UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 29, 2002
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-16699
OVERHILL FARMS, INC.
(Exact name of registrant as specified in its charter)
Nevada 75-2590292
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
2727 East Vernon Avenue
Vernon, California 90058
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(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (323) 582-9977
Securities registered under Section 12(b) of the Act:
Title of each class Name of each exchange on which
to be so registered each class is to be registered
Common Stock, par value $0.01 American Stock Exchange
Securities registered under 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 (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of voting stock held by non-affiliates of the
registrant as of December 20, 2002 (based on the closing price on such date on
the American Stock Exchange) was approximately $10,073,000. For purposes of this
computation, all executive officers, directors and 10% beneficial owners of the
registrant are deemed to be affiliates. Such determination should not be deemed
an admission that such executive officers, directors and 10% beneficial owners
are affiliates.
There were 12,338,797 shares of common stock outstanding as of December
20, 2002.
TABLE OF CONTENTS
PART I
ITEM 1 Business 1
ITEM 2 Properties 3
ITEM 3 Legal Proceedings 4
ITEM 4 Submission of Matters to a Vote of Security Holders 4
PART II
ITEM 5 Market for the Company's Common Stock and Related Stockholder Matters 5
ITEM 6 Selected Financial Data 7
ITEM 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 9
ITEM 7A Quantitative and Qualitative Disclosures About Market Risk 23
ITEM 8 Financial Statements and Supplementary Data 23
ITEM 9 Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 23
PART III
ITEM 10 Directors and Executive Officers of the Registrant 24
ITEM 11 Executive Compensation 26
ITEM 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 31
ITEM 13 Certain Relationships and Related Transactions 32
ITEM 14 Controls and Procedures 35
PART IV
ITEM 15 Exhibits, Financial Statement Schedules, and Reports on Form 8-K 36
SIGNATURES 40
CERTIFICATIONS 41
(i)
PART I
ITEM 1. Business
History
Overhill Farms, Inc. was formed in 1995 as a Nevada corporation. In May
1995, we acquired all of the operating assets of IBM Foods, Inc. for a cash
payment of $31.3 million, plus the assumption of certain liabilities. While our
business is nationwide, our headquarters are located in Vernon, California, and
we have facilities throughout Southern California. During August 2000, we
purchased the operating assets and trademarks of the Chicago Brothers food
operations from a subsidiary of Schwan's Sales Enterprises, Inc. for total
consideration of $4.2 million, consisting of cash of $3.3 million and a note
payable to the seller for $900,000.
We were a 99% owned subsidiary of TreeCon Resources, Inc., formerly known
as Overhill Corporation, until the completion of our spin-off in October 2002.
In the spin-off, TreeCon Resources distributed all of the outstanding shares of
our common stock that it owned to the holders of record of TreeCon Resources
common stock as of the close of business on September 30, 2002.
Products and Services
Overhill Farms, Inc. is a value-added manufacturer of quality frozen food
products including entrees, plated meals, meal components, soups, sauces,
poultry, meat and fish specialties. We are positioned as a provider of custom
prepared foods to a number of prominent customers such as Albertson's, Jenny
Craig Products, Carl's Jr., Jack in the Box, Panda Restaurant Group, Schwan's
and King's Hawaiian/Pinnacle Foods as well as most domestic airlines, including
American Airlines, United Airlines and Delta Airlines
Sales and Marketing
We market our products through an internal sales force and outside food
brokers. Historically, we have served four industries: airlines, weight loss,
foodservice and retail. In previous periods, we identified the foodservice and
retail markets as the two segments with the greatest potential for increased
sales. Accordingly, we have realigned our sales force and redirected our
marketing efforts to concentrate on those two areas.
Over two-thirds of our sales for the fiscal year ended September 29, 2002
were derived from six customers, Panda Restaurant Group, Jenny Craig Products,
King's Hawaiian/Pinnacle Foods, American Airlines, Delta Airlines and
Albertson's, representing approximately 21%, 15%, 11%, 9%, 8% and 8% of total
sales, respectively. Although our relationships with these customers continue to
remain strong, there can be no assurance that these relationships will continue.
When possible, we make a concerted effort to sign multi-year supply agreements
with our major customers. A decline in sales of our products to these customers
or the loss of, or a significant change in the relationship between us and any
of these key customers, without the acquisition of replacement business, could
have a material adverse effect on our business and operating results. It is our
objective to continue to reduce the reliance on a small concentration of
accounts by further expansion into custom products for retail and foodservice
customers nationwide.
1
Manufacturing and Sourcing
Our manufacturing operations are located in five separate facilities with
three in the Los Angeles area and two in the San Diego area. With the addition
of the San Diego facilities and the outsourcing of certain products, management
estimates that the combined facilities are operating at approximately 70% of
capacity based on current product mix. We are currently in the process of
implementing programs to improve manufacturing efficiencies, including the
consolidation of facilities and the addition of equipment to improve freezing
capabilities and to automate some operations. We have entered a lease for a new
facility in Vernon, California and are currently in the process of consolidating
certain of our manufacturing, home office, warehousing, product development and
marketing and quality control facilities. Specifically, we expect to close our
two facilities in the San Diego area and two of our existing Los Angeles area
facilities and consolidate these operations and certain related personnel into
our new facility in Vernon, California. The consolidation of these facilities is
currently in process and is expected to be fully completed by April 2003.
Our ability to economically produce large quantities of our products, while
at the same time maintaining a high degree of quality, depends on our ability to
procure raw materials on a reasonable basis. We rely on a few large suppliers
for our poultry products and purchase the remaining raw materials from suppliers
in the open market. We do not anticipate any difficulty in acquiring these
materials in the future. Raw materials, packaging for production and finished
goods are stored on site or in public frozen food storage facilities until
shipment.
Backlog
We typically deliver products directly from finished goods inventory. As a
result, we do not maintain a large backlog of unfilled purchase orders. While at
any given time there may be a small backlog of orders, our backlog is not
material in relation to total sales, nor is it necessarily indicative of trends
in our business. Some orders are subject to changes in quantities or to
cancellation with 30 days' notice without penalties to customers.
Competition
Our food products, consisting primarily of poultry, pasta, beef and
assorted related products, compete with products produced by numerous regional
and national firms. Many of these companies are divisions of larger fully
integrated companies such as Tyson Foods and ConAgra, which have greater
financial, technical, human and marketing resources than we have. Competition is
intense with most firms producing similar products for the foodservice and
retail industries. Competitive factors include price, product quality,
flexibility, product development, customer service and, on a retail basis, name
recognition. We are competitive in this market by our ability to produce
mid-sized/custom product runs, within a short time frame and on a cost effective
basis. We can give no assurance that we will compete successfully against
existing companies or new entrants to the marketplace.
Product Development and Marketing
We manufacture products in the retail and food service areas with branded
and private label entrees. We maintain a comprehensive, fully staffed test
kitchen which formulates recipes and upgrades specific products for current
customers and establishes production and quality standards. We develop products
based upon either customers' specifications, conventional recipes or new product
developments. We are continuously developing recipes as customers' tastes and
client requirements change. We also maintain a quality control department for
testing and quality control.
Intellectual Property
We have registered the trademark "Overhill Farms," among others, in the
United States Patent and Trademark Office, and previously acquired other
trademarks including, among others, "Chicago Brothers" and "Florence Pasta and
Cheese."
2
Employees
The Company's total hourly and salaried workforce consists of approximately
1,000 employees at September 29, 2002. Most of our operations are labor
intensive, generally requiring semi-skilled employees. Also, the Los Angeles
manufacturing employees are unionized with contracts through 2003 and 2004
covering each of the three plants. Our union contract with Teamsters Local 986,
which represents our Plant No. 1 employees, was renewed as of December 1, 2000
through November 30, 2003. Additionally, UFCW Local 770, the union for our other
Los Angeles operations, ratified a three-year renewal of their union contract on
March 1, 2002. We believe relations with the unions are good.
Manufacturing processes in San Diego are more machine intensive, requiring
more skilled machine operators, mechanics, and supervision. The workforce in San
Diego is not unionized, and we consider our relations with all of our employees
to be good.
Regulation
Food manufacturers are subject to strict government regulation,
particularly in the health and environmental areas, by the United States
Department of Agriculture, also called the "USDA," the Food and Drug
Administration, or the "FDA," Occupational Safety and Health Administration, or
"OSHA", and the Environmental Protection Agency, or the "EPA". Our food
processing facilities are subject to on-site examination, inspection and
regulation by the USDA. Compliance with the current applicable federal, state
and local environmental regulations has not had, and we do not believe that in
the future such compliance will have, a material adverse effect on our financial
position, results of operations, expenditures or competitive position. To date,
we have never been required to recall any of our products. During 1997, we
implemented a Hazard Analysis Critical Point Plan to ensure proper handling of
all food items. This plan is currently in use by us as well.
ITEM 2. Properties
We lease three manufacturing facilities in the Los Angeles, California
area. Plant No. 1 is located in Inglewood, California and has 39,000 square feet
of manufacturing area. Plants No. 2 and No. 3 are located in Vernon, California
and have 49,000 and 27,000 square feet of manufacturing area, respectively. In
addition to the manufacturing facilities, we also lease two warehouse facilities
in Inglewood, California, one of which consists of 13,500 square feet of dry
goods storage and the other consisting of 11,500 feet of dry goods storage and
7,700 square feet of frozen storage. Our Chicago Brothers operations are
conducted in leased facilities in San Diego, California consisting of a
manufacturing facility of 33,300 square feet and a 9,400 square foot warehouse
and administration facility. We believe that the existing facilities are
adequate to meet our requirements in the foreseeable future. However, we entered
into a ten-year lease for a 147,210 square foot facility in Vernon, California,
and we have begun to consolidate certain of our home office, manufacturing and
warehousing, product development, and marketing and quality control facilities
into a single location. Management believes that when the plan is fully
implemented, we should expect to achieve operating efficiencies as well as a
reduction of our dependence on outside cold storage facilities. As part of the
consolidation plan, by April 2003 we expect to close our two facilities in San
Diego, California and two of our Los Angeles area facilities, Plant No. 1 and
Plant No. 3, and consolidate these operations and certain employees into our new
Vernon, California facility.
3
ITEM 3. Legal Proceedings
During fiscal 1997, five substantially identical complaints were filed in
the United States District Court for the District of Nevada against TreeCon
Resources, then known as Polyphase Corporation, and certain of its officers and
directors. The lawsuits asserted liability based on alleged misrepresentations
that the plaintiffs claimed resulted in the market price of TreeCon Resources'
stock being artificially inflated. Although we were, at the time, a wholly owned
subsidiary of TreeCon Resources, we were not named as a defendant in any of
those actions.
Following the District Court's granting of summary judgments for the
defendants, two of the plaintiffs appealed to the United States Court of Appeals
for the Ninth Circuit. In September 2001, those two plaintiffs then requested
the Ninth Circuit to enjoin our proposed spin-off from TreeCon Resources. The
Court of Appeals denied the plaintiffs' request and directed them to address
their request to the District Court. The two plaintiffs thereafter filed an
application with the District Court, which restrained the spin-off for a few
days until a hearing could be conducted. Following an October 11, 2001 hearing
at which counsel for all parties appeared, the District Court dissolved its
temporary restraining order, thereby allowing TreeCon Resources to proceed with
the spin-off. The plaintiffs did not appeal that decision by the District Court.
On June 5, 2002, the Ninth Circuit rendered a decision that affirmed
several of the trial court's rulings but reversed other rulings and remanded
portions of the case for further proceedings in the District Court. Among other
things, the Court of Appeals remanded certain claims against TreeCon Resources
and four individual defendants for further consideration by the trial court.
Following remand, the District Court scheduled the trial of the remaining
issues in the case for March 10, 2003. The same two plaintiffs then filed a
second motion to enjoin the spin-off which the District Court denied on
September 26, 2002. The spin-off was completed in October 2002.
Two of the plaintiffs recently filed a motion for class certification which
has not yet been decided by the District Court. Those plaintiffs have advanced
damage estimates for a proposed class in excess of $3,000,000. Any monetary
recovery by the plaintiffs in that action, however, should not affect us unless
and until the plaintiffs were to file another lawsuit and were able to recover
damages directly against us.
From time to time, we are involved in various lawsuits, claims and
proceedings related to the conduct of our business. Management does not believe
that the disposition of any pending claims is likely to have a material adverse
effect on our financial condition, results of operations, or cash flows.
ITEM 4. Submission of Matters to a Vote of Security Holders
On October 29, 2002, the holders of a majority of our outstanding stock
approved by written consent proposals to:
. amend and restate our Articles of Incorporation;
. amend and restate our Bylaws;
. appoint directors to fill in three vacancies on the board of
directors; and
. approve our Employee Stock Option Plan. However, we intend to ask our
stockholders to approve the plan at our next annual meeting of
stockholders.
4
PART II
ITEM 5. Market for the Company's Common Stock and Related Stockholder Matters
Our common stock began trading on the American Stock Exchange under the
symbol OFI on November 1, 2002. At December 20, 2002, we had 188 stockholders of
record.
We have never paid cash dividends and do not anticipate paying them in the
foreseeable future. We currently anticipate that no cash dividends will be paid
on our common stock in the foreseeable future in order to conserve cash for use
in our businesses, including possible future acquisitions. Our board of
directors will periodically re-evaluate this dividend policy taking into account
our operating results, capital needs, the terms of our financing arrangements
and other factors. Also, our current financing arrangements prohibit us from
paying dividends.
Recent Sales of Unregistered Securities
In connection with the refinancing of certain indebtedness in December
1997, warrants to purchase 7.75 shares of our common stock, exercisable for a
total consideration of $50,000, were issued to Durham Capital Corporation, an
unrelated consulting firm. These warrants were exercised in December 2000.
In November 1999, in connection with the purchase of a $28 million secured
senior subordinated note by our senior subordinated creditor, we issued to it a
warrant to purchase 166.04 shares of our common stock exercisable immediately at
an exercise price of $0.01 per share. This warrant became exercisable for
1,994,141 shares of our common stock at an exercise price of $0.0000008 per
share as a result of the 12,010-shares-for-1 stock split approved by our Board
of Directors in connection with the spin-off. This warrant was exercised as to
1,994,040 shares in December 2002 and remains exercisable as to 100 shares. At
the date of issuance, this warrant was estimated to have a fair value of $2.37
million.
Our senior subordinated creditor is the holder of a secured senior
subordinated note, which it purchased from us in November 1999 pursuant to a
securities purchase agreement. We amended and restated the securities purchase
agreement, the note and various related agreements in connection with the
spin-off. The note bears interest at a base rate per annum of 13.25%, with
interest payable monthly. However, if we achieve specified EBITDA tests for the
fiscal year ending September 2003, the base rate will be reduced to 12.5%. The
note matures on October 31, 2004. We are required to make mandatory principal
payments each January for the previous fiscal year in an amount equal to 50% of
the excess cash flow, as defined. The amount of the principal prepayment for the
fiscal year ended September 29, 2002 is approximately $541,000. We may make
voluntary principal prepayments at any time, subject to prepayment premiums. The
securities purchase agreement contains various covenants, including financial
covenants covering restrictions on capital expenditures, minimum EBITDA and net
worth levels, and specified debt service and debt to equity ratios. In addition,
the terms of the securities purchase agreement prohibit changes in control,
including ownership and management personnel, and contains customary
restrictions on incurring indebtedness and liens, making investments, paying
dividends and making certain loans or advances. The note and all other
obligations owing by us to our senior subordinated creditor are secured by
subordinated liens on substantially all of our assets and by a guaranty of
Overhill L.C. Ventures, Inc., our subsidiary. In connection with the spin-off,
our senior subordinated creditor released TreeCon Resources from its guaranty
and released its lien on our common stock held by TreeCon Resources, which
secured TreeCon Resources' guaranty. The agreement requires us to pay our senior
subordinated creditor, during each January, annual consulting fees of $180,000.
5
In 2002, we entered into various amendments to our securities purchase
agreement with our senior subordinated creditor with respect to, among other
things, the consolidation of our facilities and amendments to our financial
covenants with it. In exchange for our senior subordinated creditor's consent
and agreement to amend the securities purchase agreement and other investment
documents and certain other consideration, in January 2002 we issued to it 23.57
shares of our Series A Convertible Preferred Stock valued at $750,000, and in
September 2002 we issued to it a warrant to purchase 57.57 shares of our common
stock valued at $1,100,000 and agreed to pay a restructuring fee in an aggregate
amount of $423,000 payable in three installments ending in March 2003. After
giving effect to the 12,0101-shares-for-1 stock split declared in connection
with the spin-off, the shares of Series A Convertible Preferred Stock are
convertible into 283,076 shares of our common stock, and the warrant was
exercisable for 691,416 shares of our common stock at an exercise price of
$0.0000008 per share. This warrant was exercised as to 691,315 shares in
December 2002 and remains exercisable as to 100 shares. The designations for the
Series A Convertible Preferred Stock provide the holder with, among other
things, a liquidation preference per share of $31,820.11, plus declared and
unpaid dividends, voting rights along with holders of common stock, protective
provisions, conversion rights and anti-dilution protection. In September 2002, a
previous agreement for an interest rate reduction upon our making certain
voluntary prepayments and our obligation to make a $500,000 cash payment in the
event we did not repurchase the previous warrant or shares issuable under the
warrant upon repayment of our senior subordinated debt was terminated.
Our securities purchase agreement with our senior subordinated creditor
provides that it is entitled to anti-dilution protection so that the shares of
common stock issuable upon exercise of its warrants and conversion of its shares
of our Series A Convertible Preferred Stock will represent in the aggregate not
less than 24.0% of our outstanding shares of capital stock, determined on a
fully diluted basis and including the reservation of shares of common stock for
issuance under our 2002 Employee Stock Option Plan. In November 2002, we issued
252,632 shares of our common stock to our senior subordinated creditor
representing all shares currently issuable pursuant to the anti-dilution
protection.
Pursuant to our equity repurchase option agreement with our senior
subordinated creditor, we have the right to repurchase from it, in whole but not
in part, the shares of our common stock issuable upon exercise of the warrants
and conversion of the shares of our Series A Convertible Preferred Stock it
holds and the shares of our Series A Convertible Preferred Stock it holds. We
may exercise this option if:
. a default occurs under the securities purchase agreement and the holder
provides written notice to us requesting that we make payments in
addition to those which we are then obligated to make under our then
existing financing arrangement or declares all of our obligations to the
holder under the securities purchase agreement to be immediately due and
payable, or
. if we notify the holder that we intend to merge, sell all or a
significant portion of our assets, reorganize or recapitalize or enter
into a bona fide transaction valued at more than $8.0 million and it
does not consent to the transaction.
If we exercise our repurchase option, we may repurchase its shares of our
common stock for:
. if our common stock is publicly traded, the greater of the current
market price per share or an amount per share based on a predetermined
formula, or
. if our common stock is not publicly traded, an amount based on the
predetermined formula.
We may repurchase its shares of our Series A Convertible Preferred Stock
for an amount equal to the greater of:
. the number of shares of our common stock issuable upon conversion of the
shares of Series A Convertible Preferred Stock being repurchased
multiplied by the per share amount determined with respect to our common
stock, and
6
. $540,000.
None of the transactions described above involved any underwriters,
underwriting discount or commissions, or any public offering, and we believe
that the transactions were exempt from the registration requirements of the
Securities Act of 1933, as amended, by virtue of Section 4(2) thereof or
Regulation D promulgated thereunder. Both investors represented their intentions
to acquire the securities for investment purposes only and not with a view to or
for sale in connection with any distribution thereof, and appropriate legends
were affixed to the instruments issued to them. Both investors had adequate
access, through their relationships with us, to information about us.
7
ITEM 6. Selected Financial Data
The following table sets forth selected historical financial data of
Overhill Farms, Inc. The selected financial data as of and for each of the last
five fiscal years has been derived from the consolidated financial statements of
Overhill Farms, Inc., which have been audited by Ernst & Young LLP, independent
auditors.
The selected historical statement of income data set forth below may not
reflect certain changes that will occur in the operations and capitalization of
our company as a result of the spin-off. Before the spin-off, we operated as
part of TreeCon Resources. Because the data reflect periods during which we did
not operate as an independent public company, the data may not reflect the
results of operations or the financial position that would have resulted if we
had operated as a separate, independent public company during the periods shown.
In addition, the data may not necessarily be indicative of our future results of
operations or financial position. The historical data should be read in
conjunction with sections entitled "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the consolidated financial
statements and the related notes included elsewhere in this Form 10-K.
