SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 1-12619
RALCORP HOLDINGS, INC.MISSOURI
(Exact name of Registrant as specified in its Articles)
(State of incorporation) 43-1766315
(I.R.S. Employer Identification No.)
800 MARKET STREET
ST. LOUIS, MISSOURI 63101
(Address, including zip code, and telephone number, including area code, of Registrants principal executive offices)
Securities registered pursuant to Section 12(b) of the Act:Title of each class
Common Stock, $.01 par value
Common Stock Purchase Rights Name of each exchange on which registered
New York Stock Exchange, Inc.
New York Stock Exchange, Inc.
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. YES X NO
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]
Indicate by check mark whether Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). YES X NO
On March 31, 2003, the aggregate market value of the Common Stock held by non-affiliates of Registrant was $727,992,754. Excluded from this figure is the Common Stock held by Registrants Directors, who are the only persons known to Registrant who may be considered to be its affiliates as defined under Rule 12b-2.
Number of shares of Common Stock, $.01 par value, outstanding as of November 28, 2003: 28,950,488.
DOCUMENTS INCORPORATED BY REFERENCE
Registrants Notice of Annual Meeting and Proxy Statement relating to its 2004 Annual Meeting (to be filed), to the extent indicated in Part III.
TABLE OF CONTENTSCautionary Statement On Forward-Looking Statements 2 PART I Item 1. Business 3 Item 2. Properties 7 Item 3. Legal Proceedings 8 Item 4. Submission of Matters to a Vote of Security Holders 8 Item 4A. Executive Officers of the Registrant 9 PART II Item 5. Market for Registrants Common Equity and Related Stockholder Matters 9 Item 6. Selected Financial Data 10 Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations 11 Item 7A. Quantitative And Qualitative Disclosures About Market Risk 18 Item 8. Financial Statements and Supplementary Data 19 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 42 PART III Item 10. Directors and Executive Officers of the Registrant 43 Item 11. Executive Compensation 43 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 43 Item 13. Certain Relationships and Related Transactions 43 Item 14. Controls and Procedures 43 Item 15. Principal Accountant Fees and Services 43 PART IV Item 16. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 44 Signatures 45 Exhibit Index 46
CAUTIONARY STATEMENT ON FORWARD-LOOKING STATEMENTS
Forward-looking statements, within the meaning of Section 21E of the Securities Exchange Act of 1934, are made throughout this Report. These forward-looking statements are sometimes identified by their use of terms and phrases such as believes, should, expects, anticipates, intends, plans, will, or similar expressions elsewhere in this Report. The Companys results of operations and financial condition may differ materially from those in the forward-looking statements. Such statements are based on managements current views and assumptions, and involve risks and uncertainties that could affect expected results. For example, any of the following factors cumulatively or individually may impact expected results:
(i) If the Company is unable to maintain a meaningful price gap between its private label products and the branded products of its competitors, successfully introduce new products or successfully manage costs across all parts of the Company, the Companys private label businesses could incur operating losses;
(ii) Consolidation among members of the grocery trade may lead to increased wholesale price pressure from larger grocery trade customers and could result in significant profit pressure, or in some cases, the loss of key accounts if the surviving entities are not customers of the Company;
(iii) Significant increases in the cost of certain raw materials (e.g., peanuts, wheat, soybean oil, various tree nuts, corn syrup) or energy used to manufacture the Companys products, to the extent not reflected in the price of the Companys products, could adversely impact the Companys results;
(iv) In light of its significant ownership in Vail Resorts, Inc., the Companys non-cash earnings can be adversely affected by unfavorable results from Vail Resorts;
(v) The Company is currently generating profit from certain co-manufacturing contract arrangements with other manufacturers within its competitive categories. The termination or expiration of these contracts and the inability of the Company to replace this level of business could negatively affect the Companys operating results;
(vi) The Companys businesses compete in mature segments with competitors having large percentages of segment sales;
(vii) The Company has realized increases to sales and earnings through the acquisitions of businesses, but the ability to undertake future acquisitions depends on many factors that the Company does not control, such as identifying available acquisition candidates and negotiating satisfactory terms upon which to purchase such candidates;
(viii) Presently, all of the interest on the Companys indebtedness is set on a short-term basis. Consequently, increases in interest rates will increase the Companys interest expense;
(ix) If actual or forecasted cash flows of any reporting unit deteriorate such that its fair value falls below its carrying value, goodwill would likely be impaired and an impairment loss would be recorded immediately as a charge against earnings;
(x) In September 2003, the Company began implementing a new information systems software program within its Snack Nuts & Candy segment. Implementation of the new system could cause disruptions to the segments operations. In the event the system is implemented within other segments, those segments could be similarly impacted; and
(xi) Other uncertainties, all of which are difficult to predict and many of which are beyond the control of the Company, may impact its financial position, including those risks detailed from time to time in its publicly filed documents. These and other factors are discussed in the Companys Securities and Exchange Commission filings.
The list of factors above is illustrative, but by no means exhaustive. All forward-looking statements should be evaluated with the understanding of their inherent uncertainty.
ITEM 1. BUSINESS
Ralcorp Holdings, Inc. is a Missouri corporation incorporated on October 23, 1996. Our principal executive offices are located at 800 Market Street, Suite 2900, St. Louis, Missouri 63101. The terms our, we, Company, Ralcorp, and Registrant as used herein refer to Ralcorp Holdings, Inc. and its consolidated subsidiaries.
We are primarily engaged in the manufacturing, distribution and marketing of store brand (private label) ready-to-eat and hot cereal products, store brand and branded crackers and cookies, store brand and value branded snack nuts and chocolate candy, and store brand wet-filled products such as salad dressings, mayonnaise, peanut butter, syrups, jams and jellies, and specialty sauces.
The following sections of this report contain financial and other information concerning our business developments and operations and are incorporated into this Item 1: Managements Discussion and Analysis of Financial Condition and Results of Operations under Item 7 of this Report; Note 2 Acquisitions and Goodwill, Note 9 Supplemental Earnings Statement and Cash Flow Information, and Note 19 Segment Information to the Financial Statements filed as part of this document under Item 8.
You can find additional information about Ralcorp including our previous 10-Ks, 10-Qs, 8-Ks, and other securities filings by visiting our website at http://www.ralcorp.com or the SECs website at http://www.sec.gov, from which they can be printed free of charge. The Companys Corporate Governance Guidelines; Code of Business Conduct and Ethics for Employees, including executive officers; Code of Business Conduct and Ethics for the Board of Directors; and the Charters of the Boards Audit and Corporate Governance and Compensation Committees are also available on our website, from which they can be printed free of charge. All of these documents are also available to shareholders upon request sent to the Companys Secretary.
RECENT BUSINESS DEVELOPMENTS
On December 12, 2002, we completed the purchase of 1,145,667 shares of our common stock at a price of $24.00 per share.
On January 22, 2003, we announced the restructuring of Senior Management. David P. Skarie was appointed President of Ralston Foods in addition to his position as President of the Carriage House Companies, Inc. Also, Kevin J. Hunt was appointed President of Nutcracker Brands, Inc. in addition to his position as President of Bremner, Inc.
On February 4, 2003, we announced the sale of our tomato processing factory in Williams, California.
On February 20, 2003, we announced the closure of our Kent, Washington in-store bakery facility.
On May 22, 2003, we completed the sale of $150 million Floating Rate Senior Notes due May 22, 2010.
On September 18, 2003, we announced that on September 29, 2003, Joe R. Micheletto would retire as Chief Executive Officer and President and would serve as Vice Chairman of the Board of Directors. Kevin J. Hunt and David P. Skarie were each appointed Co-CEO and President of Ralcorp in addition to their existing duties as Presidents of our operating units.
On September 18, 2003, we announced that on September 30, 2003 Robert W. Lockwood would retire as Corporate Vice President, General Counsel and Secretary and Charles G. Huber, Jr. would be appointed Corporate Vice President, General Counsel and Secretary.
On November 6, 2003, we announced that effective immediately Richard R. Koulouris was appointed Corporate Vice President, and President of Bremner, Inc. and Nutcracker Brands, Inc.
On November 12, 2003, we announced the signing of a definitive agreement to purchase Bakery Chef, Inc. for $287.5 million.
On December 3, 2003, we announced the completion of the acquisition of Bakery Chef, Inc.
On December 4, 2003, we announced that David L. Beré was appointed Corporate Vice President, and President and Chief Executive Officer of Bakery Chef, Inc.
OTHER INFORMATION PERTAINING TO THE BUSINESS OF THE COMPANY
Presently our businesses are comprised of three reportable business segments: Cereals, Crackers & Cookies (consisting of Ralston Foods and Bremner, Inc.); Dressings, Syrups, Jellies & Sauces (The Carriage House Companies, Inc.); and Snack Nuts & Candy (Nutcracker Brands, Inc.). Primarily, we produce and sell emulations of various types of branded food products that retailers, mass merchandisers and drug stores sell under their own store brands or under value brands. Each of our business segments attempts to produce products that are equivalent in quality to branded products. In the event branded producers modify their existing products or successfully introduce new products, we may attempt to emulate the modified or new products. In conjunction with our customers, we develop packaging and graphics that rival the national brands. Our goal is that the only difference consumers perceive when purchasing our store brand products is a notable cost savings when compared to branded counterparts.
Cereals, Crackers & Cookies
The Cereals, Crackers & Cookies segment is composed of two product lines: store brand ready-to-eat and hot cereals (the Store Brand Cereal Business), and store brand and branded crackers and cookies (the Cracker and Cookie Business). In fiscal 2003, these product lines accounted for approximately 44% and 56%, respectively, of the Companys Cereals, Crackers & Cookies segment sales.
Store Brand Cereal Business
Store brand ready-to-eat cereals are currently produced at three operating facilities. Our Cracker and Cookie Business produces shredded wheat cereal for the Store Brand Cereal Business. Ready-to-eat cereals include 13 extruded cereals, fourteen flaked cereals, seven biscuit cereals and three shredded cereals. Three additional cereals are produced for the Store Brand Cereal Business through certain co-manufacturing arrangements. Store brand and branded hot cereals are produced at one facility. The hot cereal products include old-fashioned oatmeal, quick oatmeal, regular instant oatmeal, flavored instant oatmeals, farina, instant Ralston®, a branded hot wheat cereal, and 3 Minute Brand® hot cereals. As expected, we sell far more hot cereals in cooler months. We believe we are the largest manufacturer in the U.S. of store brand ready-to-eat and hot cereals.
We produce cereal products based on our estimates of customer orders and consequently maintain, on average six to eight weeks inventory of finished products. Our ready-to-eat and hot cereals are warehoused in and distributed through four independent distribution facilities and two of our cereal plants, and shipped to customers principally via independent truck lines. The ready-to-eat and hot cereal products are sold through in-house district sales managers and independent food brokers.
Cracker and Cookie Business
We believe our Cracker and Cookie Business is currently the leading manufacturer of store brand crackers and cookies for sale in the United States. The business also produces branded cookies under the Rippin Good® brand. In addition, the business produces branded and store brand cookies for sale in the in-store bakery sections of food retailers. We utilize the brands Cascade® and Lofthouse® for branded in-store bakery cookies. Sales of in-store bakery cookies typically increase significantly near major holidays. The Cracker and Cookie Business also produces Ry Krisp® branded crackers. Management positions the Cracker and Cookie Business as a low cost, premier quality producer of a wide variety of store brand crackers and cookies. We produce thirty-three kinds of store brand cookies and eighteen kinds of store brand crackers.
Our Cracker and Cookie Business operates eight plants: one produces only Ry Krisp® crackers, two produce store brand crackers and cookies, three produce store brand and branded cookies, and two produce cookies for the in-store bakery sections of grocery stores. Cracker and Cookie products are largely produced to order and shipped directly to customers. In the fall and winter as consumer consumption of crackers increases, we have the ability to produce to estimated volumes, thereby building product inventories ranging from four to six weeks. The majority of the products sold to in-store bakery departments of food retailers are stored and shipped frozen. Store brand crackers and cookies are sold through a broker network and district manager sales staff. Branded Ry Krisp® crackers and many branded cookies are sold through direct store distributor networks.
Dressings, Syrups, Jellies & Sauces
Our Dressings, Syrups, Jellies & Sauces segment operates six plants. Five plants produce a variety of store brand shelf-stable dressings, syrups, jellies, salsas, sauces, and drink mixes under the Major Peters® brand. One plant produces only peanut butter. The segments products are largely produced to order and shipped directly to customers. The products are sold through an internal sales staff and a broker network.
Many wet-filled products are easier to produce than those of the cereals, crackers and cookies segments. However, due to the varied nature of branded counterparts and customer preferences, this segment produces far more variations of each type of product compared to our other segments. For example, we produce up to 40 varieties of many types of salad dressing. At any one time, we maintain over 8,000 active SKUs in this segment.
Snack Nuts & Candy
Our Snack Nuts & Candy segment operates two plants that produce a variety of jarred, canned and bagged snack nuts and one plant that produces chocolate candy. Our Snack Nut and Candy products are largely produced to order and shipped directly to customers. We sell our products through an internal sales staff and a broker network. The segment produces store brand products as well as value branded products under the Nutcracker® and Flavor House® brands. Snack nut sales are seasonal. The segment sells approximately 45% of its snack nuts in a four-month period between September and December. Profits from the sale of snack nuts are impacted significantly by the cost of raw materials (peanuts and tree nuts). Our chocolate candy products are positioned as premium chocolate products and not as an emulation of a branded product. Consequently, our chocolate candy products are sold to customers who maintain premium store brand product lines.
