and hog production facilities. Our Texas pod has only hog production operations. The geographic separation of our pods enhances
biosecurity and puts us closer to our customers and feed grain suppliers, allowing us to minimize shipping costs. Shipping, via truck, is important in a number of aspects of hog production, particularly the delivery of feed to hog production units, the shipment of feeder pigs to finishing units, and the shipment of finished hogs to processing plants. We utilize our own truck fleet and related transportation facilities for hauling feed and hogs, which allows us to reduce the risk of disease and enhances the scheduling and process coordination that our integrated approach provides. Please read Note 11 to our audited consolidated financial statements for financial information relating to our operating segments.
Pork Processing
We maintain pork processing facilities in Missouri and North Carolina. In fiscal year 2005, 99% of the hogs processed by our Missouri processing plant came from our Missouri hog production operations. During fiscal year 2005, approximately 75% of hogs used by our North Carolina processing plant were supplied by our North Carolina hog production operations, with the remaining 25% supplied through contracts with independent producers, which produce hogs in accordance with our genetic, feed and other production specifications. To help ensure the safety and quality of our products, we use the USDA’s Hazard Analysis of Critical Control Points methodology to identify food safety hazards in our operations. This approach uses a team of technically trained individuals who are familiar with the processes to be evaluated. Each separate point in the process is identified and any hazards associated with them are assessed. Methods for monitoring the quality and safety of products as they move through these points are then developed and implemented.
The quality management points listed below provide the basis for our Process Verified program. In December of 1998, we believe we became the first company in the pork industry to receive approval for this program from the USDA-Agricultural Marketing Service. This approval gave accreditation to the first Process Verified program which extends from live animal production through processing. While other pork companies have since received approval of their own Process Verified programs, we believe ours is the most comprehensive, encompassing live animal production through processing.
The Process Verified program is modeled after ISO-9000 requirements that are adapted for the livestock industry, and is administered by the USDA Agricultural Marketing Service, Livestock and Seed Division. We have designated six process points throughout our process to represent our program. These quality management points are summarized as follows:
• Every order is traceable to source farms;
• Every phase of production is managed using a food safety based control system;
• Production and processing systems are designed to continuously assess the effect of farm and plant processes on meat quality traits, including extensive genetic research;
• Personnel are trained to handle livestock according to proper animal handling guidelines;
• We are committed to environmental stewardship with the goal to protect the quality of the environment by evaluating and improving the waste management systems; and
• All antibiotic free products are derived from market animals that have never received antibiotics through feed, water, or via injection.
Our automated processing operations have been designed to achieve the benefits of vertical integration that are not available to non-integrated hog producing or pork processing competitors. Some of these benefits are as follows:
• We streamline logistics, transportation and production schedules to enhance asset utilization and reduce our cost structure because of the proximity of our processing facilities to our production operations;
• We improve the realizable value of our hogs through our control over the key factors (genetics, nutrition and environment) that affect leanness and meat quality; and
• We believe we provide a higher level of quality and safety assurance to our customers because of our control of both production and processing.
We believe that by controlling our own high quality, consistent hog supply, we can be among the more efficient processors in the industry and produce a consistent high-quality product whose value will be recognized in the market.
The design of our Missouri and North Carolina processing facilities reflect four key objectives:
• Modern equipment and proven technology have been used to build two of the most modern and technically advanced facilities in the industry;
• The facilities are designed to emphasize worker safety to help ensure compliance with all regulations and to reduce worker injury and turnover;
• The facilities are designed to enhance animal welfare and produce a product that is appealing to further processors and consumers (employing identification and tracking technology to help ensure quality control for the final pork product); and
• The facilities are designed to reduce waste products and emissions and dispose of waste in accordance with applicable environmental standards.
Hog Production
Our sow production facilities house herds generally ranging from 1,100 to 3,300 sows per unit. On average, a staff of five people is required for 1,100 sows. A typical sow production unit consists of four connected buildings, each with a specialized function- breeding, gestation, farrowing and nursery.
The production process begins in the breeding barn, where sows are artificially inseminated. Artificial insemination maximizes breeding efficiency and productivity and allows us to utilize genetic stock that maximizes our overall productivity and quality. After four weeks, conception is verified using ultrasound technology. From the breeding barn, sows are moved to the gestation barn where they are vaccinated and placed on a special diet. The gestation period is 114-days. During this period, the sows receive a specialized diet and careful attention to health and disease control in order to improve the size and health of their litters. In our gestation buildings, sows are carefully monitored and individually fed according to body weight. A few days prior to delivery, sows are moved to the farrowing barn where they give birth to an average litter of approximately 10 offspring. Sows nurse their offspring for three weeks before they are returned to the breeding barn. At approximately 12 to 15 pounds, the offspring are moved to the nursery for a six-to-seven week period. This step requires high levels of nutrition,
environmental control and minimization of disease and health risks. An increasing portion of our operations use the wean-to-finish production method where nursery pigs are transported directly to modified grow/ finish sites, skipping the traditional time spent in a nursery.
In the next phase of production, offspring are transferred from the nursery in our sanitized trailers to our grow/finish complexes or contract growers for growth from approximately 50 pounds to a target market weight of 260 pounds. Our grow/finish complexes are comprised of temperature-controlled barns, each generally housing 950 to 1,200 hogs. A manager in charge of the complex is responsible for monitoring hog welfare and health, as well as equipment. Efficiency in finishing operations is affected by the health and environment of the hogs and the formulation of the feed. These factors, as well as the genetics of the hog, can have a substantial impact on the feed-to-gain conversion ratio (the pounds of feed required to add a pound of weight) and the average daily gain. Specialized crews support the complex managers by assisting with loading and unloading hogs, health care, and sanitation. Hogs generally remain at the grow/ finish complexes for approximately 17 weeks, gaining an average of approximately 1.7 pounds per day, until they reach market weight and are transported to a processing facility.
Because diet is a critical factor in the efficient production of hogs and affects the quality of the final products, we have established five of our own feed mills. We can typically access feed grains on a cost-effective basis and manufacture and deliver feed to our facilities at a lower cost than we can buy it from commercial feed mills. In North Carolina, where we rely to some extent on commercial feed mills, we have established cost-effective toll milling arrangements with select mills. Due to excess milling capacity in North Carolina, we are generally able to purchase feed from these vendors on terms that help us remain a low cost producer. Our Missouri production facilities generally have our lowest feed costs because they are located close to the larger grain producing areas. Our feed costs are relatively higher in our North Carolina and Texas facilities due to higher transportation costs. Our feed mills and toll milling arrangements allow us to optimize production of our customized diets to a greater degree than would typical arrangements with third-party feed mills, which operate on a cost plus basis and provide feeds for many types of customers and animals. We achieve this through “least cost” formulations based on available feed ingredients. For example, while corn is the primary ingredient in hog feed, a large number of other grains, proteins, fats and supplements may be added, and the content and mix of feed ingredients can be managed to improve nutrition, feed-to-gain ratios and meat quality. The combined annual capacity of our five company-owned feed mills is approximately 1.4 million tons. These mills provided approximately 73% of the total feed/components used in our production operations (measured in tons) during our fiscal year 2005.
Biosecurity
We seek to reduce the risk of disease transmission through a number of methods, including geographic separation of, and restricted access to, production facilities, strict sanitation procedures (including thermal sanitation of livestock trailers), high health genetic stock and constant monitoring and response. All units are restricted access, “shower in/ shower out” facilities. If it is necessary for a manager or worker to enter a unit other than their designated unit, a mandatory 24 to 96-hour waiting period is required. Feed purity and truck cleanliness are continually inspected and monitored. Operating procedures within the facilities are designed to stop the spread and lessen the viability of infection agents during all phases of the production process.
We also attempt to control the risk of disease through the selection of high-health breeding stock. When disease is found, treatment is implemented to lessen its impact on performance and to prevent its spread to other facilities.
Missouri
Our Missouri pod has both processing and production operations. The Missouri processing facility is located at Milan, Missouri and employed approximately 1,000 people as of March 26, 2005, with the capacity to process 7,400 hogs daily (on an eight hour shift) or about 2.0 million hogs per year. To help ensure the safety and quality of our products, the processing facility incorporates several innovative systems, including a new dual carbon dioxide anesthetizing system, which we believe provides improved animal handling and enhanced meat quality.
We are exploring a possible 2-stage expansion of the Missouri facility. The first stage would involve improvements to increase the daily capacity of the facility to process approximately 10,000 hogs daily. The second phase would entail construction of facilities to support two shifts of processing. Engineering work on this potential
expansion is proceeding, but we have not yet committed to this expansion proposal. Management believes that the additional hogs required for this expansion could be sourced from existing independent hog producers, who would adopt our Process Verified requirements.
The Missouri production operation, based at Princeton, employed approximately 1,200 people as of March 26, 2005. A 116,000-sow herd produces approximately 2.1 million hogs per year. Eighty-two sow units, five nursery units and ninety-one finishing units are located on farms in five counties in Northwest Missouri. We also have grower relationships with ContiGroup and other independent growers who raise our livestock under long-term contracts that require them to follow our Process Verified requirements.
North Carolina
Our North Carolina pod has both processing and production operations. The North Carolina processing facility is located at Clinton and employed approximately 1,200 people at March 26, 2005, processing up to approximately 10,000 hogs daily, depending on seasonality, or up to 2.6 million hogs per year. In fiscal year 2003, we completed a major renovation which increased processing capacity and included the installation of a new dual carbon dioxide anesthetizing system. As a result, we believe the plant is one of the most advanced facilities of its kind in the United States.
The North Carolina production operation, based at Clinton, employed approximately 300 people as of March 26, 2005. A 76,000-sow herd as of March 26, 2005 produces approximately 1.4 million hogs per year. Contractual arrangements for purchasing weaned pigs produce an additional 500,000 hogs per year. There are nine sow units, three nursery units and four finishing units located on farms we own in various counties throughout the state. Most of the production operations in North Carolina are conducted on farms that are not owned by us. Instead, we have long-term contract grower agreements with local farmers who provide the land, buildings and labor needed. These grower arrangements are managed by our hog production field supervisors. The hogs are owned by us, are raised according to our specifications using our genetics, feed and supplies, and are delivered to our North Carolina processing facility. Since these arrangements allow us to control the process, from a hog’s initial genetic makeup to the pork product ultimately produced, we consider them to be a part of our integrated operations notwithstanding the fact that we do not own the farms.