Fiscal Year Ended
---------------------------------------------------------------------------------
September 29, September 30, October 1, September 26, September 27,
2002 2001 2000 1999 1998
---- ---- ----- ----- ----
Income Statement Data (in
thousands, except per share
information):
Net Revenues 138,119 $162,158 $145,418 $113,016 $93,349
Operating Income (a) 7,298 9,483 10,813 7,384 4,977
Income (Loss) Before
Extraordinary Items (a) 1,030 2,242 3,331 1,002 (136)
Net Income (Loss) (a) 1,030 2,242 2,492 1,002 (506)
Net Income (Loss) per share -
Basic (a) (b) $ 0.11 $ 0.24 $ 0.27 $ 0.11 ($0.05)
Net Income (Loss) per share -
Diluted (a) (b) $ 0.09 $ 0.20 $ 0.22 $ 0.08 ($0.05)
As of Fiscal Year Ended
---------------------------------------------------------------------------------
September 29, September 30, October 1, September 26, September 27,
2002 2001 2000 1999 1998
---- ---- ----- ----- ----
Balance Sheet Data (in
thousands):
Total Assets 59,018 $ 54,207 $ 57,946 $ 38,987 $34,108
Long-Term Debt 36,242 32,951 40,860 32,355 22,308
Total Liabilities 53,666 50,743 57,602 41,669 38,728
Retained Earnings 7,842 6,812 4,570 2,078 1,076
Stockholders' Equity
(Deficit) 5,352 3,464 344 (2,682) (4,620)
8
(a) The Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets"
effective October 1, 2001 and, accordingly, has ceased amortization of goodwill.
Had the Company been accounting for goodwill under SFAS No. 142 for all periods
presented, operating income would have increased by $850,000 in fiscal 2001 and
$650,000 in fiscal 2000, 1999 and 1998, income (loss) before extraordinary items
would have increased by $548,000 in fiscal 2001 and $429,000 in fiscal 2000,
1999 and 1998, and net income (loss) would have increased by $548,000 ($0.06 per
share and $0.05 per diluted share) in fiscal 2001, $429,000 ($0.05 per share and
$0.04 per diluted share) in fiscal 2000, $429,000 ($0.05 per share and $0.04 per
diluted share) in fiscal 1999, and $429,000 ($0.05 per share and $0.04 per
diluted share) in fiscal 1998.
(b) Per share data for all periods presented have been retroactively adjusted
for the 12,010-shares-for-1 stock split declared by the Company's Board of
Directors in October 2002 in connection with the spin-off transaction.
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
Overhill Farms, Inc. is a value-added manufacturer of quality frozen food
products including entrees, plated meals, meal components, soups, sauces,
poultry, meat and fish specialties. We provide custom prepared foods to a number
of prominent customers such as Albertson's, Jenny Craig Products, Carl's Jr.,
Jack in the Box, Panda Restaurant Group, Schwan's and King's Hawaiian/Pinnacle
Foods as well as most domestic airlines, including American Airlines, United
Airlines and Delta Airlines. We manufacture products in the retail and
foodservice areas with branded and private label entrees and components.
Historically, we have served four industries: airlines, weight loss, foodservice
and retail.
In May 1995, we acquired all the operating assets of IBM Foods, Inc. for
$31.3 million plus the assumption of certain liabilities of the acquired
business. Our headquarters are located in Vernon, California, and we have
operations throughout Southern California. During August 2000, we purchased the
operating assets and trademarks of the Chicago Brothers food operations from a
subsidiary of Schwan's Sales Enterprises, Inc. for $4.2 million, consisting of
cash of $3.3 million and a note payable to the seller for $900,000.
We were a 99% owned subsidiary of TreeCon Resources, Inc., formerly known
as Overhill Corporation, until the completion of our spin-off in October 2002.
After a strategic review initiated in fiscal year 2001, TreeCon Resources
concluded that its food group, comprised of our company, would be able to grow
faster and be a stronger competitor as a separate company. In the spin-off,
TreeCon Resources distributed all of the outstanding shares of our common stock
that it owned to the holders of record of TreeCon Resources common stock as of
the close of business on September 30, 2002. We believe the spin-off, which
occurred in October 2002, will enable our business to expand and grow more
quickly and efficiently in the following ways:
. Our business, involving the production of high quality entrees,
plated meals, meal components, soups, sauces and poultry, meat and
fish specialties, has different fundamentals, growth characteristics
and strategic priorities than TreeCon Resources' forestry segment,
which is a distributor of forestry and construction equipment and
related activities. The separation of our food business from the
forestry business will enable us to focus on our own strategic
priorities, increase our ability to capitalize on growth
opportunities for our businesses and enhance our ability to respond
more quickly to changes in the competitive markets in which we
operate.
. The spin-off will enable us to have direct access to the financial
markets, both debt and equity. We intend to raise our own equity
capital that we will use to expand our businesses by accelerating
new higher-margin product introductions through increased product
development investment; to further develop our manufacturing
capabilities; and to pursue selected acquisitions.
. The spin-off will enable us to recruit, retain and motivate key
employees by providing them with stock-based compensation incentives
directly tied to the success of our businesses.
9
Our strategy is to be the leading developer and manufacturer of value-added
food products and provider of custom prepared foods. We intend to create
superior value for our stockholders by continuing to execute our growth and
operating strategies. We employ the following corporate strategies:
. focus on sectors with attractive growth characteristics;
. invest in and operate efficient production facilities;
. provide customer service-oriented distribution;
. offer a broad range of products to customers in multiple channels of
distribution; and
. continue to pursue growth through strategic acquisitions and
investments.
Results of Operations
Fiscal Year Ended September 29, 2002 Compared to Fiscal Year Ended September 30,
2001
Net Revenues. For the fiscal year ended September 29, 2002, our net
revenues decreased $24,039,000 (14.8%) to $138,119,000 as compared to
$162,158,000 for the fiscal year ended September 30, 2001. This revenue decrease
is substantially the result of a decrease in airline sales during the period. In
2002, sales to airline customers were approximately $35.0 million, or 25.3% of
total net sales as compared to sales of $54.7 million, or 33.8% of total net
sales in 2001.
The tragic events of September 11, 2001 have significantly impacted our
sales to airline-related customers. Though the long-term effect of these events
on the airline industry, airline revenues, and on our business in particular,
cannot be accurately determined at this time, we are estimating that in the near
term, sales to airline customers will experience little to no growth from 2002
levels.
Gross Profit. Gross profit for the fiscal year ended September 29, 2002
decreased $5,895,000 to $22,621,000 from $28,516,000 for the fiscal year ended
September 30, 2001. Gross profit as a percentage of net revenues for the fiscal
year ended September 29, 2002 was 16.4% compared to 17.6% in the comparable
prior period. The decrease in gross profit as a percentage of net revenues is
primarily attributable to the significant decrease in sales to airline-related
customers, as well as lower overall margins due to higher employee insurance
costs of approximately $200,000 in 2002 as compared to 2001 and competitive
pricing, offset somewhat by increased production and materials cost efficiencies
achieved during the current year.
We have begun to consolidate certain of our home office, manufacturing and
warehousing, product development, and marketing and quality control facilities
into a single location. Though we are currently in the process of implementing
various stages of this plan, management believes that when the plan is fully
implemented, we should expect to achieve significant operating efficiencies as
well as a reduction of our dependence on outside cold storage facilities.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the fiscal year ended September 29, 2002 decreased
$3,710,000 to $15,323,000 (11.1% of sales) from $19,033,000 (11.7% of sales) in
the year earlier period. SG&A decreased overall primarily due to lower freight
expenses related to the decrease in airline revenues and the ceasing of goodwill
amortization during 2002, and additionally on a percentage basis primarily due
to lower travel, advertising and compensation costs.
Interest Expense. Interest expense for 2002 was $4,651,000 as compared to
$5,372,000 in 2001, a decrease of $721,000. This decrease is primarily the
result of lower average interest rates on outstanding borrowings.
10
Income Tax Provision. For the fiscal years ended September 29, 2002 and
September 30, 2001, our income tax provision was $668,000 and $1,168,000,
respectively, or 39.4% and 34.3% of income before income taxes, respectively.
The decrease in our income tax provision was a result of the decrease in income
before income taxes.
Net Income. Our net income for the fiscal year ended September 29, 2002
amounted to $1,030,000 as compared to $2,242,000 for the fiscal year ended
September 30, 2001.
Fiscal Year Ended September 30, 2001 Compared to Fiscal Year Ended October 1,
2000
Net Revenues. For the fiscal year ended September 30, 2001, our revenues
increased $16,740,000 (11.5%) to $162,158,000 as compared to $145,418,000 for
the fiscal year ended October 1, 2000. Compared to the prior fiscal year, we
experienced a 34.4% growth rate in foodservice sales and a 4.6% growth rate in
airline sales. These revenue increases are primarily the result of our capturing
greater market share across several of our key product lines, as well as
achieving increases in volume with several significant customers.
Gross Profit. For the fiscal year ended September 30, 2001, our gross
profit increased $354,000 to $28,516,000 as compared to $28,162,000 for the
fiscal year ended October 1, 2000. Gross profit as a percentage of net revenues
for the fiscal year ended September 30, 2001 was 17.6% compared to 19.4% in the
comparable prior year period. The 2001 decrease is primarily the result of
startup expenses incurred throughout 2001 related to our Chicago Brothers
acquisition in late 2000 (approximately 33%) and competitive airline pricing,
particularly in the fourth quarter of fiscal 2001 (approximately 67%).
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the fiscal year ended September 30, 2001 increased
$1,684,000 (9.7%) to $19,033,000 as compared to $17,349,000 for the fiscal year
ended October 1, 2000. This increase is primarily attributable to increased
selling expenses (approximately $910,000), higher freight costs (approximately
$623,000) and additional costs associated with the Chicago Brothers acquisition
(approximately $152,000). For the fiscal year ended September 30, 2001, selling,
general and administrative costs as a percentage of sales were 11.7% as compared
to 11.9% in fiscal 2000.
Other Expenses. For the fiscal year ended September 30, 2001, net other
expenses increased $389,000 from the comparable 2000 period due primarily to an
increase in interest expense.
Income Taxes. For the fiscal year ended September 30, 2001, our income tax
provision was $1,168,000, or 34.3% of income before income taxes and
extraordinary item, compared to $1,798,000 for the fiscal year ended October 1,
2000, or 35.1% of income before income taxes and extraordinary item.
Net Income. Our net income for the fiscal year ended September 30, 2001
amounted to $2,242,000 as compared to $2,492,000 after an extraordinary charge
of $838,000 related to early extinguishment of debt, for the fiscal year ended
October 1, 2000.
Liquidity and Capital Resources
Our principal sources of liquidity are cash flow from operations, cash
balances and additional financing capacity. Our cash and cash equivalents
decreased $73,000 to $8,000 as of September 29, 2002, compared to $81,000 at
September 30, 2001.
During the fiscal year ended September 29, 2002, our operating activities
provided cash of approximately $4,528,000, as compared to cash provided of
$10,432,000 during fiscal 2001. The cash provided in the current period is
primarily due to our operations, with cash favorable changes in accounts
receivable and accounts payable balances being offset by uses of cash for
changes in inventories, prepaids and other assets and accrued liabilities.
11
During the fiscal year ended September 29, 2002, our investing activities
resulted in a use of cash of approximately $5,041,000, as compared to $1,229,000
during fiscal 2001. The use of cash in the current period consisted exclusively
of additions to property and equipment. In 2002, the Company leased a new
facility in Vernon, California where it has begun the consolidation of certain
of its assets and operations from other plant and office locations. During the
year, the Company spent over $4.3 million for leasehold improvements and
equipment in the new Vernon facility.
During the fiscal year ended September 29, 2002, our financing activities
resulted in cash provided of approximately $440,000, as compared to a use of
cash of $9,680,000 during fiscal 2001. The cash provided in the current period
resulted primarily from net borrowings on our line of credit offset by principal
payments on long-term debt and cash payments to and on behalf of our Parent. In
the prior year, cash used in financing activities primarily related to net
repayments of long-term debt and amounts outstanding on our line of credit.
Immediately prior to the completion of the spin-off, we received formal
consents to the spin-off from our senior creditor, Union Bank of California,
N.A. (the "Bank"), and our senior subordinated creditor, Levine Leichtman
Capital Partners II, L.P. ("LLCP" or the "Senior Subordinated Lender"). At that
time, we entered into amendments and restatements, as appropriate, to our
financing agreements and other arrangements with them. These consents,
amendments and restatements were necessary to comply with certain provisions in
our existing financing agreements with each of these creditors that were
affected by the spin-off and related transactions.
We have a term loan with the Bank evidenced by a note in the original
principal amount of $2,400,000, with an outstanding principal balance of
$1,150,000 at September 29, 2002. The term loan bears interest at a reference
rate announced by the Bank plus one percent. We pay the principal amount of the
term loan in monthly installments of $50,000. We used the term loan to finance
the acquisition of Chicago Brothers from Schwan's Sales Enterprises, Inc. In
December 2002, the maturity of the term loan was extended through November 2003.
The line of credit with the Bank, as amended, expires in November 2003. As
of September 29, 2002, we had approximately $4.0 million available under our
revolving line of credit with the Bank. Borrowings under the revolving line of
credit bear interest at a rate, as selected by us at the time of borrowing, of
prime plus .25% or LIBOR plus 2.50%. The loan agreement provides, among other
things, that we are subject to an unused line of credit fee of on the revolving
line of credit of .25% per annum and a collateral monitoring fee of $500 per
month. The agreement contains various covenants including restrictions on
capital expenditures, specified net worth levels and debt service ratios, as
well as restrictions on loans, advances and payment of dividends. The line of
credit is collateralized by all of our assets. In connection with the spin-off,
the Bank provided a limited release to TreeCon Resources from its guaranty of
the credit facility and released our common stock owned by TreeCon Resources as
collateral for its guaranty, thereby allowing TreeCon Resources to consummate
the spin-off. In January 2002, the Bank charged us $120,000 for amendments and
waivers of our credit facility that were agreed to at that time. In November
2002, we obtained a one-month extension of the maturity date under our line of
credit and in December 2002, we amended our line of credit facility to increase
the amount available under the line of credit to $20.0 million, subject to
borrowing base availability, reduce the interest rate to prime plus 0.25% or
LIBOR plus 2.5%, and further extend the maturity date through November 2003.
Our senior subordinated creditor is the holder of a secured senior
subordinated note, which it purchased from us in November 1999 pursuant to a
securities purchase agreement. We amended and restated the securities purchase
agreement, the note and various related agreements in connection with the
spin-off. The note bears interest at a base rate per annum of 13.25%, with
interest payable monthly. However, if we achieve specified EBITDA tests for the
fiscal year ending September 2003, the base rate will be reduced to 12.5%. The
note matures on October 31, 2004. We are required to make mandatory principal
payments each January for the previous fiscal year in an amount equal to 50% of
the excess cash flow, as defined. The amount of the principal prepayment for the
fiscal year ended September 29, 2002 is approximately $541,000. We may make
voluntary principal prepayments at any time, subject to prepayment premiums. The
securities purchase agreement contains various covenants, including financial
covenants covering restrictions on capital expenditures, minimum EBITDA and net
worth levels, and specified debt service and debt to equity ratios. In addition,
the terms of the securities purchase agreement prohibit changes in
12
control, including ownership and management personnel, and contains customary
restrictions on incurring indebtedness and liens, making investments, paying
dividends and making loans or advances. The note and all other obligations owing
by us to our senior subordinated creditor are secured by subordinated liens on
substantially all of our assets and by a guaranty of Overhill L.C. Ventures,
Inc., our subsidiary. In connection with the spin-off, our senior subordinated
creditor released TreeCon Resources from its guaranty and released its lien on
our common stock held by TreeCon Resources, which secured TreeCon Resources'
guaranty. The agreement requires us to pay our senior subordinated creditor,
during each January, annual consulting fees of $180,000.
In connection with the original securities purchase agreement, we issued to
our senior subordinated creditor a warrant to purchase 166.04 shares of our
common stock exercisable immediately at an exercise price of $0.01 per share.
The warrant became exercisable for 1,994,141 shares of our common stock at an
exercise price of $0.0000008 per share after giving effect to the
12,010-shares-for-1 stock split declared in connection with the spin-off. This
warrant was exercised as to 1,994,040 shares in December 2002 and remains
exercisable as to 100 shares. At the date of issuance, this warrant was
estimated to have a fair value of $2.37 million.
In 1999 when we entered into these transactions with the Bank and our
senior subordinated creditor, we repaid in full the $22.7 million senior
subordinated notes payable and the $9.6 million revolving line of credit
outstanding to our previous lenders. Additionally, we repurchased for $3.7
million the warrants held by the previous subordinated lender to purchase 30% of
our common stock. Also in connection with the refinancing, we were permitted to
make a one-time advance of $1.25 million TreeCon Resources for working capital
and other specified purposes. We incurred costs and expenses in connection with
the refinancing totaling approximately $1.9 million, substantially all of which
was paid to the lenders. The early extinguishment of the previous indebtedness
resulted in an extraordinary loss of approximately $1.3 million (net of a
$500,000 refund for early payment of the senior subordinated notes), which was
recognized during the fiscal year ended October 1, 2000.
In 2002, we entered into various amendments to our securities purchase
agreement with our senior subordinated creditor with respect to, among other
things, the consolidation of our facilities and amendments to our financial
covenants with it. In exchange for our senior subordinated creditor's consent
and agreement to amend the securities purchase agreement and other investment
documents and certain other consideration, in January 2002 we issued to it 23.57
shares of our Series A Convertible Preferred Stock valued at $750,000, and in
September 2002 we issued to it a warrant to purchase 57.57 shares of our common
stock valued at $1,100,000 and agreed to pay a restructuring fee in an aggregate
amount of $423,000 payable in three installments ending in March 2003. After
giving effect to the 12,010-shares-for-1 stock split declared in connection with
the spin-off, the shares of Series A Convertible Preferred Stock are convertible
into 283,076 shares of our common stock, and the warrant was exercisable for
691,416 shares of our common stock at an exercise price of $0.0000008 per share.
This warrant was exercised as to 691,315 shares in December 2002 and remains
exercisable as to 100 shares. The designations for the Series A Convertible
Preferred Stock provide the holder with, among other things, a liquidation
preference per share of $31,820.11, plus declared and unpaid dividends, voting
rights along with holders of common stock, protective provisions, conversion
rights and anti-dilution protection. In September 2002, a previous agreement for
an interest rate reduction upon our making certain voluntary prepayments and our
obligation to make a $500,000 cash payment in the event we did not repurchase
the previous warrant or shares issuable under the warrant upon repayment of our
senior subordinated debt was terminated.
Our securities purchase agreement with our senior subordinated creditor
provides that, immediately following the spin-off, it is entitled to
anti-dilution protection so that the shares of common stock issuable upon
exercise of its warrants and conversion of its shares of our Series A
Convertible Preferred Stock will represent in the aggregate not less than 24.0%
of our outstanding shares of capital stock, determined on a fully diluted basis
and including the reservation of shares of common stock for issuance under our
2002 Employee Stock Option Plan. In November 2002, we issued 252,632 shares of
our common stock to our senior subordinated creditor representing all shares
currently issuable pursuant to the anti-dilution protection.
13
As of June 30, 2002, we were in violation of certain financial covenants
with respect to our financing arrangements with the Bank and our senior
subordinated creditor. As of September 11, 2002, we had received a waiver of
these violations from the Bank and an amendment to our financial covenants with
our senior subordinated creditor, effective as of June 30, 2002. Additionally,
we entered into further amendments to our financing arrangements with both
creditors, whereby, among other things, future financial covenant requirements
were modified to levels more consistent with the our current and future expected
results of operations. As of September 29, 2002, we were in compliance with all
of our amended financial covenants. We believe, based upon historical
performance, current results of operations for the fiscal year ended September
29, 2002 and forecasted performance for all of fiscal 2003, that it is probable
that we will be in compliance with all of our revised financial and other
covenant requirements. Accordingly, we have classified our outstanding senior
secured debt, which matures in November 2003, and our senior subordinated debt,
which matures in November 2004, as long-term, except for contractually current
maturities, in the accompanying consolidated balance sheet as of September 29,
2002. In the future, our failure to achieve certain revenue, expense and
profitability forecasts could result in a violation of our amended financial
covenants under our financing arrangements, which could have a material adverse
effect on our financial condition, results of operations or cash flows.