Ownership of Vail Resorts, Inc.
We own 7,554,406 shares of Vail Resorts, Inc. (Vail) common stock (approximately 21.5 percent of the shares outstanding as of September 30, 2003). Additionally, two of our Directors, Messrs. Stiritz and Micheletto, are on the Vail Board of Directors. Currently, we utilize the equity method of accounting to reflect the portion of Vails earnings (or losses) applicable to us on a non-cash basis.
Pursuant to a Shareholder Agreement entered into in connection with the acquisition of the Vail common stock, we can only sell our Vail common stock in a registered offering allowed under the Shareholder Agreement or in private transactions (provided the purchaser agrees to be bound by the Shareholder Agreement). Vails results of operations are highly seasonal and are dependent in part on weather conditions and consumers discretionary spending trends. In light of the significance of our ownership in Vail in comparison to our earnings and assets, changes in the price of Vails Common Stock can impact our stock price.
We own a number of trademarks that are substantially important to our businesses, including Lofthouse®, Nutcracker®, Flavor House®, Rippin Good®, Golden Batch®, and Major Peters®.
Our businesses face intense competition from large branded manufacturers and highly competitive store label manufacturers in each of their product lines. Top branded ready-to-eat and hot cereal competitors include Kellogg, General Mills, Kraft Foods Post division, and Quaker Oats (owned by PepsiCo). Large branded competitors of the Cracker and Cookie Business include Nabisco (owned by Kraft) and Keebler (owned by Kellogg), which possess large portions of the branded cracker and cookie categories. The Snack Nuts & Candy segment faces significant competition from one significant branded snack nut producer (Planters, owned by Kraft). Top branded competitors of the Dressings, Syrups, Jellies & Sauces segment include Kraft Foods, Bestfoods, Smuckers, and Heinz. In addition, privately owned store brand manufacturers provide significant competition in all of the Companys segments.
The industries in which we compete are highly sensitive to both pricing and promotion. Competition is based upon product quality, price, effective promotional activities, and the ability to identify and satisfy emerging consumer preferences. These industries are expected to remain highly competitive in the foreseeable future. Our customers do not typically commit to buy predetermined amounts of products. Moreover, many food retailers utilize bidding procedures to select vendors. Consequently, in any segment up to 50% of our business can be subject to a bidding process conducted by our customers.
Future growth opportunities are expected to depend on our ability to implement strategies for competing effectively in all of our businesses, including strategies relating to enhancing the performance of our employees, maintaining effective cost control programs, developing and implementing methods for more efficient manufacturing and distribution operations, and developing successful new products, while at the same time maintaining aggressive pricing and promotion of our products.
In fiscal 2003, Wal-Mart Stores, Inc. accounted for approximately 14% of our aggregate net sales. Each of our reporting segments sells products to Wal-Mart. Additionally, we sell our products to retail chains, mass merchandisers, grocery wholesalers, warehouse club stores and drug stores across the country and in Canada.
We employ approximately 5,000 people in the United States (as of September 30, 2003). Approximately 1,700 of our personnel are covered by thirteen union contracts and, from time to time, the Company has experienced union organizing activities at its non-union plants. The contracts expire at times from January 31, 2004, to October 7, 2007. The production employees at the Lancaster facility are presently working without a contract and have the ability to engage in a strike at any time, but the operations of the Lancaster facility have not been disrupted by the lack of a contract. Notwithstanding the foregoing, we believe relations with our employees, including union employees, are good.
Raw Materials and Energy
Our principal raw materials are grain and grain products, flour, corn syrup, sugar, soybean oil, tomatoes, various nuts such as peanuts and cashews, and liquid chocolate. We purchase raw materials and a variety of packaging materials from local, regional, national and international suppliers. The cost of raw materials used in the Companys products may fluctuate widely due to weather conditions, government regulations, economic climate or other unforeseen circumstances. From time to time, we will enter into supply contracts for periods up to three years to secure favorable pricing for ingredients and up to five years for packaging supplies. We also purchase natural gas, electricity, and steam for use in our processing facilities. Where possible, and when advantageous to the Company, we enter into long-term normal purchase contracts to reduce the price volatility of these items and the cost impact upon our operations. In fiscal 2003, ingredients, packaging, and energy represented approximately 43%, 22%, and 2%, respectively, of our total cost of goods sold.
Due to our equity interest in Vail, which typically yields more than the entire years equity income during our second and third fiscal quarters, our net earnings are seasonal. In addition, certain aspects of our operations, especially in the Snack Nuts & Candy business, are seasonal, with a higher percentage of sales and operating profits expected to be recorded in the first and fourth fiscal quarters. See Note 20 in Item 8 for historical quarterly data.
Governmental Regulation; Environmental Matters
We are subject to regulation by federal, state and local governmental entities and agencies. As a producer of goods for human consumption, our operations are subject to stringent production and labeling standards. For example, in the early 1990s, new labeling regulations were promulgated and implemented which required us to modify information disclosed on our packaging. Recently, new labeling regulations relating to trans fatty acids have been adopted by regulatory bodies. Management expects that changes in packaging and formulations can be implemented without a material adverse impact on our businesses if existing packaging stock can be used during a transition period while formulas are modified.
Our operations, like those of similar businesses, are subject to various federal, state and local laws and regulations with respect to environmental matters, including air and water quality, underground fuel storage tanks, waste handling and disposal, and other regulations intended to protect public health and the environment. While it is difficult to quantify with certainty the potential financial impact of actions regarding expenditures for environmental matters, particularly remediation, and future capital expenditures for environmental control equipment, in the opinion of management, based upon the information currently available, the ultimate liability arising from such environmental matters, taking into account established accruals for estimated liabilities, should not have a material effect on our consolidated results of operations, financial position, capital expenditures or other cash flows.
From time to time, any of our segments may provide products for branded companies. Often such products are new branded products for which branded companies lack capacity. Most often, branded products retain ownership for the formulas and trademarks related to products we produce for them. Also, the contract manufacturing business tends to be inconsistent in volume. Often, initial orders can be significant and favorably impact a fiscal period but later volume will level off or the branded company will ultimately produce the product internally and cease purchasing product from us.
ITEM 2. PROPERTIES
Our principal properties are our manufacturing locations. Shown below are our principal owned and leased properties. We also lease our principal executive offices and research and development facilities in St. Louis, Missouri. Management believes its facilities are suitable and adequate for the purposes for which they are used and are adequately maintained. We believe each segments combination of facilities provides adequate capacity for current and anticipated future customer demand.
Plant Locations Size
(Sq. Ft.) Owned/
Lines Products Battle Creek, MI 476,896 Owned 7 Cereal Cedar Rapids, IA 150,000 Owned 5 Cereal Lancaster, OH 478,719 Owned 11 Cereal Sparks, NV 243,000 Owned 7 Cereal Freeport, UT 124,000 Leased 4 Cookies Princeton, KY 700,000 Owned 6 Crackers and Cookies Poteau, OK 250,000 Owned 5 Crackers and Cookies Minneapolis, MN 40,000 Owned 3 Crackers Ogden, UT 325,000 Leased 5 Cookies Tonawanda, NY 95,000 Owned 3 Cookies Ripon, WI (two plants) 350,000 Owned 11 Cookies Billerica, MA 80,000 Owned 8 Snack Nuts Dothan, AL 135,000 Leased 14 Snack Nuts Womelsdorf, PA 100,000 Owned 5 Candy Buckner, NY 269,250 Owned 6 Dressings, Syrups, Jellies & Sauces Dunkirk, NY 306,000 Owned 6 Dressings, Syrups, Jellies & Sauces Fredonia, NY 367,000 Owned 10 Dressings, Syrups, Jellies & Sauces Kansas City, KS 67,000 Owned 4 Dressings, Syrups, Jellies & Sauces Los Angeles, CA 81,000 Leased 4 Dressings, Syrups, Jellies & Sauces Streator, IL 165,000 Owned 1 Peanut Butter
ITEM 3. LEGAL PROCEEDINGS
We are a party to a number of legal proceedings in various state and federal jurisdictions. These proceedings are in varying stages and many may proceed for protracted periods of time. Some proceedings involve complex questions of fact and law. Additionally, our operations, like those of similar businesses, are subject to various federal, state, and local laws and regulations intended to protect public health and the environment, including air and water quality and waste handling and disposal.
Pending legal liability, if any, from these proceedings cannot be determined with certainty; however, in the opinion of management based upon the information presently known, the liability of the Company, if any, arising from the pending legal proceedings, as well as from asserted legal claims and known potential legal claims which are likely to be asserted, taking into account established accruals for estimated liabilities (if any), are not expected to be material to our consolidated financial position, results of operations and cash flows. In addition, while it is difficult to quantify with certainty the potential financial impact of actions regarding expenditures for compliance with regulatory matters, in the opinion of management, based upon the information currently available, the ultimate liability arising from such compliance matters should not be material to the Companys consolidated financial position, results of operations and cash flows.
Additionally, we retained certain potential liabilities associated with divested businesses (former branded cereal business and ski resort business). Presently, management believes that taking into account applicable liability caps, sharing arrangements with acquiring entities and the known facts and circumstances regarding the retained liabilities, potential liabilities of the divested businesses should not be material to the Companys consolidated financial position, results of operations and cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to the security holders during the fourth quarter of fiscal year 2003.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
Kevin J. Hunt 52 Co-Chief Executive Officer and President of the Company since September 2003; Chief Executive Officer of Bremner, Inc. and Nutcracker Brands, Inc. since November 2003. He served as Corporate Vice President of the Company from October 1995 to September 2003; President of Bremner from October 1995 to November 2003; and President of Nutcracker Brands from January 2003 to November 2003. David P. Skarie 57 Co-Chief Executive Officer and President of the Company since September 2003; President, The Carriage House Companies, Inc. and Ralston Foods since October 2002 and January 2003, respectively. He served as Corporate Vice President of the Company from March 1994 to September 2003; President of Nutcracker Brands, Inc. from April 2002 to January 2003; President of Ralston Foods from June 2000 to September 2002; and Director of Customer Development of Ralston Foods from March 1994 to June 2000. David L. Beré 50 Corporate Vice President, and President and Chief Executive Officer of Bakery Chef, Inc. since the acquisition of Bakery Chef in December 2003. He served as President and Chief Executive Officer of Bakery Chef since December 1998; and President and Chief Executive Officer of McCain Foods USA from April 1996 to December 1998. Thomas G. Granneman 54 Corporate Vice President and Controller since January 1999. He served as Vice President and Controller from December 1996 to January 1999. Charles G. Huber, Jr. 39 Corporate Vice President, General Counsel and Secretary of the Company since October 2003. He served as Vice President and Assistant General Counsel from September 2001 to October 2003; and Assistant General Counsel from March 1994 to September 2001. Richard R. Koulouris 47 Corporate Vice President, and President, Bremner, Inc. and Nutcracker Brands, Inc. since November 2003. He served as Vice President Operations, Bremner from September 1995 to November 2003. Scott Monette 42 Corporate Vice President and Treasurer since September 2001. He joined Ralcorp in January 2001 as Vice President and Treasurer. Prior to joining Ralcorp, Mr. Monette was Chief Investment Officer/Benefit Plans for Hallmark Cards, Inc. from December 1998 to January 2001. He served as Corporate Debt Manager for Hallmark Cards, Inc. from January 1996 to December 1998. Ronald D. Wilkinson 53 Corporate Vice President, and Director of Product Supply of Ralston Foods and The Carriage House Companies, Inc. He has held the Corporate Vice President position and the Ralston Foods position since October 1996, and the Carriage House position since January 2003. (Ages are as of December 31, 2003)
ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Companys common stock is traded on the New York Stock Exchange under the symbol RAH. There were 11,402 shareholders of record on November 28, 2003. The Company has never paid cash dividends and has no plan to pay cash dividends in the foreseeable future. The range of high and low sale prices of Ralcorp common stock as reported on the NYSE Composite Tape is set forth in Note 20 of the financial statements filed as a part of this document under Item 8.