In addition to the production operations discussed above, we purchase approximately 500,000 hogs annually for our North Carolina processing operations that are not supplied by our production operations. These hogs are obtained pursuant to long-term supply arrangements with a limited number of external hog suppliers who have agreed to follow our Process Verified requirements.
Texas
Our Texas pod has only production operations. These operations are headquartered at Dalhart, Texas and employed approximately 300 people as of March 26, 2005. A 34,000-sow herd is designed to produce approximately 600,000 hogs per year. Twenty-three sow units, six nursery units and eight finishing units are located on farms in Dallam and Hartley counties. Substantially all the hogs produced are sold under two contracts with major processors.
In fiscal year 2003, we completed the addition of a new 10,000 sow and wean-to-finish operation at our Texas facilities. Our Texas production facilities are located on approximately 53,000 acres with adequate space and all environmental and land use permits required for further expansion.
We have been experiencing health issues in our Texas hog production operations in recent periods due to PRRS, which is common in swine herds in the United States. PRRS has had a negative effect on reproduction and general herd health in these operations, which has decreased production volume and increased costs. We are currently operating a health-improvement program intended to stabilize the impact of PRRS in the system. This program has increased pigs born alive per sow and improved health performance in recent quarters. There can be no assurance these measures will continue to be successful.
Research and Development
We use an applied research strategy designed to allow rapid and early implementation of technologies in production, nutrition and processing. This effort is driven by our technical team, some of whom have advanced degrees in nutrition, veterinary science, meat science, health assurance and animal welfare. This team also uses an extensive network of outside scientists and other contacts to enable us to access the latest technology.
We continually seek to improve the genetics of our production herds and to produce hogs that are the highest quality commercially available. Our female and male breeding stock are purchased from several of the world’s leading hog genetics suppliers, which employ extensive research efforts in molecular genetics, biosecurity, food safety and meat quality to help ensure strong genetic lineage.
We routinely evaluate alternate genotypes to validate and compare them to existing products. In addition, we conduct intense research trials to further develop existing genotypes to meet economic and customer demands for composition and quality. These arrangements enhance the quality of our genetics and diversify our genetic sources. We also incorporate careful computer-based monitoring of the breeding performance of all our breedstock to improve breeding patterns and remove sub-optimal parents from the herd.
We have a proprietary sire line genetics improvement program with Sygen (PIC), the largest hog genetics firm. This program focuses on quality characteristics of the meat and improved performance traits.
We also have been a leader in the implementation of new technologies at our processing facilities. For example, we believe we were the first U.S. company to introduce the use of European-designed carbon dioxide anesthesia systems in pork processing to reduce livestock stress and increase meat quality and yields. Today, both of our processing facilities employ this technology. Specially designed trucks and holding areas also enhance the welfare and handling of our hogs. In addition, we use rapid chilling technologies to improve product quality traits like color, texture and moisture retention. We continue to explore additional ways to utilize robotics and ergonomic enhancements in our processing operations.
We are committed to install improved wastewater, air and odor technology at all of our finisher farms in northern Missouri by 2010. See “Business- Regulation.” Included in this commitment is the soon to be completed fertilizer plant in northern Missouri that will convert waste at one of our production facilities into useable commercial grade fertilizer. We believe that this facility, which is scheduled to begin operations in the summer of 2005, will be the first plant to commercially produce an odorless, dried pellet fertilizer at a livestock production facility.
Competition
The pork industry is highly competitive and we compete with many other pork processors and hog producers of varying sizes. Our products also compete with a large number of other protein sources, including beef, chicken, turkey and seafood. However, our principal competition comes from other large pork processors. We believe that the principal areas of competition in the pork industry are price, quality, product distribution, and brand loyalty. We believe that we are the sixth largest hog processor in the United States with a number of competitors, including Smithfield Foods (the largest pork processor) being substantially larger than we are. We believe that we are the second largest producer of hogs in the United States, but are substantially smaller than the leader, Smithfield Foods. Some of our competitors are larger than us, have greater financial and other resources and enjoy wider recognition for their branded products.
Intellectual Property
We hold several trademark and other intellectual property rights. For example, we have registered the trademarks “Premium Farms,” “Natural Excellence,” “Premium Standard Farms,” “Premium Standard Certified,” “Fresh from the Farm Taste,” “Carolinian,” “Lundy’s,” “Tomahawk Farms,” “Fresh & Tender” and “Gold Banner” with the United States Patent and Trademark Office. We have also registered “Premium Standard Farms” in some of the foreign countries to which we sell our products. In addition to trademark registrations, we attempt to protect our unregistered marks under common law trademark laws and other proprietary information under trade secret laws, employee and third-party non-disclosure agreements and other laws and methods of protection.
Employees
We had approximately 4,100 employees as of March 26, 2005, of which approximately 2,200 were in processing, approximately 1,600 were in production and approximately 300 were in administration. None of our employees are subject to collective bargaining arrangements, although there can be no assurance that employees will not enter into such agreements in the future. We generally consider our employee relations to be good.
Regulation
Environmental, Health and Safety
Our operations are subject to federal, state, and local environmental, health, and safety laws and regulations, including those governing air emissions and wastewater discharges and, in some jurisdictions, odor. Among other things, these laws and regulations impose standards and limitations on our waste treatment lagoons, water treatment facilities and new construction projects and regulate the management of animal waste from our hog production facilities. We also have been and are subject to lawsuits from neighboring property owners in Missouri based on the law of nuisance.
We are committed to promoting environmental stewardship, and we strive to comply with environmental, health and safety requirements and to improve our environmental performance on a continuing basis. We cannot assure you, however, that we will at all times operate in compliance with environmental requirements, and if we fail to comply with such requirements, we could incur material penalties, fines and damages, and negative publicity.
Environmental, health, and safety laws and regulations are subject to amendment, to the imposition of new or additional requirements and to changing interpretations by governmental agencies or courts. In particular, environmental laws and regulations may become more stringent for our industry. Additionally, various citizen and advocacy groups have been advocating changes in animal handling and environmental practices in the industry. Although we believe we are a leader in installing advanced environmental controls, more stringent requirements could result in changes in industry practices that could increase our costs and reduce margins.
In 2003, the Environmental Protection Agency (EPA) issued Effluent Limitation Guidelines for Concentrated Animal Feeding Operations (CAFOs). These regulations require animal feeding operations to obtain wastewater permits and implement nutrient management plans. A U.S. Court of Appeals recently invalidated certain provisions of these regulations. In any event, our facilities and related operating procedures already comply with or exceed most of these requirements, and we do not anticipate any material costs in complying with these rules.
The State of Missouri promulgated a rule that came into effect on January 1, 2002 to regulate odor emissions from large animal feeding operations such as ours. This rule required us to develop plans to reduce odor emissions and to submit such plans to state authorities, which we have done. This rule also required us to make certain changes to reduce odors at the property line to certain established levels. The Company does not anticipate material costs to comply with the rule as promulgated.
Environmental Consent Decrees and Agreements
In order to settle enforcement actions and citizen suits, and to ensure that we, the regulatory agencies, and independent experts all agree that we are implementing appropriate advanced technology, we have entered into consent decrees with the State of Missouri, and with the federal government and a citizens group, and signed a voluntary agreement with the State of North Carolina. The decrees have generally required that we pay penalties to settle past alleged regulatory violations, and the decrees and the voluntary agreement require that we research, develop, and implement new technologies for environmental controls at our Missouri and North Carolina operations.
In 1999, we entered into a consent decree to settle a suit filed by the State of Missouri. The settlement required us to invest $25 million in capital expenditures on what was characterized in the decree as “Next Generation Technology” for researching, installing and operating improved technology to control wastewater, air and odor emissions from our Missouri farms. Our proposed technologies were to be approved by a panel of independent
university experts and were to be completed by 2004. In 2002, the State of Missouri filed a suit against us for alleged new violations of air and water regulations. We settled that matter by entering into a second consent decree in 2004. The 2004 consent decree required us to pay a civil penalty of $333,000. It also modified the 1999 consent decree by (i) removing the $25 million spending requirement, instead specifying that Next Generation Technology be installed on the 11 largest farms and (ii) extending the schedule to implement Next Generation Technology from 2004 until 2010, in each case to ensure that the technology we install will be effective in reducing impacts to the environment. As a result of the 2004 consent decree, we now estimate that we will invest approximately $33 million in Next Generation Technology by the 2010 deadline, of which $8.4 million has been spent as of March 26, 2005.
In 2001, we entered into a consent decree with a citizens group and the United States to resolve alleged violations of the Clean Air Act, Clean Water Act and the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”). This consent decree was built upon the 1999 consent decree with the State of Missouri referenced above and requires that the Next Generation Technology we employ meet certain performance standards, such as a 50 percent reduction in nitrogen concentration of the effluent applied to area fields over a prescribed time period. We paid a civil penalty in the amount of $350,000 in connection with this settlement.
In 2000, we voluntarily entered into an agreement with the Attorney General of North Carolina. Under this agreement, we committed to implement “Environmentally Superior Technologies” for the management of swine waste at our company-owned farms after an independent panel determined that such technologies are both effective and economically feasible to construct and operate. Environmentally Superior Technologies are generally identified as waste treatment technologies that meet certain performance standards with respect to release of materials into the environment. We also paid $2.5 million to a fund for the development of such technologies, for environmental enhancement activities and for the defrayal of costs incurred by the state related thereto. We have met all of our commitments to date under this agreement and continue to work closely with the state’s designated representative at North Carolina State University in the development of Environmentally Superior Technologies.
On January 21, 2005, the EPA announced the opportunity for animal feeding operations to enter into an agreement regarding air emissions from animal feeding operations. The agreement is known as the “Air Quality Compliance Agreement.” The purpose of the agreement is to allow EPA to monitor the operations and gather data for future regulations. Participating parties would pay a civil penalty. In exchange for this, the parties will receive a limited conditional release and covenant not to sue for any past violations and future violations of applicable environmental air emission laws until such time as EPA establishes emission methodologies enabling Animal Feeding Operations (AFOs) to certify compliance. EPA’s proposal is not yet final, and we are evaluating whether we will participate in this program. Our Missouri operations would not be eligible because they are subject to the consent decrees described above. As proposed by EPA, the amount of the civil penalty that would be assessed in order for our North Carolina and Texas operations to participate would not be expected to exceed $100,000. If we decide to participate in the program, we do not anticipate that the penalty and required compliance actions will have a material adverse effect on us.