Pursuant to our equity repurchase option agreement with our senior
subordinated creditor, we have the right to repurchase from it, in whole but not
in part, the shares of our common stock issuable upon exercise of the warrants
and conversion of the shares of our Series A Convertible Preferred Stock it
holds and the shares of our Series A Convertible Preferred Stock it holds. We
may exercise this option if:
. a default occurs under the securities purchase agreement and the holder
provides written notice to us requesting that we make payments in
addition to those which we are then obligated to make under our then
existing financing arrangement or declares all of our obligations to
the holder under the securities purchase agreement to be immediately
due and payable, or
. if we notify the holder that we intend to merge, sell all or a
significant portion of our assets, reorganize or recapitalize or enter
into a bona fide transaction valued at more than $8.0 million and it
does not consent to the transaction.
If we exercise our repurchase option, we may repurchase its shares of our
common stock for:
. if our common stock is publicly traded, the greater of the current
market price per share or an amount per share based on a predetermined
formula, or
. if our common stock is not publicly traded, an amount based on the
predetermined formula.
We may repurchase its shares of our Series A Convertible Preferred Stock
for an amount equal to the greater of:
. the number of shares of our common stock issuable upon conversion of
the shares of Series A Convertible Preferred Stock being repurchased
multiplied by the per share amount determined with respect to our
common stock, and
. $540,000.
14
Below is a summarization of our contractual obligations at September 29,
2002.
Maturities of long-term debt at September 29, 2002
Fiscal Year
-----------------
2003 $ 1,481,600
2004 12,557,048
2005 24,713,291
2006 55,242
-----------
Total 38,807,181
Less unamortized debt discount (1,083,667)
-----------
$37,723,514
Future minimum lease payments at September 29, 2002
Fiscal Year
-----------------
2003 $ 3,704,724
2004 3,271,500
2005 3,158,180
2006 2,738,115
2007 and thereafter 5,774,044
-----------
Total $18,646,563
In January 2002, we entered into a lease for a 147,210 square foot facility
in Vernon, California, and we have begun to consolidate certain of our home
office, manufacturing and warehousing, product development, and marketing and
quality control facilities into a single location. See "Business-Manufacturing
and Sourcing".
From time to time, we have made advances to TreeCon Resources for various
purposes in the context of our parent-subsidiary relationship. Additionally, we
have netted accumulated federal income tax liabilities payable to TreeCon
Resources against amounts owed from TreeCon Resources to us. We had
approximately $10.5 million in net receivables from TreeCon Resources as of
September 29, 2002. During the fiscal years ended September 29, 2002, September
30, 2001 and October 1, 2000, we made cash payments to, or on behalf of, TreeCon
Resources of approximately $1.2 million, $500,000 and $1.6 million, respectively
for various purposes including tax payments, expense reimbursement and other
corporate purposes. In connection with the spin-off, TreeCon Resources
transferred to us as partial payment of these net receivables the two promissory
notes made in the amounts of $207,375 and $184,875, made by Mr. Rudis and Mr.
Shatley, respectively. In connection with the spin-off, TreeCon indemnified us
with respect to any current or future tax liabilities for which we might
otherwise be liable resulting from the operations of any entity other than us
and we agreed with TreeCon resources to cancel any remaining amounts owed to us
by TreeCon Resources, or owed to TreeCon Resources by us, as of September 29,
2002 after obtaining the appropriate consents under our financing arrangements.
The tragic events of September 11, 2001 have significantly impacted our
sales to airline-related customers. The effect of these events have been widely
publicized, and have included, among other things, a decreased demand for air
travel to due a variety of factors and increased costs and reduced operations by
airlines, including meal services. Most of our largest airline customers have
announced meal service reductions as part of cost efficiency programs. Though
the long-term effect of these events on the airline industry, airline revenues,
and on our business in particular, cannot be accurately determined at this time,
we are estimating that in the near term, sales to airline customers will
experience little to no growth from 2002 levels. In 2002, sales to airline
customers were approximately $35.0 million, or 25.3% of total net sales as
compared to sales of $54.7 million, or 33.8% of total net sales in 2001. Future
adverse events in the airline industry, including additional terrorist attacks
or other safety issues, additional regulation, significant bankruptcies, or
significant continued cost reduction initiatives that further reduce the meal
requirements of our largest airline customers, could negatively impact our
financial position, results
15
of operations or cash flows. See "Risk Factors Related to Our Business and
Industry-Decline in air travel may negatively impact our revenues and costs" and
"Business-Sales and Marketing".
We believe that the funds available to us from operations and existing
capital resources will be adequate for our capital requirements for at least the
next 12 months.
Recent Accounting Pronouncements
In June 2002, the Financial Accounting Standards Board issued Statement No.
146, Accounting for Costs Associated with Exit or Disposal Activities (SFAS
146), which addresses financial accounting and reporting for costs associated
with exit or disposal activities. These rules supersede ETIF 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity. SFAS 146 requires that costs related to an exit or disposal activity
can only be accrued when a liability is actually incurred. SFAS 146 is required
to be adopted by us for exit or disposal activities occurring after December 31,
2002. We do not believe the adoption of SFAS 146 will have a material effect on
our financial position, results of operations or cash flows.
In November 2001, the Financial Accounting Standards Board issued Statement
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS
144). These rules supersede FASB Statement No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,
providing a single accounting model for long-lived assets to be disposed of.
Although retaining many of the fundamental recognition and measurement
provisions of Statement 121, the new rules significantly change the criteria
that would have to be met to classify an asset as held-for-sale. SFAS 144 also
supersedes the provisions of APB Opinion 30 with regard to reporting the effects
of a disposal of a segment of a business and requires expected future operating
losses from discontinued operations to be displayed in discontinued operations
in the period(s) in which the losses are incurred (rather than as of the
measurement date as previously required by APB 30). SFAS 144 is effective for
fiscal years beginning after December 15, 2001 and interim periods within those
fiscal years, although earlier application is encouraged. We have adopted SFAS
144 as of October 1, 2001. The adoption of SFAS 144 did not have a material
effect on our financial position, results of operations or cash flows.
In June 2001, the Financial Accounting Standards Board issued Statement No.
142, Goodwill and Other Intangible Assets (SFAS 142), which requires that
goodwill no longer be amortized but instead be tested at least annually for
impairment. We have adopted SFAS 142 as of October 1, 2001 and no impairment of
goodwill was recorded upon adoption. Had we been accounting for goodwill under
SFAS 142 for all periods presented, our income before income taxes and
extraordinary item would have increased for fiscal years 2001 and 2000 by
$830,000 and $650,000, respectively, and net income would have increased by
$548,000 ($0.06 per share and $0.05 per diluted share) and $429,000 ($0.05 per
share and $0.04 per diluted share) for fiscal years 2001 and 2000, respectively,
with per share data reflecting the effect of the 12,010-shares-for-1 stock split
declared in connection with the spin-off.
Critical Accounting Policies
Management's discussion and analysis of its financial condition and results
of operations are based upon our consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires management
to make estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Actual results could differ from
those estimates. See Note 2 to the Consolidated Financial Statements. Management
believes the following critical accounting policies are related to its more
significant estimates and assumptions used in the preparation of its
consolidated financial statements.
Concentrations of Credit Risk. Our financial instruments that are exposed
to concentrations of credit risk consist primarily of trade receivables. We
perform ongoing credit evaluations of our customers' financial condition and
generally require no collateral from our customers. Our allowance for doubtful
accounts is calculated based primarily upon historical bad debt experience and
current market conditions. Historically, bad debt expense and
16
accounts receivable write-offs, net of recoveries, have been immaterial as we
generally transact the substantial portion of our business with large,
established food or service related businesses. However, a bankruptcy or other
significant financial deterioration of any significant customers could impact
their future ability to satisfy their receivables with us.
For the fiscal years ended September 29, 2002, September 30, 2001, and
October 1, 2000, revenues from airline-related customers accounted for
approximately 25.3%, 33.7%, 35.0% of total revenues, respectively. Additionally,
accounts receivable from airline-related customers accounted for approximately
12.8% of the total accounts receivable balance at September 29, 2002. The
results of the tragic events of September 11, 2001 have significantly impacted
our sales to airline-related customers. The long-term effect of these events on
the airline industry, airline revenues, and on our business in particular, still
cannot be accurately determined at this time. These effects, depending upon
their scope and duration, which we cannot predict at this time, could negatively
impact our financial position, results of operations, or cash flows.
For the year ended September 29, 2002, net sales of approximately $3.9
million were made to United Airlines. In December 2002, United Airlines filed a
petition for bankruptcy reorganization. The Company continues to do business
with United and is subject to credit risk as a result thereof. Upon United's
filing for bankruptcy, the Company had already collected substantially all of
its receivables related to sales that occurred during the fiscal year ended
September 29, 2002 through the normal course of business. Additionally,
outstanding receivables from United as of the bankruptcy filing date were less
than $200,000. The Company will continue to evaluate its business relationship
with United on an ongoing basis and, if necessary, will provide reserves against
any receivables from United that are determined to be uncollectible.
Inventories. Inventories, which include material, labor and manufacturing
overhead, are stated at the lower of cost, which approximates the first-in,
first-out (FIFO) method, or market. We use a standard costing system to estimate
our FIFO cost of inventory at the end of each reporting period. Historically,
standard costs have been materially consistent with actual costs. We determine
the market value of our raw ingredients, finished product and packaging
inventories based upon references to current market prices for such items as of
the end of each reporting period and record a write down of inventory standard
cost to market, when applicable.
Excess of Cost Over Fair Value of Net Assets Acquired. The excess of cost
over fair value of net assets acquired (goodwill) is evaluated annually for
impairment in accordance with SFAS 142. We have one reporting unit and estimate
fair value based on a variety of market factors, including discounted cash flow
analysis, market capitalization, and other market-based data. No impairment of
goodwill was recorded during 2002. A significant deterioration of our operating
results and related cash flow reductions could decrease the estimated fair value
of our business and thus, cause our goodwill to become impaired.
Income Taxes. Deferred income taxes recorded using the liability method
reflect the net tax effects of temporary differences between the carrying amount
of assets and liabilities for financial reporting purposes and the amounts used
for income tax purposes. For 2002, we are included in the consolidated federal
tax return of TreeCon Resources and have provided for federal taxes on a
separate company basis in accordance with SFAS No. 109, "Accounting for Income
Taxes." Historically, with respect to our state income taxes, primarily in
California, we have been able to reduce our tax liability by offsetting
otherwise taxable income with other losses under the TreeCon Resources entity.
On a separate company basis, we would have an approximate effective state tax
rate of 5%-6%.
17
Forward-Looking Statements
This report contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. These forward-looking
statements are based on current expectations or beliefs, including, but not
limited to, statements concerning our operations and financial performance and
condition. For this purpose, statements of historical fact may be deemed to be
forward-looking statements. Forward-looking statements include statements which
are predictive in nature, which depend upon or refer to future events or
conditions, which include words such as "expects," "anticipates," "intends,"
"plans," "believes," "estimates," or similar expressions. In addition, any
statements concerning future financial performance (including future revenues,
earnings or growth rates), ongoing business strategies or prospects, and
possible future Company actions, which may be provided by management are also
forward-looking statements. We caution that these statements by their nature
involve risks and uncertainties, and actual results may differ materially
depending on a variety of important factors, including, among others, the impact
of competitive products and pricing; market conditions and weather patterns that
may affect the cost of raw material as well as the market for our products;
changes in our business environment, including actions of competitors and
changes in customer preferences; the occurrence of acts of terrorism, such as
the events of September 11, 2001, or acts of war; changes in governmental laws
and regulations, including income taxes; market demand for new and existing
products; and other factors as may be discussed in this report, including those
factors described under "Risk Factors," and other reports filed with the
Securities and Exchange Commission.
Risk Factors Related to Our Business and Industry
Our ability to compete effectively in the highly competitive food industry may
affect our operational performance and financial results.
The food industry is highly competitive, and our continued success depends
in part on our ability to be an efficient producer in a highly competitive
industry. We face competition in all of our markets from large, national
companies and smaller, regional operators. Some of our competitors, including
other diversified food companies, are larger and may have greater financial
resources than we do. From time to time we experience price pressure in certain
of our markets as a result of competitors' promotional pricing practices as well
as market conditions generally. Our ability to reduce costs is limited to the
extent efficiencies have already been achieved. Our failure to reduce costs
through productivity gains or by eliminating redundant costs resulting from
acquisitions would weaken our competitive position. Competition is based on
product quality, distribution effectiveness, brand loyalty, price, effective
promotional activities and the ability to identify and satisfy emerging consumer
preferences. We may not be able to effectively compete with these larger, more
diversified companies.
The loss or consolidation of any of our key customers could have a significant
negative impact on our financial results.
The largest purchasers of our products, Panda Restaurant Group, Jenny Craig
Products, King's Hawaiian/Pinnacle Foods, American Airlines, Albertson's and
Delta Airlines, accounted for approximately 21%, 15%, 11%, 9%, 8% and 8%,
respectively, of our sales during the fiscal year ended September 29, 2002. We
expect that our sales to these customers will continue to constitute a
significant percentage of our revenues. The loss of any of these customers as an
outlet for our products could significantly harm our competitive position and
operating results.
In addition, the continued consolidation of food retailers and foodservice
distributors has somewhat reduced the number of customers for our products. The
additional consolidation of customers for our products could have a significant
adverse impact on our financial results. The resulting companies may choose to
terminate their relationship with us and purchase products from our competitors.
Additionally, if our customers consolidate and grow larger, our customers may
demand lower pricing and more favorable terms. Further, these customers may
reduce inventories and increase their use of other suppliers. If we fail to use
our sales, marketing and manufacturing expertise to respond to these trends, our
volume growth could slow or we may need to lower our prices or increase
promotional support of our products, any of which would adversely affect our
profitability.
18
Decline in air travel may negatively impact our revenues and costs.
A significant portion of our business is derived from the airline industry.
In 2002, sales to airline customers were approximately $35.0 million, or 25.3%
of total net sales as compared to sales of $54.7 million, or 33.8% of total net
sales in 2001. The terrorist attacks on the World Trade Center in New York and
the Pentagon in Washington, D.C. using hijacked commercial aircraft have been
highly publicized. The tragic events of September 11, 2001 have significantly
adversely impacted our sales to airline-related customers. Though the long-term
effect of these events on the airline industry, airline revenues, and on our
business in particular, cannot be accurately determined at this time, we
estimate that in the near term, sales to airline customers will experience
little to no growth from 2002 levels. The impact that these events may have on
the airline industry in general, and on our business in particular, are not
known at this time. The effect of these events have included, among other
things, a decreased demand for air travel due to a variety of factors and
increased costs and reduced operations by airlines, including meal services.
Most of our largest airline customers have announced meal service reductions as
part of cost efficiency programs. A significant portion of our business focuses
on the airline industry, and these effects, depending on their scope and
duration, which we cannot predict at this time, could negatively impact our
financial position, results of operations or cash flows.
We are subject to cost fluctuations in our operations that may adversely affect
our profitability.
Our business operations may experience operating cost volatility caused by
external conditions, market fluctuations and changes in governmental policies.
For example, increases in our manufacturing costs and a decrease in our gross
profits and operating income in 2001 as compared to 2000 were attributable in
part to expenses related to increased energy costs in our California-based
facilities. In addition, we use refrigerants in our business extensively, and
the cost of refrigerants has increased substantially in recent years. Any
substantial fluctuation in our manufacturing or operating costs, if not offset
by product price increases, hedging activities or improved efficiencies, may
have an adverse impact on our operating performance, business and financial
condition.
We are major purchasers of many commodities that we use for raw materials and
packaging, and price changes for the commodities we depend on may adversely
affect our profitability.
The raw materials used in our business are largely commodities that
experience price volatility caused by external conditions, commodity market
fluctuations, currency fluctuations and changes in governmental agricultural
programs. Commodity price changes may result in unexpected increases in raw
material and packaging costs, and we may be unable to increase our prices to
offset these increased costs without suffering reduced volume, revenue and
income. Any substantial fluctuation in the prices of raw materials, if not
offset by increases in our sales prices, could have an adverse impact on our
profitability.
We attempt to recover our commodity cost increases by increasing prices,
promoting a higher-margin product mix and obtaining additional operating
efficiencies. We may not be able to continue to offset raw material price
increases to the same extent in the future. We enter into contracts for the
purchase of raw materials at fixed prices, which are designed to protect us
against raw material price increases during their term. We also use paper
products, such as corrugated cardboard, aluminum products, and films and
plastics to package our products. Substantial fluctuations in prices of
packaging materials or continued higher prices of our raw materials could
adversely affect our operating performance and financial results.
19
Concerns with the safety and quality of food products could cause customers to
avoid our products.
We could be adversely affected if our customers and their customers lose
confidence in the safety and quality of certain food products. Adverse publicity
about these types of concerns, like the recent publicity about genetically
modified organisms, "mad cow disease" and foot and mouth disease in Europe,
whether or not valid, may discourage our customers from buying our products or
cause production and delivery disruptions. Any negative change in customer
perceptions about the safety and quality of our products could cause a material
adverse effect on our business and financial condition.
If our food products become adulterated or misbranded, we would need to recall
those items and may experience product liability claims if consumers are injured
as a result.
Food products occasionally contain contaminants due to inherent defects in
those products or improper storage or handling. We have never been required to
recall any of our products. Under adverse circumstances food manufacturers may
need to recall some of their products if they become adulterated or misbranded
and may also be liable if the consumption of any of their products causes
injury. A widespread product recall or a significant product liability judgment
against us could cause products to be unavailable for a period of time and a
loss of customer confidence in our food products and could have a material
adverse effect on our business. If we are required to defend against a product
liability claim, whether or not we are found liable under such a claim, we could
incur substantial costs, our reputation could suffer and our customers might
substantially reduce their orders or ordering from us. While we maintain
insurance that we believe is adequate to cover this type of loss, liability of
this sort could require us to implement measures to reduce our exposure to this
liability, which may require us, among other things, to expend substantial
resources or to modify our product offerings or to make changes to one or more
of our business processes.
Any acquisitions that we undertake could be difficult to integrate, disrupt our
business, dilute our stockholder value and adversely affect our operating
results.
Although we have no currently identified acquisition plans, we intend to
acquire or make investments in complementary businesses, technologies, services
or products from time to time as part of our long term business strategy.
Expansion of our operations in this manner would require significant additional
expenses and resources. Expansion also could strain our management, financial
and operational resources. If we acquire a company, we could have difficulty in
assimilating that company's personnel, operations, technology and software. In
addition, the key personnel of the acquired company may decide not to work for
us. We could also have to incur indebtedness to pay for any future acquisitions.
We also may issue equity securities to pay for any future acquisitions, which
could be dilutive to our existing stockholders.
Our business is subject to federal, state and local government regulations, the
impact of which could have a negative impact on our business and financial
position.
Food manufacturing operations are subject to regulation by various federal,
state and local government entities and agencies. As a producer of food products
for human consumption, our operations are subject to stringent production,
packaging, quality, labeling and distribution standards, including regulations
mandated by the Federal Food and Drug Act. We cannot predict whether future
regulation by various federal, state and local governmental entities and
agencies would harm our business and financial results.
In addition, our business operations and the past and present ownership and
operation of our properties are subject to extensive and changing federal, state
and local environmental laws and regulations pertaining to the discharge of
materials into the environment, the handling and disposition of wastes
(including solid and hazardous wastes) or otherwise relating to protection of
the environment. We cannot assure you that additional environmental issues
relating to presently known matters or identified sites or to other matters or
sites will not require additional, currently unanticipated investigation,
assessment or expenditures.
20
We may not be able to protect our intellectual property and proprietary rights,
which could harm our competitive position, resulting in decreased revenue.
We believe that our trademarks and other proprietary rights are important
to our success and competitive position. Accordingly, we devote what we believe
are adequate resources to the establishment and protection of our trademarks and
proprietary rights. We have taken actions to establish and protect our
trademarks and other proprietary rights. However, these actions may be
inadequate to prevent imitation of our products by others or to prevent others
from claiming violations of their trademarks and proprietary rights by us.
From time to time we license content from third parties. While we generally
require adequate indemnifications, it is possible that in the future we could
face infringement actions based upon the content licensed from these third
parties. If any of these claims are proved valid, through litigation or
otherwise, we may be required to do any of the following, which could adversely
affect our business:
. cease using the third party trademarks;
. acquire other licenses;
. develop our own proprietary marks; or
. pay financial damages.
