Late in fiscal year 2006, the Pro-Fac Board announced that it expected to suspend the declaration and payment of dividends on Pro-Fac’s Class A cumulative preferred stock beginning with the quarter ended June 2007.
This decision was based, in part, on Pro-Fac’s minority ownership status in Holdings LLC, and Holdings LLC’s advice that it would not speculate as to whether distributions would be made under the Limited Liability Company Agreement.
Accordingly, Pro-Fac has been operating under a business plan that assumes no distributions will be made under the Limited Liability Agreement.
In July 2007, Pro-Fac received a distribution of approximately $120.1 million from Holdings LLC. Pro-Fac invested the $120.1 million distribution in high quality, low risk investments pending use of the funds.
Pro-Fac expects to earn investment income of approximately $2.2 million in fiscal year 2008 as a result of its investment. During the first quarter of fiscal year 2008, Pro-Fac used this distribution to: redeem all of its retained earnings, pay
dividends on its non-cumulative preferred stock and its Class A cumulative preferred stock and repay principal and interest owed under its Credit Agreement with Birds Eye Foods. In the second quarter of fiscal 2008, Pro-Fac redeemed all of its
non-cumulative preferred stock and approximately 3.2 million shares of its Class A cumulative preferred stock and paid dividends on its preferred stock to affect the foregoing redemptions. Pro-Fac has also set-aside approximately $24.0 million
in cash as a reserve for taxes that it may incur as a result of the distribution. Although the Cooperative currently expects that the majority of the distribution will be a non-taxable return of capital, a definite determination of the taxability of
the distribution may not be possible until at least June 2008 because transactions affecting Holdings LLC will determine how the distribution will ultimately be taxed.
Although the $120.1 million distribution has provided the Cooperative with additional available cash, Pro-Fac’s current business plan provides for the suspension of dividends on the Cooperative’s preferred
stock. Depending upon the final determination as to the taxability of the distribution, the Pro-Fac Board of Directors will evaluate its current business plan. The Board currently believes that Pro-Fac has sufficient sources of cash to fund its
operations at least through the end of fiscal 2010, but continues to explore other sources of cash and opportunities for the marketing and sale of its member-crops.
RESULTS OF OPERATIONS - FIRST QUARTER 2008 COMPARED TO FIRST QUARTER 2007
Net sales, cost of sales and gross profit
:
Net sales and cost of sales increased
in the quarter ended September 29, 2007, as the Cooperative entered into more sales transactions as a principal for its members than in the quarter ended September 23, 2006.
Gain from transaction with Birds Eye Foods and related agreements
:
In accordance with the Termination Agreement, Pro-Fac
was entitled to the payment of a termination fee of $10.0 million per year for five years payable in quarterly installments as follows: $4.0 million on each July 1, and $2.0 million each October 1, January 1, and April 1 with the final
payment received in July 2007.
Payments under the Termination Agreement
are considered additional consideration related to the Transaction. Accordingly,
the portion of the payments received under the Termination Agreement related
to Pro-Fac’s
continuing ownership percentage are recorded as a reduction to Pro-Fac’s investment in Holdings LLC. The remaining portion of payments received is recognized as additional gain on the Transaction with Birds Eye Foods in the period it is
received. Accordingly, in the first quarter of fiscal 2008 and the first quarter of fiscal 2007, Pro-Fac recognized approximately $1.2 million and $2.4 million, respectively, as additional gain (approximately 60 percent) from the receipt of
termination payments.
Margin on delivered product
:
The Cooperative negotiates certain sales transactions on behalf of its members, which result in
margin being earned by the Cooperative. The Cooperative earned $24 thousand in margin during the first quarter of fiscal 2008 and $58 thousand in margin during the first quarter of fiscal 2007.
Selling, administrative, and general expense
:
Selling, administrative, and general expenses totaled $0.4 million and
$0.3 million for the quarters ended September 29, 2007 and September 23, 2006, respectively.
Investment income
:
Investment income increased from $57 thousand for the quarter ended September 23, 2006, to $1.4
million for the quarter ended September 29, 2007, due to higher on-hand cash, cash equivalents and investments resulting from receipt of a $120.1 million distribution from Holdings LLC in July 2007. Investment income for the quarter ended
September 29, 2007, included unrealized gains of approximately $57 thousand.
Distribution from Holdings LLC
:
During the first quarter of 2008, Pro-Fac received a distribution of approximately
$120.1 million from Holdings LLC under the Limited Liability Agreement. In accordance with the cost method of accounting for the investment in Holdings LLC, Pro-Fac reduced its investment in Holdings LLC by $3.5 million to zero with the
remaining $116.6 million of the distribution recorded as income.
Income taxes
:
The Cooperative qualifies for tax exempt status as a farmers’ cooperative under Section 521 of the Internal
Revenue Code. Exempt cooperatives are permitted to reduce or eliminate taxable income through the use of special deductions such as dividends paid on its common and preferred stock and distributions of patronage income.