Environmental Capital Expenditures
We have incurred, and will continue to incur, significant capital and operating expenditures to comply with environmental requirements and our obligations under the consent decrees. We expect to spend about $4.0 million in fiscal year 2006, and roughly $4.0 million in fiscal year 2007. The fiscal year 2005 expenditures were primarily for the construction of Next Generation Technology in the form of a fertilizer plant in northern Missouri that will convert hog waste into commercial grade fertilizer. Our fiscal year 2006 and fiscal year 2007 expenditures will be primarily for Next Generation upgrades at certain additional farm locations.
North Carolina Moratorium
In 1997, North Carolina enacted a moratorium on the construction of farms with more than 250 hogs or the expansion of existing large farms in North Carolina. In 2003, the moratorium was extended until 2007. North Carolina is concerned about the use of waste treatment lagoons and spray fields for the disposal of swine waste, especially in areas of that state that are prone to flooding or hurricanes. It is anticipated that this moratorium will be extended until more effective technologies are developed to protect the environment. Currently, we do not expect that the North Carolina moratorium will have a material adverse effect on us.
2003 BSE Case
On December 23, 2003, a case of BSE was confirmed in a dairy cow in the State of Washington. On December 30, 2003, the USDA announced additional safeguards to further minimize the risk for human exposure to BSE in the United States. World markets reacted to this event and several countries banned the import of beef products from the United States, pending further investigation and action by the U.S. beef industry. For the most part, these bans continue today and have caused a moderation of beef prices in the U.S. since the discovery. The U.S. Congress has reacted by considering potential legislation that includes banning “downer” livestock from the food chain, re-assessing country-of-origin labeling, implementing mandatory animal identification and traceability requirements, and requiring potential changes in the current practice of feeding animal by-products. At this time, it is uncertain what impact these events may have on the pork industry.
Nuisance Lawsuits
We are defendants in several lawsuits based on the law of nuisance in Missouri, including one class action lawsuit. We believe we have good defenses to these actions and intend to vigorously defend them. These lawsuits are described in more detail in “Legal Proceedings.”
ContiGroup Indemnity
The Company indemnified its majority shareholder, ContiGroup, Inc., against any liabilities, including environmental liabilities, relating to the Missouri operations at the time that ContiGroup sold its Missouri hog production facilities to the Company and made its initial investment in 1998. This indemnification obligation currently extends to the Company’s obligations under the State of Missouri consent decree and the pending nuisance suits, as well as any potential future claims regarding our Missouri operations.
Other Regulatory Matters
In February 2002, the U.S. Senate initially passed a Farm Bill that included a provision known as the “Johnson Amendment,” which would have prohibited meat packers, like us, from owning or controlling livestock intended for slaughter for more than fourteen days prior to slaughter. The U.S. House of Representatives passed a different version of the Farm Bill that did not contain any provision similar to the Johnson Amendment. A Conference Committee was convened for the Farm Bill, composed of members of both the House and the Senate. This Conference Committee rejected the Johnson Amendment and approved a uniform Farm Bill without the Johnson Amendment or any similar provision.
If the Johnson Amendment had become law, it may have had a material adverse effect on our vertically integrated business. It may have caused us to consider a restructuring of our operations. We, along with industry groups, succeeded in educating lawmakers as to the adverse effects and unintended consequences of the Johnson Amendment, leading to its subsequent rejection by the Conference Committee. We and others in the industry will continue efforts to educate lawmakers, but the parties advocating passage of the Johnson Amendment continue to propose similar legislation. Legislation of this type was recently introduced in the U.S. Senate. If this or a provision like the Johnson Amendment becomes law, it could have a material adverse effect on us.
The Country of Origin Labeling requirements became law pursuant to the Farm Security and Rural Investment Act of 2002, but implementation of the labeling requirements has been delayed. Due to our vertical integration, we do not anticipate any material compliance problems.
Several states have enacted “corporate farming laws” that restrict the ability of corporations to engage in farming activities. Missouri is among these states, but Texas and North Carolina currently are not. Missouri’s corporate farming law in many cases bars corporations from owning agricultural land and engaging in farming activities. Our operations have been structured to comply with the Missouri corporate farming law and its existing exemptions. The Missouri laws, however, could be subject to challenge or amendment by Missouri governmental bodies in the future. Further, even with the exemptions, the corporate farming laws restrict our ability to expand beyond the counties in which we currently operate.
At the time of ContiGroup’s acquisition of its interest in us in 1998, ContiGroup submitted the proposed ownership structure to the Office of the Attorney General of the State of Missouri for its review. At that time, the Office of the Attorney General indicated that it had no objection to our current structure under the corporate farming laws. There can be no assurance, however, that this position will be maintained in the future as our operations continue and develop.
In addition to Missouri’s “corporate farming law,” Missouri law prohibits a person who is not a citizen or resident of the United States from holding a controlling interest in a business that owns land used for farming. A controlling interest in us is not currently held by a foreign person or entity in violation of this law. Our certificate of incorporation includes provisions intended to prevent foreign ownership in violation of this law.
Executive Officers of the Registrant
The names, ages and positions of our executive officers as of May 6, 2005, are set forth below:
Name
Age
Position(s)
John M. Meyer
Chief Executive Officer and Director
Robert W. Manly
President
Stephen A. Lightstone
Executive Vice President, Chief Financial Officer and Treasurer
Gerard J. Schulte
General Counsel and Secretary
Dennis D. Rippe
Vice President, Controller and Assistant Secretary
Calvin R. Held
Vice President Processing Operations
Richard L. Morris
Vice President Sales and Marketing
Set forth below is a description of the backgrounds of each of our executive officers.
John M. Meyer has been a Director and our Chief Executive Officer since May 1998. Prior to May 1998, he spent 15 years with ContiGroup, most recently as Vice President and General Manager of ContiGroup’s pork division. While with ContiGroup, Mr. Meyer served in the sales, credit and financial services functions.
Robert W. Manly has been our President since October 1996. From April 1986 to October 1996, Mr. Manly served as Executive Vice President of Smithfield Foods, Inc., a meat producer and processor. He also served as President and Chief Operating Officer of the Smithfield Packing Company, a subsidiary of Smithfield Foods from June 1994 to June 1995. Mr. Manly held the position of Assistant to the President of IBP, Inc., a meat producer and processor from January 1981 to April 1986.
Stephen A. Lightstone has been our Executive Vice President, Chief Financial Officer and Treasurer since August 1998. From 1983 to 1998, Mr. Lightstone was with Payless Cashways, Inc., a building materials retailer, most recently serving as Senior Vice President, Chief Financial Officer and Treasurer.
Gerard J. Schulte has been our General Counsel and Secretary since July 1998. Mr. Schulte has been Vice President and Assistant General Counsel of ContiGroup Companies, the majority shareholder of the Company, since February 2001, and previously served as Vice President and General Counsel of ContiIndustries, an operating group of ContiGroup Companies, since 1990.
Dennis D. Rippe has been our Vice President, Controller and Assistant Secretary since January 1999. Prior to that date, Mr. Rippe had been our Vice President Finance and Administration-Operations (Missouri) since February 1997.
Calvin R. Held has been our Vice President of Processing Operations since April 2004. Prior to that date, Mr. Held was the Company’s Vice President of Milan, Missouri Processing Operations from December 1994 to April 2004 and was Controller of Farm Production and the Milan, Missouri Plant from August 1992 to December 1994. From 1978 to 1992, Mr. Held was with Jimmy Dean Foods, a division of the Sara Lee Corporation, a manufacturer and marketer of consumer products.
Richard L. Morris has been our Vice President of Sales and Marketing since November 2003. Prior to joining the Company, Mr. Morris was a consultant with Morris Group, a consulting company, from September 2002 to November 2003, and prior to that spent 22 years with Sara Lee Corporation, a manufacturer and marketer of consumer products, and affiliates from February 1980 to August 2002, most recently as Vice President of Distributor Sales-Meat and Bakery with Sara Lee Foodservice.
Available Information
Additional information regarding the company can be found at our Internet address (http://www.psfarms.com), provided that none of the information contained on our website is incorporated by reference into this report on Form 10-K. We file annual, quarterly and current reports with the SEC. These reports, and any amendments to these reports, filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are made available by us free of charge on our Internet website as soon as reasonably practicable after we electronically file or furnish such material with the SEC.
Item 2.
Item 2. Properties
Pork Processing
We own two pork processing facilities located in Missouri and North Carolina. Combined, these two facilities have the capacity to process approximately 4.6 million hogs per year.
The Missouri facility has a processing capacity of 7,400 hogs per day and is one of the most modern and technically advanced facilities of its kind. Substantially all of the hogs processed at this plant are produced by our Missouri hog production operation.
In fiscal year 2003, we completed a major renovation of our North Carolina processing facility which increased its processing capacity. The facility is now capable of processing up to approximately 10,000 hogs daily, depending on seasonality and market conditions, and we believe it is now, along with our Missouri processing plant, one of the most advanced facilities of its kind in the United States. The majority of the hogs processed at the facility are provided by our North Carolina hog production operations with the remainder being sourced from outside suppliers.
Hog Production
We have a combination of owned, contracted and leased hog production facilities which support approximately 270,000 sows and their respective offspring. As detailed below, there are three geographic areas where our hog production operations are located.
The Missouri production operation has a 116,000-sow herd which produces approximately 2.1 million hogs per year. The production facilities are located on approximately 44,000 acres and are supported by three owned feedmills with a combined annual capacity of 840,000 tons per year. Of these 44,000 acres, approximately 6,200 acres are owned by ContiGroup but the facilities located thereon are owned by us. See “Certain Relationships and Related Transactions.”
The Texas production operation has a 34,000-sow herd which is designed to produce approximately 600,000 hogs per year. The production facilities are located on approximately 53,000 acres and are supported by one owned feedmill with an annual capacity of 220,000 tons per year.
The North Carolina production operation has a 76,000-sow herd which produces approximately 1.4 million hogs per year. Most of the production operations in North Carolina are conducted on farms that are not owned by us. The hogs, however, are owned by us. Our North Carolina production operations are supported by one owned feedmill with an annual capacity of 380,000 tons per year and through an arrangement with a large feedmill operator for the rest of our feed requirements.
Headquarters
Our corporate office is located in Kansas City, Missouri, and consists of approximately 18,000 square feet of leased space. This lease has an initial term expiring in July 2013.
All of our Missouri production and processing facilities, as well as substantially all of our inventory, breeding stock and receivables, are subject to liens under our credit agreement.
Item 3.