Some of our significant customer and supplier contracts are short-term.
Some of our customers and suppliers operate through purchase orders or
short-term contracts. Though we have long-term business relationships with many
of our customers and suppliers, we cannot assure you that any of these customers
or suppliers will continue to do business with us on the same basis.
Additionally, though we try to renew these contracts as they come due, there can
be no assurance that these customers or suppliers will renew the contracts on
terms that are favorable to us, if at all. The termination of any number of
these contracts may have a material adverse effect on our business and
prospects, including our financial performance and results of operations.
Because there has been a limited trading history for our common stock, our stock
price may be volatile.
Our common stock began trading on the American Stock Exchange under the
symbol OFI on November 1, 2002. Our shares may not be actively traded, and the
prices at which our shares trade could be volatile. Some TreeCon Resources
stockholders who received our common stock may decide that they do not want to
remain invested in us and may sell their shares during a short period following
the spin-off. This may delay the development of an orderly trading market for
our common stock for a period of time following the spin-off. Prices for our
shares will be determined in the marketplace and may be influenced by many
factors, including, but not limited to:
. the depth and liquidity of the market for the shares;
. quarter-to-quarter variations in our operating results;
. announcements about our performance as well as the announcements
of our competitors about the performance of their business;
. investors' evaluations of our future prospects and the food
industry generally;
. changes in earnings estimates by, or failure to meet the
expectations of, securities analysts;
. our dividend policy; and
21
. general economic and market conditions.
In addition, the stock market often experiences significant price
fluctuations that are unrelated to the operating performance of the specific
companies whose stock is traded. These market fluctuations could have a material
adverse effect on the trading price of our shares.
The loss of certain of our executive officers would constitute a change in
control and, therefore, an event of default under our securities purchase
agreement with Levine Leichtman Capital Partners II, L.P. and would likely have
an adverse effect on our financial condition.
Our future success depends to a significant extent on the continued
services of our senior management, particularly James Rudis, our President and
Chief Executive Officer, Richard A. Horvath, our Senior Vice President and
Secretary and William E. Shatley, our Senior Vice President and Treasurer.
Though we have employment agreements with Mr. Rudis, Mr. Horvath and Mr.
Shatley, each of these agreements provides for voluntary resignation prior to
the end of the term of the agreement.
The loss of the services of Mr. Rudis, Mr. Horvath or Mr. Shatley would
likely have an adverse effect on our business, results of operations and
financial condition. In addition, our securities purchase agreement with Levine
Leichtman Capital Partners II, L.P., our senior subordinated creditor, provides
that a change in control would occur if Mr. Rudis, Mr. Horvath or Mr. Shatley
ceases to have certain management responsibilities in our business, or Mr. Rudis
and Mr. Shatley do not continue to hold a minimum number of shares of our common
stock. The occurrence of a change in control would permit our senior
subordinated creditor to accelerate all indebtedness owing under the senior
subordinated note we issued to it and constitute an event of default under the
securities purchase agreement. Our senior subordinated creditor would then have
the right to require us to immediately repay all of our obligations then owing
to it. We may not have sufficient funds to repay this indebtedness upon an event
of default. Accordingly, the occurrence of a change in control could have a
material adverse effect on our financial condition, results of operations or
cash flows.
Our failure to attract and retain key management personnel could harm our
business.
Our business requires managerial, financial and operational expertise and
our future success depends upon the continued service of key personnel. As a
value-added manufacturer of quality frozen food products and customer prepared
foods, we operate in a specialized industry. Our key personnel have experience
and skills specific to this industry, and there is a limited number of
individuals with the relevant experience and skills. Though we have employment
agreements with Mr. Rudis, Mr. Horvath and Mr. Shatley, each of these agreements
provides for voluntarily resignation on the part of the executive prior to the
end of the term of the agreement. If we lose any of our key personnel, our
business operations could suffer.
A small group of stockholders controls a significant amount of our common stock.
After giving effect to the shares of our common stock issuable upon the
exercise of options and warrants and conversion of shares of our Series A
Convertible Preferred Stock described below, our executive officers and
directors and stockholders who own greater than 5% of our common stock will own,
in the aggregate, approximately 42% of our outstanding common stock. These
stockholders, if acting together, could be able to significantly influence
matters requiring approval by the stockholders, including the election of
directors and the approval of mergers or other business combination
transactions.
22
In addition, our securities purchase agreement with our senior subordinated
creditor provides that it is entitled to anti-dilution protection so that the
shares of common stock issuable upon exercise of its warrants and conversion of
its shares of our Series A Convertible Preferred Stock will represent in the
aggregate not less than 24.0% of our outstanding shares of capital stock,
determined on a fully diluted basis. We also granted to our senior subordinated
creditor, as an equity holder, the right to nominate a designee to our board of
directors. If it exercises its warrants, our senior subordinated creditor will
control no less than 24.0% of the voting power of our outstanding capital stock
and may have the ability to influence matters requiring approval of the
stockholders.
Our articles of incorporation, our bylaws and provisions of Nevada law could
make it more difficult for a third party to acquire us, even if doing so could
be in your interest.
Provisions of our articles of incorporation and bylaws could make it more
difficult for a third party to acquire us, even if doing so might be in the best
interest of our stockholders. It could be difficult for a potential bidder to
acquire us because our articles of incorporation and bylaws contain provisions
which may discourage takeover attempts. These provisions may limit stockholders'
ability to approve a transaction that stockholders may think is in their best
interests. These provisions include a requirement that certain procedures must
be followed before matters can be proposed for consideration at meetings of our
stockholders and the ability of our board of directors to fix the rights and
preferences of an issue of shares of preferred stock without stockholder action.
Provisions of Nevada's business combinations statute also restrict certain
business combinations with interested stockholders. We have elected not to be
governed by these provisions in our amended and restated articles of
incorporation. However, this election is not effective until 18 months after the
approval of our amended and restated articles of incorporation in September 2002
and may not be effective at that time unless we meet certain conditions under
the Nevada statute.
The provisions of our articles of incorporation, bylaws and Nevada law are
intended to encourage potential acquirers to negotiate with us and allow the
board of directors the opportunity to consider alternative proposals in the
interest of maximizing stockholder value. However, such provisions may also
discourage acquisition proposals or delay or prevent a change in control.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
Our interest expense is affected by changes in prime and LIBOR rates as a
result of our revolving line of credit facility and term loan with the Bank. If
these market and reference rates increase by an average of 1 percent, our
interest expense for the next twelve months would increase by approximately
$130,000 based on the outstanding loan balances at September 29, 2002. We do not
own, nor do we have an interest in any other market risk sensitive instruments.
ITEM 8. Financial Statements and Supplementary Data
See Index to Consolidated Financial Statements included in Item 15.
ITEM 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
None.
23
PART III
ITEM 10. Directors and Executive Officers of the Registrant
The following table sets forth certain information regarding our current
directors and executive officers.
Present
Office(s) Held Director
Name Age In the Company Since
------ ----- ---------------- ----------
James Rudis .............................. 53 President, Chief Executive Officer and 1995
Chairman of the Board of Directors
Richard A. Horvath ...................... 56 Senior Vice President, Secretary, Chief 1999
Financial Officer and Director
William E. Shatley ....................... 56 Senior Vice President, Treasurer and 1998
Director
Harold Estes ............................. 62 Director 2002
Geoffrey A. Gerard ....................... 57 Director 2002
John E. McConnaughy, Jr. ................. 73 Director 2002
Robert W. Schleizer ...................... 49 Director 2002
The following information regarding the principal occupations and other
employment of our directors during the past five years and their directorships
in certain companies is as reported by the respective directors:
James Rudis was elected to our board of directors in April 1995 and has
served as President since June 1997. He has also served as a director of TreeCon
Resources since December 1992, Chairman and Chief Executive Officer of TreeCon
Resources since February 1998 and President of TreeCon Resources since July
1997. He served as Executive Vice President of TreeCon Resources from March 1994
until July 1997. Mr. Rudis resigned as President and Chief Executive Officer of
TreeCon Resources in connection with the spin-off but will remain as a director
of TreeCon Resources for a period of no greater than one year after the spin-off
to facilitate the transition of TreeCon Resources and Overhill Farms, Inc. into
two separate companies. Prior to his employment with us and with TreeCon
Resources, Mr. Rudis was President of Quorum Corporation, a private consulting
firm involved in acquisitions and market development. From 1970 until 1984, he
held various executive positions in CIT Financial Corporation, including Vice
President and Regional Manager of that company's Commercial Finance Division.
Richard A. Horvath was elected to our board of directors in November 1999
and has served as our Senior Vice President and Secretary since November 1997.
Mr. Horvath has been in the food industry for almost 30 years. Prior to his
employment at Overhill Farms, Mr. Horvath served as the Chief Financial Officer
of Martino's. During the period of 1973 to 1996, he held various positions with
the Carnation Company, Star Kist Foods, and Mission Foods.
William E. Shatley was elected to our board of directors and was named as
our Senior Vice President and Treasurer in February 1998. Mr. Shatley has served
as Senior Vice President of TreeCon Resources from March 1994 until October 2002
and as a director of TreeCon Resources from February 1998 until October 2002. He
joined TreeCon Resources in an executive capacity in October 1993, having
previously served on an advisory basis since the relocation of its corporate
offices to Texas in 1992. Mr. Shatley, a certified public accountant since 1970,
previously conducted his own consulting and accounting practice from 1982 to
1993, after having served as Vice President and Chief Financial Officer of
Datotek, Inc. from 1977 to 1982 and in an executive capacity with Arthur
Andersen from 1968 to 1977.
24
Harold Estes was appointed to our board of directors in October 2002. Mr.
Estes is the President of Texas Timberjack, Inc. ("TTI"), a wholly owned
subsidiary of TreeCon Resources. He was elected as a director of TreeCon
Resources in February 1996 and resigned from the TreeCon Resources board of
directors in April 1997. TTI is a distributor of industrial and commercial
timber and logging equipment and is also engaged in certain related timber and
sawmill operations. Mr. Estes has been President of TTI since 1984, when he
acquired TTI from Eaton Corporation. Mr. Estes previously served as a director
of Newton Bancshares, Inc., the parent of First National Bank of Newton (Texas)
for approximately 10 years until the sale of the bank in October 2001.
Geoffrey A. Gerard was elected to our board of directors in February 2002.
Mr. Gerard served as Secretary and General Counsel of Equivest, Inc. from 1975
to 1977. Mr. Gerard then served as Secretary and General Counsel for two
privately held oil and gas exploration companies until 1978. Mr. Gerard has been
in the private practice of law in Dallas County, Texas since 1978 specializing
in business transactions. Mr. Gerard received his B.S. in Business-Finance and
his J.D. from Indiana University.
John E. McConnaughy, Jr. was appointed to our board of directors in October
2002. Mr. McConnaughy has served as Chairman and Chief Executive Officer of JEMC
Corporation, a personal holding company since he founded it in 1985. His career
includes positions of management with Westinghouse Electric and the Singer
Company, as well as service as a director of numerous public and private
companies. In addition, he previously served as Chairman and CEO of Peabody
International Corp. and Chairman and CEO of GEO International Corp. He retired
from Peabody in February 1986 and GEO in October 1992. Mr. McConnaughy served as
Chairman of Excellence Group, LLC, which filed a petition for bankruptcy under
Chapter 11 in January 1999, and currently serves on the boards of five other
public companies (Wave Systems, Inc., Mego Financial Corp., Riddell Sports,
Inc., Levcor International, Inc., and DeVlieg Bullard, Inc.), and one private
company (PetsChoice, Ltd.). He also serves on the Board of Trustees and
Executive Committee of the Strang Cancer Prevention Center and as Chairman of
the Board for the Harlem School of the Arts. Mr. McConnaughy holds a B.A. of
Economics from Denison University, and an M.B.A. in Marketing and Finance from
Harvard's Graduate School of Business Administration.
Robert W. Schleizer was appointed to our board of directors in October
2002. Mr. Schleizer has been a partner with Tatum CFO Partners, LLP, a national
firm of Chief Financial Officers, since October 1999. Mr. Schleizer also served
as Chief Financial Officer and Chief Operating Officer of Barber Trucking, a
privately held national trucking company, from January 1998 to November 1999.
From 1995 to 1997, Mr. Schleizer was President, Treasurer and a director of
Pegasus Industries, Inc., a retail and financial services firm. Mr. Schleizer
has been Executive Vice President, Chief Financial Officer, Treasurer and
Director of PawnMart, Inc. since January 2001. PawnMart, Inc. filed for
bankruptcy in July 2001 and its plan of reorganization was confirmed by the
bankruptcy court in May 2002. From 1987 to 1997, Mr. Schleizer served as a
business and financial consultant with Pegasus Financial Services, Inc. Mr.
Schleizer previously served as a director of Overhill Farms, Inc. from July 2000
until December 2001.
Board of Directors and Committees
Our board of directors did not hold regularly scheduled meetings during the
fiscal year ended September 30, 2002. Following the spin-off, our board of
directors may use working committees with functional responsibility in the more
complex recurring areas where disinterested oversight is required. In addition
to other committees established by our board of directors from time to time, our
board of directors has established the Audit Committee and the Compensation
Committee.
25
Audit Committee
We formed the Audit Committee to be composed of three independent outside
directors. The Audit Committee will operate pursuant to a charter approved by
our board of directors, according to the rules and regulations of the Securities
and Exchange Commission and the American Stock Exchange. Its functions are to
monitor our financial reporting process and internal control system, review and
appraise the audit efforts of our independent auditors and provide an avenue of
communication among our independent accountants, financial and senior management
and our board of directors. The Audit Committee consists of Mr. Gerard, Mr.
Schleizer and Mr. McConnaughy.
Compensation Committee
We formed the Compensation Committee to be composed entirely of
disinterested non-employee directors. The Compensation Committee functions are
to administer our employee stock option plans and approve the granting of stock
options and approve compensation for officers. The Compensation Committee
consists of Mr. Gerard, Mr. Schleizer and Mr. McConnaughy.
Director Compensation
We have never paid any compensation to our directors for their services as
directors. However, we intend to pay director compensation following the
spin-off, though we have not yet determined the director compensation.
Section 16(a) Beneficial Ownership Reporting Compliance
Form 3 filings for TreeCon Resources, James Rudis, William E. Shatley,
Richard A Horvath, Geoffrey Gerard, and Robert Schleizer were filed late
following the effective date of our Form 10. Harold Estes and John E.
McConnaughy have not yet filed a Form 3, but we are providing them assistance in
this regard. A Form 4 filing for Mr. Gerard for one option grant was also filed
late.
ITEM 11. Executive Compensation
The following table sets forth for fiscal 2002, 2001 and 2000 compensation
awarded or paid to Mr. James Rudis, our Chairman, Chief Executive Officer and
President, Mr. William E. Shatley, our Senior Vice President and Treasurer, for
services rendered to TreeCon Resources and its subsidiaries (including Overhill
Farms, Inc.). Mr. Rudis and Mr. Shatley are the only individuals who served as
executive officers of TreeCon Resources for the year ended September 30, 2002
who also will serve as Overhill Farms, Inc. executive officers. The following
table also sets forth for fiscal 2002, 2001 and 2000 compensation awarded to Mr.
Richard A. Horvath, our Senior Vice President and Secretary, for services
rendered to Overhill Farms, Inc. The compensation described in this table for
Mr. Rudis and Mr. Shatley was paid by TreeCon Resources or Overhill Farms. Mr.
Rudis, Mr. Shatley and Mr. Horvath are also referred to in this section as
"named executive officers." Other than as indicated in the table below, none of
our executive officers received salary plus bonus in excess of $100,000 for
fiscal year 2002.
26
Summary Compensation Table
Annual Compensation
---------------------------------------------------
Name and Principal Fiscal Other Annual
Position Year Salary Compensation Bonus
-----------------------------------------------------------------------------------------------------------------
James Rudis ................................ 2002 $ 230,000 $ - (1) $ -
Chief Executive Officer and President 2001 $ 230,000 $ - (1) $ 40,000
2000 $ 225,769 $ - (1) $ 25,000
William E. Shatley ......................... 2002 $ 168,000 $ - (1) $ -
Senior Vice President and Treasurer 2001 $ 168,000 $ - (1) $ 15,000
2000 $ 165,000 $ - (1) $ 15,000
Richard A. Horvath ......................... 2002 $ 140,000 $ - (1) $ -
Senior Vice President and Secretary 2001 $ 140,000 $ - (1) $ 20,000
2000 $ 140,000 $ - (1) $ 15,000
--------------------
(1) The named executive officers each received certain perquisites and other
personal benefits from TreeCon Resources or Overhill Farms during fiscal
2002, 2001 and 2000. These perquisites and other personal benefits,
however, did not equal or exceed 10% of the named executive officers'
salary and bonus during fiscal 2002, 2001 or 2000.
Employment Agreements
James Rudis, our President, and William E. Shatley, our Senior Vice
President and Treasurer, have each entered into an employment agreement with us
and TreeCon Resources. We may, in the future, replace these agreements with Mr.
Rudis and Mr. Shatley, and TreeCon Resources would not be a party to the
replacement agreements. Richard A. Horvath, our Senior Vice President and
Secretary, also has entered into an employment agreement with us. We do not
maintain employment agreements with any of our other personnel.
James Rudis and William E. Shatley Employment Agreements
Mr. Rudis' and Mr. Shatley's current employment agreements each have an
initial term of five years, commencing November 1, 1999, automatically renewing
from year to year thereafter unless terminated by either party thereto. These
agreements provide that we will review their compensation annually and may
increase it in a percentage not less than that of the annual increase in the
cost of living. Each employment agreement contains a covenant by the executive
not to compete with us during the term of his employment and for a period of one
year thereafter.
These employment agreements also provide that if the executive is
terminated by reason of his death or disability, he or his estate is entitled to
receive:
. his base salary through the date of termination;
. all bonuses earned through the date of termination, paid in accordance
with the terms of the bonus plan pursuant to which the bonus was
earned;
. accrued but unused vacation and sick leave pay;
27
. reimbursement for reasonable and necessary business expenses incurred
before termination;
. all rights to which he is granted under our life insurance policy; and
. all amounts to which he is entitled under any profit sharing plan of
our company.
If the executive voluntarily resigns prior to the end of the term, he is
entitled to receive all amounts that he would receive as if he was terminated as
a result of death or disability and accrued but unused personal business days
paid at a per diem rate equivalent to the executive's then current salary,
provided, however, that he will not be entitled to receive any bonus payments.
In the event the executive is terminated for cause, he is entitled to receive
all amounts that he would receive as if he was terminated as a result of death
or disability. If he is terminated other than for cause, he is entitled to
receive:
. in a lump sum, the remainder of his salary for the remainder of the
term of the agreement;
. any bonus earned through the date of termination, paid in accordance
with the terms of the bonus plan pursuant to which any bonus may have
been earned;
. accrued but unused vacation and sick leave pay;
. reimbursement for reasonable and necessary business expenses incurred
prior to termination;
. all rights to which he is granted under our life insurance policy;
. all amounts to which he is entitled under any profit sharing plan of
our company; and
. monthly payments for one year equal to the monthly premium required to
maintain his life and health insurance benefits pursuant to the
Consolidated Omnibus Budget Reconciliation Act of 1985 under our group
insurance plan.
If he is terminated other than for cause, he is also entitled to have all
indebtedness by him to us and TreeCon Resources forgiven and to use the car
provided to him in his employment agreement for one year following the date of
termination.
Richard A. Horvath Employment Agreement
Mr. Horvath's employment agreement has an initial term of three years,
commencing November 1, 1999, automatically renewing from year to year thereafter
unless terminated by either party thereto. Compensation is set in his agreement,
subject to our review on an annual basis. His agreement contains a covenant by
him not to compete with us during the term of his employment and for a period of
one year thereafter. His employment agreement also provides that if he is
terminated by reason of his death or disability, he or his estate is entitled to
receive:
. his base salary through the date of termination;
. all bonuses earned through the date of termination, paid in accordance
with the terms of the bonus plan pursuant to which the bonus was
earned;
. accrued but unused vacation and sick leave pay;
. reimbursement for reasonable and necessary business expenses incurred
before termination; and
28
. all amounts to which he is entitled under any profit sharing plan of
our company.
If Mr. Horvath voluntarily resigns prior to the end of the term, he is
entitled to receive all amounts that he would receive as if he was terminated as
a result of death or disability and accrued but unused personal business days,
provided, however, that he will not be entitled to receive any bonus payments.