The Cooperative has historically used these special deductions and distributions of patronage income to reduce the Cooperative's taxable income. The Pro-Fac Board of Directors determined that there would be no payment or
allocation of patronage income for the fiscal year ended June 30, 2007. As a result, the Cooperative recorded a tax provision of $0.5 million for the three month period ended September 23, 2006. For fiscal year 2008, after deductions for
dividends paid, the Cooperative expects to have a loss for tax purposes which will be carried back to recover taxes paid in prior periods. A tax benefit of $0.1 million has been recorded for the three month period ended September 29, 2007.
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CRITICAL ACCOUNTING POLICIES
“NOTE 1. Description of Business and Summary of Accounting Policies” under “Notes to Condensed Financial Statements” included in Part I, Item 1 of this Report discusses the significant accounting
policies of Pro-Fac. Pro-Fac’s discussion and analysis of its financial condition and results of operations are based upon its condensed financial statements, which have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these financial statements requires Pro-Fac’s management to make estimates, judgments and assumptions that affect the reported amount of assets, liabilities, revenues and expenses. On an ongoing basis,
Pro-Fac evaluates its estimates.
Certain accounting policies deemed critical to Pro-Fac’s results of operations or financial position are discussed below.
The Cooperative accounts for its investment in Holdings LLC under the cost method of accounting. Under the cost method, the Cooperative’s share of earnings or losses is not included in the Cooperative’s balance
sheet or statement of operations and the Cooperative does not record its proportionate share of the other comprehensive income and loss items of Holdings LLC. Also, as a result of the $120.1 million distribution received from Holdings LLC during
the first quarter of fiscal year 2008, Pro-Fac’s investment was reduced to zero. Pro-Fac continues to own an approximate 40% interest in Holdings LLC through its ownership of Class B common units.
At September 29, 2007, the Cooperative estimates that $10.1 million of the distribution received will be a taxable dividend, subject to the qualified dividends received deduction, with the remaining amount representing
a return of capital. The allocation of the distribution between taxable dividend and return of capital will not be finally determinable until at least June 2008 because the final allocation is dependent on the earnings and profits of Holdings LLC
and its direct and indirect wholly-owned subsidiaries, including Birds Eye Foods, for the year ending June 2008. A deferred income tax asset has not been recognized on the estimated excess of the tax basis over the recorded financial statement value
of the investment in Holdings LLC at September 30, 2007, of approximately $76.4 million. This asset would only be realized upon the sale of the investment based on the proceeds received or receipt of a distribution representing a return of
capital, which was not considered probable at September 29, 2007.
Pro-Fac markets and sells its members’ crops to food processors. Under the provisions of Emerging Issues Task Force Issue No. 99-19, “Reporting Revenue Gross Versus Net as an Agent”, the Cooperative records
activity among its customers, itself and its members on a net basis. For transactions in which Pro-Fac acts a principal rather than an agent, sales and cost of sales are reported.
LIQUIDITY AND CAPITAL RESOURCES
Historically, Pro-Fac has had four sources or potential sources of available cash to fund its operating expenses and the payment of its quarterly dividends: (i) cash from its sale of raw products to its customers, (ii)
payments received under the Termination Agreement with Birds Eye Foods, (iii) cash distributions related to its investment in Holdings LLC, and (iv) borrowings.
Historically, net cash available to Pro-Fac, after payment of CMV to Pro-Fac’s member-growers, has been used to pay Pro-Fac’s operating expenses as well as its quarterly dividends on its preferred stock and to
fund repurchases of its common stock.
The final installment payment of $2.0 million to Pro-Fac under the Termination Agreement was received in July 2007. Another principal source of cash to Pro-Fac is the CMV payments made to it by Birds Eye Foods, Allens,
Inc. and other customers for crops sold pursuant to the Amended and Restated Marketing and Facilitation Agreement, the Allens supply agreement and other supply agreements. Although CMV payments are considered a potential source of cash to Pro-Fac,
with the exception of the Board’s decision to deduct 1 percent of CMV otherwise payable to its member-growers for crops delivered in fiscal years 2003 and 2004, Pro-Fac has typically paid 100 percent of CMV to its member-growers for crops
delivered and did so in fiscal years 2006 and 2005. Since CMV payments are approximately equal to the cash Pro-Fac receives from its customers for its raw products, CMV payments are not a significant source of available cash from which Pro-Fac can
pay operating expenses and quarterly dividends.
While Pro-Fac principally acts as agent for its member-growers in the marketing and sale of crops, Pro-Fac does occasionally engage in crop sales transactions as a principal, resulting in gross profit or margin being earned
by the Cooperative. The amounts earned have been increasing through fiscal year 2007. Future increases are not expected to be significant.