Item 3. Legal Proceedings
Two suits based on the law of nuisance were filed against ContiGroup and us during the second quarter of fiscal year 2003 in the Circuit Court of Jackson County, Kansas City, Missouri (Steven Adwell, et al. vs. PSF, et al., and Michael Adwell, et al. vs. PSF, et al.). Two other suits based on the law of nuisance were filed in March of 2004 by the same attorney (Fred Torrey, et al. vs. PSF, et al., and, Doyle Bounds, et al. vs. PSF, et al.). Two additional suits were filed in May 2004 in Daviess County Circuit Court, Gallatin, Missouri entitled Vernon Hanes et al. v. Premium Standard Farms, Inc. et al., and Steve Hanes et al. v. Premium Standard Farms, Inc., et al. There are multiple plaintiffs in each suit, who claim to live near swine farms owned or under contract with us. The plaintiffs allege that odors from these farms interfered with their right to use and have quiet enjoyment of their respective properties and are seeking unspecified damages. We believe we have good defenses to these actions and intend to vigorously defend these suits.
In May 2004, the same lawyer who filed the Adwell, Bounds and Torrey lawsuits filed a class action lawsuit (Daniel Herrold, et al. and Others Similarly Situated v. ContiGroup Companies, Inc, Premium Standard Farms, Inc., and PSF Group Holdings, Inc.) in the Circuit Court of Jackson County, Kansas City, Missouri. The action seeks to create a class of plaintiffs living within 10 miles of our farms in northern Missouri, including contract grower farms, who are alleged to have suffered interference with their right to use and have quiet enjoyment of their respective properties and are seeking unspecified damages. We have removed this case to the U.S. District Court in Kansas City, Missouri. We believe we have good defenses to this action and intend to vigorously defend this suit.
On November 30, 2004, International Casings Group (“ICG”) filed an action against us in the Federal Court in Kansas City, Missouri (International Casings Group, Inc. vs. Premium Standard Farms, Inc.) seeking a preliminary injunction and specific performance of a contract by which we sold product from our Clinton and Milan plants to ICG. We believed we had properly terminated our contractual relations with ICG, but the Court has granted ICG a preliminary injunction. We believe we have good defenses to this action and intend to vigorously defend this suit.
In addition, we are involved from time to time in routine litigation incidental to our business. Although no assurance can be given as to the outcome or expense associated with any of these routine proceedings, we believe that none of the proceedings currently pending should, individually or in the aggregate, have a material adverse effect on our financial statements.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of security holders during the last quarter of the fiscal year covered by this report.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters
(a) Market Information. There is no established public trading market for our common stock.
(b) Holders. As of March 26, 2005, there were approximately 150 record holders of the Class A Common Stock and one record holder of the Class B Common Stock.
(c) Dividends. On May 6, 2005, the board of directors declared a 145-for-1 stock split in the form of a stock dividend on account of its common stock. Except for this stock dividend, the Company, and its predecessor, PSF Group Holdings, Inc., has not declared or paid any dividends on its common stock since its issuance. Our credit agreement limits the amount of cash dividends the Company may pay to $15 million annually. For more detailed information on our current credit facility, see Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operation - Liquidity and Capital Resources” and Notes to our audited Consolidated Financial Statements.
(d) Securities Authorized for Issuance Under Equity Compensation Plans. The following table sets forth information regarding our equity compensation plans as of March 26, 2005 (giving effect to the 145-for-1 stock split discussed above):
Item 6.
Item 6. Selected Financial Data
The following table sets forth our selected historical consolidated financial information and other data for the periods presented. The consolidated financial information for the fiscal years ended March 31, 2001, and March 30, 2002, was derived from our consolidated financial statements, which were audited by Arthur Andersen LLP, independent public accountants, which has ceased operations. The consolidated financial information presented for the fiscal years ended March 29, 2003, March 27, 2004, and March 26, 2005, was derived from our consolidated financial statements, which have been audited by Deloitte & Touche LLP, independent registered public accounting firm. This data should be read in conjunction with Item 7
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of financial condition, results of operations, liquidity and capital resources should be read in conjunction with our audited consolidated financial statements, including the notes thereto, and the other financial information appearing elsewhere in this report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties, including information with respect to our plans, intentions and strategies for our business. See “Forward-Looking Statements.” Our actual results may differ materially from those estimated or projected in any of these forward-looking statements.
Overview
Historically, the United States pork industry has been highly cyclical in nature due to the natural inverse relationship of prices and production and the tendency of independent hog producers to increase production levels in response to higher hog prices. A typical cycle begins with higher hog prices, which leads to incremental production. This, in turn, leads to overproduction, which drives market prices lower. Eventually, lower market prices will generally cause production to moderate or decline which generally leads to higher market prices. Because of the length of the production cycle, there is relatively little ability of hog producers to adjust their production in the short-term, although some changes in supply may occur through net increases or decreases of pork products held in freezers.
We operate in two business segments- pork processing and hog production. The costs of pork processors are highly dependent on the cost of hogs, and net sales are determined in large part by the prices they receive (cut-out prices) for pork products. Conversely, cost of goods sold from hog production is determined in large part by the costs of feed, primarily corn and soybean meal, and net sales from hog production are highly dependent on the prices the producer receives for hogs. Sales of hogs from our production segment are transferred to our processing segment at daily market prices. High feed prices can negatively impact production results since these increases can raise the costs to the producer. Given the volatility of prices of these commodities, the results of both our segments can vary substantially.
The prices for all of these commodities are volatile and the spreads between these prices vary substantially. High prices for hogs normally hurt the profitability of processing operations unless pork prices increase sufficiently to offset these cost increases. On the other hand, hog producers tend to record better results when prices for hogs are high, especially in relation to grain prices. As a result of changes in the hog and pork prices, results of our pork processing segment in certain periods may be better or worse than results for our production segment.
The following graphs set forth various hog, pork and grain price data for recent periods and illustrate the volatility in market prices.
Pork and Hog Prices (April 2002-March 2005)
(1)
Average monthly price based on the market price of lean hogs, as published by the Chicago Mercantile Exchange.
(2)
Average monthly price based on the 185# cutout pricing method, a standard measure for determining current market prices of pork primal cuts that is published by the USDA.
Corn $/Bushel (April 2002-March 2005)
(1)
Based on the monthly average of daily close prices of the Nearby Corn Futures quoted by the Chicago Board of Trade.
Soybean Meal $/Ton (April 2002-March 2005)
(1)
Based on the monthly average of daily close prices of the Nearby Soybean Futures quoted by the Chicago Board of Trade.
On March 24, 2005, the USDA issued its Hogs and Pigs Inventory Report that indicated a 0.3% decrease in the breeding herd and current hog inventories just fractionally above the 2004 level. Continued strong demand has kept hog prices at relatively high levels for the fiscal year ended March 26, 2005. Ongoing strength in hog prices is contingent on continued or increased demand for pork products or a reduced supply of hogs in the future.
On January 12, 2005, the USDA issued a crop production report, showing a record corn crop of 11.8 billion bushels, up 1.7 billion bushels from the prior year. In the same report, the USDA reported a record 3.2 billion bushel soybean crop, which is 700 million bushels greater than the previous year. Both of these estimates of production have moderated the near-term price increases of corn and soybean meal, the primary ingredients in our feed rations.
Components of Revenue and Expenses
Net Sales
Our net sales are generated from the sale of pork products to retailers, wholesalers, foodservice suppliers, further processors, export buyers, and to a lesser extent the sale of hogs to other pork processors. Sales of hogs from our production segment are transferred to our processing segment at daily market prices. In fiscal year 2005, sales of pork products accounted for approximately 91% of our net sales, with the remaining 9% coming from sales of hogs to outside processors.
Pork product sales are of primal cuts, such as hams, loins, bellies, butts, picnics and ribs, and to a lesser extent cooked pork, further processed pork and pork by-products. Primal cuts are also converted further into boneless items or, in our North Carolina operations, further processed into items such as smoked hams, sliced bacon and microwave cooked bacon. Our processing revenues are primarily driven by the operating rate of our facilities and the value that we extract from the hogs that we process. For our fiscal years ended March 29, 2003, March 27, 2004 and March 26, 2005, we processed 4.1 million, 4.3 million and 4.5 million hogs, respectively. Our Missouri processing plant is currently capable of processing 7,400 hogs per day and our North Carolina processing plant is currently capable of processing up to approximately 10,000 hogs per day, depending on seasonality. The value that
we extract from hogs processed is primarily driven by pork prices, processing yields and to a lesser extent, by product mix, as premium products, boneless and further processed products generate higher prices and operating margins.
Wholesale pork prices fluctuate seasonally and cyclically due to changes in supply and demand for pork. We believe that our vertical integration allows us to obtain higher prices for our products than our more commodity-oriented competitors.
We utilize hog futures to hedge future pork product sales. While this may tend to limit our ability to participate in gains from favorable commodity price fluctuation, it also tends to reduce earnings volatility and secure future margins. Our hedging contracts relating to hogs are marked to market monthly. Consequently, any gains or losses on these instruments are reflected in net sales. See Item 7A
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Our operating results are influenced by fluctuations in the price of our primary feed components, corn and soybean meal, and by fluctuations in hog and wholesale pork sales prices. The cost and supply of feed components and hog and wholesale pork sales prices are determined by constantly changing market forces of supply and demand, which are driven by matters over which we have no control, including weather, current and projected worldwide grain stocks and prices, grain export prices and supports, hog production, consumer demand and governmental agricultural policies. In our hog production segment we use forward contracts, as well as futures and options contracts, to establish adequate supplies of future grain requirements, to help secure margins and to help reduce the risk of market fluctuations. To help secure margins and minimize earnings volatility in our pork processing segment, we utilize hog futures to hedge future pork product sales. While this may tend to limit our ability to participate in gains from favorable commodity price fluctuation, it also tends to reduce earnings volatility and secure future margins.
For the fiscal years ended March 26, 2005, and March 27, 2004 we recognized losses under SFAS 133 of $5.9 million and income of $5.3 million, respectively, in net sales for losses and gains related to hog futures and losses of $3.3 million and gains of $6.1 million, respectively, in costs of goods sold relating to the hedging of feed
components and outside hog purchases at processing facilities. For open futures contracts, we use a sensitivity analysis technique to evaluate the effect that changes in the market value of commodities will have on these commodity derivative instruments. As of March 26, 2005, the potential change in fair value of exchange-traded contracts, assuming a 10% change in the underlying commodity price, would be $13.7 million.