In the event Mr. Horvath is terminated for cause, he is entitled to receive all
amounts that he would receive as if he was terminated as a result of death or
disability, provided, however, that he will not be entitled to receive any bonus
payments or any reimbursement expenses. If he is terminated other than for
cause, he is entitled to receive:
. in a lump sum, an amount equal to the greater of the remainder of his
salary for the current year or $200,000;
. any bonus earned through the date of termination, paid in accordance
with the terms of the bonus plan pursuant to which any bonus may have
been earned;
. accrued but unused vacation and sick leave pay;
. reimbursement for reasonable and necessary business expenses incurred
prior to termination;
. all amounts to which he is entitled under any profit sharing plan of
our company; and
. monthly payments for one year equal to the monthly premium required to
maintain his life and health insurance benefits pursuant to the
Consolidated Omnibus Budget Reconciliation Act of 1985 under our group
insurance plan.
2002 Employee Stock Option Plan of Overhill Farms, Inc.
Our board of directors adopted the 2002 Employee Stock Option Plan of
Overhill Farms, Inc. to become effective after the spin-off, and our
stockholders will be asked to approve the plan at our next annual meeting of
stockholders following the spin-off. We have reserved 800,000 shares of our
common stock for issuance under the plan. The plan is intended to advance our
best interests to attract, retain and motivate directors, officers, key
employees and consultants by providing them with additional incentives through
the award of incentive stock options and non-qualified stock options.
Eligibility
Our employees, directors and consultants will be eligible to be granted
awards under the plan. However, only our employees will be eligible to receive
incentive stock options.
Administration
The plan is administered by the Compensation Committee of our board of
directors or another committee appointed by our board of directors composed of
outside directors. The committee will have the discretion and the authority to
adopt rules and regulations for carrying out the purposes of the plan.
Stock Options
The stock option plan provides for the grant of both options intended to
qualify as "incentive stock options" under Section 422 of the Internal Revenue
Code, as well as non-qualified stock options. The maximum term of a stock option
granted under the stock option plan is ten years, except that with respect to
incentive stock options granted to a person who owns stock having more than 10%
of the voting power of our stock, the term of an option shall not exceed five
years.
29
Options will be issued at an exercise price determined by the committee
except that the exercise price of incentive stock options granted under the
stock option plan must be at least equal to the fair market value of our common
stock on the date of the grant. However, for any optionee who owns stock
possessing more than 10% of the voting power of our stock, the exercise price
for incentive stock options must be at least 110% of the fair market value of
our common stock on the date of the grant. The exercise price of non-qualified
stock options will be determined by the committee and may be less than, equal to
or greater than the fair market value of our common stock on the date of the
grant. The aggregate fair market value on the date of grant of the common stock
for which incentive stock options are exercisable by an optionee during any
calendar year may not exceed $100,000.
Options granted under the stock option plan may be exercised in whole or in
part as specifically set forth in the option agreement, and, except as provided
by law, no incentive stock options may be transferred except by will or by the
laws of descent and distribution. The committee may provide in an agreement
granting non-qualified options that the non-qualified options are transferable
and the extent to which the non-qualified options are transferable. The board of
directors may terminate the stock option plan after its adoption in whole or in
part at any time and may amend the stock option plan after its adoption from
time to time without stockholder approval so long as no stock option award is
revoked or altered in a manner unfavorable to the holder. The stock option plan
is expected to terminate on the tenth anniversary of the effective date of the
stock option plan, unless terminated earlier by the board of directors.
Compensation Committee Interlocks and Insider Participation
No member of the Compensation Committee will be an officer or employee of
our company or any of our subsidiaries or has had any relationship requiring
disclosure pursuant to Item 404 of Regulation S-K under the Securities Act of
1933, as amended. None of our executive officers serves as a member of a
compensation committee of another corporation (or other board committee of such
company performing similar functions or, in the absence of any such committee,
the entire board of directors of such corporation), one of whose executive
officers serves on the Compensation Committee. None of our executive officers
serves as a director of another corporation, one of whose executive officers
served on the Compensation Committee. None of our executive officers serves as a
member of a compensation committee of another corporation (or other board
committee of such corporation performing similar functions or, in the absence of
any such committee, the entire board of directors), one of whose executive
officers serves as one of our directors.
30
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
The following table sets forth certain information with respect to
beneficial ownership of our common stock as of December 20, 2002, for:
. each person who is known by us to beneficially own more than 5%
of our common stock,
. each of our directors and named executive officers, and
. all directors and officers as a group.
The percentage of ownership is based on 12,338,797 shares of common stock
outstanding as of December 20, 2002. Except as otherwise indicated below, the
persons named in the table have sole voting and investment power with respect to
all shares of common stock held by them. Unless otherwise indicated, the
principal address of each of the parties listed below is c/o Overhill Farms,
Inc., 2727 East Vernon Avenue, Vernon, California 90058.
Shares Beneficially Owned (1)(2)
--------------------------------
Name of Beneficial Owner Number Percent
------------------------ ------ -------
James Rudis (3) ........................................... 578,950 4.6
William E. Shatley (4) .................................... 352,350 2.8
Richard A. Horvath (5) .................................... 25,750 *
Harold Estes (6). ......................................... 2,007,750 16.3
Geoffrey A. Gerard (7) .................................... 2,000 *
John E. McConnaughy, Jr. (8) .............................. 610,300 4.9
Levine Leichtman Capital Partners II, L.P. (9) ............ 3,221,263 24.0(9)
All directors and officers as a group
(6 persons)(3)(4)(5) ................................... 3,577,100 27.9
____________________________________________________________
* Indicates ownership of less than 1% of our common stock
(1) Beneficial ownership as reported in the above table has been determined in
accordance with Rule 13d-3 under the Securities Exchange Act of 1934, as
amended. The persons and entities named in the table have sole voting and
investment power with respect to all shares shown as beneficially owned by
them, except as noted below. Amounts shown include shares of common stock
issuable upon exercise of certain outstanding options within 60 days after
December 20, 2002.
(2) Except for the percentages of certain parties that are based on presently
exercisable options which are indicated in the following footnotes to the
table, the percentages indicated are based on 12,338,797 shares of common
stock issued and outstanding on December 20, 2002.
(3) Includes options to purchase 300,000 shares of common stock.
(4) Includes options to purchase 150,000 shares of common stock and 79,100
shares that Mr. Shatley may be deemed to beneficially own as a general
partner in a family limited partnership.
(5) Includes options to purchase 20,000 shares of common stock.
(6) Mr. Estes' address is Highway 59 South, Route 15, Box 9475, Lufkin, Texas
75901.
(7) Consists of options to purchase 2,000 shares of common stock.
(8) Mr. McConnaughy's address is 3 Parklands Drive, Darien, Connecticut 06820.
31
(9) Includes (a) 200 shares of our common stock issuable upon exercise of two
warrants owned by Levine Leichtman Capital Partners II, L.P. ("LLCP") and (b)
23.57 shares of our Series A Convertible Preferred Stock convertible into
283,076 shares of our common stock owned by LLCP. LLCP California Equity
Partners II, L.P., a California limited partnership, is the sole general partner
of LLCP. Our securities purchase agreement with LLCP provides that it is
entitled to anti-dilution protection so that the shares of common stock issuable
upon exercise of its warrants and conversion of its shares of our Series A
Convertible Preferred Stock will represent in the aggregate not less than 24.0%
of our outstanding shares of capital stock, determined on a fully diluted basis
and including the reservation of 800,000 shares of common stock for issuance
under our 2002 Employee Stock Option Plan. Levine Leichtman Capital Partners,
Inc., a California corporation, is the sole general partner of the LLCP
California Equity Partners II, L.P. Arthur E. Levine is a director, the
President and a shareholder of Levine Leichtman Capital Partners, Inc. Lauren B.
Leichtman is a director, the Chief Executive Officer and a shareholder of Levine
Leichtman Capital Partners, Inc. The address of each of LLCP, LLCP California
Equity Partners II, L.P., Levine Leichtman Capital Partners, Inc., Mr. Levine
and Ms. Leichtman is c/o Levine Leichtman Capital Partners II, L.P., 335 North
Maple Drive, Suite 240, Beverly Hills, California 90210.
ITEM 13. Certain Relationships and Related Transactions
TreeCon Resources, in prior years, charged us management fees for various
expenses related to the oversight of our business. Management fees were $0 in
2002 and 2001, and were $350,000 in 2000.
In September 2001, James Rudis, our President, Chief Executive Officer and
a director, exercised options to purchase 276,500 shares of TreeCon Resources
common stock, and William E. Shatley, our Senior Vice President, Treasurer and a
director, exercised options to purchase 246,500 shares of TreeCon Resources
common stock, each of which were granted under individual option agreements in
1993 and TreeCon Resources' 1994 Employee Stock Option Plan in 1996. These
options were exercised with the issuances of two-year promissory notes to
TreeCon Resources bearing interest at 3.82% and collateralized by the shares
issued. The outstanding principal amounts of the notes are $207,375 for Mr.
Rudis and $184,875 for Mr. Shatley.
From time to time, we have made advances to TreeCon Resources for various
purposes in the context of our parent-subsidiary relationship. Additionally, we
have netted accumulated federal income tax liabilities payable to TreeCon
Resources against amounts owed from TreeCon Resources to us. We had
approximately $10.5 million in net receivables from TreeCon Resources as of
September 29, 2002. During the fiscal years ended September 29, 2002, September
30, 2001 and October 1, 2000, we made cash payments to, or on behalf of, TreeCon
Resources of approximately $1.2 million, $500,000 and $1.6 million, respectively
for various purposes including tax payments, expense reimbursement and other
corporate purposes. In connection with the spin-off, TreeCon Resources
transferred to us as partial payment of these net receivables the two promissory
notes made in the amounts of $207,375 and $184,875, made by Mr. Rudis and Mr.
Shatley, respectively. In connection with the spin-off, TreeCon indemnified us
with respect to any current or future tax liabilities for which we might
otherwise be liable resulting from the operations of any entity other than us
and we agreed with TreeCon resources to cancel any remaining amounts owed to us
by TreeCon Resources, or owed to TreeCon Resources by us, as of September 29,
2002 after obtaining the appropriate consents under our financing arrangements.
Following the spin-off, Mr. Rudis will remain as a director of TreeCon
Resources for a period of no greater than one year after the spin-off to
facilitate the transition of TreeCon Resources and Overhill Farms, Inc. into two
separate companies. Among our outside directors we appointed to our board of
directors in connection with the spin-off, Harold Estes was appointed to our
board of directors. Mr. Estes is the President of Texas Timberjack, Inc., a
wholly owned subsidiary of TreeCon Resources. He was elected as a director of
TreeCon Resources in February 1996 and resigned from the TreeCon Resources board
of directors in April 1997. Mr. Estes has been President of Texas Timberjack,
Inc. since 1984, when he acquired Texas Timberjack, Inc. from Eaton Corporation.
Mr. Rudis and Mr. Shatley have entered into employment agreements with us
and TreeCon Resources. Richard A. Horvath, our Senior Vice President and
Secretary, also has entered into an employment agreement with us. We do not
maintain employment agreements with any of our other personnel. Mr. Rudis' and
Mr. Shatley's employment agreements provide for, among other things, an initial
term of five years, commencing November 1, 1999, automatically renewing from
year to year thereafter unless terminated by either party thereto. These
agreements provide that we will review their compensation annually and may
increase it in a percentage not less than that of the
32
annual increase in the cost of living. Each employment agreement contains a
covenant by the executive not to compete with us during the term of his
employment and for a period of one year thereafter. Prior to the spin-off, the
compensation for Mr. Rudis and Mr. Shatley was paid by TreeCon Resources or an
affiliate of TreeCon Resources. Mr. Horvath's employment agreement provides for,
among other things, an initial term of three years, commencing November 1, 1999,
automatically renewing from year to year thereafter unless terminated by either
party thereto. Compensation is set in his agreement, subject to our review on an
annual basis. His agreement contains a covenant by him not to compete with us
during the term of his employment and for a period of one year thereafter.
Our senior subordinated creditor is the holder of a secured senior
subordinated note, which it purchased from us in November 1999 pursuant to a
securities purchase agreement. We amended and restated the securities purchase
agreement, the note and various related agreements in connection with the
spin-off. The note bears interest at a base rate per annum of 13.25%, with
interest payable monthly. However, if we achieve specified EBITDA tests for the
fiscal year ending September 2003, the base rate will be reduced to 12.5%. The
note matures on October 31, 2004. We are required to make mandatory principal
payments each January for the previous fiscal year in an amount equal to 50% of
the excess cash flow, as defined. The amount of the principal prepayment for the
fiscal year ended September 29, 2002 is approximately $541,000. We may make
voluntary principal prepayments at any time, subject to prepayment premiums. The
securities purchase agreement contains various covenants, including financial
covenants covering restrictions on capital expenditures, minimum EBITDA and net
worth levels, and specified debt service and debt to equity ratios. In addition,
the terms of the securities purchase agreement prohibit changes in control,
including ownership and management personnel, and contains customary
restrictions on incurring indebtedness and liens, making investments, paying
dividends and making loans or advances. The note and all other obligations owing
by us to our senior subordinated creditor are secured by subordinated liens on
substantially all of our assets and by a guaranty of Overhill L.C. Ventures,
Inc., our subsidiary. In connection with the spin-off, our senior subordinated
creditor released TreeCon Resources from its guaranty and released its lien on
our common stock held by TreeCon Resources, which secured TreeCon Resources'
guaranty. The agreement requires us to pay our senior subordinated creditor,
during each January, annual consulting fees of $180,000.
In connection with the original securities purchase agreement, we issued to
our senior subordinated creditor a warrant to purchase 166.04 shares of our
common stock exercisable immediately at an exercise price of $0.01 per share.
The warrant became exercisable for 1,994,141 shares of our common stock at an
exercise price of $0.0000008 per share after giving effect to the
12,010-shares-for-1 stock split declared in connection with the spin-off. This
warrant was exercised as to 1,994,040 shares in December 2002 and remains
exercisable as to 100 shares. At the date of issuance, this warrant was
estimated to have a fair value of $2.37 million.
In 2002, we entered into various amendments to our securities purchase
agreement with our senior subordinated creditor with respect to, among other
things, the consolidation of our facilities and amendments to our financial
covenants with it. In exchange for our senior subordinated creditor's consent
and agreement to amend the securities purchase agreement and other investment
documents and certain other consideration, in January 2002 we issued to it 23.57
shares of our Series A Convertible Preferred Stock valued at $750,000, and in
September 2002 we issued to it a warrant to purchase 57.57 shares of our common
stock valued at $1,100,000 and agreed to pay a restructuring fee in an aggregate
amount of $423,000 payable in three installments ending in March 2003. After
giving effect to the 12,010-shares-for-1 stock split declared in connection with
the spin-off, the shares of Series A Convertible Preferred Stock are convertible
into 283,076 shares of our common stock, and the warrant was exercisable for
691,416 shares of our common stock at an exercise price of $0.0000008 per share.
This warrant was exercised as to 691,315 shares in December 2002 and remains
exercisable as to 100 shares. The designations for the Series A Convertible
Preferred Stock provide the holder with, among other things, a liquidation
preference per share of $31,820.11, plus declared and unpaid dividends, voting
rights along with holders of common stock, protective provisions, conversion
rights and anti-dilution protection. In September 2002, a previous agreement for
an interest rate reduction upon our making certain voluntary prepayments and our
obligation to make a $500,000 cash payment in the event we did not repurchase
the previous warrant or shares issuable under the warrant upon repayment of our
senior subordinated debt was terminated.
33
Our securities purchase agreement with our senior subordinated creditor
provides that, immediately following the spin-off, it is entitled to
anti-dilution protection so that the shares of common stock issuable upon
exercise of its warrants and conversion of its shares of our Series A
Convertible Preferred Stock will represent in the aggregate not less than 24.0%
of our outstanding shares of capital stock, determined on a fully diluted basis
and including the reservation of shares of common stock for issuance under our
2002 Employee Stock Option Plan. In November 2002, we issued 252,632 shares of
our common stock to our senior subordinated creditor representing all shares
currently issuable pursuant to the anti-dilution protection.
We are party to an amended and restated investor rights agreement with our
senior subordinated creditor, as the holder of our equity securities. Under the
agreement:
. the holder has the right to designate a nominee to our board of
directors, and Mr. Rudis and Mr. Shatley each agreed to vote their
shares of our common stock for that nominee;
. the holder has co-sale rights with respect to shares of our common
stock owned by Mr. Rudis and Mr. Shatley such that it has the right to
participate in certain proposed sales of those shares by Mr. Rudis or
Mr. Shatley;
. Mr. Rudis and Mr. Shatley are each permitted to sell up to 50,000
shares of our common stock in open market transactions during any
fiscal year without complying with the co-sale procedures, but a change
in control will occur if Mr. Rudis does not continue directly or
beneficially to own or hold 300,000 shares and Mr. Shatley does not
continue directly or beneficially to own or hold 150,000 shares;
. the holder has a right of first refusal to purchase its pro rata share
of certain issuances of our capital stock;
. we will continue to pay to the holder, or one of its affiliates,
installments of a consulting fee of $180,000 in each of January 2003
and 2004 for its review and analysis of financial matters and
participation in the operating committee. The consulting fees are
subject to acceleration in the event of a change in control or the
payment in full of all of our obligations under the senior subordinated
note we issued to the holder; and
. the agreement contains certain restrictions regarding our ability to
grant options to our directors, executive officers, consultants and key
employees and to amend any existing stock option plans or adopt or
approve any new stock option or stock purchase plans.
Pursuant to our equity repurchase option agreement with our senior
subordinated creditor, we have the right to repurchase from it, in whole but not
in part, the shares of our common stock issuable upon exercise of the warrants
and conversion of the shares of our Series A Convertible Preferred Stock it
holds and the shares of our Series A Convertible Preferred Stock it holds and
the shares of our Series A Convertible Preferred Stock it holds. We may exercise
this option if:
. a default occurs under the securities purchase agreement and the holder
provides written notice to us requesting that we make payments in
addition to those which we are then obligated to make under our then
existing financing arrangement or declares all of our obligations to
the holder under the securities purchase agreement to be immediately
due and payable, or
. if we notify the holder that we intend to merge, sell all or a
significant portion of our assets, reorganize or recapitalize or enter
into a bona fide transaction valued at more than $8.0 million and it
does not consent to the transaction.
If we exercise our repurchase option, we may repurchase its shares of our
common stock for:
. if our common stock is publicly traded, the greater of the current
market price per share or an amount per share based on a predetermined
formula, or
34
. if our common stock is not publicly traded, an amount based on the
predetermined formula.
We may repurchase its shares of our Series A Convertible Preferred Stock
for an amount equal to the greater of:
. the number of shares of our common stock issuable upon conversion of
the shares of Series A Convertible Preferred Stock being repurchased
multiplied by the per share amount determined with respect to our
common stock, and
. $540,000.
In connection with our financing arrangements with our senior subordinated
creditor, we entered into an amended and restated registration rights agreement
with it, as the holder of the warrant we issued to it, whereby we agreed to
register under the Securities Act of 1933, as amended, shares of our common
stock it holds or acquires, which includes shares of our common stock it
acquires upon exercise of its warrants to purchase our common stock, conversion
of its shares of our Series A Convertible Preferred Stock and any other
acquisition of our common stock. In addition, we agreed under certain
circumstances, upon the request of the holder, to include its shares of our
common stock in a securities registration that we undertake on our behalf or on
behalf of others.
ITEM 14. Controls and Procedures
Our management, including our Chief Executive Officer and Chief Financial
Officer, after evaluating the effectiveness of our disclosure controls and
procedures (as defined in Rules 13a-14(c) and 15-d-14(c) under the Securities
Exchange Act of 1934) as of a date (the "Evaluation Date"), which was within 90
days of this annual report on Form 10-K, has concluded in its judgment that, as
of the Evaluation Date, our disclosure controls and procedures were adequate and
designed to ensure that material information relating to us and our subsidiaries
would be made known to them.
There were no significant changes in our internal controls or, to our
knowledge, in other factors that could significantly affect our disclosure
controls and procedures subsequent to the Evaluation Date.