ITEM 6. SELECTED FINANCIAL DATA
FIVE YEAR FINANCIAL SUMMARY
(In millions except per share data)
Year Ended September 30,
2003 2002 2001 2000 1999
Statement of Earnings Data Net sales (a) $ 1,303.6 $ 1,280.3 $ 1,178.0 $ 847.0 $ 666.2 Cost of products sold (1,045.6 ) (1,027.6 ) (952.4 ) (672.0 ) (511.6 )
Gross profit 258.0 252.7 225.6 175.0 154.6 Selling, general and administrative expenses (171.3 ) (163.1 ) (153.2 ) (111.1 ) (99.6 ) Interest expense, net (3.3 ) (5.9 ) (15.9 ) (8.8 ) (1.4 ) Goodwill impairment loss (b) (59.0 ) - - - - Restructuring charges (c) (14.3 ) - (2.6 ) (2.5 ) - Litigation settlement income (d) 14.6 1.6 - - - Merger termination fee (e) - - 4.2 - -
Earnings before income taxes and equity earnings 24.7 85.3 58.1 52.6 53.6 Income taxes (16.9 ) (30.7 ) (22.1 ) (19.6 ) (20.1 ) Equity in (loss) earnings of Vail Resorts, Inc., net of related deferred income taxes (f) (.4 ) (.8 ) 3.9 3.4 2.9
Net earnings $ 7.4 $ 53.8 $ 39.9 $ 36.4 $ 36.4
Earnings per share: Basic $ 0.25 $ 1.79 $ 1.34 $ 1.21 $ 1.17 Diluted $ 0.25 $ 1.77 $ 1.33 $ 1.19 $ 1.15 Weighted average shares outstanding: Basic 29.1 30.0 29.9 30.2 31.1 Diluted 29.7 30.4 30.1 30.6 31.7 Statement of Cash Flows Data Cash provided (used) by: Operating activities $ 105.8 $ 110.8 $ 131.0 $ 33.0 $ 42.0 Investing activities (30.7 ) (69.0 ) (90.2 ) (236.0 ) (75.6 ) Financing activities (49.3 ) (42.5 ) (41.0 ) 205.2 23.2 Depreciation and amortization 38.7 35.8 41.6 34.3 23.1 Balance Sheet Data Working capital (excl. cash and cash equivalents) $ 84.2 $ 85.4 $ 95.6 $ 144.8 $ 66.4 Total assets 794.3 832.5 817.9 804.7 483.8 Long-term debt 155.9 179.0 223.1 264.4 42.8 Shareholders equity 412.7 436.1 389.4 350.3 324.1
In 1999, Ralcorp acquired Martin Gillet & Co., Inc. and Southern Roasted Nuts of Georgia, Inc. In 2000, Ralcorp acquired Ripon Foods, Inc., Cascade Cookie Company, Inc., James P. Linette, Inc., and The Red Wing Company, Inc. In 2001, Ralcorp acquired The Torbitt & Castleman Company, LLC. In 2002, Ralcorp acquired Lofthouse Foods Incorporated. For more information about the 2001 and 2002 acquisitions, see Note 2 to the financial statements in Item 8.(b)
In 2003, a non-cash goodwill impairment loss related to the Carriage House reporting unit was recorded in accordance with FAS 142. See Note 2 to the financial statements in Item 8.(c)
In 2003, restructuring charges related to the reduction of operations in Streator, IL, the sale of the ketchup business and the tomato paste business, and the relocation of in-store bakery production. In 2001, restructuring charges related to plant closures in San Jose, CA and Baltimore, MD. In 2000, restructuring charges related to the plant closure in Baltimore, MD. See Note 3 to the financial statements in Item 8.(d)
In 2003 and 2002, Ralcorp received payments in settlement of its claims related to vitamin antitrust litigation. The amounts received were recorded net of related expenses.(e)
In 2001, Agribrands International, Inc. terminated a merger agreement with Ralcorp. Ralcorp received a payment of $5.0 as a termination fee, which was recorded net of related expenses.(f)
In 2003 and 2002, Ralcorp adjusted its equity earnings to reflect the cumulative effect of earnings restatements made by Vail Resorts, Inc. See Note 7 to the financial statements in Item 8.
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion summarizes the significant factors affecting the consolidated operating results, financial condition, liquidity and capital resources of Ralcorp Holdings, Inc. This discussion should be read in conjunction with the financial statements under Item 8, especially Note 19, and the Cautionary Statement on Forward-Looking Statements on page 2. The terms our, we, Company, and Ralcorp as used herein refer to Ralcorp Holdings, Inc. and its consolidated subsidiaries.
RECENTLY ISSUED ACCOUNTING STANDARDS
See Note 1 for a discussion regarding recently issued accounting standards, including FAS 141, 142, 143, 144, 145, 146, 148, 149, and 150; FIN 45 and 46; and EITF 00-10, 00-14, 00-25, 01-09, and 02-17.
RESULTS OF OPERATIONS
Net Sales Net sales grew from less than $1.2 billion in fiscal 2001 to nearly $1.3 billion in 2002 and over $1.3 billion in 2003. The 9% increase from 2001 to 2002 and the 2% increase from 2002 to 2003 were due primarily to the timing of business acquisitions. Refer to the segment discussions below for specific factors affecting results.
Operating Expenses Cost of products sold was 80.2%, 80.3%, and 80.9% of net sales in 2003, 2002, and 2001, respectively, while selling, general and administrative (SG&A) was 13.1%, 12.7%, and 13.0%. In fiscal 2002, gross margins increased as a result of improved operating efficiencies in the Dressings, Syrups, Jellies & Sauces division and lower ingredient costs in the Snack Nuts & Candy division. In fiscal 2002 we adopted FAS 142 which discontinued the amortization of goodwill, while 2001 SG&A included $8.0 million of goodwill amortization. In fiscal 2003, SG&A included $2.5 million of incremental expenses associated with a pilot project to upgrade information systems, $1.5 million related to accounts receivable losses caused by the bankruptcy of the Fleming Companies, Inc. (Fleming), and $1.2 million related to the recall of a product produced for a co-manufacturing customer. Again, refer to the segment discussions below for other factors affecting results.
Interest Expense, Net Net interest expense fell from $15.9 million in 2001 to $5.9 million in 2002 and $3.3 million in 2003 as a result of decreasing debt levels and interest rates. We reduced our long-term debt from $264.4 million at the beginning of fiscal 2001 to $155.9 million by September 30, 2003 as cash from operations exceeded cash needs for business acquisitions, capital expenditures, and stock repurchases. Since nearly all of our interest rates are set on a short-term basis, the declining market rates throughout fiscal 2001, 2002, and 2003 had a favorable effect on interest expense. For more information about our long-term debt, see Note 14. Refer to Note 11 for information about our agreement to sell our trade accounts receivable on an ongoing basis, including amounts of related discounts.
Goodwill Impairment Loss We recorded a goodwill impairment loss in fiscal 2003. In accordance with FAS 142, Goodwill and Other Intangible Assets, we completed our annual goodwill impairment test of each of our reporting units during the fourth quarter. In the first step of the test, the fair value of each reporting unit was compared with its carrying amount. Based on that indicator, only the Carriage House reporting unit (i.e., the Dressings, Syrups, Jellies & Sauces segment) had a potential impairment, and the second step of the test was conducted for that unit to determine the amount of impairment loss by comparing the implied fair value of goodwill to its carrying value. The implied fair value of goodwill is the excess of the fair value of the reporting unit over the fair value of its identifiable net assets. Estimated fair values were determined based on the best information available, including independent appraisals and the results of valuation techniques such as EBITDA multiples and discounted future cash flows. The implied fair value of goodwill was calculated to be $38.8 million, compared to the carrying value of $97.8 million, so the goodwill impairment loss was determined to be $59.0 million. A portion of Carriage Houses goodwill is not deductible for tax purposes, so the deferred tax benefit of the loss was only $13.5 million. Factors leading to the impairment included the bankruptcy of Fleming (formerly a significant customer of Carriage House), the inability to quickly replace lost co-manufacturing business, the increasing competitive pricing pressures in the private label food industry, and the near-term production inefficiencies arising from the Carriage House restructuring initiatives discussed below. For more information about Carriage House operations and our commitment to improving results, refer to the Dressings, Syrups, Jellies & Sauces sections below.
Restructuring Charges In the quarter ended December 31, 2002, we finalized our plans to reduce operations at our Streator, IL facility and transfer production of all product lines except peanut butter to other Dressings, Syrups, Jellies & Sauces locations. Related termination benefits and equipment write-offs totaled $1.4 million in fiscal 2003.
Also in the quarter ended December 31, 2002, we sold our ketchup business, including certain equipment and inventory, resulting in a net loss of $1.4 million. Further, we determined that the resulting reduced cash flows from our tomato paste business, which had supplied the Companys ketchup production, was less than the carrying value of our paste production facility located near Williams, CA, and an impairment charge of $5.0 million was recorded as of December 31, 2002. On February 4, 2003, we sold the tomato paste business, including the Williams, CA facility. The sale resulted in an additional loss of $3.6. The ketchup and paste operations were both part of the Dressings, Syrups, Jellies & Sauces segment.
In the quarter ended March 31, 2003, we announced our plans to close our in-store bakery (ISB) facility in Kent, WA, part of the Cereals, Crackers & Cookies segment, and transfer production to a new ISB plant located in Utah. We are also in the process of transferring production from two other ISB facilities located near the new plant and expect to complete the project by April of 2004. We recorded $2.9 million of expenses related to this ISB restructuring in fiscal 2003.
On July 24, 2000 and January 23, 2001, respectively, we announced plans to close plants in Baltimore, MD and San Jose, CA and move production to other Dressings, Syrups, Jellies & Sauces facilities. Both of these closures were essentially completed by the end of fiscal 2001. During 2001, Baltimore closure and relocation costs of $1.9 million were expensed along with $.7 million related to San Jose, for a total of $2.6 million.
For more information regarding these restructuring charges, see Note 3.
Litigation Settlement Income We received payments in fiscal 2003 and 2002 in settlement of our claims related to vitamin antitrust litigation. The respective amounts recorded were $14.6 and $1.6, net of related expenses.
Merger Termination Fee Agribrands International, Inc. terminated a merger agreement with Ralcorp on December 1, 2000. In accordance with the agreement, we received a payment of $5.0 million as a termination fee, which was recorded in the first quarter of fiscal 2001 net of related expenses.
Income Taxes Income tax provisions generally reflect statutory tax rates, adjusted by the effects of non-deductible goodwill amortization expense or impairment losses. The effective rate was approximately 38% in fiscal 2001, 36% in 2002, and 68.5% in 2003. The 2001 rate included the effect of non-deductible goodwill amortization expense, while goodwill amortization was eliminated in 2002 with the adoption of FAS 142. The 2003 rate included the effect of the non-deductible portion of the goodwill impairment loss. Excluding that effect, the 2003 rate was about 36%. The effective rate is expected to be approximately 36.5% for fiscal 2004. See Note 6 for more information about income taxes.
Equity in Earnings of Vail Resorts, Inc. Our pre-tax earnings from Vail were $6.0 million for fiscal 2001, as snowfall amounts and timing were favorable. For fiscal 2002 and 2003, we recorded pre-tax losses of $1.2 million and $.7 million, respectively, from our investment in Vail. Those losses included adjustments totaling $4.9 million in 2002 and $.8 million in 2003 to reflect the cumulative effect of Vails earnings restatements for prior years. In addition, Vails results were hurt by reduced travel in the past two years. See Note 7 for more information about this equity investment.
Cereals, Crackers & Cookies
Fiscal 2003 vs. Fiscal 2002
Net sales for the Cereals, Crackers & Cookies segment were up 9 percent in fiscal 2003 from fiscal 2002, with the Ralston Foods cereal division and the Bremner cracker and cookie division contributing increases of $4.2 million and $54.1 million, respectively. About $30 million of the Bremner growth is attributable to an additional four months of sales from Lofthouse, acquired on January 30, 2002, while the remainder came through ongoing expansion with existing customers. Cracker volume was up 14 percent and base cookie volume was down 5 percent. Excluding Lofthouse sales for the first four months, ISB volume was up 4 percent year-over-year. For Ralston Foods, an increase in co-manufactured ready-to-eat (RTE) cereal sales offset a decline in store brand RTE cereal for the year (largely due to the Fleming bankruptcy), so combined RTE volume was flat. Hot cereal volume was up 5 percent (despite losses related to the Fleming bankruptcy), but most of the relative sales dollar improvement at Ralston Foods was due to the amount and timing of promotional discounts.
The segments profit contribution was up $6.8 million (10 percent) for fiscal 2003. The improvement is primarily attributable to the increased sales, but also to the reduced promotional activity in the current year, reduced expenses related to capital projects, lower freight costs, and favorable product mix. Those benefits were partially offset by rising costs of insurance, employee benefits, and ingredients such as wheat flour, soybean oil, honey, cocoa, and sugar.
Fiscal 2002 vs. Fiscal 2001
Net sales for the Cereals, Crackers & Cookies segment were up $80.8 million in fiscal 2002 from fiscal 2001, as the Ralston Foods cereal division and the Bremner cracker and cookie division contributed increases of $1.9 million and $78.9 million, respectively. While most of Bremners growth came from the addition of the Lofthouse business, sales at its other cookie businesses grew more than 25 percent as a result of additional co-manufacturing business and ongoing expansion with existing private label customers. Cracker sales volumes were down slightly due to lower demand for saltines. At Ralston Foods, incremental sales to existing customers, driven by several recent product introductions and additional distribution of established items, were offset by price concessions, additional product promotions, and less co-manufacturing business. RTE cereal volumes were up 1 percent from last year and hot cereal volume was up 4 percent.
Profit contribution for the segment increased $11.7 million from $58.4 million (10.2% of net sales) in fiscal 2001 to $70.1 million (10.7% of net sales) in fiscal 2002. Again, most of the improvement was the result of the acquired Lofthouse business and related synergies. In addition, the segments profit was reduced by $2.4 million of goodwill amortization in fiscal 2001, while goodwill was not amortized in 2002 due to the adoption of FAS 142. Finally, in fiscal 2002 the segment benefited from favorable volumes, plant efficiencies, and lower freight and energy costs, greatly offset by price concessions, promotional programs and rising ingredient costs.