The table below sets forth fair values of futures and options, and gross contract or notional amounts of forward contracts, in place as of March 26, 2005 (all amounts in thousands except contract quantity and wtd.-avg. price/unit):
We also are exposed to changes in interest rates. The credit agreement has variable interest rates. Interest rate changes therefore generally do not affect the market value of such debt but do impact the amount of our interest payments and, therefore, our future earnings and cash flows. Assuming other factors are held constant, a 1% change in interest rates would have no impact on interest expense due because there was no variable rate debt outstanding as of March 26, 2005. Conversely, for fixed rate debt, interest rate changes do not impact future cash flows and earnings, but do impact the fair market value of such debt, assuming other factors are held constant. During the fiscal year ended March 30, 2002, we entered into an interest rate swap agreement to convert the variable base interest rate of our bank term debt to a fixed rate of 3.0125% plus the agent bank’s applicable margin (2.0% at maturity). The swap matured on September 30, 2004. The swap was accounted for as a cash flow hedge under SFAS 133. During the fiscal year ended March 26, 2005, we recognized a $0.1 million gain, net of tax, into Accumulated Other Comprehensive Loss, Net of Tax for the market value of the swap.
The 9 1/4% senior notes had a fair value of approximately $190.8 million as of March 26, 2005 based on inter-dealer prices, as compared to the book value of $175.0 million as of March 26, 2005. On May 9, 2005 as discussed earlier, we purchased $173.0 million of the 9 1/4% senior notes in the Tender Offer for a price of $190.8 million.
Item 8.
Item 8. Financial Statements and Supplementary Data
Our audited consolidated financial statements are filed under this Item, beginning on page of this Report. Our financial statement schedule is filed under Item 15 “Exhibits and Financial Statement Schedules.”
Selected quarterly financial data required under this Item is included in Note 12 to the consolidated financial statements.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
As of the end of the period covered by this report, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures under the supervision and with the participation of the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”). Based on this evaluation, our management, including the CEO and CFO, concluded that our disclosure controls and procedures were effective. There have been no changes in our internal controls over financial reporting that occurred during the fourth quarter of fiscal 2005 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of Registrant
Except for the information required by this item with respect to our executive officers and the information provided below, the information required by this item is incorporated herein by reference to the 2005 Proxy Statement. Pursuant to Item 401(b) of Regulation S-K, the information required by this item with respect to our executive officers is set forth in Item 1 of Part I of this Report under the caption “Executive Officers of the Registrant.”
Code of Ethics
We have adopted a code of professional ethics for all employees of the Company. The company intends to satisfy its disclosure requirements regarding any amendment to, or waiver from, a provision of its code of ethics that applies to its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions and that relates to any element of our code of ethics by posting such information for a period of at least 12 months on our Internet website (http://www.psfarms.com) beginning within four business days following the date of the amendment or waiver.
Item 11.
Item 11. Executive Compensation
The information required by this item is incorporated herein by reference to the 2005 Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this item is incorporated herein by reference to the 2005 Proxy Statement.
Item 13.
Item 13. Certain Relationships and Related Transactions
The information required by this item is incorporated herein by reference to the 2005 Proxy Statement.
Item 14.
Item 14. Principal Accounting Firm Fees and Services
The information required by this item is incorporated herein by reference to the 2005 Proxy Statement.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules.
(a) Financial Statements and Schedules
(1) The following financial statements are filed as a part of this Report on Form 10-K:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of March 26, 2005 and March 27, 2004
Consolidated Statements of Operations and Comprehensive (Loss) Income for the three years ended March 26, 2005, March 27, 2004 and March 29, 2003
Consolidated Statements of Shareholders’ Equity for the three years ended March 26, 2005, March 27, 2004 and March 29, 2003
Consolidated Statements of Cash Flows for the three years ended March 26, 2005, March 27, 2004 and March 29, 2003
Notes to the Consolidated Financial Statements
(2) The following financial statement schedule is filed as a part of this Report on Form 10-K:
Schedule II
Valuation and Qualifying Accounts
(Dollars in thousands)
(b) Exhibits
The following documents are filed as a part of this Report on Form 10-K or incorporated herein by reference as indicated below:
*
Indicates management or compensatory plan or contract
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Each individual whose signature appears below hereby designates and appoints John M. Meyer, Stephen A. Lightstone and Gerard J. Schulte, and each of them, for him or her and in his or her name, place and stead, in any and all capacities, to file on behalf of Premium Standard Farms, Inc., a Delaware corporation (the “Company”), the Company’s Annual Report on Form 10-K for the fiscal year ended March 26, 2005 (the “Annual Report”), with the Securities and Exchange Commission (the “Commission”), to sign any and all subsequent amendments to the Annual Report (the “Amendments”), to file any and all such Amendments with the Commission, with all exhibits to the Annual Report and such Amendments, together with any and all other documents in connection therewith, and to appear before the Commission in connection with any matter relating to such Annual Report and such Amendments, hereby granting to the attorneys-in-fact and agents, and each of them, full power and authority to do and perform any and all acts and things requisite and necessary to be done in and about the premises as fully and to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that such attorneys-in-fact and agents, or any of them, may lawfully do or cause to be done by virtue hereof.
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.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Premium Standard Farms, Inc. and Subsidiaries
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Premium Standard Farms, Inc. and Subsidiaries
Kansas City, Missouri
We have audited the accompanying consolidated balance sheets of Premium Standard Farms, Inc. and Subsidiaries (the “Company”) as of March 26, 2005 and March 27, 2004 and the related consolidated statements of operations and comprehensive income (loss), shareholders’ equity, and cash flows for each of the three fiscal years in the period ended March 26, 2005. Our audits also included the financial statement schedule listed in the Index at Item 15(a)2. These financial statements and the financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits.
We conducted our audits 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. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also 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, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of March 26, 2005 and March 27, 2004, and the results of their operations and their cash flows for each of the three fiscal years in the period ended March 26, 2005, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
Deloitte & Touche LLP
Kansas City, Missouri
May 10, 2005
PREMIUM STANDARD FARMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share information)
The accompanying notes are an integral part of these consolidated financial statements.
PREMIUM STANDARD FARMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(in thousands, except share and per share information)
The accompanying notes are an integral part of these consolidated financial statements.
PREMIUM STANDARD FARMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(in thousands, except share information)
The accompanying notes are an integral part of these consolidated financial statements.
PREMIUM STANDARD FARMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
PREMIUM STANDARD FARMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of significant accounting policies:
Nature of operations
On May 2, 2005, PSF Group Holdings, Inc. merged with and into its wholly owned subsidiary, Premium Standard Farms, Inc., with Premium Standard Farms, Inc. being the surviving corporation.
Premium Standard Farms, Inc. (PSF) is a Delaware company formed in 1996 and is currently 53% owned by ContiGroup Companies, Inc. (CGC). PSF and its subsidiaries, collectively referred to as the Company, are an integrated business engaged principally in the business of hog production and pork processing and selling to domestic and international markets. The Company succeeded the Continental Grain Company North Missouri Pork Operations and PSF Holdings L.L.C. (Holdings) on May 13, 1998, pursuant to a stock purchase transaction.
Fiscal year
The Company’s fiscal year is the 52 or 53-week period, which ends on the last Saturday in March. The accompanying consolidated statements of operations and comprehensive (loss) income, statements of shareholders’ equity and cash flows include activity from the period of March 31, 2002, through March 29, 2003 (52 weeks), the period of March 30, 2003, through March 27, 2004 (52 weeks), and the period of March 28, 2004, through March 26, 2005 (52 weeks).
Principles of consolidation
The consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. Entities in which the Company has ownership of 20 percent to 50 percent and does not control are accounted for using the equity method. All significant intercompany balances and transactions have been eliminated in consolidation.
Use of estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Revenue recognition
Revenues from product sales are recorded when title to the goods and risks of ownership has transferred to the customer, generally upon shipment. Net sales reflect units shipped at selling prices reduced by certain sales allowances.
Cash and cash equivalents
The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. The carrying value of cash equivalents approximates market value.
Inventories
Inventories are valued at the lower of cost, determined on a first-in, first-out (FIFO) basis, or market. Inventories consist of the following (in thousands):
Property, plant, equipment and breeding stock
Depreciation of property, plant, equipment and breeding stock is computed using the straight-line method over the estimated useful lives of the assets as follows:
Assets held under capital leases are classified as property, plant, equipment and breeding stock and amortized over the lease terms. Lease amortization is included in depreciation expense.
Maintenance, repairs and minor renewals are charged to operations while major renewals and improvements are capitalized.
Depreciation and amortization expense relating to the Company’s property, plant, equipment and breeding stock amounted to $61,508,000, $61,306,000 and $60,645,000 for fiscal years ended March 29, 2003, March 27, 2004, and March 26, 2005, respectively.
Capitalized interest relating to the Company’s additions of property, plant, equipment and breeding stock amounted to $365,000, $147,000 and $295,000 for fiscal years ended March 29, 2003, March 27, 2004 and March 26, 2005, respectively. These amounts were capitalized with the related project in property, plant, equipment and breeding stock on the consolidated balance sheets.
Impairment of long-lived assets
Long-lived assets, primarily property, plant and equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying value of the asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying value of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying value or fair value less costs to sell.
Market-risk management instruments
The Company uses price-risk management techniques to enhance sales and reduce the effect of adverse price changes on the Company’s profitability. The Company’s price-risk management and hedging activities currently are utilized in the areas of forward grain sales and hog production margin management. The Company’s currently held commodity contracts do not qualify as hedges for financial reporting purposes. These instruments are marked to market and included in revenue or cost of goods sold in the consolidated statements of operations and comprehensive income (loss).
The Company held an interest rate swap agreement, which matured on September 30, 2004, in order to effectively convert the base interest rate on the bank term note from variable to a fixed rate. The swap had been designated as a cash flow hedge and qualified for hedge accounting with the changes in fair value recorded in other comprehensive income. See “Derivative instruments and hedging activities” below.
Self-insurance programs
The Company is self-insured for certain levels of general and vehicle liability, workers’ compensation and health care coverage. The cost of these self-insurance programs is accrued based upon estimated settlements for known and anticipated claims incurred through the balance sheet date. Any resulting adjustments to previously recorded reserves are reflected in current operating results.
Income taxes
The Company uses the liability method of accounting for income taxes. Under this method, deferred income tax assets and liabilities are determined based on the difference between financial reporting and income tax basis of assets and liabilities using the enacted tax rates. The deferred income tax provision or benefit is based on changes in the asset or liability from period to period.