35
PART IV
ITEM 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Financial Statements
1. The following financial statements are filed as part of this report:
Report of Independent Auditors
Consolidated Balance Sheets--September 29, 2002 and September 30, 2001
Consolidated Statements of Operations--Years Ended September 29, 2002,
September 30, 2001 and October 1, 2000
Consolidated Statements of Shareholders' Equity--Years Ended September
29, 2002, September 30, 2001 and October 1, 2000
Consolidated Statements of Cash Flows--Years Ended September 29, 2002,
September 30, 2001 and October 1, 2000
Notes to Consolidated Financial Statements
2. Schedules for which provision is made in the applicable rules and
regulations of the Securities and Exchange Commission are not required
under the related instructions or are inapplicable, and therefore have
been omitted.
3. Exhibits
Exhibit
-------
Number Exhibit Title
------ -------------
3.1* Form of Amended and Restated Articles of Incorporation of Overhill
Farms, Inc. (Exhibit 3.1)
3.2* Form of Amended and Restated Bylaws of Overhill Farms, Inc.
(Exhibit 3.2)
4.1* Form of the specimen common stock certificate of Overhill Farms, Inc.
(Exhibit 4.1)
10.1* # 2002 Employee Stock Option Plan for Overhill Farms, Inc. (Exhibit
10.1)
10.2+ Term Loan Agreement in the amount of $22,500,000, dated December 4,
1997, among Overhill Farms, Inc. as borrower, Polyphase Corporation
as guarantor and The Long Horizons, Fund, L.P. as lender (Exhibit
10.14)
10.3+ # Employment Agreement, entered into as of November 1, 1999 between
Polyphase Corporation and Overhill Farms, Inc., jointly and
severally, and James Rudis (Exhibit 10.36)
10.4+ # Employment Agreement, entered into as of November 1, 1999 between
Polyphase Corporation and Overhill Farms, Inc., jointly and
severally, and William E. Shatley (Exhibit 10.37)
10.5* # Employment Agreement, entered into as of November 1, 1999 between
Overhill Farms, Inc. and Andrew Horvath (Exhibit 10.5)
36
10.6* Form of Amended and Restated Loan and Security Agreement among
Overhill Farms, Inc., Overhill L.C. Ventures, Inc. and Union Bank of
California, N.A. (Exhibit 10.6)
10.7+ Revolving Note, dated as of November 24, 1999, in the principal
amount of $16,000,000, payable to the order of Union Bank of
California, N.A., as payee, by Overhill Farms, Inc., as borrower
(Exhibit 10.40)
10.8* Form of Reaffirmation of Continuing Guaranty by Overhill L.C.
Ventures, Inc. in favor of Union Bank of California, N.A. (Exhibit
10.8)
10.9* Form of First Amendment to Pledge Agreement by Overhill Farms, Inc.
and Overhill L.C. Ventures, Inc. in favor of Union Bank of California,
N.A. (Exhibit 10.9)
10.10+ Term Note, dated as of August 23, 2000, by Overhill Farms, Inc. in
favor of Union Bank of California, N.A. (Exhibit 10.52)
10.11* Form of Amended and Restated Intercreditor and Subordination
Agreement by and between Levine Leichtman Capital Partners II, L.P.,
as subordinated lender, and Union Bank of California, N.A., as senior
lender (Exhibit 10.11)
10.12+ Securities Purchase Agreement, dated as of November 24, 1999, by and
among Overhill Farms, Inc., as issuer, Polyphase Corporation and
Overhill L.C. Ventures, Inc., as guarantors, and Levine Leichtman
Capital Partners II, L.P., as purchaser (Exhibit 10.44)
10.13+ Consent and First Amendment to Securities Purchase Agreement,
entered into as of August 23, 2000, by and among Overhill Farms, Inc.,
Levine Leichtman Capital Partners II, L.P., Polyphase Corporation and
Overhill L.C. Ventures, Inc. (Exhibit 10.53)
10.14* Second Amendment to Securities Purchase Agreement, dated as of
January 11, 2002, by and among Overhill Farms, Inc., Overhill
Corporation, Overhill L.C. Ventures, Inc. and Levine Leichtman Capital
Partners II, L.P. (Exhibit 10.14)
10.15* Consent and Third Amendment to Securities Purchase Agreement, dated
as of January 31, 2002, by and among Overhill Farms, Inc., Overhill
Corporation, Overhill L.C. Ventures, Inc. and Levine Leichtman Capital
Partners II, L.P. (Exhibit 10.15)
10.16* Fourth Amendment to Securities Purchase Agreement, dated as of June
28, 2002, by and among Overhill Farms, Inc., Overhill Corporation,
Overhill L.C. Ventures, Inc. and Levine Leichtman Capital Partners II,
L.P. (Exhibit 10.16)
10.17* Fifth Amendment to Securities Purchase Agreement, dated as of
September 11, 2002, by and among Overhill Farms, Inc., Overhill
Corporation, Overhill L.C. Ventures, Inc. and Levine Leichtman Capital
Partners II, L.P. (Exhibit 10.17)
10.18* Form of Amended and Restated Securities Purchase Agreement by and
among Overhill Farms, Inc., as issuer, the entities from time to time
parties thereto as guarantors, and Levine Leichtman Capital Partners
II, L.P., as purchaser (Exhibit 10.18)
10.19+ Secured Senior Subordinated Note, dated November 4, 1999, in the
principal amount of $28,000,000, payable to the order of Levine
Leichtman Capital Partners II, L.P. (Exhibit 10.45)
10.20* Amendment to Secured Senior Subordinated Note Due 2004, dated as of
May 1, 2001, by Overhill Farms, Inc. in favor of Levine Leichtman
Capital Partners II, L.P. (Exhibit 10.20)
37
10.21* Second Amendment to Secured Senior Subordinated Note Due 2004, dated
as of September 11, 2002, by Overhill Farms, Inc. in favor of Levine
Leichtman Capital Partners II, L.P. (Exhibit 10.21)
10.22* Form of Amended and Restated Secured Senior Subordinated Note in the
principal amount of $28,000,000, payable to the order of Levine
Leichtman Capital Partners II, L.P., as holder, by Overhill Farms,
Inc., as borrower (Exhibit 10.22)
10.23+ Form of Amended and Restated Warrant to Purchase 166.04 Shares of
Common Stock of Overhill Farms, Inc., in favor of Levine Leichtman
Capital Partners II, L.P. (Exhibit 10.46)
10.24* Warrant to Purchase 57.57 Shares of Common Stock of Overhill Farms,
Inc., dated September 11, 2002, in favor of Levine Leichtman Capital
Partners II, L.P. (Exhibit 10.24)
10.25+ Investor Rights Agreement, entered into as of November 24, 1999, by
and among Overhill Farms, Inc., Polyphase Corporation and Levine
Leichtman Capital Partners II, L. P. (Exhibit 10.47)
10.26+ Amendment to Investor Rights Agreement, entered into as of August
25, 2000, by and among Overhill Farms, Inc., Polyphase Corporation and
Levine Leichtman Capital Partners II, L.P. (Exhibit 10.54)
10.27* Second Amendment to Investor Rights Agreement, dated as of January
11, 2002, by and among Overhill farms, Inc., Overhill Corporation and
Levine Leichtman Capital Partners II, L.P. (Exhibit 10.27)
10.28* Form of Amended and Restated Investor Rights Agreement by and among
Overhill Farms, Inc., James Rudis, William E. Shatley and Levine
Leichtman Capital Partners II, L.P. (Exhibit 10.28)
10.29* Registration Rights Agreement, dated as of November 24, 1999, by and
between Overhill Farms, Inc. and Levine Leichtman Capital Partners II,
L.P. (Exhibit 10.29)
10.30* Form of Amended and Restated Registration Rights Agreement by and
between Overhill Farms, Inc. and Levine Leichtman Capital Partners II,
L.P. (Exhibit 10.30)
10.31* Form of Amended and Restated Security Agreement, by Overhill Farms,
Inc. and Overhill L.C. Ventures, Inc. in favor of Levine Leichtman
Capital Partners II, L.P. (Exhibit 10.31)
10.32* Form of Amended and Restated Patent, Trademark and Copyright
Security Agreement by Overhill Farms, Inc. and Overhill L.C. Ventures,
Inc. in favor of Levine Leichtman Capital Partners II, L.P. (Exhibit
10.32)
10.33* Form of Amended and Restated Stock Pledge and Control Agreement, by
Overhill Farms, Inc. in favor of Levine Leichtman Capital Partners II,
L.P. (Exhibit 10.33)
10.34* Equity Repurchase Option Agreement, dated as of September 11, 2002,
between Overhill Farms, Inc. and Levine Leichtman Capital Partners II,
L.P. (Exhibit 10.34)
10.35+ Asset Purchase Agreement, entered into as of August 7, 2000, by and
between Overhill Farms, Inc. and SSE Manufacturing, Inc. (Exhibit
10.48)
38
10.36+ Master Co-Pack Agreement, entered into as of August 7, 2000, by and
between Schwan's Sales Enterprises, Inc. and Overhill Farms, Inc.
(Exhibit 10.49)
21.1* Subsidiaries of the registrant
99.1* Information Statement, dated October 8, 2002
99.2** Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.3** Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
-------------------
* Incorporated by reference to the exhibit shown in parenthesis included in
the Company's Registration Statement on Form 10 (File No. 1-16699)
+ Incorporated by reference to the exhibit shown in parenthesis included in
Overhill Corporation's Annual Report on Form 10-K for the fiscal year ended
September 30, 2001, filed by Overhill Corporation with the Securities and
Exchange Commission
** Filed herewith
# Management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the last quarter of the period covered
by this report.
39
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the undersigned Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized in the
City of Vernon, the State of California, on January 3, 2003.
By: /s/ James Rudis
--------------------------------------------
Name: James Rudis
Title: President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/James Rudis President, Chief Executive Officer and Chairman of the January 3, 2003
-------------------------------- Board of Directors
James Rudis
/s/Richard A. Horvath Senior Vice President, Secretary, Chief Financial January 3, 2003
-------------------------------- Officer and Director
Richard A. Horvath
/s/William E. Shatley Senior Vice President, Treasurer and Director January 3, 2003
--------------------------------
William E. Shatley
Director January , 2003
--------------------------------
Harold Estes
/s/Geoffrey A. Gerard Director January 3, 2003
--------------------------------
Geoffrey A. Gerard
/s/John E. McConnaughy, Jr. Director January 3, 2003
--------------------------------
John E. McConnaughy, Jr.
/s/Robert W. Schleizer Director January 3, 2003
--------------------------------
Robert W. Schleizer
40
CERTIFICATIONS
I, James Rudis, certify that:
1. I have reviewed this annual report on Form 10-K of Overhill Farms, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: January 3, 2003
By: /s/ James Rudis
---------------------------------
James Rudis
President and Chief Executive Officer
41
CERTIFICATIONS
I, Richard A. Horvath, certify that:
1. I have reviewed this annual report on Form 10-K of Overhill Farms, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: January 3, 2003
By: /s/ Richard A. Horvath
---------------------------------------
Richard A. Horvath
Senior Vice President, Secretary and Chief
Financial Officer
42
OVERHILL FARMS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Audited Financial Statements:
Report of Independent Auditors ................................... F-2
Consolidated Balance Sheets ...................................... F-3
Consolidated Statements of Operations ............................ F-5
Consolidated Statements of Shareholders' Equity .................. F-7
Consolidated Statements of Cash Flows ............................ F-8
Notes to Consolidated Financial Statements ....................... F-11
F-1
Report of Independent Auditors
The Board of Directors and Shareholders
Overhill Farms, Inc.
We have audited the accompanying consolidated balance sheets of Overhill Farms,
Inc. and subsidiary (the Company), formerly a subsidiary of TreeCon Resources,
Inc. (formerly Overhill Corporation or Polyphase Corporation), as of September
29, 2002 and September 30, 2001, and the related consolidated statements of
operations, shareholders' equity, and cash flows for the years ended September
29, 2002, September 30, 2001 and October 1, 2000. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Overhill Farms,
Inc. and subsidiary as of September 29, 2002 and September 30, 2001, and the
consolidated results of their operations and their cash flows for the years
ended September 29, 2002, September 30, 2001 and October 1, 2000, in conformity
with accounting principles generally accepted in the United States.
/s/ Ernst & Young LLP
Dallas, Texas
December 20, 2002
F-2
OVERHILL FARMS, INC.
CONSOLIDATED BALANCE SHEETS
Assets
September 29, September 30,
2002 2001
--------------- ---------------
Current assets:
Cash $ 8,115 $ 81,414
Accounts receivable, net of allowance for doubtful accounts
of $102,285 and $25,000 in 2002 and 2001, respectively 13,450,103 16,537,116
Inventories 18,489,530 17,634,092
Prepaid expenses and other 1,537,791 1,544,330
Deferred taxes 166,895 11,256
------------ ------------
Total current assets 33,652,434 35,808,208
------------ ------------
Property and equipment:
Fixtures and equipment 12,689,934 10,474,403
Leasehold improvements 3,932,842 1,144,898
Automotive equipment 52,669 62,028
------------ ------------
16,675,445 11,681,329
Less accumulated depreciation (7,504,929) (6,862,237)
------------ ------------
9,170,516 4,819,092
------------ ------------
Other assets:
Excess of cost over fair value of net assets acquired 12,188,435 12,188,435
Deferred financing costs, net of accumulated amortization
of $1,395,829 and $747,085 in 2002 and 2001, respectively 2,952,587 1,184,037
Deferred taxes - 133,670
Other 1,053,610 73,609
------------ ------------
16,194,632 13,579,751
------------ ------------
Total assets $ 59,017,582 $ 54,207,051
============ ============
The accompanying notes are an integral part
of these consolidated financial statements
F-3
OVERHILL FARMS, INC.
CONSOLIDATED BALANCE SHEETS (continued)
Liabilities and Shareholders' Equity
September 29, September 30,
2002 2001
--------------- ---------------
Current liabilities:
Accounts payable, primarily trade $ 13,768,891 $ 13,301,410
Accrued liabilities 1,908,439 2,468,337
Current maturities of long-term debt 1,481,600 2,021,600
------------- -------------
Total current liabilities 17,158,930 17,791,347
------------- -------------
Deferred taxes 265,127 -
Long-term debt, less current maturities 36,241,914 32,951,294
------------- -------------
Total liabilities 53,665,971 50,742,641
------------- -------------
Commitments and contingencies
Shareholders' equity:
Series A Preferred stock, $0.01 par value, authorized
50,000,000 shares, issued and outstanding, 23.57 shares
at September 29, 2002 and none at September 30, 2001 - -
Common stock, $0.01 par value, authorized 100,000,000
shares, issued and outstanding 9,400,828 shares 94,008 94,008
Additional paid-in capital 4,480,614 3,730,614
Receivable from Parent (10,534,679) (9,541,993)
Warrants to purchase common stock 3,470,000 2,370,000
Retained earnings 7,841,668 6,811,781
------------- -------------
Total shareholders' equity 5,351,611 3,464,410
------------- -------------
Total liabilities and shareholders' equity $ 59,017,582 $ 54,207,051
============= =============
The accompanying notes are an integral part
of these consolidated financial statements
F-4
OVERHILL FARMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended
-------------------------------------------------
September 29, September 30, October 1,
2002 2001 2000
------------- ------------- -------------
Net revenues $ 138,118,605 $ 162,158,070 $ 145,417,999
Cost of sales 115,497,957 133,642,074 117,256,375
------------- ------------- -------------
Gross profit 22,620,648 28,515,996 28,161,624
Selling, general and administrative expenses 15,322,922 19,033,214 17,348,632
------------- ------------- -------------
Operating income 7,297,726 9,482,782 10,812,992
Other income (expense):
Interest expense (4,651,184) (5,372,023) (5,141,739)
Amortization of deferred financing costs (648,744) (435,825) (409,375)
Other income (expense) (299,498) (265,580) (133,812)
------------- ------------- -------------
Total other expenses (5,599,426) (6,073,428) (5,684,926)
------------- ------------- -------------
Income before income taxes and extraordinary item 1,698,300 3,409,354 5,128,066
Income tax provision 668,413 1,167,809 1,797,502
------------- ------------- -------------
Income before extraordinary item 1,029,887 2,241,545 3,330,564
Extraordinary item - early extinguishment of debt, net
of income tax benefit of $452,296 in 2000 - - (838,135)
------------- ------------- -------------
Net income $ 1,029,887 $ 2,241,545 $ 2,492,429
============= ============= =============
The accompanying notes are an integral part
of these consolidated financial statements
F-5
OVERHILL FARMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (continued)
For the Years Ended
-----------------------------------------------
September 29, September 30, October 1,
2002 2001 2000
------------- ------------- ------------
(Note 1) (Note 1) (Note 1)
Per share data - basic and diluted:
Net Income per common share - basic and diluted:
Income before extraordinary item $0.11 $0.24 $0.36
Extraordinary item - - (0.09)
------------- ------------- ------------
Net income per common share - basic $0.11 $0.24 $0.27
============= ============= ============
Net income per common share - diluted $0.09 $0.20 $0.22
============= ============= ============
Weighted average shares outstanding - basic 9,400,828 9,377,558 9,307,750
============= ============= ============
Weighted average shares outstanding - diluted 11,617,713 11,394,968 11,527,999
============= ============= ============
Note 1 - Share and per share data for the fiscal years ending September 29,
2002, September 30, 2001 and October 1, 2000 have been retroactively
restated to reflect the effect of a 12,010-shares-for-1 stock split
declared in October 2002 in connection with the spin-off of Overhill Farms,
Inc. from TreeCon Resources. See Note 14 to the consolidated financial
statements for further discussion.
The accompanying notes are an integral part
of these consolidated financial statements
F-6
OVERHILL FARMS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Additional Warrants
Preferred Stock Common Stock Paid-In To Purchase Receivable Retained
Shares Amount Shares Amount Capital Common Stock From Parent Earnings Total
--------------- ----------------- ---------- ------------ ------------ ---------- ------------
Balance, September 26, 1999 - $ - 9,307,750 $93,078 $3,906,922 $ 1,200,000 $ (9,959,750) $2,077,807 $(2,681,943)
Repurchase of warrants - - - - (225,378) (1,200,000) - - (1,425,378)
Issuance of warrants - - - - - 2,370,000 - - 2,370,000
Net increase in receivable
from Parent - - - - - - (411,658) - (411,658)
Net income (comprehensive income) - - - - - - - 2,492,429 2,492,429
--------------- ----------------- ---------- ------------ ------------ ---------- ------------
Balance, October 1, 2000 - - 9,307,750 93,078 3,681,544 2,370,000 (10,371,408) 4,570,236 343,450
Exercise of warrants - - 93,078 930 49,070 - - - 50,000
Net decrease in receivable
from Parent - - - - - - 829,415 - 829,415
Net income (comprehensive income) - - - - - - - 2,241,545 2,241,545
--------------- ----------------- ---------- ------------ ------------ ---------- ------------
Balance, September 30, 2001 - - 9,400,828 94,008 3,730,614 2,370,000 (9,541,993) 6,811,781 3,464,410
Issuance of preferred stock 24 - - - 750,000 - - - 750,000
Issuance of warrants - - - - - 1,100,000 - - 1,100,000
Net increase in receivable
from Parent - - - - - - (992,686) - (992,686)
Net income (comprehensive income) - - - - - - - 1,029,887 1,029,887
--------------- ----------------- ---------- ------------ ------------ ---------- ------------
Balance, September 29, 2002 24 $ - 9,400,828 $94,008 $4,480,614 $ 3,470,000 $(10,534,679) $7,841,668 $ 5,351,611
=============== ================= ========== ============ ============ ========== ============
The accompanying notes are an integral part
of these consolidated financial statements
F-7
OVERHILL FARMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended
-----------------------------------------------------------
September 29, September 30, October 1,
2002 2001 2000
------------------ ------------------ --------------
Operating Activities
Net income $ 1,029,887 $ 2,241,545 $ 2,492,429
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 689,377 587,213 754,552
Amortization 1,222,744 1,879,589 1,609,546
Early extinguishments of debt - - 1,290,431
Provision for doubtful accounts 90,000 - 30,000
Deferred income taxes 243,158 (177,932) 178,662
Changes in:
Accounts receivable 2,997,013 1,508,340 (4,429,925)
Inventories (855,438) 1,159,744 (5,167,968)
Prepaid expenses and other (973,462) (198,744) (970,547)
Accounts payable 467,481 2,805,865 2,963,125
Accrued liabilities (382,898) 626,273 1,432,955
------------------ ------------------ --------------
Net cash provided by operating activities 4,527,862 10,431,893 183,260
------------------ ------------------ --------------
Investing Activities
Net additions to property and equipment (5,040,801) (1,196,831) (1,021,167)
Acquisition of Chicago Brothers - (32,238) (4,221,551)
------------------ ------------------ --------------
Net cash used in investing activities (5,040,801) (1,229,069) (5,242,718)
------------------ ------------------ --------------
The accompanying notes are an integral part
of these consolidated financial statements
F-8
OVERHILL FARMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
For the Years Ended
-------------------------------------------------------
September 29, September 30, October 1,
2002 2001 2000
---------------- ---------------- ----------------
Financing Activities
Net borrowings (principal payments) on
line of credit arrangements $ 4,034,478 $ (6,571,152) $ 4,846,962
Principal payments on long-term debt (2,017,858) (2,659,218) (22,730,639)
Borrowings on long-term debt - - 30,682,504
Deferred financing costs (584,294) - (1,932,907)
Repurchase of stock warrants - - (3,700,000)
Exercise of stock warrants - 50,000 -
Changes in receivable from Parent (992,686) (500,000) (1,575,000)
---------------- ---------------- ----------------
Net cash provided by (used in) financing
activities 439,640 (9,680,370) 5,590,920
---------------- ---------------- ----------------
Net increase (decrease) in cash (73,299) (477,546) 531,462
Cash at beginning of year 81,414 558,960 27,498
---------------- ---------------- ----------------
Cash at end of year $ 8,115 $ 81,414 $ 558,960
================ ================ ================
Supplemental Schedule of Cash Flow
Information
Cash paid during the year for:
Interest $ 3,842,297 $ 4,940,893 $ 4,764,516
================ ================ ================
Income taxes $ 9,775 $ 16,326 $ 2,000
================ ================ ================
The accompanying notes are an integral part
of these consolidated financial statements
F-9
OVERHILL FARMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Supplemental Schedule of Noncash Investing and Financing Activities:
The Company has netted accumulated federal income tax liabilities payable to the
Parent against the receivable from Parent balance for all periods presented.