The Limited Liability Company Agreement provides that, subject to restrictions contained in any financing arrangements of Holdings LLC or its subsidiaries (including Birds Eye Foods), Holdings LLC will use commercially
reasonable efforts to cause Birds Eye Foods to distribute annually to Holdings LLC up to $24.8 million of cash flow from operations of Birds Eye Foods, which Holdings LLC will then distribute to the holders of its common units, including
Pro-Fac.
Holdings LLC has advised Pro-Fac that it will not speculate as to whether distributions will be made under the Limited Liability Company Agreement and, as a minority owner of Holdings LLC, Pro-Fac has no control over the
determination of whether such distributions will be made. Accordingly, Pro-Fac’s Board of Directors developed, and Pro-Fac has been operating under, a business plan that assumes no distributions will be made under the Limited Liability
Agreement.
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In July 2007, Pro-Fac received a distribution of approximately $120.1 million from Holdings LLC under the Limited Liability Company Agreement. During the first quarter of fiscal year 2008, Pro-Fac used this
distribution: to redeem all retained earnings allocated to its members at a cost of approximately $6.8 million; to pay dividends on its non-cumulative preferred stock and its Class A cumulative preferred stock at a cost of approximately $5.4
million; and to repay principal and interest owed under its Credit Agreement with Birds Eye Foods in an amount equal to approximately $1.1 million. During the second quarter of fiscal year 2008, Pro-Fac used this distribution to: redeem all of
Pro-Fac’s non-cumulative preferred stock at a price of $25.00 per share for an aggregate redemption cost of approximately $0.7 million; to redeem approximately 3.2 million shares of its Class A cumulative preferred stock at a price of
$25.00 per share for an aggregate redemption cost of not more than $80 million related to the Class A cumulative preferred stock; to pay dividends on its preferred stock to the date of redemption as required to affect the redemption at a
cost of approximately $2.1 million; and to establish the reserve discussed below. At September 29, 2007, the preferred shares subject to the subsequent redemption totaled approximately $79.6 million and were classified as current
liabilities.
Pro-Fac has set-aside cash totaling approximately $24.0 million as a reserve for taxes that it may incur as a result of the $120.1 million distribution. A definite determination of the taxability of the
distribution may not be possible until at least June 2008. Transactions affecting Holdings LLC, which Pro-Fac has no control or influence over, will determine to what extent the amount received will be taxable to the Cooperative.
The Board of Directors intends to re-evaluate its business plan, which currently includes the suspension of dividends on the Cooperative’s preferred stock, as additional information regarding the taxability of the
$120.1 million distribution becomes available. Notwithstanding receipt of the $120.1 million distribution, there can be no assurances that Pro-Fac will pay dividends after October 31, 2007. The declaration of any future dividends is subject
to Board action in advance of any such declaration based upon all of the facts and circumstances at such time.
Pro-Fac invested the proceeds of the $120.1 million distribution in high quality, low risk investments pending use of the funds. Pro-Fac expects to earn investment income of approximately $2.2 million in fiscal year
2008 as a result of the investment of these funds.
A discussion of “Statement of Cash Flows” for the three months ended September 29, 2007, follows:
Net cash provided by operating activities
was $107.5 million for the first three months of
fiscal 2008 compared to cash used in operating activities of approximately $2.7 million in the first three months of fiscal 2007. The change primarily represents income from the receipt of a $120.1 million distribution from Holdings LLC net
of the investment of a portion of the funds (approximately $9.5 million) from the distribution into trading securities in the first quarter of fiscal year 2008, and changes in the timing of cash receipts from customers other than Birds Eye Foods
and related cash payments to member-growers between the first quarter of fiscal year 2008 and the first quarter of fiscal year 2007.
Cash provided by investing activities for the first three months of fiscal 2008 was $5.5 million related to the receipt of $2.0 million from Birds Eye Foods under the Termination Agreement and the portion of the
distribution from Holdings LLC classified as a return of capital, approximately $3.5 million. In the first three months of fiscal 2007, $4.0 million was received from Birds Eye Foods under the Termination Agreement.
Net cash used in financing activities during the first three months of fiscal 2008 included $1.0 million to repay amounts previously borrowed, $6.8 million to redeem all retained earnings allocated to members and
$5.4 million in dividends paid. During the first three months of fiscal 2007, the Cooperative borrowed $1.0 million and paid dividends of $2.2 million.
In January 2003 the Pro-Fac Board of Directors suspended the payment of dividends on the Cooperative’s common stock for an indefinite period of time and in January 2006 the Board placed a moratorium on Pro-Fac’s
repurchase of shares of its common stock from its member-growers, excluding approximately 9,000 shares which were repurchased under prior policies. Any repurchases by Pro-Fac of its common stock are subject to pre-approval by the Board.
The Board currently believes that Pro-Fac has sufficient sources of cash to fund its operations at least through the end of fiscal 2010, which the Board believes will provide time to monitor Pro-Fac’s investment in
Holdings LLC and explore other sources of cash.