Fair value of financial instruments
The fair value of long-term debt and capital lease obligations is determined using quoted market prices from interdealers. At March 27, 2004, and March 26, 2005, the fair value of the Company’s debt was $288,833,000 and $192,908,000, respectively, with a carrying value of $287,084,000 and $177,158,000, respectively.
Accounts receivable, accounts payable and cash equivalents are carried at historical cost, which approximates fair value.
Goodwill
The Company follows Statements of Financial Accounting Standards No. 142 (SFAS 142), “Goodwill and Intangible Assets,” which established reporting and accounting standards for goodwill and intangible assets. Under SFAS 142, companies no longer amortize goodwill over the estimated useful life. Goodwill is assessed each year during the second quarter for impairment by applying a fair value based test. No impairment was recorded during the fiscal years ended March 27, 2004 and March 26, 2005.
Deferred financing costs
Costs associated with debt issuance and amendments of debt facilities are capitalized and amortized using the interest method over the related debt facility life. Accumulated amortization on deferred financing costs at March 27, 2004 and March 26, 2005 was $5,594,000 and $2,280,000, respectively.
Asset retirement obligations
The Company accrues for an asset retirement obligation in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. The Company has determined that it has a legal obligation to close lagoons in the future should the Company ever cease operations or plan to close lagoons voluntarily in accordance with a changed operating plan. Based on estimates and assumptions as to the cost and timing of any potential lagoon closure, the Company has determined and recorded the present value of the projected costs which are not considered material to the consolidated financial statements.
Derivative instruments and hedging activities
The Company follows Financial Accounting Standards Board Statement No. 133 (SFAS 133), “Accounting for Derivative Instruments and Hedging Activities” which requires every derivative instrument be recorded in the
balance sheet as either an asset or liability at its fair value, and changes in a derivative’s fair value be recognized in current earnings or other comprehensive income.
The Company believes that its exchange traded commodity contracts serve as economic hedges, however, management has elected not to designate and account for these contracts as hedges. Accordingly, these contracts are marked to market through earnings in the period in which they occur. For the fiscal years ended March 29, 2003, March 27, 2004, and March 26, 2005, gains (losses) marked to market on commodity contracts recognized in revenue for lean hog futures were $1,392,000, $5,344,000, and ($5,909,000), respectively. Gains (losses) recognized in cost of goods sold relating to the hedging of feed components were ($868,000), $6,067,000, and ($3,305,000), respectively. The Company has recorded the fair value of its open exchange traded commodity contracts of $4,918,000 and $2,175,000 in Prepaid Expenses and Other in the consolidated balance sheets at March 27, 2004 and March 26, 2005, respectively.
During the fiscal year ended March 30, 2002, the Company entered into an interest rate swap agreement in order to effectively convert the base interest rate on the bank term note from variable to a fixed rate. The interest rate swap matured on September 30, 2004. The Company had designated the interest rate swap as a cash flow hedge and had recorded ($88,000) in the consolidated balance sheets relating to the fair value of the swap for fiscal year ended March 27, 2004. For the fiscal year ended March 29, 2003, the Company decreased accumulated other comprehensive income by $692,000, net of $440,000 of deferred taxes. For the fiscal year ended March 27, 2004, the Company increased accumulated other comprehensive income by $293,000, net of $186,000 in deferred taxes, and for the fiscal year ended March 26, 2005, the Company increased accumulated other comprehensive income by $54,000, net of $34,000 in deferred taxes.
Stock-based compensation
The Company follows the disclosure provisions of Statement of Financial Accounting Standards No. 148 (SFAS 148), “Accounting for Stock-Based Compensation - Transition and Disclosure, and amendment of FASB Statement No. 123.” SFAS 148 requires prominent disclosures in both annual and interim financial statements regarding the method of accounting for stock-based employee compensation and the effect of the method used on report results.
In the fiscal year ended March 31, 2001, the Company’s board of directors authorized an equity incentive plan whereby options have been granted to senior management for the purchase of 994,287 shares of Class B common stock at an exercise price of $11.49 per share. In January 2004, the Company’s board of directors granted an additional 124,287 options at the same exercise price as the previous option grants. In April 2004, 165,715 options were terminated in accordance with the option agreements due to departures of individuals in the plan. All of the outstanding options are fully exercisable at March 26, 2005, except for 55,515, which are exercisable December 31, 2006. At December 31, 2005, 870,002 shares expire, and at December 31, 2010, 82,857 shares expire. No options have been exercised as of March 26, 2005.
The Company records stock compensation in accordance with Accounting Principles Board Opinion No. 25 (APB 25). For fiscal years ending March 29, 2003, March 27, 2004 and March 26, 2005, the Company recorded compensation expense of $20,000, $15,000 and $0, respectively, in accordance with APB 25. The fair value of stock options granted was calculated using the minimum value method as defined in the Statement of Financial Accounting Standards No. 123 (SFAS 123). Under SFAS 123, the pro forma net income is disclosed as if it reflected the estimated fair value of options as compensation at the date of grant or issue over the vesting period. For the fiscal years ended March 29, 2003, and March 26, 2005, there was no pro forma expense as the effect of option grants are recorded in the year of grant. For the fiscal year ended March 27, 2004, on a pro forma basis, net income would not have been impacted by the options granted.
Earnings per share
Basic earnings per common share (EPS) are computed by dividing net earnings available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that would occur if securities or other contracts to issue common stock were exercised or converted into common stock. In fiscal years ended March 29, 2003, March 27, 2004, and March 26, 2005, there were 20,482 warrants, with the right to acquire 2,969,878 shares, that were considered antidilutive. In fiscal years ended March 29, 2003, and March 27, 2004, there were 1,077,144 and 1,034,565 options, respectively (based on
weighted-average number outstanding during the year), that were considered antidilutive. The following schedule shows computation of net earnings (loss) per share for the last three fiscal years (dollars in thousands, except share and per share information).
New accounting pronouncements
In November 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 151 (SFAS 151), “Inventory Costs - an Amendment of ARB No. 43 Chapter 4.” SFAS 151 requires that items such as idle facility expense, excessive spoilage, double freight, and rehandling be recognized as current-period charges rather than being included in inventory regardless of whether the costs meet the criterion of abnormal as defined in ARB 43. SFAS 151 is applicable for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company will adopt this standard beginning the first quarter of fiscal year 2006 and does not believe the adoption will have a material impact on its financial statements as such costs have historically been expensed as incurred.
In December 2004, FASB issued SFAS No. 153 (SFAS 153), “Exchanges of Nonmonetary Assets - an amendment of APB Opinion No. 29” which addresses the measurement of exchanges of nonmonetary assets and eliminates the exception from fair value accounting for nonmonetary exchanges of similar productive assets and replaces it with an exception for exchanges that do not have commercial substance. SFAS 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of an entity are expected to change significantly as a result of the exchange. This statement is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005 and is not expected to have a significant impact on the Company’s financial statements.
In December 2004, FASB issued SFAS No. 123 (revised 2004) (SFAS 123R), “Share-Based Payment.” SFAS 123R sets accounting requirements for “share-based” compensation to employees, requires companies to recognize in the income statement the grant-date fair value of stock options and other equity-based compensation issued to employees and disallows the use of the intrinsic value method of accounting for stock compensation. SFAS 123R, as recently amended, is applicable for all fiscal years beginning after June 15, 2005. This statement is effective for the Company beginning fiscal year 2007 and is not expected to have a significant impact on its financial statements
with respect to currently issued stock options, but could have a significant impact with respect to options issued in the future.
In December 2004, FASB issued FASB Staff Position 109-1 (FSP 109-1) “Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004.” FSP 109-1 specifies that a qualified production activities deduction should be accounted for as a special deduction in accordance with SFAS 109. FSP 109-1 was effective upon issuance. The Company is currently evaluating the impact this deduction will have on its results of operations or financial position for subsequent years.
In March 2005, FASB issued FASB Interpretation No. 47 (“FIN 47”) “Accounting for Conditional Asset Retirement Obligations.” FIN 47 provides guidance relating to the identification of and financial reporting for legal obligations to perform an asset retirement activity. The Interpretation requires recognition of a liability for the fair value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. The Company does not expect adoption of FIN 47 to have a material effect on its results of operations or financial position.
Reclassifications
Certain reclassifications were made to the prior years financial statements to conform to the 2005 presentation.
Risk factors
There are certain risk factors that can materially impact the Company’s business, financial condition and results of operations. These risks include sensitivity to pork and hog prices, sensitivity to grain commodity prices, environmental factors and legislation, changes in herd productivity and feed efficiency, impact of disease, international market risks, competition, restrictions under corporate farming laws, dependence on favorable labor relations, pork product contamination and product liability claims, distribution channels and consumer preferences.
2. Shareholders’ equity
Common stock
There are two classes of common stock which may be issued. Class A common stock was issued to the holders of the outstanding units of Holdings. Class B common stock was issued to CGC. Class A holders have the sole right to vote in the election or for removal, without cause, of four Class A directors. Class B holders have the sole right to vote in the election or for removal, without cause, of five Class B directors. All distributions, dividends and liquidation preferences are equal between the two classes of stock.
Preferred stock
The Company has authorized 10,000,000 shares at $.01 par value of preferred stock. No shares have been issued or are outstanding. Terms of the preferred stock including voting rights, dividend preference and other limitations or restrictions have yet to be assigned.
Stockholder warrants
The Company has warrants outstanding entitling the holders to purchase 2,969,878 shares of Class A common stock at an exercise price of $15.21 per share. As of March 26, 2005, all warrants were exercisable and none have been exercised. All unexercised warrants expire on September 17, 2006. Warrant holders are entitled to certain registration rights associated with their ownership.
3. Accrued expenses
Accrued expenses are comprised of the following (in thousands):
4. Long-term debt and capital leases
Long-term debt and capital leases consists of the following (in thousands):
Future maturities of long-term debt and capital leases are as follows (in thousands), as adjusted for the Tender Offer discussed below:
The indenture associated with the $175,000,000 9 1/4% Notes limits the Company’s ability, among other things, to incur additional debt, pay dividends, acquire shares of capital stock, make payments on subordinated debt or make certain investments. In addition, the indenture places limitations on the Company’s ability to: make distributions from subsidiaries, issue or sell capital stock of subsidiaries, issue guarantees, sell or exchange assets, enter into transactions with shareholders and affiliates, create liens, and effect mergers.
The 9 1/4% Notes may be redeemed beginning on June 15, 2006, at an initial redemption price of 104.625 percent of their principal amount plus accrued interest, declining to 100 percent on and after June 15, 2009. In addition, before June 15, 2004, up to 35 percent of the 9 1/4% Notes may be redeemed at a price of 109.25 percent of principal plus accrued interest, using proceeds from the sale of capital stock.