During the fiscal year ended September 29, 2002, the Company issued warrants to
purchase approximately 750,000 shares of common stock at a nominal exercise
price. The warrants issued had an estimated value of $1.1 million and were
recorded as deferred financing costs in the consolidated balance sheet.
During the fiscal year ended September 29, 2002, the Company issued 23.57 shares
of a newly created Series A Preferred Stock having an estimated value of
$750,000 as consideration for financing costs to LLCP.
In connection with the Company's refinancing in November 1999, warrants to
purchase 17.5% of the Company's common stock at a nominal exercise price were
issued having an estimated fair market value of $2,370,000.
In connection with the Company's refinancing in November 1999, the Company
accrued a $500,000 liability related to a cash payment obligation of the Company
in the event the Company does not repurchase the warrants to purchase 17.5% of
its common stock, which were issued in connection with the refinancing. See Note
5 to the consolidated financial statements.
In connection with the Company's acquisition of Chicago Brothers during fiscal
2000, $900,000 of the purchase price was represented by a note payable to the
seller.
The accompanying notes are an integral part
of these consolidated financial statements
F-10
OVERHILL FARMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 29, 2002
1. COMPANY AND ORGANIZATIONAL MATTERS
Nature of Business and Basis of Presentation
Overhill Farms, Inc. (the Company or Overhill Farms) is a producer of
high-quality entrees, plated meals, meal components, soups, sauces, and
poultry, meat and fish specialties. From May 5, 1995 through October 29,
2002, the Company was a majority-owned subsidiary of TreeCon Resources, Inc.
(formerly Overhill Corporation and Polyphase Corporation) (the Parent),
whose ownership was subject to warrants outstanding to purchase Overhill
Farms' common stock (see Note 6). On October 29, 2002, TreeCon Resources,
Inc. distributed to its shareholders, in the form of a tax-free dividend,
all of its ownership of the Company (see Note 14).
On May 5, 1995, the Company purchased substantially all of the operating
assets and assumed certain liabilities of IBM Foods, Inc. (IBM), for $31.3
million. Prior to its acquisition by the Company, IBM was engaged in the
business of producing high-quality entrees, plated meals, soups, sauces, and
poultry, meat and fish specialties primarily for customers in the airline,
weight loss, and restaurant chain industries in the United States. The
Company is using the net assets acquired in substantially the same business.
In October 2002, in connection with the spin-off transaction (see Note 14),
the Company's Board of Directors authorized a 12,010-shares-for-1 stock
split. Share and per share data as of and for all periods presented herein
have been restated to reflect the stock split.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of Overhill Farms
and its wholly owned subsidiary, Overhill L.C. Ventures, Inc. All material
intercompany accounts and transactions are eliminated. Certain prior year
amounts have been reclassified to conform with the current period
presentation.
Fiscal Year
The Company utilizes a 52- to 53-week accounting period, which ends on the
last Sunday of September in each fiscal year if September 30 does not fall
on a Saturday, or October 1 if September 30 falls on a Saturday. In fiscal
2000, the Company had a 53-week accounting period.
F-11
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Deferred Financing Costs
Debt financing costs are deferred and amortized as additional interest
expense using the straight-line method over the term of the related debt.
Amortization of these costs totaled $648,744, $435,825, and $409,375 for the
years ended September 29, 2002, September 30, 2001, and October 1, 2000,
respectively. As a result of the November 1999 refinancing related to the
Union Bank line of credit and LLCP debt (see Note 5), the Company recorded
an extraordinary charge of $838,135, net of an income tax benefit of
$452,296, to write off certain of these deferred costs related to previous
financings.
Concentrations of Credit Risk
The Company's financial instruments that are exposed to concentrations of
credit risk consist primarily of trade receivables. The Company performs
ongoing credit evaluations of its customers' financial condition and
generally requires no collateral from its customers.
For the fiscal years ended September 29, 2002, September 30, 2001, and
October 1, 2000 revenues from airline-related customers accounted for
approximately 25.3%, 33.7%, and 35.0% of total net revenues, respectively.
Additionally, accounts receivable from airline-related customers accounted
for approximately 12.8% and 33.0% of the total accounts receivable balance
at September 29, 2002 and September 30, 2001, respectively. The results of
the tragic events of September 11, 2001 have significantly impacted the
Company's sales to airlines. The long-term effect of these events on the
airline industry, airline revenues, and on Overhill Farms' business in
particular, still cannot be accurately determined at this time. These events
have resulted in a decreased demand for air travel and a reduction in the
number of meals served as a result of airlines' cost savings measures. These
effects, depending upon their scope and duration, which cannot be predicted
at this time, could negatively impact the Company's financial position,
results of operations or cash flows.
For the years ended September 29, 2002, September 30, 2001, and October 1,
2000 the Company's write-offs, net of recoveries, to the allowance for
doubtful accounts were immaterial.
Financial Instruments
The fair value of financial instruments is determined by reference to market
data and by other valuation techniques as appropriate. Unless otherwise
disclosed, the fair value of financial instruments approximates their
recorded values.
F-12
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Inventories
Inventories, which include material, labor, and manufacturing overhead, are
stated at the lower of cost, which approximates the first-in, first-out
(FIFO) method, or market. For the years ended September 29, 2002, September
30, 2001, and October 1, 2000 the Company's inventory write-offs were
immaterial.
Concentration of Sources of Labor
The Company's total hourly and salaried workforce consists of approximately
1,000 employees at September 29, 2002. Approximately 67% of the Company's
workforce is covered by collective bargaining agreements expiring in fiscal
years 2003 and 2005.
Property and Equipment
The cost of property and equipment is depreciated over the estimated useful
lives of the related assets, which range from three to ten years. Leasehold
improvements are amortized over the lesser of the term of the related lease
or the estimated useful lives of the assets. Depreciation is generally
computed using the straight-line method.
Expenditures for maintenance and repairs are charged to expense as incurred.
Betterments and major renewals are capitalized. Costs and related
accumulated depreciation of properties sold or otherwise retired are
eliminated from the accounts, and gains or losses on disposals are included
in other income (expense).
Excess of Cost Over Fair Value of Net Assets Acquired
The excess of cost over fair value of net assets acquired (goodwill) is
evaluated annually for impairment in accordance with SFAS 142. The Company
has one reporting unit and estimates fair value based upon a variety of
factors, including discounted cash flow analysis, market capitalization and
other market-based information. The Company reviewed its goodwill for
impairment as of July 1, 2002. No impairment was recorded as a result of
this review.
F-13
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Derivative Financial Instruments
The Company had no derivative financial instruments in place as of
September 29, 2002 and September 30, 2001 or during the fiscal years ended
September 29, 2002, September 30, 2001 and October 1, 2000.
Revenue Recognition
Sales are recognized when products are shipped, which is when title and
risk of loss pass to the customer. The Company provides for estimated
returns and allowances, which have historically been immaterial, at the
time of sale.
The Company classifies customer rebate costs as a reduction in net
revenues. Customer rebate costs were approximately $0, $375,000, and $0 for
the fiscal years ended September 29, 2002, September 30, 2001, and October
1, 2000.
Income Taxes
Deferred income taxes recorded using the liability method 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.
Shipping and Handling Costs
The Company classifies shipping and handling costs as a component of
selling, general and administrative expenses. Shipping and handling costs
were approximately $7.3 million, $9.2 million, and $7.8 million for the
fiscal years ended September 29, 2002, September 30, 2001, and October 1,
2000, respectively.
F-14
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Recent Accounting Pronouncements
In June 2002, the Financial Accounting Standards Board issued Statement No.
146, Accounting for Costs Associated with Exit or Disposal Activities (SFAS
146), which addresses financial accounting and reporting for costs
associated with exit or disposal activities. These rules supersede EITF
94-3, Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity. SFAS 146 requires that costs related to an
exit or disposal activity can only be accrued when a liability is actually
incurred. SFAS 146 is required to be adopted for exit or disposal
activities occurring after December 31, 2002. The Company does not believe
the adoption of SFAS 146 will have a material effect on the Company's
financial position, results of operations or cash flows.
In November 2001, the Financial Accounting Standards Board issued Statement
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets
(SFAS 144). These rules supersede FASB Statement No. 121, Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of, providing a single accounting model for long-lived assets to
be disposed of. Although retaining many of the fundamental recognition and
measurement provisions of Statement 121, the new rules significantly change
the criteria that would have to be met to classify an asset as
held-for-sale. SFAS 144 also supersedes the provisions of APB opinion 30
with regard to reporting the effects of a disposal of a segment of a
business and requires expected future operating losses from discontinued
operations to be displayed in discontinued operations in the period(s) in
which the losses are incurred (rather than as of the measurement date as
previously required by APB 30). SFAS 144 is effective for fiscal years
beginning after December 15, 2001 and interim periods within those fiscal
years, although earlier application is encouraged. The Company adopted SFAS
144 as of October 1, 2001. The adoption of SFAS 144 did not have a material
effect on the Company's financial position, results of operations or cash
flows.
In June 2001, the Financial Accounting Standards Board issued Statement No.
142, Goodwill and Other Intangible Assets (SFAS 142), which requires that
goodwill no longer be amortized but instead be tested at least annually for
impairment. The Company adopted SFAS 142 as of October 1, 2001 and no
impairment of goodwill was recorded upon adoption. Had the Company been
accounting for goodwill under SFAS 142 for all periods presented, the
Company's income before income taxes and extraordinary item would have
increased by $830,000 and $650,000 for fiscal years 2001 and 2000,
respectively, and the Company's net income would have increased by $548,000
($0.06 per share and $0.05 per diluted share) and $429,000 ($0.05 per share
and $0.04 per diluted share) for fiscal years 2001 and 2000, respectively.
F-15
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to
make estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Actual results could differ
from those estimates.
3. RECEIVABLE FROM PARENT
From time to time, Overhill Farms has made advances to or on behalf of the
Parent for various purposes. Additionally, Overhill Farms has netted
accumulated federal income tax liabilities payable to the Parent against
the receivable from Parent balance. The net receivable from Parent balance
totaled approximately $10.5 million at September 29, 2002 and $9.5 million
at September 30, 2001. No interest is being charged to the Parent on net
amounts outstanding. As there was substantial doubt as to its
collectibility at September 29, 2002 and September 30, 2001, the Company
has classified this receivable from Parent as a reduction in shareholders'
equity.
During the fiscal years ended September 29, 2002, September 30, 2001 and
October 1, 2000, the Company made cash payments to, or on behalf of, its
Parent of approximately $1.2 million, $500,000 and $1.6 million,
respectively, for various purposes including tax payments, expense
reimbursement and other corporate purposes. Additionally, during the fiscal
year ended September 29, 2002, the Company and its Parent agreed to an
allocation to the parent of salary and other payroll costs and expenses of
the Company's chief executive officer relating to the spin-off transaction
(see Note 14), which resulted in approximately $290,000 of costs and
expenses being allocated to the receivable from Parent account.
In October 2002, TreeCon Resources, Inc. made a partial payment on amounts
due by TreeCon to the Company by transferring to the Company certain notes
receivable totaling approximately $400,000. These notes receivable are due
from certain officers of both the Parent and the Company who, subsequent to
the spin-off, remained officers of the Company and are no longer employed
by the Parent. In October 2002, the Company made final cash payments to, or
on behalf of, its Parent and simultaneously with the spin-off, which
occurred on October 29, 2002, after giving effect to the partial payment
described above and the netting of accumulated federal income tax
liabilities payable to the Parent as of October 29, 2002 against the
receivable from Parent balance, all net intercompany amounts due to the
Company by its Parent were charged to retained earnings.
F-16
4. INVENTORIES
Inventories are summarized as follows:
September 29, September 30,
2002 2001
--------------------------------------
Raw ingredients $ 8,003,573 $ 7,662,980
Finished product 8,681,091 8,334,363
Packaging 1,804,866 1,636,749
--------------------------------------
$ 18,489,530 $ 17,634,092
======================================
5. LONG-TERM DEBT
Long-term debt consists of the following:
September 29, September 30,
2002 2001
------------------ ------------------
Revolving credit agreement with Union Bank of
California, N.A. (Union Bank), bearing interest at
prime plus 0.50% or LIBOR plus 3.0%, collateralized
by certain assets of Overhill Farms. Effective interest
rate on outstanding borrowings at September 29, 2002 was 5.25%. $ 11,957,293 $ 7,922,815
Secured senior subordinated note payable to Levine
Leichtman Capital Partners II, L.P. (LLCP), net of
discount of $1,083,667 and $1,817,667 at
September 29, 2002 and September 30, 2001,
respectively, bearing interest payable monthly at
13.25% until maturity in October 2004, collateralized
by certain assets of Overhill Farms. 24,115,222 24,162,333
Term loan payable to Union Bank, bearing interest at
prime plus 1.0% (approximately 5.75% at September
29, 2002), payable in monthly installments of $50,000
plus interest, collateralized by certain assets of Overhill
Farms. 1,150,000 1,750,000
F-17
5. LONG-TERM DEBT (continued)
September 29, September 30
2002 2001
--------------------- -----------------
Unsecured promissory note, bearing interest at 9%,
payable quarterly through June 2001 and thereafter in
quarterly installments of $150,000 plus interest through
maturity in December 2002. This note was issued in
connection with the Chicago Brothers purchase and is
subordinated to all indebtedness to Union Bank and to
LLCP described above. $ 300,000 $ 900,000
Other 200,999 237,746
-------------------- ------------------
37,723,514 34,972,894
Less current maturities (1,481,600) (2,021,600)
-------------------- ------------------
Total long-term debt $ 36,241,914 $ 32,951,294
==================== ==================
Scheduled maturities of long-term debt are summarized as follows:
2003 $ 1,481,600
2004 12,557,048
2005 24,713,291
2006 55,242
------------------
Total 38,807,181
Less unamortized debt discount (1,083,667)
------------------
$ 37,723,514
==================
In November 1999, Overhill Farms refinanced substantially all of its existing
debt. The total facility amounted to $44 million, consisting of a $16 million
line of credit provided by Union Bank together with $28 million in the form
of a five-year term loan provided by LLCP. Both of these agreements have
subsequently been amended on multiple occasions as discussed further below.
Additionally, the Company issued a term loan payable to Union Bank in
connection with an acquisition that occurred in August 2000.
F-18
5. LONG-TERM DEBT (continued)
As a result of the November 1999 refinancing, Overhill Farms repaid in full
the $22.7 million senior subordinated notes payable and the $9.6 million
revolving line of credit that were outstanding at September 26, 1999.
Additionally, Overhill Farms repurchased for $3.7 million the warrants held
by the previous subordinated lender to purchase 30% of Overhill Farms'
common stock. This transaction was treated as a reacquisition of minority
interest, resulting in approximately $2.2 million of goodwill being
recorded. Also in connection with the refinancing, Overhill Farms was
permitted to make a one-time advance of $1.25 million to its Parent for
working capital and other specified purposes. Overhill Farms incurred costs
and expenses in connection with the refinancing totaling approximately $1.9
million, substantially all of which was paid to the lenders. The early
extinguishment of the previous indebtedness resulted in an after-tax,
extraordinary charge of $838,135 during the year ended October 1, 2000.
The Company's revolving line of credit, senior subordinated note payable
and term loan agreements all contain various financial covenants including
restrictions on changes in control, capital expenditures, minimum EBITDA
and net worth levels, specified debt service and debt-to-equity ratios, and
prohibitions on certain loans, advances and dividend payments.
In January 2002, the Company entered into amendments to its loan agreements
with Union Bank and its senior subordinated lender to provide for revised
financial covenants, including one covenant which had been violated as of
September 30, 2001. As of June 30, 2002, the Company was in violation of
certain financial covenants with respect to its financing arrangements with
its senior secured and subordinated creditors. In September 2002, the
Company received a waiver of these violations from Union Bank and an
amendment to its financial covenants with its senior subordinated lender.
Additionally, the Company entered into further amendments with each of its
senior secured and subordinated lenders whereby, among other things, future
financial covenant requirements were modified to levels more consistent
with the Company's current and future expected results of operations. As of
September 29, 2002, the Company was in compliance with all of its amended
financial covenants. The Company believes, based upon historical
performance, current results of operations for the fiscal year ended
September 29, 2002, and forecasted performance in fiscal 2003, that it is
probable the Company will be in compliance with all of its revised
financial and other covenant requirements. Accordingly, the Company has
classified all of its outstanding senior secured debt, which matures in
November 2003, and all of its outstanding senior subordinated debt, which
matures in November 2004, as long-term, except for contractually current
maturities, in the accompanying consolidated balance sheet as of September
29, 2002. In the future, failure of the Company to achieve certain revenue,
expense or profitability levels could result in a violation of the
Company's amended financial covenants under its lending arrangements, which
could have a material adverse effect on the Company's financial condition,
results of operations or cash flows.
F-19
5. LONG-TERM DEBT (continued)
Line of Credit and Term Loan
In January 2002, as part of its amendment with Union Bank, the Company also
agreed to certain additional covenants, increased interest rates and
amended the Union Bank agreement to accommodate a lease of a new facility,
which the Company entered into effective in January 2002. The Company paid
Union Bank $120,000 in connection with this amendment.
At September 29, 2002, the line of credit with Union Bank, as amended, has
a maturity date of November 2002 and provides for borrowings limited to the
lesser of $16.0 million or an amount determined by a defined borrowing base
consisting of eligible receivables and inventories ($18.7 million at
September 29, 2002). Borrowings under the line of credit bear interest at a
rate, as selected by Overhill Farms at the time of borrowing, of prime plus
0.50% or LIBOR plus 3.0%. The Union Bank agreement provides, among other
things, that Overhill Farms is subject to an unused line of credit fee of
0.25% per annum.
In November 2002, the Company obtained a one-month extension of its
revolving line of credit with and term loan payable to Union Bank. In
December 2002, the Company entered into an amendment with Union Bank
whereby the line of credit amount was increased to $20.0 million, the
maturity date of the revolving line of credit was extended through the end
of November 2003, and the interest rate was reduced to prime plus 0.25% or
LIBOR plus 2.5%, at the Company's election. Additionally, the Company
amended its term loan payable to Union Bank whereby the maturity date was
extended to November 30, 2003 with continued periodic payments of $50,000
per month plus interest at prime plus 1.0%.
Senior Subordinated Note Payable
The term loan with LLCP, as amended, provides for principal payments in an
amount equal to 50% of the excess cash flow, as defined, for Overhill
Farms' previous fiscal year, payable annually commencing in January 2001.
The amount of such principal payment, based on excess cash flows, as
defined, for the year ended September 29, 2002 was approximately $541,000.