Dressings, Syrups, Jellies & Sauces
The Companys Dressings, Syrups, Jellies & Sauces segments net sales increased from $420.5 million in fiscal 2001 to $451.5 million in 2002, then decreased to $405.8 in 2003. The 2002 increase was primarily due to the benefit of a full year of results from The Torbitt & Castleman Company, LLC, acquired January 31, 2001. The favorable impact of sales to new customers and increased business with some major existing customers was offset by pricing concessions in certain categories and a reduction of volume with a major co-manufacturing customer. The 2003 decline is attributable primarily to the loss of that co-manufacturing customer at the beginning of the year, as well as to the sale of the ketchup business in November 2002, reduced sales resulting from the Fleming bankruptcy, and continued pricing pressures, partially offset by increased business with continuing customers.
The segments profit contribution increased from $7.6 million (1.8% of net sales) in fiscal 2001 to $13.5 million (3.0%) in fiscal 2002 and $8.0 million (2.0%) in fiscal 2003. Except as discussed below, the dollar changes from year to year generally reflect the changes in sales described above. During fiscal 2001, profit as a percent of sales began to improve as the segment benefited from savings from the closure of two facilities and additional synergies with Torbitt & Castleman. Those savings and synergies continued into fiscal 2002, but the benefits were offset by a gross margin decline due to increased ingredient costs, lower co-manufacturing volumes, and competitive pricing pressures. In fiscal 2003, the profit percentage fell as a result of increased production costs due to inefficiencies related to the lower volumes and restructuring initiatives, pricing pressures, and charges related to the Fleming bankruptcy. In addition, the segments profit was reduced by $3.2 million of goodwill amortization expense in fiscal 2001, while goodwill was not amortized in 2002 or 2003 due to the adoption of FAS 142.
Snack Nuts & Candy
Net sales for the Snack Nuts & Candy segment decreased from $182.3 million in fiscal 2001 to $172.8 million in fiscal 2002, then increased to $183.5 million in fiscal 2003. The 2002 decline was the result of the loss of a few customers in competitive bidding, partially offset by increased business with continuing customers. The 2003 growth was generated primarily through continuing increases in volume with several customers, partially offset by continued competitive pricing pressures, an unfavorable product mix, and a significant reduction in first quarter holiday orders from a major customer.
The segments profit contribution increased from $15.9 million (8.7% of net sales) in fiscal 2001 to $20.6 million (11.9%) in fiscal 2002 and $22.8 million (12.4%) in fiscal 2003. The fiscal 2002 and 2003 percentages improved primarily as a result of favorable costs on some ingredients, partially offset by increased costs on others and competitive pricing pressures. Also, the segments profit was reduced by $2.4 million of goodwill amortization expense in fiscal 2001, while goodwill was not amortized in 2002 or 2003 due to the adoption of FAS 142.
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have funded operating needs by generating positive cash flows through operations. We expect to continue generating operating cash flows through our mix of businesses and expect that short-term and long-term liquidity requirements will be met through a combination of operating cash flows and strategic use of borrowings under committed and uncommitted credit arrangements. Capital resources remained strong at September 30, 2003, with a net worth of $412.7 million and a long-term debt to total capital ratio of 27 percent, compared to corresponding figures for September 30, 2002, of $436.1 million and 29 percent. Working capital, excluding cash and cash equivalents, was down to $84.2 million at September 30, 2003 from $85.4 million at September 30, 2002 as a result of continuing reduction efforts, offset by an increase in our investment in Ralcorp Receivables Corporation of nearly $23 million.
Cash flows from operating activities were $105.8 million, $110.8 million, and $131.0 million in 2003, 2002, and 2001, respectively. Operating cash flows were augmented in fiscal 2001 by $61.0 million of proceeds from the sale of receivables in September. Conversely, cash was reduced in fiscal 2003 by a $22.4 million net outflow as remittance of receivables collections to the buyer exceeded payments received for new receivables. See Off-Balance Sheet Financing below for more information about the sale of receivables. In fiscal 2002 and especially in fiscal 2003, an emphasis on working capital reduction resulted in lower inventory levels. Accounts payable have fluctuated due to the timing of purchases. In 2003, operating cash flows were reduced by a $10 million contribution to our qualified pension plan, included in Other, net on the statement of cash flows. We do not expect to be required to make any significant contributions to this plan in the next three years. See Note 16 for more information about this plan.
Net cash paid for business acquisitions totaled $52.1 million in fiscal 2002 (Lofthouse Foods) and $55.6 million in fiscal 2001 (Torbitt & Castleman). See Note 2 for more information about acquisitions.
Capital expenditures were $36.1 million, $29.1 million, and $35.7 million in fiscal years 2003, 2002, and 2001, respectively. Capital expenditures for fiscal 2004 are expected to be between $40 and $50 million.
In fiscal 2002, Ralcorp received $10.0 million of proceeds from the sale of its Carriage House facility in San Jose, CA, with no material gain or loss.
Strong operating cash flows and reduced acquisition activity allowed the Company to reduce its long-term debt in fiscal 2001, 2002, and 2003 by $41.7 million, $44.1 million, and $23.1 million, respectively. On May 22, 2003, the Company issued Floating Rate Senior Notes, Series A, in the amount of $150.0, maturing on May 22, 2010. Borrowings under this private placement debt financing incur interest at a rate of 3-month LIBOR plus 0.85%, adjusted quarterly, with interest payable quarterly in arrears. We used the proceeds to repay borrowings under our shorter-term credit arrangements. As of September 30, 2003, total remaining availability under our $275 million revolving credit agreement and our $35 million uncommitted credit arrangements was $309.9 million and Ralcorp was in compliance with all covenants (see Note 14). In addition, our September 30 balance sheet included $29.0 million of cash and cash equivalents. Further cash needs could be met through the sale of the Companys investment in Vail Resorts, Inc., which had a market value of $108 million at September 30, 2003. See Note 7 for more information about this investment, including restrictions on sale.
In November 2002, the Board approved a tender offer for up to 4,000,000 shares at a single price not in excess of $24.00 and not less than $21.00 per share. The offer was in the form of a modified Dutch Auction where the final price is determined based upon the number of shares, and the respective prices, tendered. The offer resulted in the purchase of 1.15 million shares at a purchase price of $24.00 per share. As of September 30, 2003, 1,665,300 shares remained available for repurchase by the Company pursuant to previous authorizations by the Board of Directors.
Off-Balance Sheet Financing
As an additional source of liquidity, on September 24, 2001 the Ralcorp entered into a three-year agreement to sell, on an ongoing basis, all of its trade accounts receivable to a wholly owned, bankruptcy-remote subsidiary called Ralcorp Receivables Corporation (RRC). RRCs only business activities relate to acquiring and selling interests in Ralcorps receivables. RRCs purchases of Ralcorp trade receivables are funded by selling an undivided percentage ownership interest in each individual receivable to a bank commercial paper conduit (the Conduit), as well as by a portion of the cash collected on previously purchased receivables. Upon the agreements termination, the Conduit would be entitled to all cash collections on RRCs accounts receivable until its purchased interest has been repaid.
The trade receivables sale arrangement with RRC represents off-balance sheet financing since the sale results in assets being removed from our balance sheet rather than resulting in a liability to the Conduit. The organization documents of RRC and the terms of the agreements governing the receivables sale transactions make RRC a qualifying special purpose entity. As such, it is not to be consolidated in Ralcorps financial statements under generally accepted accounting principles. Furthermore, the true sale nature of the arrangement requires Ralcorp to account for RRCs transactions with the Conduit as a sale of accounts receivable instead of reflecting the Conduits net investment as debt with a pledge of accounts receivable as collateral. If RRC were not a qualifying special purpose entity and if the arrangement were not considered a true sale, the outstanding balance of receivables would remain on Ralcorps balance sheet, proceeds received from the Conduit would be shown as short-term debt, and there would be no investment in RRC. See further discussion in Note 11.
We recognize that inflationary pressures may have an adverse effect on the Company through higher asset replacement costs, related depreciation and higher material costs. We try to minimize these effects through cost reductions and productivity improvements as well as price increases to maintain reasonable profit margins. It is our view that inflation has not had a significant impact on operations in the three years ended September 30, 2003.
We believe the opportunities in the private label, value brand, and food service areas are favorable for long-term growth. In the past few years, we have taken significant steps to reshape the Company, reducing our reliance on any one business segment while achieving sufficient scale in the categories in which we operate. We expect to continue to improve our business mix through volume and profit growth of existing businesses, as well as through acquisitions or alliances. We will continue to explore those acquisition opportunities that strategically fit with our intention to be the premier provider of value-oriented food products.
On July 11, 2003, the Food and Drug Administration issued a final rule amending its regulations on nutrition labeling to require that trans fat be declared in the nutrition label of conventional foods and dietary supplements on a separate line immediately under the line for the declaration of saturated fat. The new rule will be effective January 1, 2006. Because of this regulatory change, we may incur costs related to packaging modifications. Furthermore, given the increased focus on trans fat content and the related health risks indicated by recently published scientific studies, we may incur additional costs to research and implement formulation changes on certain products.
The following sections contain discussions of the specific factors affecting the outlook for each of our reportable segments.
Cereals, Crackers & Cookies
The level of competition in the cereal category continues to be intense for our Ralston Foods division. Competition comes from branded box cereal manufacturers, branded bagged cereal producers and other private label cereal providers. For the last several years, category growth in ready-to-eat and hot cereals has been minimal, which has exacerbated its competitive nature. When branded competitors focus on price/promotion, the environment for private label producers becomes more challenging. We must maintain an effective price gap between our quality private label cereal products and those of branded cereal producers, thereby providing the best value alternative for the consumer. Importantly, pricing and volume agreements with customers are generally determined by the customers periodic requests for competitive category reviews in each of our divisions. Ralston Foods anticipates additional category review requests to occur in fiscal 2004. Further, Ralston Foods is being negatively impacted by reduced sales resulting from the Fleming bankruptcy.
Cost increases, including recent increases in ingredient costs, contribute to margin pressures. On an enterprise-wide basis, we manage these cost increases by selected forward purchasing and hedging of certain ingredients. Increased employee health care and other benefit costs will continue into the foreseeable future. Accordingly, aggressive cost containment remains an important goal of the organization. In addition, increased distribution is required to remain competitive whether through new and improved product emulations or new co-manufacturing opportunities.
Our cracker and cookie operation, Bremner, also conducts business in a highly competitive category and is affected by many of the same cost and pricing challenges. Major branded competitors continue to market and promote their offerings aggressively and many smaller, regional branded and private label manufacturers provide additional competitive pressures. Bremners ability to maintain a sufficient price gap between products of branded producers and Bremners quality private label emulations and its ability to realize improved operating efficiencies from recent acquisitions will be important to its results of operations.
The division continues its effort to maximize synergies through the combination of Lofthouse with Cascade, which has given Bremner a significant presence in the in-store bakery cookie category. As previously mentioned, we plan to complete the restructuring of our ISB group by the end of April 2004, with expected annual cost savings of approximately $3.0 to $3.6 million. In addition, Bremner will continue to focus on cost containment, new products and volume growth of existing products in order to improve operating results.
Dressings, Syrups, Jellies & Sauces
Carriage Houses competitors, both large and small, continue to be aggressive on pricing. In addition, the division continues to be negatively affected by certain ingredient cost increases as well as increased employee health care and benefit costs. Wherever possible, we will continue to implement slight price increases to help offset these rising costs. Encouragingly, the cost of peanuts, a major ingredient for Carriage House (peanut butter), has been favorably impacted by the Farm Act of 2002. Although we expect the segment to benefit from lower peanut costs in fiscal 2004, such benefit will likely be more than offset by the aforementioned cost increases and pricing pressures.
We have undertaken an aggressive plan to improve performance by selling unprofitable businesses and continuing to rationalize production capacity. In June 2002, we sold our honey operations. In September 2002, we announced our intention to significantly reduce operations at the Streator, IL facility and transfer production of all product lines except peanut butter to other facilities. As a result of this restructuring, we ultimately expect to realize annual savings in cost of products sold of $2.5 million to $3.0 million (approximately $1.0 million of which is non-cash) beginning in fiscal 2004. In November 2002, we sold our ketchup operations, although production continued through the end of the first quarter, and on February 4, 2003, we sold our industrial tomato paste processing facility. While net sales from the honey, ketchup, and paste businesses totaled approximately $30 million in fiscal 2002, related operating profit was immaterial, so we were able to reduce our capital investment without reducing returns.
Snack Nuts & Candy
Snack nuts and candy continue to be very competitive categories. This segment of Ralcorp faces significant competition from branded manufacturers as well as private label and regional producers. During fiscal 2002, competitive bids for store brand customer business resulted in either loss of margins or loss of customers to competitors. We expect this pricing pressure to continue into the foreseeable future. In fiscal 2003, results were positively impacted by lower peanut prices. In fiscal 2004, we expect competitive pressures could reduce net selling prices while ingredient prices, particularly peanuts, will not decrease any further. The segment will continue to focus on maintaining its customer base and the high quality of its products and on developing new products. In addition, Snack Nuts & Candy segment sales have been, and may continue to be, negatively impacted by the bankruptcy of Fleming.