Although the 9 1/4% Notes were issued by Premium Standard Farms, Inc., its parent, PSF Group Holdings, Inc. (the registrant), and Premium Standard Farms, Inc.’s wholly owned subsidiaries, fully and unconditionally jointly and severally guarantee Premium Standard Farms, Inc.’s obligation to pay principal and interest on these notes. Supplemental consolidating financial information is not presented as the parent company has no independent assets or operations and less than 3 percent of the total assets exist in non-guarantor subsidiaries.
On May 9, 2005, the Company completed a tender offer and consent solicitation (the “Tender Offer”) with respect to the 9 1/4% Notes pursuant to which the Company purchased $173,000,000 principal amount of the aggregate $175,000,000 of the 9 1/4% Notes previously outstanding and eliminated substantially all of the restrictive covenants relating to the remaining 9 1/4% Notes. The purchase price and related consent payment was $197.2 million based on a price determined generally by discounting the redemption price of the 9 1/4% Notes when they may be first called on June 15, 2006 (i.e., $1,046.25 per $1,000 9 1/4% Note) to present value using the market yield of a comparable U.S. treasury note as of April 19, 2005 plus 0.50%, including accrued interest of $6.4 million. The Tender Offer was financed through borrowings under the existing bank credit agreement and available cash and will result in a charge of approximately $21.8 million to be recognized in the first quarter of fiscal year 2006.
The Company had a bank credit agreement that included a term loan and revolving loan. On April 9, 2004, the Company entered into an amended and restated loan and security agreement (the “credit agreement”) with U.S. Bank National Association as a lender and agent for the other lenders which provided for a $175.0 million revolving credit facility. The amount available under the revolving credit facility is determined by a borrowing base formula derived from the sum of eligible accounts receivable, a fixed asset component and a formula for inventory based on the lower of cost or market valuation. At March 26, 2005, the Company had no borrowings outstanding under the credit agreement, $11.2 million in letters of credit and $163.8 million available for borrowing. All borrowings under the revolving credit facility mature on April 9, 2009.
On April 20, 2005, the Company amended the credit agreement to reduce the applicable margin and to permit:
• the contemplated initial public offering of shares of common stock by certain holders thereof,
• the merger of PSF Group Holdings, Inc., the parent, with and into the Company, and
• the Tender Offer for the 9 1/4% Notes.
As of May 9, 2005, the credit agreement was amended to provide for extension of credit not to exceed $220.0 million from the previous limit of $175.0 million.
Borrowings under the credit agreement are secured by a first priority security interest in, and mortgages on, substantially all of inventory, breeding stock and receivables, as well as the production and processing facilities.
Amounts borrowed under the credit agreement bear interest at fluctuating rates. These rates are based on the agent’s base rate (the greater of the agent’s prime rate or the federal funds rate plus one half of one percent) or LIBOR plus, in each case, an applicable margin, ranging from 0.0% to 3.0% determined by the leverage ratio.
Letter-of-credit fees are based on the applicable margin and are paid quarterly only on outstanding letter-of-credit amounts. In addition, the revolving credit facility provides for an annual administration fee to be paid to the agent, and a quarterly non-use fee payable to the lenders calculated on the average daily unused amount under the revolving credit facility.
The credit agreement contains both negative and affirmative covenants. The credit agreement contains the following affirmative covenants, among others: delivery of financial and other information to the agent, notice to the agent upon the occurrence of certain material events, and maintenance of earnings before interest, taxes, depreciation and amortization (“EBITDA”) and a maximum leverage ratio. Both the EBITDA and maximum leverage ratio covenants are based on a four quarter minimum rolling EBITDA average during the most recent eight
quarters. The Company is required under the credit agreement to maintain EBITDA, as defined in the credit agreement, of at least $55,000,000 as of the end of each quarter in fiscal year 2006 and $60,000,000 as of the end of each fiscal quarter thereafter. The maximum leverage ratio (based on the EBITDA calculation) as of the end of each fiscal year cannot be greater than 6.0-to-1.0 as of the end of each quarter through fiscal year 2006, 5.0-to-1.0 as of the end of each quarter in fiscal year 2007 and 4.0-to-1.0 as of the end of each fiscal quarter thereafter. At March 26, 2005, the Company was in compliance with all covenants under the credit agreement.
In addition, the credit agreement contains the following negative covenants, among others: limitations on encumbrances, disposal of assets, acquisitions, additional indebtedness, capital investment and pre-payment of subordinated debt. The credit agreement limits also the amount of cash dividends the Company may pay to $15.0 million annually.
The credit agreement specifies certain events of default, including, among others: failure to pay principal, interest or other amounts, violation of covenants, inaccuracy of representations and warranties, default with respect to other material indebtedness, certain bankruptcy and insolvency events and certain undischarged judgments.
5. Income taxes
A reconciliation of statutory federal income tax and income tax expense is shown below (in thousands):
Components of the net deferred tax balances are as follows (in thousands):
At March 26, 2005, the Company has no federal operating loss carryforwards.
The amount of income taxes the Company pays is subject to ongoing audits by federal and state tax authorities, which may result in proposed assessments. The Company’s estimate for the potential outcome for any uncertain tax issue is highly judgmental. The Company believes it has adequately provided for any reasonable foreseeable outcome related to these matters. However, the Company’s future results may include favorable or unfavorable adjustments to estimated tax liabilities in the period the assessments are made or resolved or when statutes of limitation on potential assessments expire. Additionally, the jurisdictions in which the Company’s earnings or deductions are realized may differ from current estimates.
6. Investments in partnerships
The Company has a 50 percent ownership interest in the L&H Farms partnership. L&H Farms partnership is in the business of breeding and raising hogs in rural North Carolina. The Company accounts for the earnings and losses of the partnership using the equity method of accounting. As of March 27, 2004, and March 26, 2005, the investment in the L&H Farms partnership was $1,184,000 and $1,461,000, respectively, and is included in other long-term assets in the consolidated balance sheets. The Company’s share of the partnership’s (losses) earnings was ($240,000) for fiscal year ended March 29, 2003, $291,000 for fiscal year ended March 27, 2004, and $627,000 for fiscal year ended March 26, 2005. These amounts are included in other income, net, in the consolidated statements of operations and comprehensive income.
In addition, the Company has a 60 percent ownership in L&S Farms, a general partnership, in the business of breeding and raising hogs in rural North Carolina. The Company consolidates this operation for financial reporting purposes. Minority interest of $113,000 for fiscal year ended March 29, 2003, $166,000 for fiscal year ended March 27, 2004, and $289,000 for fiscal year ended March 26, 2005, was charged to other income, net, in the consolidated statements of operations and comprehensive income. As of March 27, 2004, and March 26, 2005, the minority interest obligation was $515,000 and $671,000, respectively, recorded in other long-term liabilities in the consolidated balance sheets.
On March 28, 2003, the Company funded a 50 percent ownership interest in Oldham’s LLC (Oldham’s) for $2,184,000, which subsequently was finalized on April 4, 2003. Oldham’s is in the business of processing sows and producing raw materials for sausage products. The Company accounts for the earnings and losses of Oldham’s using the equity method of accounting. As of March 27, 2004, and March 26, 2005, the investment in Oldham’s was $2,308,000 and $1,850,000, respectively, and is included in other long-term assets in the consolidated balance sheets. The Company’s share of Oldham’s earnings was $327,500 and $327,600 for fiscal years ended March 27, 2004 and March 26, 2005, respectively. These amounts are included in other income, net, in the consolidated statements of operations and comprehensive income.
The Company has a 50 percent ownership interest in Crystal Peak Technologies, LLC (CPT) formed by the Company and Crystal Peak Farms, Inc to develop and market technologies for the processing of animal waste. Both the Company and Crystal Peak Farms contributed patents and other technology to this LLC. The Company accounts for the earnings and losses of CPT using the equity method of accounting. As of March 27, 2004, and March 26, 2005, the investment in CPT was $0 and $46,500, respectively, and is included in other long-term assets in the consolidated balance sheets. The Company’s share of the partnership’s earnings was $46,500 for fiscal year ended March 26, 2005. This amount is included in other income, net, in the consolidated statements of operations and comprehensive income.
7. Related parties
The Company has contracted with ContiGroup to provide certain services pursuant to an amended and restated services agreement and a contract grower finish agreement. Under these agreements, ContiGroup provides purchasing assistance, legal services, employee benefits, payroll and grow finishing services to the Company. For fiscal years ended March 29, 2003, March 27, 2004, and March 26, 2005, the total amount of these expenses and other related-party expenses with CGC were $5,331,000, $5,389,000, and $4,868,000, respectively. At March 27, 2004, and March 26, 2005, the Company recorded amounts due to related party for these items of $56,000 and $29,000, respectively, included in the consolidated balance sheets.
During fiscal year ended March 25, 2000, an agreement was entered into with CGC to pay $1,000,000 annually for five years, in consulting fees to CGC for work done in the settlement agreement with the attorney general of Missouri (Note 10). The Company paid the final installment in fiscal 2004.
The Company leases farmland and hog production buildings from the former owners of Lundy, one of whom was a board member of PSF, Inc. until such member resigned in September 2003, under a capital lease agreement that existed prior to the acquisition. The capital lease obligation as of March 27, 2004, and March 26, 2005 was $1,729,000 and $1,384,000, respectively, and is included in long-term debt and capital leases in the consolidated balance sheets.
8. Commitments
The Company enters into forward grain purchase contracts with market risk in the ordinary course of business. In the opinion of management, settlement of such commitments, which were open at March 27, 2004 and March 26, 2005, will have no adverse impact on the financial position or results of operations of the Company.
The Company utilizes forward contracts, as well as exchange traded futures and options contracts, to establish adequate supplies of future grain purchasing requirements and minimize the risk of market fluctuations. These contracts are dependent on fluctuations in the grain, lean hog, and natural gas commodity markets. Market risk resulting from a position in a particular contract may be offset by other on or off-balance-sheet transactions. The Company continually monitors its overall market position. Fair values of futures and options, and gross contract or notional amounts of forward contracts, in place as of March 26, 2005 are as follows (in thousands except wtd.-avg. price/unit):
Substantially all these contracts expire within one year.