Such amount has been included in current maturities of long-term debt on
the September 29, 2002 consolidated balance sheet. Any unpaid balance will
be payable at maturity in October 2004. The agreement also requires
Overhill Farms to pay to LLCP, during each January, annual consulting fees
of $180,000.
In connection with the November 1999 agreement, LLCP was granted warrants
to purchase 17.5% of the common stock of Overhill Farms, exercisable
immediately at a nominal exercise price (see Note 6). At the date of
issuance, the warrants granted to LLCP were estimated to have a fair value
of $2.37 million, which was recorded as a debt discount to be amortized on
a straight-line basis through October 2004.
F-20
5. LONG-TERM DEBT (continued)
In connection with, and as consideration for, the January 2002 amendment to
its senior subordinated loan agreement, the Company agreed to issue LLCP
shares of a newly created Series A Preferred Stock with certain voting
rights and preferences valued at $750,000 (see Note 6).
In connection with, and as consideration for, the September 2002 amendment
to its senior subordinated loan agreement, the Company agreed to issue LLCP
certain warrants valued at $1.1 million to purchase shares of the Company's
common stock at a nominal exercise price (see Note 6). Under this
agreement, these warrants are intended to bring the total equity ownership
of the Company by the senior subordinated lender, on a fully diluted basis,
to 24.0%. The warrants have certain anti-dilution protection provisions and
were exercisable immediately upon issuance. Additionally, the Company
agreed to pay LLCP a restructuring fee of approximately $423,000 payable at
various installments over a seven-month period and increase the base
interest rate under the loan agreement to 13.25% per annum. However, if the
Company meets certain specified EBITDA levels for the fiscal year ended
September 28, 2003, the base rate will be reduced to 12.5%. Also in
connection with the September 2002 amendment, a previous agreement for an
interest rate reduction upon the Company making voluntary principal
payments of approximately $1.1 million was terminated and the Company and
its senior subordinated lender agreed to eliminate the Company's previous
obligation to make a $500,000 cash payment in the event the Company did not
repurchase the existing warrants or warrant shares upon repayment of the
senior subordinated note payable at maturity.
Also in September 2002, the Company and LLCP entered into an equity
repurchase option agreement whereby, among other things, the Company has
the right, upon the occurrence of certain conditions, to purchase from
LLCP, in whole but not in part, all shares of the Company's common stock
owned by LLCP or issuable to LLCP upon exercise of any warrants or shares
of Series A preferred stock it holds. Generally, the repurchase price under
the equity repurchase option agreement is the greater of an amount based
upon the current market price of the Company's publicly traded common stock
or based upon a predetermined formula or minimum stated amount.
6. SHAREHOLDERS' EQUITY
Warrants to Purchase Common Stock
In connection with the refinancing in December 1997, an unrelated
consultant was issued a warrant to purchase 1% of Overhill Farms' common
stock at a purchase price of $50,000. The warrant was exercised during the
fiscal year ended September 30, 2001.
In November 1999, the Company repurchased warrants to purchase 30% of its
common stock, which were held by a previous subordinated lender for total
consideration of $3.7 million. This transaction was treated by the
Company's Parent, and thus the Company, as a reacquisition of minority
interest, resulting in approximately $2.2 million of goodwill being
recorded in connection with this repurchase transaction.
F-21
6. SHAREHOLDERS' EQUITY (continued)
In connection with the financing provided by LLCP in November 1999 (see
Note 5), the Company granted stock purchase warrants that entitle LLCP to
immediately acquire 17.5% of its common stock at a nominal exercise price.
Such warrants were valued at $2.37 million, which has been recorded as a
debt discount and is being amortized over the term of the LLCP loan.
In connection with, and as consideration for, the September 2002 amendment
to its senior subordinated loan agreement, the Company agreed to issue LLCP
certain warrants, valued at $1.1 million, to purchase shares of the
Company's common stock at a nominal exercise price (see Note 5). Under this
agreement, these warrants are intended to bring the total equity ownership
of the Company by the senior subordinated lender, on a fully diluted basis,
to 24.0%. The warrants have certain anti-dilution protection provisions and
were exercisable immediately upon issuance.
Preferred Stock
Effective January 31, 2002, the Company and LLCP reached agreement relative
to further amendment of the credit arrangement with LLCP to accommodate the
consolidation of the Company's facilities and to permit additional
indebtedness to be incurred by the Company in connection therewith. As
consideration for financing costs of this amendment with LLCP, the value of
which was agreed to be $750,000, the Company agreed to issue to LLCP 23.57
shares of a newly created Series A Preferred Stock. These shares were
issued in March 2002. The designations for the new preferred stock provide
the holder with, among other things, a liquidation preference totaling
$750,000, voting rights along with holders of common stock, conversion
rights into a like number of common shares, subject to adjustment, and
provide for adjustment to prevent dilution of the holders' interests. The
Company has recorded the $750,000 of Series A Preferred Stock issued to
LLCP as deferred financing costs, which is being amortized as additional
interest expense over the remaining life of the LLCP agreement.
Amendments to Articles of Incorporation
During February 2002 the stockholders and Board of Directors of the Company
unanimously approved an amendment to the Company's Articles of
Incorporation to increase the number of shares which the Company shall have
authority to issue to a total of 150,000,000, consisting of (i) 50,000,000
shares of preferred stock, $.01 par value and (ii) 100,000,000 shares of
common stock, $.01 par value. Such shares may be issued in one or more
series from time to time, without action by the stockholders, and for such
consideration as may be fixed by the Board of Directors. Additionally, the
Board of Directors is authorized to fix the designations, preferences, and
relative participating, option or other special rights of the shares of
each such series of preferred stock, and the qualifications, limitations or
restrictions thereon.
F-22
7. INCOME PER SHARE
The following table sets for the calculation of earnings per share for the
periods presented:
For the Years Ended
-----------------------------------------------------
September 29, September 30, October 1,
2002 2001 2000
-----------------------------------------------------
Numerator:
Income before extraordinary item $ 1,029,887 $2,241,545 $3,330,564
Extraordinary item - - (838,135)
-----------------------------------------------------
Net income attributable to common stockholders $ 1,029,887 $2,241,545 $2,492,429
=====================================================
Denominator:
Denominator for basic earnings
per share - weighted average shares 9,400,828 9,377,558 9,307,750
-----------------------------------------------------
Effect of dilutive securities:
Warrants 2,051,758 2,017,410 2,220,249
Series A Preferred Stock 165,127 - -
------------------------------------------------------
Dilutive potential common shares 2,216,885 2,017,410 2,220,249
-----------------------------------------------------
Denominator for diluted earnings per share 11,617,713 11,394,968 11,527,999
=====================================================
Net income per share - basic and diluted:
Income before extraordinary item $ 0.11 $ 0.24 $ 0.36
Extraordinary Item - - (0.09)
-----------------------------------------------------
Net income per share - basic $ 0.11 $ 0.24 $ 0.27
=====================================================
Net income per share - diluted $ 0.09 $ 0.20 $ 0.22
=====================================================
Share and per share data for all periods presented have been retroactively
restated to reflect the 12,010-shares-for-1 stock split declared by the
Company's Board of Directors in October 2002.
F-23
8. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
September 29, September 30,
2002 2001
--------------------------------------------
Compensation $ 853,680 $ 1,023,451
Taxes other than income taxes 226,999 218,706
Interest payable 349,806 57,419
Other 477,954 1,168,761
--------------------------------------------
$ 1,908,439 $ 2,468,337
============================================
9. INCOME TAXES
Income tax provision consists of the following:
For the Years Ended
------------------------------------------------------------------
September 29, September 30, October 1,
2002 2001 2000
------------------ ----------------- ---------------
Current:
Federal $ 423,655 $ 1,344,141 $ 1,164,944
State 1,600 1,600 1,600
------------------ ----------------- ---------------
Total current 425,255 1,345,741 1,166,544
Deferred:
Federal 243,158 (177,932) 178,662
State - - -
------------------ ----------------- ---------------
Total deferred 243,158 (177,932) 178,662
------------------ ----------------- ---------------
Total income tax provision $ 668,413 $ 1,167,809 $ 1,345,206
================== ================= ===============
For the years ended September 29, 2002, September 30, 2001 and October 1,
2000, the Company is included in the consolidated federal tax return of its
Parent and has provided for federal taxes on a separate company basis in
accordance with SFAS No. 109, Accounting for Income Taxes. Historically,
with respect to state income taxes, primarily in California, the Company
has been able to reduce its tax liability by offsetting otherwise taxable
income with other losses under the Parent entity. On a separate company
basis, the Company would have an approximate effective state tax rate of
5%-6%.
F-24
9. INCOME TAXES (continued)
The total income tax provision was 39.2%, 34.3%, and 35.1% of pretax income
for the years ended September 29, 2002, September 30, 2001, and October 1,
2000, respectively. A reconciliation of income taxes with the amounts
computed at the statutory federal rate follows:
For the Years Ended
------------------------------------------------------------------
September 29, September 30, October 1,
2001 2001 2000
------------------ ------------------ ---------------
Computed tax provision at
federal statutory rate (34%) $ 577,422 $ 1,159,181 $ 1,304,796
State income tax provision,
net of federal benefit 1,024 1,024 1,024
Permanent items 54,318 33,846 12,032
Other 35,649 (26,242) 27,354
------------------ ------------------ ---------------
$ 668,413 $ 1,167,809 $ 1,345,206
================== ================== ===============
The deferred tax assets and deferred tax liabilities recorded on the
balance sheet are as follows:
September 29, 2002 September 30, 2001
---------------------------------------- --------------------------------------
Deferred Deferred Deferred Deferred
Tax Tax Tax Tax
Assets Liabilities Assets Liabilities
------------------- ------------------- ------------------- -----------------
Current:
Inventory, A/R $ 207,035 $ - $ 225,240 $ -
Accrued liabilities 192,367 - 212,414 -
Prepaid expenses - (142,667) - -
Other - (89,840) - (426,398)
------------------- ------------------- ------------------- -----------------
399,402 (232,507) 437,654 (426,398)
Noncurrent:
Depreciation - (21,640) 613,461 -
Goodwill - (243,487) - (479,791)
------------------- ------------------- ------------------- -----------------
- (265,127) 613,461 (479,791)
------------------- ------------------- ------------------- -----------------
Total deferred taxes $ 399,402 $ (497,634) $ 1,051,115 $ (906,189)
=================== =================== =================== =================
F-25
10. COMMITMENTS AND CONTINGENCIES
Commitments
Future minimum lease payments for all operating leases at September 29,
2002 are as follows:
2003 $ 3,704,724
2004 3,271,500
2005 3,158,180
2006 2,738,115
2007 and thereafter 5,774,044
-----------------
$ 18,646,563
=================
The Company leases substantially all of its facilities under operating
leases expiring through December 2011. Certain of the leases provide for
renewal options at substantially the same terms as the current leases.
Rent expense, including monthly equipment rentals, was approximately $2.8
million, $2.4 million, and $2.1 million for the years ended September 29,
2002, September 30, 2001, and October 1, 2000, respectively.
Significant Customers
Significant customers accounted for the following percentages of the
Company's sales during the years ended:
September 29, September 30, October 1,
2002 2001 2000
-------------------------------------------------------------------
Jenny Craig Products 15% 12% 13%
American Airlines 9% 10% 13%
Delta Airlines 8% 12% 11%
Panda Restaurant Group 21% 14% 12%
King's Hawaiian/Pinnacle Foods 11% 14% 15%
No other customer accounted for sales of 10% or more in the periods
presented.
F-26
10. COMMITMENTS AND CONTINGENCIES (continued)
Contingencies
The spin-off of the Company to TreeCon Resources, Inc. shareholders
occurred on October 29, 2002. In the event that the creditors of the
Company, or TreeCon, successfully challenges the spin-off as a fraudulent
conveyance, due to the insolvency, as defined, of either company, a court
could be asked to void the spin-off. The court could then require TreeCon,
or the Company, to fund certain liabilities of the other company for the
benefit of creditors. The Company and TreeCon believe each company to be
solvent at the time of and following the spin-off.
TreeCon, as well as certain of its current and former officers and
directors, are parties to a lawsuit, originally filed in 1997, which
alleges misrepresentations which the plaintiffs claim resulted in the
market price of the TreeCon's stock being artificially inflated. The
plaintiffs twice attempted to enjoin the spin-off of the Company and, in
each instance, the district court denied the plaintiffs' attempts to enjoin
the spin-off. TreeCon has indicated that it would continue to vigorously
defend against what it believes to be unsupportable claims by the
plaintiff's attorneys. The Company has never been a named defendant in
these actions and believes that, in any event, it would have no liability
as a result thereof.
TreeCon received an opinion with respect to the spin-off to the effect
that, among other things, the spin-off should qualify as a tax-free
spin-off to TreeCon's stockholders and to TreeCon for federal income tax
purposes. The opinion is based upon various factual representations and
assumptions, as well as certain undertakings, which if untrue or incomplete
in a material respect, or any undertaking was not complied with, or if the
facts upon which the opinion was based were materially different from the
facts at the time of the spin-off, the spin-off may not qualify for
tax-free treatment. If, for these reasons or due to events occurring
subsequent to the spin-off, it is determined that the spin-off does not
qualify for tax-free treatment, then, in general, a very substantial tax
would be payable by TreeCon and its stockholders. In certain circumstances,
the Company and TreeCon would be jointly and severally liable, and the
Company could be required to pay for all or a portion of such taxes
resulting from the spin-off being taxable. The Company and TreeCon are
unaware of any facts or circumstances, which could result in the spin-off
being determined to be taxable.
In connection with the spin-off, TreeCon indemnified the Company with
respect to any current or future tax liabilities for which the Company
might otherwise be liable resulting from the operations of any entity other
than the Company. Additionally, as discussed in Note 14 to the consolidated
financial statements, in connection with the spin-off, the Company and
TreeCon have agreed to cancel all existing intercompany receivables and
payables between the entities as of the date of the spin-off.
The Company is involved in certain legal actions and claims arising in the
ordinary course of business. Management believes (based, in part, on advice
of legal counsel) that such contingencies will be resolved without material
effect on the Company's financial position, results of operations or cash
flows.
F-27
11. RELATED PARTY TRANSACTIONS
The Company's Parent charges management fees for various expenses related
to the oversight of the Company. Management fees totaled $0, $0, and
$350,000 for each of the years ended September 29, 2002, September 30,
2001, and October 1, 2000, respectively, and are included in selling,
general and administrative expenses.
12. EMPLOYEE BENEFIT PLANS
In April 1997, Overhill Farms introduced a retirement savings plan under
Section 401(k) of the Internal Revenue Code. The plan covers substantially
all non-union employees meeting minimum service requirements. Under the
plan, contributions are voluntarily made by employees. Overhill Farms does
not provide for a match to the employees' contributions, and its expenses
related to the plan have not been significant.
13. ASSETS ACQUIRED
In August 2000, Overhill Farms purchased certain assets of the Chicago
Brothers food operations from SSE Manufacturing, Inc., a subsidiary of
Schwan's Sales Enterprises, Inc. (Schwan's). Under the terms of the
agreement, Overhill Farms acquired the production and food processing
equipment, together with certain leasehold interests and improvements in
two plants, and an administrative facility in San Diego, California. The
transaction was accounted for using the purchase method of accounting. The
purchase price of the assets amounted to a total of $4.2 million,
consisting of cash of $3.3 million, a significant portion of which was
provided by a term loan from Union Bank, and a $900,000 note payable to the
seller (see Note 5). The Company recorded approximately $3.3 million of
goodwill on the transaction (see Note 2). In addition, Overhill Farms also
entered into a three-year renewable agreement to provide Schwan's with a
specified number of pounds of meals and meal components. Results of the
acquired operations have been combined with the Company's results for the
periods subsequent to the acquisition date. As this acquisition was not
material, the Company has not presented any pro forma financial
information.
F-28
14. SPIN-OFF TRANSACTION AND SUBSEQUENT EVENTS
On August 14, 2001, Overhill Corporation's Board of Directors approved a
plan to spin-off Overhill Farms, Inc. to stockholders of the Parent. On
October 29, 2002, Overhill Corporation accomplished the spin-off by
distributing, in the form of a dividend, 100% of its ownership of Overhill
Farms, Inc. common stock, representing 99% of the issued and outstanding
common stock of Overhill Farms, Inc., to Overhill Corporation stockholders
of record as of September 30, 2002. Overhill Corporation stockholders each
received one share of Overhill Farms, Inc. common stock for every two
shares of Overhill Corporation common stock they owned as of the date of
record. Any Overhill Corporation stockholder entitled to a fractional share
under this formula received cash, which was immaterial.
The spin-off was intended to separate Overhill Farms, Inc. and its Parent's
subsidiary, Texas Timberjack, Inc., so that each company's management team
could focus on its specific industry. The spin-off was also intended to
enable both companies to attract and retain key employees and to reward
them with compensation plans directly tied to the success of each business.
Also, the assets, debts, liabilities, and organizational structure of the
two post-spin-off companies can be more clearly defined. Immediately after
the spin-off transaction became effective, Overhill Corporation no longer
owned any shares of Overhill Farms, Inc. common stock.
Stock Split and Income Per Share
To facilitate the spin-off, in October 2002, the Company's Board of
Directors authorized a stock split of 12,010-shares-for-1, which increased
outstanding common shares, based upon outstanding common shares as of
September 29, 2002, to approximately 9.4 million shares. Shares issuable
pursuant to outstanding warrants and conversion rights of preferred stock
were similarly increased. Share and per share data for all periods
presented herein have been adjusted to reflect the 12,010-shares-for-1
stock split.
Stock Option Plan
In connection with the spin-off, the Company's Board of Directors adopted a
stock option plan for eligible employees. A total of 800,000 post spin-off
shares of the Company's common stock were reserved for issuance under this
plan. This reservation of shares also gives effect to the dilution
protection for LLCP (see Notes 5 and 6) and the adoption of the option
plan, as anticipated, resulted in an increase in the amount of common
shares subject to the LLCP warrant and preferred conversion options.
In October, concurrent with the spin-off, pursuant to the Company's 2002
Employee Stock Option Plan, the Company's Board of Directors granted
approximately 472,000 nonqualified stock options to various employees at an
exercise price of $1.60 per share, the fair market value per share as of
the date of grant. These options are exercisable on or after January 1,
2003 and generally have a ten-year life.
F-29
14. SPIN-OFF TRANSACTION AND SUBSEQUENT EVENTS (continued)
Warrant Exercise
In December 2002, LLCP exercised warrants to purchase 2,685,355 shares of
the Company's common stock for a nominal exercise price.
15. QUARTERLY FINANCIAL DATA (unaudited)
For the Year Ended September 29, 2002
---------------------------------------------------------
December 30 March 31 June 30 September 29
------------ ------------ ------------ --------------
Net revenues $ 33,357,719 $ 34,103,055 $ 34,466,865 $ 36,190,966
Gross profit 5,184,865 5,185,485 5,811,323 6,438,975
Operating income 1,642,431 1,723,011 1,900,956 2,031,328
Net income 178,407 219,936 285,037 346,507
Net income per share-basic $ 0.02 $ 0.02 $ 0.03 $ 0.04
Net income per share-diluted $ 0.02 $ 0.02 $ 0.02 $ 0.03
For the Year Ended September 30, 2001
---------------------------------------------------------
December 31 April 1 July 1 September 30
------------ ------------ ------------ --------------
Net revenues $ 38,478,489 $ 40,437,492 $ 40,669,972 $ 42,572,117
Gross profit 6,646,054 7,239,960 7,689,599 6,940,383
Operating income (a) 2,151,114 2,544,268 2,623,314 2,164,086
Net income (a) 324,662 605,803 702,307 608,773
Net income per share-basic (a) $ 0.03 $ 0.06 $ 0.07 $ 0.06
Net income per share-diluted (a) $ 0.03 $ 0.05 $ 0.06 $ 0.05
(a) In October 2001, the Company adopted SFAS No. 142, "Goodwill and Other
Intangible Assets", and has ceased amortization of goodwill accordingly. Had the
company been accounting for goodwill under SFAS No. 142 for all periods
presented, operating income would have increased by $213,000 for each of the
quarters in fiscal 2001, net income would have increased by $137,000 for each of
the quarters in fiscal 2001, net income per share (basic) would have increased
by $0.02 for each of the quarters in fiscal 2001 and net income per share
(diluted) would have increased by $0.01, $0.02 $0.01 and $0.02 for the quarters
ended December 31, 2000, April 1, 2001, July 1, 2001 and September 30, 2001,
respectively.
F-30