The segment has recently benefited from lower raw material costs on some ingredients. The cost of cashews, a major ingredient, has trended down from significant highs in fiscal 2000 but now appears to have stabilized. As discussed above, 2002 legislation has resulted in lower peanut costs and may have a favorable effect on profitability. While some benefits of reduced peanut costs were realized in fiscal 2003, the future effect cannot be quantified at this time and is expected to be greatly offset by continued pricing pressures and increasing costs of other ingredients, healthcare, and other employee benefits.
Bakery Chef Acquisition
On December 3, 2003, the Company purchased Bakery Chef, Inc., for $287.5 in cash. We financed the acquisition primarily through borrowings under our existing $275 revolving credit facility. Bakery Chef is a leading manufacturer of frozen griddle products (pancakes, waffles and French toast) and frozen pre-baked biscuits sold primarily in the food service channel, and also produces pre-baked frozen muffins, breads and rolls. Bakery Chef became a wholly owned subsidiary of Ralcorp and will operate as a platform for entry into the food service channel and frozen food segment. Bakery Chef operates five manufacturing facilities, employs approximately 800 people, and had net sales of $165 for the year ended December 31, 2002. Based upon Bakery Chefs 2002 results, our initial assessment of its intangible asset valuation and related amortization, and interest rate assumptions, we anticipate the acquisition will immediately add $.25 to $.35 to our diluted earnings per share on an annual basis.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The following discussion is presented pursuant to the United States Securities and Exchange Commissions Financial Reporting Release No. 60, Cautionary Advice Regarding Disclosure About Critical Accounting Policies. The policies below are both important to the representation of the Companys financial condition and results and require managements most difficult, subjective or complex judgments.
Under generally accepted accounting principles in the United States, we make estimates and assumptions that impact the reported amounts of assets, liabilities, revenues, and expenses as well as the disclosure of contingent liabilities. We base estimates on past experience and on various other assumptions that are believed to be reasonable under the circumstances. Those estimates form the basis for making judgments about carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We record estimated reductions to revenue for customer incentive offerings. Should a greater proportion of customers redeem incentives than estimated, additional reductions to revenue may be required.
Inventories are valued at the lower of cost or market value and have been reduced by an allowance for obsolete product and packaging materials. The estimated allowance is based on a review of inventories on hand compared to estimated future usage and sales. If market conditions and actual demands are less favorable than projected, additional inventory write-downs may be required.
We review long-lived assets, including leasehold improvements and property and equipment, for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. Long-lived assets to be disposed of are reported at the lower of the carrying amount or fair value less the cost to sell.
Goodwill represents the excess of the cost of acquired businesses over the fair market value of their identifiable net assets. At the beginning of fiscal 2002, Ralcorp adopted FAS 142, which requires that we no longer amortize goodwill but review for impairment on a regular basis. The goodwill impairment tests require us to estimate the fair value of our businesses and certain assets and liabilities, for which we utilize valuation techniques such as EBITDA multiples and discounted cash flows based on projections. In our fiscal 2003 tests, we assumed an EBITDA multiple of about 5.75 and a discount rate of 9.5%.
Pension assets and liabilities are determined on an actuarial basis and are affected by the estimated market-related value of plan assets; estimates of the expected return on plan assets, discount rates, and future salary increases; and other assumptions inherent in these valuations. We annually review the assumptions underlying the actuarial calculations and makes changes to these assumptions, based on current market conditions, as necessary. Actual changes in the fair market value of plan assets and differences between the actual return on plan assets and the expected return on plan assets will affect the amount of pension expense or income ultimately recognized. The other postretirement benefits liability is also determined on an actuarial basis and is affected by assumptions including the discount rate and expected trends in healthcare costs. Changes in the discount rate and differences between actual and expected healthcare costs will affect the recorded amount of other postretirement benefits expense. See Note 16 for more information about pension and other postretirement benefit assumptions.
Liabilities for workers compensation and accrued health care costs are estimated based on historical experience and expected trends.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the ordinary course of business, the Company is exposed to commodity price risks relating to the acquisition of raw materials. The Company utilizes derivative financial instruments, including futures contracts and options, to manage certain of these exposures when it is practical to do so. As of September 30, 2003 and 2002, a hypothetical 10% adverse change in the market price of the Companys principal commodities, including corn, oats, wheat and soybean oil, would have decreased the fair value of the Companys derivatives portfolio by $2.6 million and $1.1 million, respectively. This volatility analysis ignores changes in the exposures inherent in the underlying hedged transactions. Because the Company does not hold or trade derivatives for speculation or profit, all changes in derivative values are effectively offset by corresponding changes in the underlying exposures. For more information, see Note 1 and Note 13 to the financial statements included in Item 8.
The Company has interest rate risk with respect to interest expense on variable rate debt. At September 30, 2003 and 2002, the Company had $155.7 million and $178.6 million of variable rate debt outstanding. A hypothetical 10% adverse change in weighted average interest rates during fiscal 2002 and 2001 would have had an unfavorable impact of $.3 million and $.4 million, respectively, on both the Companys net earnings and cash flows. For more information, see Note 14 and Note 21 to the financial statements included in Item 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF MANAGEMENT
Management of Ralcorp Holdings, Inc. is responsible for the preparation and integrity of the Companys financial statements. These statements have been prepared in accordance with generally accepted accounting principles and in the opinion of management fairly present the Companys financial position, results of operations and cash flow.
The Company maintains accounting and internal control systems that it believes are adequate to provide reasonable assurance that assets are safeguarded against loss from unauthorized use or disposition and that the financial records are reliable for preparing financial statements. The selection and training of qualified personnel, the establishment and communication of accounting and administrative policies and procedures, and an extensive program of internal audits are important elements of these control systems.
The Board of Directors, through its Audit Committee consisting solely of independent directors, meets periodically with management and the independent auditors to discuss audit and financial reporting matters. To ensure independence, PricewaterhouseCoopers LLP has direct access to the Audit Committee.
The report of PricewaterhouseCoopers LLP, independent auditors, on their audits of the accompanying financial statements follows. This report states that their audits were performed in accordance with generally accepted auditing standards. These standards include an evaluation of internal control for the purpose of establishing a basis for reliance thereon relative to the scope of their audits of the financial statements.
REPORT OF INDEPENDENT AUDITORS
To the Shareholders and Board of Directors of Ralcorp Holdings, Inc.:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of earnings, of shareholders equity and of cash flows present fairly, in all material respects, the financial position of Ralcorp Holdings, Inc. and its subsidiaries at September 30, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2003 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Companys management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 1 to the consolidated financial statements, in 2002 the Company changed its method of accounting for goodwill to conform to Statement of Financial Accounting Standards No. 142.
/s/ PRICEWATERHOUSECOOPERS LLP
St. Louis, Missouri
November 13, 2003, except for Note 21, which is as of December 3, 2003
RALCORP HOLDINGS, INC.
CONSOLIDATED STATEMENT OF EARNINGS
(Dollars in millions except per share data, shares in thousands)
Year Ended September 30,
2003 2002 2001
Net Sales $ 1,303.6 $ 1,280.3 $ 1,178.0 Cost of products sold (1,045.6 ) (1,027.6 ) (952.4 )
Gross Profit 258.0 252.7 225.6 Selling, general and administrative expenses (171.3 ) (163.1 ) (153.2 ) Interest expense, net (3.3 ) (5.9 ) (15.9 ) Goodwill impairment loss (59.0 ) - - Restructuring charges (14.3 ) - (2.6 ) Litigation settlement income 14.6 1.6 - Merger termination fee - - 4.2
Earnings before Income Taxes and Equity Earnings 24.7 85.3 58.1 Income Taxes (16.9 ) (30.7 ) (22.1 )
Earnings before Equity Earnings 7.8 54.6 36.0 Equity in (Loss) Earnings of Vail Resorts, Inc., Net of Related Deferred Income Taxes (.4 ) (.8 ) 3.9
Net Earnings $ 7.4 $ 53.8 $ 39.9
Basic Earnings per Share $ 0.25 $ 1.79 $ 1.34
Diluted Earnings per Share $ 0.25 $ 1.77 $ 1.33
Weighted Average Shares for Basic Earnings per Share 29,131 29,961 29,889 Dilutive effect of: Stock options 486 471 197 Restricted stock awards 2 1 - Deferred compensation awards 127 - -
Weighted Average Shares for Diluted Earnings per Share 29,746 30,433 30,086
See accompanying Notes to Consolidated Financial Statements.
RALCORP HOLDINGS, INC.
CONSOLIDATED BALANCE SHEET
(In millions except share and per share data)
Assets Current Assets Cash and cash equivalents $ 29.0 $ 3.2 Investment in Ralcorp Receivables Corporation 52.4 29.7 Miscellaneous receivables 10.9 6.2 Inventories 145.7 161.6 Deferred income taxes 2.9 5.1 Prepaid expenses and other current assets 3.0 2.8
Total Current Assets 243.9 208.6 Investment in Vail Resorts, Inc. 80.1 80.8 Property, Net 265.3 282.6 Goodwill 177.6 238.0 Intangible Assets, Net 15.7 13.9 Other Assets 11.7 8.6
Total Assets $ 794.3 $ 832.5
Liabilities and Shareholders Equity Current Liabilities Accounts payable $ 85.1 $ 75.2 Other current liabilities 45.6 44.8
Total Current Liabilities 130.7 120.0 Long-term Debt 155.9 179.0 Deferred Income Taxes 20.0 36.3 Other Liabilities 75.0 61.1
Total Liabilities 381.6 396.4
Commitments and Contingencies Shareholders Equity Common stock, par value $.01 per share Authorized: 300,000,000 shares Issued: 33,011,317 shares .3 .3 Capital in excess of par value 114.1 110.0 Retained earnings 393.8 386.4 Common stock in treasury, at cost (4,070,954 and 2,985,066 shares) (76.9 ) (49.9 ) Unearned portion of restricted stock (.1 ) (.1 ) Accumulated other comprehensive loss (18.5 ) (10.6 )
Total Shareholders Equity 412.7 436.1
Total Liabilities and Shareholders Equity $ 794.3 $ 832.5
See accompanying Notes to Consolidated Financial Statements.
RALCORP HOLDINGS, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
Year Ended September 30,
2003 2002 2001
Cash Flows from Operating Activities Net earnings $ 7.4 $ 53.8 $ 39.9 Adjustments to reconcile net earnings to net cash flow provided by operating activities: Depreciation and amortization 38.7 35.8 41.6 Sale of receivables, net (22.4 ) (4.4 ) 61.0 Deferred income taxes (12.8 ) .6 6.3 Equity in loss (earnings) of Vail Resorts, Inc. .7 1.2 (6.0 ) Goodwill impairment loss 59.0 - - Tomato paste asset impairment 5.0 - - Loss on sale of tomato paste business 3.6 - - Changes in current assets and liabilities, net of effects of acquisitions: (Increase) decrease in receivables (1.8 ) 23.0 .4 Decrease (increase) in inventories 15.9 6.2 (7.6 ) (Increase) decrease in prepaid expenses and other current assets (.8 ) .4 .6 Increase (decrease) in accounts payable and other current liabilities 10.7 (10.8 ) (6.7 ) Other, net 2.6 5.0 1.5
Net Cash Provided by Operating Activities 105.8 110.8 131.0
Cash Flows from Investing Activities Business acquisitions, net of cash acquired - (52.1 ) (55.6 ) Additions to property and intangible assets (36.1 ) (29.1 ) (35.7 ) Proceeds from sale of property 2.5 12.4 1.1 Proceeds from sale of tomato paste business 2.9 - - Other, net - (.2 ) -
Net Cash Used by Investing Activities (30.7 ) (69.0 ) (90.2 )
Cash Flows from Financing Activities Purchase of treasury stock (28.6 ) - - Proceeds from issuance of debt 150.0 - - Net repayments under credit arrangements (173.1 ) (44.1 ) (41.7 ) Proceeds from exercise of stock options 2.4 1.6 .7
Net Cash Used by Financing Activities (49.3 ) (42.5 ) (41.0 )
Net Increase (Decrease) in Cash and Cash Equivalents 25.8 (.7 ) (.2 ) Cash and Cash Equivalents, Beginning of Year 3.2 3.9 4.1
Cash and Cash Equivalents, End of Year $ 29.0 $ 3.2 $ 3.9
See accompanying Notes to Consolidated Financial Statements.
RALCORP HOLDINGS, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS EQUITY
(Dollars in millions)
Balance, September 30, 2000 $.3 $110.0 $292.7 $(52.7 ) $- $- $350.3 Net earnings 39.9 39.9 Minimum pension liability adjustment, net of $1.1 tax benefit (1.9 ) (1.9 ) Net gain on cash flow hedging instruments, net of $.2 tax expense .4 .4
Comprehensive income 38.4 Activity under stock plans (approx. 49,000 shares) (.1 ) .8 .7
Balance, September 30, 2001 $ .3 $ 109.9 $ 332.6 $ (51.9 ) $ - $ (1.5 ) $ 389.4 Net earnings 53.8 53.8 Minimum pension liability adjustment, net of $5.7 tax benefit (9.8 ) (9.8 ) Net gain on cash flow hedging instruments, net of $.4 tax expense .7 .7
Comprehensive income 44.7 Activity under stock plans (approx. 117,000 shares) .1 2.0 (.1 ) 2.0
Balance, September 30, 2002 $ .3 $ 110.0 $ 386.4 $ (49.9 ) $ (.1 ) $ (10.6 ) $ 436.1 Net earnings 7.4 7.4 Minimum pension liability adjustment, net of $6.1 tax benefit (10.8 ) (10.8 ) Net gain on cash flow hedging instruments, net of $1.6 tax expense 2.9 2.9
Comprehensive loss (.5 ) Purchases of treasury stock (approx. 1,181,000 shares) (28.8 ) (28.8 ) Deferred compensation 3.3 3.3 Activity under stock plans (approx. 95,000 shares) .8 1.8 2.6
Balance, September 30, 2003 $ .3 $ 114.1 $ 393.8 $ (76.9 ) $ (.1 ) $ (18.5 ) $ 412.7
See accompanying Notes to Consolidated Financial Statements.