The Company leases rolling stock and certain equipment under noncancelable operating leases. Rental expense under operating leases was approximately $6,861,000, $7,335,000 and, $6,453,000, in the fiscal years ended
March 29, 2003, March 27, 2004, and March 26, 2005, respectively. Future minimum rental commitments at March 26, 2005, are as follows (in thousands):
At the Company’s Clinton, North Carolina pork processing facility, the Company has contracts with producers to provide this facility with market hogs for the amount the Company’s hog production operations cannot provide in order to meet this facility’s processing needs. These contracts vary in length but are all based on a market price and grade and yield formula. Over the next 5 years the Company is contracted to purchase approximately 1,260,000 market hogs under these contracts.
The Company also has contracts with two large processors to sell the Company’s hogs produced from its Texas hog production operations in which the Company is to deliver approximately 500,000 hogs annually.
9. Employee benefit plans
The Company has a 401(k) plan covering substantially all employees meeting certain minimum service requirements. The plan allows all qualifying employees to contribute up to 60 percent of employee compensation limited to the tax deferred contribution allowable by the Internal Revenue Code. The Company matches 100 percent of the employee’s contribution up to 3 percent of employee compensation and 50 percent of the employee’s next 2 percent of employee compensation, for a maximum company match of 4 percent of employee compensation. Effective January 1, 2000, the Company amended its 401(k) plan from a three-year cliff-vesting period to a 100 percent immediate vesting. Employer contribution expense related to the plan was approximately $1,870,000, $1,878,000 and $2,001,000 for the fiscal years ended March 29, 2003, March 27, 2004, and March 26, 2005, respectively.
The Company has a long-term incentive plan with performance thresholds tied to return on net assets in place for key executives selected by the compensation committee. At March 27, 2004, the Company had no liability recorded for the long-term incentive plan. At March 26, 2005, the Company had a liability recorded of $2,020,000 in other long-term liabilities toward the long-term incentive plan. The Company expensed $2,020,000, in the fiscal year ended March 26, 2005. In fiscal year ended March 29, 2003, the Company credited the amount of $1,507,000 accrued for the year ended March 30, 2002, due to the probability of the Company not meeting its minimum requirement for payout because of its fiscal year 2003 performance.
The Company has a deferred compensation plan which is restricted to a select group of management employees. Under the plan, participating employees are allowed to defer payment of compensation awarded under the long-term incentive plan until a date elected by the employee in accordance with the plan. The plan generally allows payment in the form of a single lump sum or ten substantially equal annual installments following the date of payment. At March 27, 2004 and March 26, 2005, the plan had $1,501,000 and $759,000, respectively, of investments held by an independent trustee. The investments are classified as trading and are reflected in other long-term assets with a corresponding liability included in other long-term liabilities in the consolidated balance sheets.
The Company has a nonqualified, unfunded special executive retirement plan for certain key executives. Benefits generally accrue based on pay and years of credited service. Specific data related to the plan is as follows ($ in thousands):
The following benefit payments, which reflect expected future service as appropriate, are expected to be paid:
10. Litigation
Environmental matters
In order to settle enforcement actions and citizens suits, and to ensure that the Company, the regulatory agencies, and independent experts all agree that the Company is implementing appropriate advanced technology, the Company has entered into consent decrees with the State of Missouri, and with the federal government and a citizens group. The decrees have generally required that the Company pay penalties to settle past alleged regulatory violations, and the decrees and the voluntary agreement require that the Company research, develop, and implement new technologies for environmental controls at the Missouri operations.
In 1999, the Company entered into a consent decree to settle a suit filed by the State of Missouri. The settlement required the Company to invest $25 million in capital expenditures on what was characterized in the decree as “Next Generation Technology” for researching, installing and operating improved technology to control wastewater, air and odor emissions from the Missouri farms. The proposed technologies were to be approved by a panel of independent university experts and were to be completed by 2004. In 2002, the State of Missouri filed a suit against the Company for alleged new violation of air and water regulations. The Company settled that matter by entering into a second consent decree in 2004.The 2004 consent decree required the Company to pay a civil penalty of $333,000. It also modified the 1999 consent decree by (i) removing the $25 million spending requirement, instead specifying that Next Generation Technology be installed on the 11 largest farms and (ii) extending the schedule to implement Next Generation Technology from 2004 until 2010, in each case to ensure that the technology the Company installs will be effective in reducing impacts to the environment. As a result of the 2004 consent decree, the Company now estimates that it will invest approximately $33 million in Next Generation Technology by the 2010 deadline, of which $8.4 million has been spent as of March 26, 2005. Included in this commitment is a fertilizer plant in northern Missouri that will convert solid waste into commercial grade fertilizer. The fertilizer plant construction should be complete within the first quarter of fiscal year 2006, and the Company has spent $7.8 million to date of an estimated $9.6 million to complete the plant.
Two nuisance suits were filed against ContiGroup and the Company during the second quarter of fiscal year 2003 in the Circuit Court of Jackson County, Kansas City, Missouri (Steven Adwell, et al. vs. PSF, et al., and, Michael Adwell, et al. vs. PSF, et al.). Two other nuisance lawsuits were filed in March of 2004 by the same attorney (Fred Torrey, et al. vs. PSF, et al., and, Doyle Bounds, et al. vs. PSF, et al.). Two additional nuisance suits were filed in May 2004 in Daviess County Circuit Court, Gallatin, Missouri entitled Vernon Hanes et al. v. Premium Standard Farms, Inc. et al. and Steve Hanes et al. v. Premium Standard Farms, Inc., et al. There are multiple plaintiffs in each suit, who claim to live near swine farms owned or under contract with the Company. Plaintiffs allege that odors from these farms interfered with the plaintiffs’ right to use and have quiet enjoyment of their respective properties. The Company believes it has good defenses to these actions and intends to vigorously defend these suits.
On May 18, 2004 the same lawyer who filed the Adwell, Bounds and Torrey lawsuits filed a class action lawsuit (Daniel Herrold, et al. and Others Similarly Situated v. ContiGroup Companies, Inc, Premium Standard Farms, Inc., and PSF Group Holdings, Inc.) in the Circuit Court of Jackson County, Kansas City, Missouri. The action seeks to create a class of plaintiffs living within 10 miles of the Company’s farms in northern Missouri, including contract grower farms, who are alleged to have suffered interference with their right to use and have quiet enjoyment of their respective properties. The Company has removed this case to the U.S. District Court in Kansas City, Missouri. The Company believes it has good defenses to these actions and intends to vigorously defend this suit.
In 1998, the Company engaged in a series of transactions with ContiGroup pursuant to which it purchased from ContiGroup its North Missouri Farms hog production operations and ContiGroup purchased a 51.0% ownership interest in the Company (the 1998 ContiGroup transaction). To the extent that ContiGroup incurs any liability in the above described nuisance litigation, the Company assumed that liability pursuant to the terms of the 1998 ContiGroup transaction.
Other legal matters
On November 30, 2004, International Casings Group (“ICG”) filed an action against the Company in the Federal Court in Kansas City, Missouri (International Casings Group, Inc. vs. Premium Standard Farms, Inc.) seeking a preliminary injunction and specific performance of a contract by which the Company sold product from its Clinton
and Milan plants to ICG. The Company believed it had terminated its contractual relations with ICG, but the Court has granted ICG a preliminary injunction. The Company believes it has good defenses to this action and intends to vigorously defend this suit.
In addition, the Company is involved from time to time in routine litigation incidental to its business. Although no assurance can be given as to the outcome or expense associated with any of these routine proceedings, the Company believes that none of the currently pending proceedings should, individually or in the aggregate, have a material adverse effect on its financial statements.
11. Segment information
The Company operates a vertically integrated business with two business segments, Pork Processing and Hog Production. The Pork Processing segment sells fresh and value-added pork products to food retailers, distributors, wholesalers, further processors, pharmaceutical and animal feed manufacturers in both domestic and international markets. The Hog Production segment supplies a majority of the live hogs used in the Pork Processing segment and sells the excess production to other hog processing operations. Intersegment live hog sales are based on market prices. The following tables present specific financial information about each segment as reviewed by the Company’s management. The Corporate and Other classification in the following tables represent unallocated corporate expenses and assets, deferred and current taxes, interest expense and intersegment elimination (in thousands):
Geographic information
No individual foreign country or customer accounts for 10 percent or more of sales to external customers. The following table provides a geographic summary of the Company’s net sales based on the location of product delivery (in thousands):
All of the Company’s assets are located within the United States.
12. Quarterly results of operations (unaudited in thousands, except share and per share information):
The following represents the unaudited quarterly results of operations for fiscal years 2004 and 2005. All amounts are expressed in thousands, except share and per share information.
13. Subsequent events
On May 2, 2005, the former parent, PSF Group Holdings, merged with and into its wholly owned subsidiary Premium Standard Farms, Inc., with Premium Standard Farms, Inc. being the surviving corporation. In connection with the merger the Company adopted PSF Group Holdings’ Certificate of Incorporation (the “Certificate”). Immediately prior to the merger, the Certificate was amended to increase PSF Group Holdings’ authorized capital to
50,000,000 shares of Class A Common Stock, 50,000,000 shares of Class B Common Stock and 10,000,000 shares of Preferred Stock.
On May 6, 2005, the board of directors of the Company authorized a 145-for-1 stock split effected in the form of a stock dividend to shareholders of record at the close of business on May 6, 2005, the record date. The Company issued approximately 30,715,000 shares of Class A and Class B common stock as a result of the stock split. All references to the number of shares and per share amounts of common stock have been restated to reflect the stock split. The Company reclassified an amount equal to the par value of the number of shares issued to common stock from additional paid-in capital.
As discussed in Note 4, on April 20, 2005 and May 9, 2005, the Company amended its credit agreement in connection with the Tender Offer and transactions described above and increased the availability under the credit agreement to $220 million. The Company also on May 9, 2005 entered into a ten-year $125 million swap agreement which will convert the interest on these loans to an effective fixed interest rate of approximately 5.9%.
On May 10, 2005, Premium Standard Farms of North Carolina, Inc., a wholly owned subsidiary, merged with and into Premium Standard Farms, Inc., with Premium Standard Farms, Inc. being the surviving corporation.
The Company filed a S-1 registration statement with the Securities and Exchange Commission (“SEC”) on March 11, 2005. The S-1 registration statement relates to a contemplated initial public offering in which shares will be sold by certain shareholders of the Company. It is contemplated that in connection with the initial public offering, the Company’s charter will be amended to cause all shares of common stock to be a single class with directors being elected by the vote of holders of common stock generally. The Company anticipates the S-1 registration statement will become effective subsequent to year end.