RALCORP HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions except per share data)
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Consolidation The financial statements are presented on a consolidated basis and include the accounts of Ralcorp and its majority-owned subsidiaries. All significant intercompany transactions have been eliminated. Investments in 20%50%-owned companies are presented on the equity basis (see Note 7).
Estimates The financial statements have been prepared in conformity with generally accepted accounting principles, which require management to make estimates and assumptions that affect reported amounts and disclosures. Actual results could differ from those estimates and assumptions.
Cash Equivalents include all highly liquid investments with original maturities of three months or less.
Inventories are valued generally at the lower of average cost or market. In connection with purchasing key raw ingredient materials, the Company often uses commodities futures contracts to reduce the risk of price fluctuations related to future raw materials requirements for commodities such as corn, wheat, oats and soybean oil. For more information on these commodity hedging activities, see Note 13.
Property, Plant and Equipment is recorded at cost and depreciation expense is generally provided on the straight-line basis by charges to costs or expenses at rates based on the estimated useful lives of the properties. Estimated useful lives range from 3 to 15 years for machinery and equipment and 10 to 50 years for buildings and leasehold improvements. Depreciation expense was $35.4, $32.3, and $29.4 in fiscal 2003, 2002, and 2001, respectively.
Other Intangible Assets consist of a trademark and computer software developed or obtained for internal use. The trademark currently has an indefinite life and is not subject to amortization. The computer software is recorded at cost and amortized evenly over its estimated useful life, ranging from 3 to 5 years. Amortization expense related to software was $3.3, $3.5, and $4.2 in fiscal 2003, 2002, and 2001, respectively, with $2.3 scheduled for fiscal 2004 and $1.1 scheduled each year for fiscal 2005, 2006, 2007, and 2008.
Recoverability of Long-lived Assets The Company continually evaluates whether events or circumstances have occurred which might impair the recoverability of the carrying value of its long-lived assets, including identifiable intangibles and goodwill. An asset is deemed impaired and written down to its fair value if estimated related future cash flows are less than its carrying amount.
Investments The Company funds a portion of its deferred compensation liability by investing in certain mutual funds in the same amounts as selected by the participating employees. Because managements intent is to invest in a manner that matches the deferral options chosen by the participants and those participants can elect to transfer amounts in or out of each of the designated deferral options at any time, these investments have been classified as trading assets and are stated at fair value in Other Assets. Both realized and unrealized gains and losses on these assets are included in earnings and offset the related change in the deferred compensation liability.
Revenue is recognized in accordance with shipping terms. Net sales reflect gross sales, including amounts billed to customers for shipping and handling, less sales discounts and allowances.
Shipping and Handling costs defined as freight are included in Cost of products sold, while storage and other warehousing costs are included in Selling, general, and administrative. Storage and other warehousing costs totaled $42.0, $40.1, and $34.2 in fiscal 2003, 2002, and 2001, respectively.
Advertising costs are expensed as incurred.
Stock-based Compensation is recognized using the intrinsic value method. Accordingly, no compensation expense has been recognized for the stock options granted since the exercise price was equal to the fair market value of the shares at the grant date, except for $.5 recorded in fiscal 2003 related to the modification of some awards.
If the Company had accounted for the stock-based compensation using the fair value method, which requires recognition of the fair value of the options as compensation cost ratably over the vesting period of the options, net earnings and earnings per share would have been reduced as shown in the following table. See Note 18 for more information about the Companys stock-based compensation plans.
2003 2002 2001
Net earnings, as reported $ 7.4 $ 53.8 $ 39.9 Add: Stock-based employee compensation expense included in reported net earnings, net of related tax effects .5 - - Deduct: Total stock-based employee compensation expense determined under fair value based method, net of related tax effects (2.4 ) (2.5 ) (1.7 )
Pro forma net earnings $ 5.5 $ 51.3 $ 38.2
Earnings per share: Basic - as reported $ 0.25 $ 1.79 $ 1.34 Basic - pro forma $ 0.19 $ 1.71 $ 1.28
Diluted - as reported $ 0.25 $ 1.77 $ 1.33 Diluted - pro forma $ 0.19 $ 1.68 $ 1.27
Recently Issued Accounting Standards Significant developments in accounting rules are discussed below.
During the fourth quarter of fiscal 2001, the Company implemented accounting reclassifications as a result of the consensus of the Emerging Issues Task Force (EITF) on issue 00-10, as well as 00-14 and 00-25 which were later codified and reconciled in EITF 01-9. These reclassifications had no impact on net earnings or earnings per share but did affect reported net sales, cost of products sold, and selling, general and administrative expenses.
In June 2001, the Financial Accounting Standards Board (FASB) issued FAS 141, Business Combinations, which applies to all business combinations initiated after June 30, 2001. The major provisions of FAS 141 include (a) the elimination of the pooling-of-interests method of accounting for business combinations, (b) additional criteria for the recognition of intangible assets independent of goodwill, and (c) disclosure of the primary reasons for a business combination and the allocation of the purchase price paid to the assets acquired and liabilities assumed by major balance sheet caption (see Note 2).
On October 1, 2001, the Company adopted FAS 142, Goodwill and Other Intangible Assets, which stops the amortization of goodwill and requires a goodwill impairment test at least annually. Neither the transitional impairment test at adoption nor the first annual test as of June 30, 2002 resulted in impairment of Ralcorps goodwill. See Note 2 for information regarding the impairment loss recorded in fiscal 2003. The following schedule shows fiscal 2001 net earnings and earnings per share (EPS) adjusted to exclude Ralcorps goodwill amortization expense (net of tax effects) and to adjust Ralcorps equity earnings to exclude the goodwill amortization expense of Vail Resorts, Inc.
Reported $39 .9 $1 .34 $1 .33 Add back: Goodwill amortization 6 .2 .21 .21 Adjust: Equity in earnings of Vail Resorts, Inc. .6 .02 .02
Adjusted $46 .7 $1 .57 $1 .56
On October 1, 2003, the Company adopted FAS 143, Accounting for Asset Retirement Obligations, which addresses financial accounting and reporting for legal obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The Company does not currently have any obligations within the scope of FAS 143, and therefore the application of this statement has had no impact on its financial position, earnings, or cash flows.
FAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets, was adopted by the Company for its financial statements issued for fiscal year 2003, including interim periods. FAS 144 superseded FAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, but retained the requirements to (a) recognize an impairment loss only if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash flows and (b) measure an impairment loss as the difference between the carrying amount and fair value of the asset. The adoption of FAS 144 has not had a material impact on the Companys financial position, earnings, or cash flows.
FAS 145, Rescission of FASB Statements No. 4, 55, and 64, Amendment of FASB Statement No. 13, and Technical Corrections, was generally effective for the Company for fiscal year 2003. The adoption of FAS 145 did not have a material impact on the Companys financial position, earnings, or cash flows.
FAS 146, Accounting for Costs Associated with Exit or Disposal Activities, addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). FAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred rather than at the date of an entitys commitment to an exit plan. Costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity. The Company adopted FAS 146 prospectively for exit or disposal activities initiated after December 31, 2002. The adoption has not had a material impact on the Companys financial position, earnings, or cash flows.
FAS 148, Accounting for Stock-Based Compensation-Transition and Disclosure, amends FAS 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. The Company currently has no plans to change to the fair value based method from the intrinsic value method currently used. In addition, FAS 148 amends the disclosure requirement of FAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Those disclosure provisions were adopted by the Company in fiscal 2003 (see Note 18).
FAS 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, was issued in April 2003 and is generally effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. The amendment has not had a material impact on the Companys financial position, earnings, or cash flows.
FAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, became effective during fiscal 2003. The Company has not issued any financial instruments within the scope of FAS 150.
FASB Interpretation No. (FIN) 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also clarifies that, in certain cases, a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. FIN 45 became effective during fiscal 2003. The Company currently has no obligations from guarantees which would require disclosure or the recognition of a liability, except as disclosed in Note 14 and Note 15.
FIN 46, Consolidation of Variable Interest Entities, an interpretation of ARB 51, was issued January 13, 2003. The Company currently has no involvement with variable interest entities as defined by FIN 46. FIN 46 specifically states that qualifying special-purpose entities, such as Ralcorp Receivables Corporation (RRC) discussed in Note 11, shall not be consolidated unless the holder has the unilateral ability to cause the entity to liquidate or to change the entity so that it no longer meets certain conditions described in Statement 140. Because RRCs Board of Directors must include an independent director, the Company does not have such unilateral ability.
EITF Issue No. 02-17, Recognition of Customer Relationship Intangible Assets Acquired in a Business Combination clarifies certain recognition requirements in FAS 141, Business Combinations. This additional guidance was adopted by the Company in fiscal 2003 and was applied during the annual goodwill impairment tests performed during the year. Its application did not have a material impact on the Companys financial position, earnings, or cash flows.
Reclassifications Certain prior years amounts have been reclassified to conform to the current years presentation.
NOTE 2 ACQUISITIONS AND GOODWILL
Each of the following acquisitions was accounted for using the purchase method of accounting, whereby the results of operations are included in the consolidated statement of earnings from the date of acquisition. The purchase price, including costs of acquisition, was allocated to acquired assets and liabilities based on their estimated fair values at the date of acquisition, and any excess was allocated to goodwill.
On January 30, 2002, the Company completed the purchase of 100 percent of the stock of Lofthouse Foods Incorporated (Lofthouse) for $52.8 in cash obtained through borrowings from the Companys revolving credit agreement. Lofthouse is a producer of high quality cookies sold to the in-store bakeries of major U.S. grocers and mass merchandisers. The combination of Lofthouse with Cascade, acquired in 2000, gave Ralcorp a significant presence in this fast-growth category. The acquired business, with approximately $70 in annual sales, is reported in the Cereals, Crackers and Cookies segment. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. The assigned goodwill is deductible for tax purposes. The trademark has an indefinite life and is not subject to amortization.
Current assets $ 9 .1 Property 12 .1 Goodwill 28 .4 Trademark 9 .0 Other assets .1
Total assets acquired 58 .7
Accounts payable (3 .8) Other current liabilities (2 .1)
Total liabilities assumed (5 .9)
Net assets acquired $ 52 .8
On January 31, 2001, the Company completed the purchase of the wet products portion of The Torbitt & Castleman Company, LLC (T&C), located in Buckner, KY. Acquired product lines include private label syrups, Mexican sauces, jams and jellies, barbecue sauces, flavored syrups and other specialty sauces and are part of the Dressings, Syrups, Jellies & Sauces segment. The $55.6 cost exceeded the fair value of the net assets acquired by $38.9. Before the adoption of FAS 142, that goodwill was being amortized on a straight-line basis over 25 years. The goodwill is deductible for tax purposes.
Pro Forma Information
The following unaudited pro forma information presents the 2002 and 2001 results of operations of the Company, including equity earnings from Vail, as if the fiscal 2002 and 2001 acquisitions described above had occurred as of October 1, 2000. Pro forma adjustments to earnings are net of income taxes at Ralcorps rates and include actual Lofthouse and T&C earnings before taxes, additional interest expense and, in 2001, amortization of related goodwill totaling $1.7 after taxes. These pro forma results may not necessarily reflect the actual results of operations that would have been achieved, nor are they necessarily indicative of future results of operations.
Net sales $ 1,306.1 $ 1,274.3 Net earnings 54.0 39.0 Basic earnings per share 1.80 1.31 Diluted earnings per share 1.77 1.30
The changes in the carrying amount of goodwill by reportable segment (see Note 19) were as follows:
Balance, September 30, 2001 $ 56 .0 $ 99 .1 $ 54 .4 $ 209 .5 Goodwill acquired 28 .4 - - 28 .4 Purchase price allocation adjustment - .1 - .1
Balance, September 30, 2002 $ 84 .4 $ 99 .2 $ 54 .4 $ 238 .0 Goodwill written off related to sale of industrial tomato paste business - (1 .4) - (1 .4) Goodwill impairment loss - (59 .0) - (59 .0)
Balance, September 30, 2003 $ 84 .4 $ 38 .8 $ 54 .4 $ 177 .6
The Companys reporting units are tested for impairment in the fourth fiscal quarter, after the annual forecasting process. In September 2003, a goodwill impairment loss of $59.0 was recognized in the Dressings, Syrups, Jellies & Sauces reporting unit ($45.5 after taxes, or $1.53 per diluted share). Factors leading to the impairment included lost sales and additional charges related to the bankruptcy of Fleming Companies, Inc. (filed April 1, 2003), the inability to quickly replace co-manufacturing business lost at the beginning of fiscal 2003, increasing competitive pricing pressures, and the near-term production inefficiencies arising from restructuring initiatives. Those factors resulted in lower than expected operating profits and cash flows in fiscal 2003, prompting management to revise earnings forecasts for coming years. Estimated fair values of the reporting unit and its identifiable net assets were determined based on the best information available, including independent appraisals and the results of valuation techniques such as EBITDA multiples and expected present value of future cash flows.
NOTE 3 RESTRUCTURING CHARGES
In the quarter ended December 31, 2002, the Company finalized its plans to reduce operations at its Streator, IL facility and transfer production of all product lines except peanut butter to other Dressings, Syrups, Jellies & Sauces locations. Termination benefits totaling $1.2 were paid (145 employees) and equipment with a net book value of $.2 was written off, for a total of $1.4 charged to restructuring expenses in fiscal 2003.
Also in the quarter ended December 31, 2002, the Company sold its ketchup business, including certain equipment and inventory. The resulting net loss on the sale was $1.4 and included writing off or reducing the carrying value of related inventories of packaging, ingredients, and finished products, as well as $.4 for other exit costs incurred. Further, management determined that the resulting reduced cash flows from its tomato paste business, which had supplied the Companys ketchup production, was less than the carrying value of its paste production facility located near Williams, CA. Accordingly, the fair value of the related fixed assets as of December 31, 2002, was assessed based on a preliminary market quote, resulting in an impairment charge of $5.0. On February 4, 2003, the Company sold its tomato paste business, including the Williams, CA, facility. The sale resulted in an additional loss of $3.6, including the write-off of $1.4 of goodwill associated with that business. The ketchup and paste operations were both part of the Dressings, Syrups, Jellies & Sauces segment.
In the quarter ended March 31, 2003, Ralcorp announced its plans to close its in-store bakery (ISB) facility in Kent, WA, part of the Cereals, Crackers & Cookies segment, and transfer production to a new ISB plant located in Utah. The Company is also in the process of transferring production from two other ISB facilities located near the new plant and expects to complete the project by April of 2004. The Company recorded $.2 of Kent employee termination benefits (68 employees), $1.3 of costs to remove and relocate equipment, and $.2 to write-off abandoned leasehold improvements. In addition, $1.2 of Kent operating lease termination costs were recorded as a liability when the facility was vacated, with $.5 in Other current liabilities and $.7 in Other Liabilities on the balance sheet. That amount represents the present value of the remaining lease rentals (through February 2007), reduced by estimated sublease rentals that could be reasonably obtained for the property. Together, these costs totaled $2.9 charged to restructuring expenses in fiscal 2003. All other costs associated with this project are charged to operating expenses as incurred or capitalized, as appropriate.
On January 23, 2001, the Company announced its plan to close the San Jose, CA, plant of its Dressings, Syrups, Jellies & Sauces segment and move production to its other facilities. This process was essentially complete by the end of fiscal 2001. Related costs totaling $.7 were recorded as restructuring charges in fiscal 2001.
On July 24, 2000, the Company announced its plan to close the Baltimore, MD, plant of its Dressings, Syrups, Jellies & Sauces segment and move production to its Dunkirk, NY, facility. This process was completed in fiscal 2001. Related costs totaling $1.9 were recorded as restructuring charges in fiscal 2001.
The following table reconciles the restructuring costs described above to Restructuring Charges shown on the statement of earnings. The after-tax effect was $9.2, or $.31 per diluted share, in 2003 and $1.7, or $.06 per diluted share, in 2001. Other than the Kent lease obligations recorded as described above, there were no restructuring reserves at September 30, 2003 or 2002.
2003 2002 2001
Streator plant downsizing $ 1 .4 $ - $ - Ketchup business sale 1 .4 - - Tomato paste asset impairment 5 .0 - - Tomato paste business sale 3 .6 - - ISB plant restructuring 2 .9 - - San Jose plant closure - - .7 Baltimore plant closure - - 1 .9
$ 14 .3 $ - $ 2 .6
NOTE 4 LITIGATION SETTLEMENT INCOME
The Company received payments in settlement of its claims related to vitamin antitrust litigation. The amounts received were recorded net of related expenses. The after-tax effect was $9.3, or $.31 per diluted share, in 2003 and $1.0, or $.03 per diluted share, in 2002.
NOTE 5 MERGER TERMINATION FEE
Agribrands International, Inc. terminated a merger agreement with Ralcorp on December 1, 2000. In accordance with the agreement, Ralcorp received a payment of $5.0 as a termination fee, which was recorded in the first quarter of fiscal 2001 net of related expenses. The after-tax effect was $2.6, or $.09 per diluted share.
NOTE 6 INCOME TAXES
The provision for income taxes consisted of the following:
2003 2002 2001
Current: Federal $ 26 .8 $ 27 .6 $ 16 .7 State 2 .6 2 .1 1 .2
29 .4 29 .7 17 .9
Deferred: Federal (12 .3) .8 4 .4 State ( .2) .2 ( .2)
(12 .5) 1 .0 4 .2
Income taxes 16 .9 30 .7 22 .1 Deferred income taxes on equity earnings (federal) ( .3) ( .4) 2 .1
Total provision for income taxes $ 16 .6 $ 30 .3 $ 24 .2
A reconciliation of income taxes with amounts computed at the statutory federal rate follows:
2003 2002 2001
Computed tax at federal statutory rate (35%) $ 8 .4 $ 29 .4 $ 22 .4 State income taxes, net of federal tax benefit 1 .6 1 .5 .7 Non-deductible goodwill impairment/amortization 7 .6 - 1 .2 Other, net (1 .0) ( .6) ( .1)
$ 16 .6 $ 30 .3 $ 24 .2
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Deferred tax assets (liabilities) at September 30 were as follows:
Assets Liabilities Net Assets Liabilities Net
Current: Accrued liabilities $ 4 .0 $ - $ 4 .0 $ 2 .4 $ - $ 2 .4 Inventories - (1 .5) (1 .5) 2 .1 - 2 .1 Other items .4 - .4 .6 - .6
4 .4 (1 .5) 2 .9 5 .1 - 5 .1
Noncurrent: Equity investment in Vail - (21 .5) (21 .5) - (21 .8) (21 .8) Property basis differences - (33 .5) (33 .5) - (32 .6) (32 .6) Intangible assets 4 .9 - 4 .9 - (5 .1) (5 .1) Pension 11 .8 - 11 .8 8 .2 - 8 .2 Postretirement benefits 5 .8 - 5 .8 5 .4 - 5 .4 Deferred compensation 7 .4 - 7 .4 5 .6 - 5 .6 Insurance reserves 4 .7 - 4 .7 3 .8 - 3 .8 Other items .4 - .4 .2 - .2
35 .0 (55 .0) (20 .0) 23 .2 (59 .5) (36 .3)
Total deferred taxes $ 39 .4 $ (56 .5) $ (17 .1) $ 28 .3 $ (59 .5) $ (31 .2)
NOTE 7 EQUITY INVESTMENT IN VAIL RESORTS, INC.
On January 3, 1997, the Company sold its ski resorts holdings (Resort Operations) to Vail Resorts, Inc. (Vail) in exchange for 7,554,406 shares of Vail common stock (NYSE:MTN). At the date of the exchange, the Companys equity interest in the underlying net assets of Vail exceeded the net book value of the net assets contributed by the Company to Vail by $37.5. This excess is being amortized ratably to the investment in Vail over 20 years. The unamortized excess was $24.8 and $26.7 as of September 30, 2003 and 2002, respectively. The amount of retained earnings that represents undistributed earnings of Vail was $14.2 and $14.6 as of September 30, 2003 and 2002, respectively.
The following table summarizes information about the Companys equity investment in Vail at September 30:
Ownership percentage 21 .5% 21 .5% Carrying value $ 80 .1 $ 80 .8 Market value 108 .0 107 .0
Terms of a shareholder agreement provide that the Company will not acquire any additional shares of Vail stock except in limited circumstances. The Company has registration rights with respect to the Vail stock, but the shareholder agreement provides that, with certain limited exceptions, Vail and its largest shareholder can purchase at market prices any Vail stock the Company desires to sell. The Company can only sell its Vail stock in a registered offering allowed under the shareholder agreement or in private transactions (provided the purchaser agrees to be bound by the shareholder agreement). The shareholder agreement provides that the Company will vote the shares of Vail stock in accordance with the recommendation of Vails Board of Directors with respect to shareholder proposals and nominations to that Board, and with respect to other proposals, in proportion to the votes of all other shareholders. However, the Company may vote as it deems appropriate with respect to proposals for the merger of Vail, the sale of all Vail assets, the creation of any other class of voting stock of Vail or changes to Vails certificate of incorporation or bylaws if such changes adversely affect the Companys rights under the shareholder agreement. The Company has two representatives on the 17-member Vail Board of Directors.
Vails fiscal year ends July 31, so the Company reports equity earnings on a two-month time lag. In October 2002, Vail filed an amended Annual Report on Form 10-K for July 31, 2001, which included restatements and reclassifications of previously issued financial information. Because the effects on Ralcorps earnings were immaterial for any single year and in total, the Company chose to reflect the full $4.9 impact ($3.2 after taxes, or $.10 per diluted share) in fiscal 2002 rather than restate its previously reported financial statements. In November 2003, Vail again restated its financial statements for prior years. Because the effects on Ralcorps earnings were immaterial for any single year and in total, the Company chose to reflect the full $.8 impact ($.5 after taxes, or $.02 per diluted share) in fiscal 2003 rather than restate its previously reported financial statements. Vails summarized financial information, as restated, follows.
July 31, 2003
July 31, 2002
July 31, 2001
Net revenues $ 710 .4 $ 615 .3 $ 543 .8 Total operating expenses 675 .9 566 .2 497 .9
Income from operations $ 34 .5 $ 49 .1 $ 45 .9
Income before cumulative effect of change in accounting principle $ (8 .5) $ 8 .8 $ 11 .5
Net income $ (8 .5) $ 7 .1 $ 11 .5
July 31, 2003
July 31, 2002
Current assets $ 117 .0 $ 109 .4 Noncurrent assets 1,338 .4 1,339 .6
Total assets $ 1,455 .4 $ 1,449 .0
Current liabilities $ 180 .0 $ 154 .4 Noncurrent liabilities 750 .0 767 .0 Minority interest 29 .2 23 .6 Stockholders equity 496 .2 504 .0
Total liabilities and stockholders equity $ 1,455 .4 $ 1,449 .0
NOTE 8 EARNINGS PER SHARE
The following schedule shows common stock options and deferred compensation awards which were outstanding and could potentially dilute basic earnings per share in the future but which were not included in the computation of diluted earnings per share for the periods indicated because to do so would have been antidilutive. See Note 18 for more information about outstanding options and deferred compensation plans.
Fiscal 2003 Stock options at $25.09 per share 461,500 - - - Stock options at $25.23 per share 4,500 - - - Stock options at $28.15 per share 4,000 4,000 4,000 4,000 Stock options at $29.85 per share - - - 22,500 Fiscal 2002 Stock options at $25.09 per share - - - 461,500 Stock options at $25.23 per share - - - 4,500 Stock options at $28.15 per share - - - 4,000 Deferred compensation awards 113,263 99,856 93,301 - Fiscal 2001 Stock options at $14.63 per share 407,000 - - - Stock options at $16.31 per share 5,000 - - - Stock options at $17.19 per share 432,500 423,500 423,500 - Stock options at $18.50 per share - 458,000 458,000 - Stock options at $19.30 per share - - - 22,500 Deferred compensation awards 220,489 150,889 151,266 125,068
NOTE 9 SUPPLEMENTAL EARNINGS STATEMENT AND CASH FLOW INFORMATION
2003 2002 2001
Repair and maintenance expenses $ 41 .1 $ 41 .8 $ 36 .7 Advertising and promotion expenses 8 .7 8 .7 8 .2 Research and development expenses 6 .2 5 .0 4 .4 Interest paid 3 .6 6 .1 16 .4 Income taxes paid, net of refunds 32 .3 29 .9 13 .6
NOTE 10 SUPPLEMENTAL BALANCE SHEET INFORMATION
Inventories Raw materials and supplies $ 62 .2 $ 59 .3 Finished products 85 .4 102 .3
147 .6 161 .6 Allowance for obsolete inventory (1 .9) (2 .9)
$ 145 .7 $ 158 .7
Property Land $ 5 .0 $ 5 .2 Buildings and leasehold improvements 84 .3 86 .6 Machinery and equipment 378 .7 365 .1 Construction in progress 16 .7 18 .7
484 .7 475 .6 Accumulated depreciation (219 .4) (193 .0)
$ 265 .3 $ 282 .6
Other Intangible Assets Computer software $ 26 .7 $ 21 .6 Trademark 9 .0 9 .0
35 .7 30 .6 Accumulated amortization (20 .0) (16 .7)
$ 15 .7 $ 13 .9
Other Current Liabilities Compensation $ 16 .0 $ 15 .1 Advertising and promotion 14 .6 14 .7 Other items 12 .0 15 .0
$ 42 .6 $ 44 .8
NOTE 11 SALE OF RECEIVABLES
To reduce its long-term debt, on September 24, 2001 the Company entered into a three-year agreement to sell, on an ongoing basis, all of its trade accounts receivable to a wholly owned, bankruptcy-remote subsidiary called Ralcorp Receivables Corporation (RRC). RRC funds its purchases of Ralcorp trade receivables by selling up to $66.0 of ownership interests in such receivables to a bank commercial paper conduit, which issues commercial paper to investors. Ralcorp continues to service the receivables as agent for RRC and the bank conduit. RRC is a qualifying special purpose entity under FAS 140 and the sale of Ralcorp receivables to RRC is considered a true sale for accounting, tax, and legal purposes. Therefore, the trade receivables sold and the related commercial paper borrowings are not recorded on Ralcorps consolidated balance sheet. However, the Companys consolidated balance sheet does reflect an investment in RRC that in substance represents a subordinated retained interest in the trade receivables sold. As of September 30, 2003, the outstanding balance of receivables (net of an allowance for doubtful accounts) sold to RRC was $86.6 and proceeds received were $34.2, resulting in a retained interest of $52.4. As of September 30, 2002, the outstanding balance of receivables sold was $86.3 and proceeds received were $56.6, resulting in a retained interest of $29.7. Discounts related to the sale of receivables totaled $.7 and $1.2 for the years ended September 30, 2003 and September 30, 2002, respectively, and are included on the statement of earnings in Selling, general and administrative expenses.
NOTE 12 ALLOWANCES FOR DOUBTFUL ACCOUNTS AND OBSOLETE INVENTORY
2003 2002 2001
Allowance for Doubtful Accounts Balance, beginning of year $ - $ - $ 1 .6 Provision charged to expense 1 .7 .1 .4 Write-offs, less recoveries (2 .2) ( .3) ( .3) Acquisitions - - .2 Transfers to Ralcorp Receivables Corporation .5 .2 (1 .9)
Balance, end of year $ - $ - $ -
Allowance for Obsolete Inventory Balance, beginning of year $ 2 .9 $ 2 .5 $ 1 .6 Provision charged to expense 4 .7 5 .5 3 .6 Write-offs of inventory (5 .7) (5 .2) (2 .8) Acquisitions - .1 .1
Balance, end of year $ 1 .9 $ 2 .9 $ 2 .5
NOTE 13 DERIVATIVES AND OTHER FINANCIAL INSTRUMENTS
The carrying amounts reported on the Consolidated Balance Sheet for cash and cash equivalents, receivables and accounts payable approximate fair value because of the short maturities of these financial instruments. The estimated fair value of the Companys long-term debt (see Note 14) approximates book value since the interest rates on nearly all of the outstanding borrowings are adjusted frequently.
Concentration of Credit Risk
The Companys primary concentration of credit risk is related to certain trade accounts receivable due from several highly leveraged or at risk customers. At September 30, 2003 and 2002, the amount of such receivables was immaterial. Consideration was given to the financial position of these customers when determining the fair value of the Companys subordinated retained interest in accounts receivable (see Note 11).
On October 1, 2000, the Company implemented Statement of Financial Accounting Standards (FAS) No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by FAS 137 and FAS 138 (collectively, the Statement). This Statement requires all derivatives to be recognized in the balance sheet at fair value, with changes in that fair value to be recorded in current earnings or deferred in other comprehensive income, depending on whether the derivative instrument qualifies as a hedge and, if so, the nature of the hedging activity. The Companys transition adjustment upon adoption of the Statement was immaterial. In the ordinary course of business, the Company is exposed to commodity price risks relating to the acquisition of raw materials and supplies and interest rate risks relating to debt. Authorized individuals within the Company may utilize derivative financial instruments, including (but not limited to) futures contracts, option contracts, forward contracts and swaps, to manage certain of these exposures by hedging when it is practical to do so. The terms of these instruments generally do not exceed twelve months. The Company is not permitted to engage in speculative or leveraged transactions and will not hold or issue financial instruments for trading purposes. Hedge accounting is only applied when the derivative is deemed to be highly effective at offsetting changes in fair values or anticipated cash flows of the hedged item or transaction. Earnings impacts for all designated hedges are recorded in the Consolidated Statement of Earnings within the same line item as the gain or loss on the item being hedged. For a fair value hedge of a recognized asset or liability or unrecognized firm commitment, the entire change in fair value of the derivative is recorded in earnings as incurred. For a cash flow hedge of an anticipated transaction, the ineffective portion of the change in fair value of the derivative is recorded in earnings as incurred, whereas the effective portion is deferred in accumulated other comprehensive income in the Consolidated Balance Sheet until the transaction is realized, at which time any deferred hedging gains or losses are recorded in earnings. During fiscal 2003, 2002, and 2001, hedging activities consisted only of cash flow hedges on ingredient and packaging purchases. Hedge gains totaling $5.3 were deferred into accumulated other comprehensive income during fiscal 2003, $.8 was reclassified into
earnings, and $.1 of ineffectiveness was recorded in earnings as incurred. During fiscal 2002, hedge gains totaling $2.0 were deferred into accumulated other comprehensive income, $.9 was reclassified into earnings, and $.1 of ineffectiveness was recorded in earnings as incurred. Corresponding amounts were immaterial during fiscal 2001. The contractual amounts of the related derivatives totaled $21.2 and $10.5 at September 30, 2003 and 2002, respectively, while the corresponding fair values were $5.2 and $1.0.
NOTE 14 LONG-TERM DEBT
Long-term debt consisted of the following at September 30:
Floating Rate Senior Notes, Series A $150.0 1.980 % $ - n/a $275 Revolving Credit Agreement - n/a 165.0 2.754 % Uncommited credit arrangements .1 2.000 % 8.0 2.700 % Industrial Development Revenue Bond 5.6 0.990 % 5.6 1.540 % Other .2 Various .4 Various
On May 22, 2003, the Company issued Floating Rate Senior Notes, Series A, in the amount of $150.0. Borrowings under this private placement debt financing incur interest at a rate of 3-month LIBOR plus 0.85%, adjusted quarterly, with interest payable quarterly in arrears. Borrowings under this agreement are unsecured and mature on May 22, 2010. The note agreement contains certain representations, warranties, covenants, and conditions customary to agreements of this nature. The covenants include requirements that debt not exceed 3.5 times EBITDA (defined generally as net earnings plus interest expense, taxes, depreciation, and amortization) and that adjusted net worth remain above a certain minimum amount.
On October 16, 2001, the Company entered into a $275 revolving credit agreement. Borrowings under the credit agreement incur interest at the Companys choice of either (1) LIBOR plus the applicable margin rate (currently 0.875%) or (2) the maximum of the federal funds rate plus 0.50% or the prime rate. Such borrowings are unsecured and mature on October 16, 2004 unless such date is extended. The credit agreement calls for an unused fee (currently 0.20%), payable quarterly in arrears, and contains certain representations, warranties, covenants, and conditions customary to credit facilities of this nature. The covenants include requirements that debt not exceed three times EBITDA (defined generally as net earnings plus taxes, interest expense, depreciation, and amortization), EBIT (defined generally as net earnings plus interest and taxes) be at least three times interest expense, and adjusted net worth remain above a certain minimum amount.
The Company has entered into uncommitted credit arrangements with banks that totaled $35.0 as of September 30, 2003. Borrowings under these arrangements typically have terms of less than a week. The amounts outstanding under these arrangements at September 30, 2003 matured October 1, 2003. Based upon managements intent and ability to refinance these amounts on a long-term basis, they were classified as long-term.
Through the acquisition of The Red Wing Company, Inc., the Company acquired an Industrial Development Revenue Bond in the amount of $5.6, which bears interest at a variable rate and matures on April 1, 2005.
As of September 30, 2003, $10.2 in letters of credit and surety bonds were outstanding with various financial institutions, principally related to self-insurance requirements.
NOTE 15 COMMITMENTS AND CONTINGENCIES
The Company is a party to a number of legal proceedings in various state and federal jurisdictions. These proceedings are in varying stages and many may proceed for protracted periods of time. Some proceedings involve complex questions of fact and law. Additionally, the operations of the Company, like those of similar businesses, are subject to various federal, state, and local laws and regulations intended to protect public health and the environment, including air and water quality and waste handling and disposal.
Pending legal liability, if any, from these proceedings cannot be determined with certainty; however, in the opinion of Company management, based upon the information presently known, the ultimate liability of the Company, if any, arising from the pending legal proceedings, as well as from asserted legal claims and known potential legal claims which are probable of assertion, taking into account established accruals for estimated liabilities (if any), are not expected to be material to the Companys consolidated financial position, results of operations and cash flows. In addition, while it is difficult to quantify with certainty the potential financial impact of actions regarding expenditures for compliance with regulatory matters, in the opinion of management, based upon the information currently available, the ultimate liability arising from such compliance matters should not be material to the Companys consolidated financial position, results of operations and cash flows.
Additionally, the Company has retained certain potential liabilities associated with divested businesses (its former branded cereal business and ski resort business). Presently, management believes that taking into account applicable liability caps, sharing arrangements with acquiring entities and the known facts and circumstances regarding the retained liabilities, potential liabilities of the divested businesses should not be material to the Companys consolidated financial position, results of operations and cash flows.
Future minimum rental payments (receipts) under noncancelable operating leases and subleases in effect as of September 30, 2003 were:
2004 2005 2006 2007 2008 Later Total
Leases $ 5.2 $ 5.0 $ 2.5 $ 1.7 $ .9 $ 2.9 $ 18.2 Subleases (.6 ) (.7 ) (.1 ) - - - (1.4 )
Rent expense for all operating leases was $7.9, $7.6, and $7.2 in fiscal 2003, 2002, and 2001, respectively, net of sublease income of $.6 in each year.
Container Supply Agreement
During fiscal 2002, the Company entered into a ten-year agreement to purchase certain containers from a single supplier. It is believed that the agreement was related to the suppliers financing arrangements regarding the container facility. The Companys total purchases under the agreement were $7.7 in fiscal 2003 and $2.6 in fiscal 2002. Generally, to avoid a shortfall payment requirement, the Company must purchase approximately 655 million additional containers by the end of the ten-year term. The minimum future payment obligation cannot be determined at this time, but is currently estimated at $4.7.
In connection with the sale of the Companys Resort Operations in 1997, Vail assumed the obligation to repay, when due, certain indebtedness of Resort Operations consisting of the following: Series 1990 Sports Facilities Refunding Revenue Bonds in the aggregate principal amount of $19.0, bearing interest at rates ranging from 7.75% to 7.875% and maturing in installments in 2006 and 2008; and Series 1991 Sports Facilities Refunding Revenue Bonds in the aggregate principal amount of $1.5, bearing interest at 7.375% and maturing in 2010 (collectively, Resort Operations Debt). The Resort Operations Debt is guaranteed by Ralston Purina Company (Ralston). Pursuant to an Agreement and Plan of Reorganization signed when the Company was spun-off from Ralston in 1994, the Company agreed to indemnify Ralston for any liabilities associated with the guarantees. To facilitate the sale of the Companys branded cereal business to General Mills in 1997, General Mills acquired the legal entity originally obligated to so indemnify Ralston. Pursuant to the Reorganization Agreement with General Mills, however, the Company has agreed to indemnify General Mills for any liabilities it may incur with respect to indemnifying Ralston relating to aforementioned guarantees. Presently, management believes there is not a significant likelihood that Vail will default on its repayment obligations with respect to the Resort Operations Debt.
NOTE 16 PENSION AND OTHER POSTRETIREMENT BENEFITS
The Company sponsors qualified and supplemental noncontributory defined benefit pension plans and other postretirement benefit plans for its employees. The following tables provide a reconciliation of the changes in the plans benefit obligations and fair value of assets over the two-year period ending September 30, 2003, and a statement of the funded status as of September 30 of both years.
Pension Benefits Other Benefits
2003 2002 2003 2002
Change in benefit obligation Benefit obligation at beginning of year $ 138 .2 $ 124 .2 $ 27 .7 $ 20 .6 Service cost 5 .4 4 .8 .1 .1 Interest cost 9 .1 8 .8 1 .8 1 .4 Actuarial loss 20 .7 6 .2 1 .6 7 .7 Curtailment gain (15 .8) - - - Benefit payments (6 .1) (5 .8) (1 .4) (2 .1)
Benefit obligation at end of year $ 151 .5 $ 138 .2 $ 29 .8 $ 27 .7
Change in fair value of plan assets Fair value of plan assets at beginning of year $ 99 .6 $ 107 .6 $ - $ - Actual return on plan assets 11 .3 (2 .3) - - Employer contributions 10 .1 .1 - - Benefit payments (6 .1) (5 .8) - -
Fair value of plan assets at end of year $ 114 .9 $ 99 .6 $ - $ -
Funded status $ (36 .6) $ (38 .6) $ (29 .8) $ (27 .7) Unrecognized net actuarial loss 40 .1 35 .0 14 .0 13 .3 Unrecognized prior service cost - - ( .1) ( .2) Unrecognized transition asset ( .1) ( .1) - -
Net amount recognized $ 3 .4 $ (3 .7) $ (15 .9) $ (14 .6)
Amounts recognized Accrued benefit liability $ (32 .0) $ (22 .2) $ (15 .9) $ (14 .6) Accumulated other comprehensive income 35 .4 18 .5 - -
Net amount recognized $ 3 .4 $ (3 .7) $ (15 .9) $ (14 .6)
Weighted-average assumptions as of September 30 Discount rate 6.00 % 6.75 % 6.00 % 6.75 % Rate of compensation increase 4.75