MICHAEL FOODS INC /MN - 10-K Annual Report

Minnesota (State or other jurisdiction of incorporation or organization)		41-0498850 (IRS Employer Identification No.)
Suite 324, Signal Bank Building 5353 Wayzata Boulevard Minneapolis, Minnesota (Address of principal executive offices)		55416 (Zip Code)

Securities registered pursuant to Section 12(g) of the Act: Common Stock $.01 par value

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 March 5, 2001 was approximately $405 million based on the last price of such stock as reported by the Nasdaq National Market.

The number of shares outstanding of the registrant's Common Stock, $.01 par value, as of March 5, 2001, was 18,365,730 shares.

Certain items in this Form 10-K are forward-looking statements, which are made in reliance upon the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to numerous risks and uncertainties, including changes in domestic and international economic conditions. Additional risks and uncertainties include variances in the demand for the Company's products due to consumer and industry developments, as well as variances in the costs to produce such products, including normal volatility in egg and feed costs. The Company's actual financial results could differ materially from the results estimated by, forecasted by, or implied by the Company in such forward-looking statements.

Michael Foods, Inc. (the "Company", "we", "us") is a diversified producer and distributor of food products in four areas—egg products, refrigerated distribution, dairy products, and potato products. We are, through our Egg Products Division, the largest producer of processed egg products in the United States. The Refrigerated Distribution Division distributes a broad line of refrigerated grocery products to retail grocery outlets, including cheese, shell eggs, bagels, butter, margarine, muffins, potato products, juice and ethnic foods. The Dairy Products Division processes and distributes soft serve mix, ice cream mix, and extended shelf-life ultrapasteurized milk, creamers and other specialty dairy products to domestic fast food businesses and other foodservice outlets, ice cream manufacturers and others. The Potato Products Division processes and distributes refrigerated potato products sold to the foodservice and retail grocery markets in the United States. Financial information about the Company's business segments is included elsewhere herein (see Items 7 and 8).

Our strategy is to grow value-added food product sales, primarily in the foodservice market, by focusing on developing, marketing and distributing innovative, refrigerated products. The key to this strategy is "value-added", whether that is in the product, the distribution channel or in the service provided to customers.

In December 2000, we announced the signing of a definitive merger agreement ("Merger") providing for the acquisition of the Company for $30.10 per share in cash, by an investor group comprised of a management group led by our Chairman, President and Chief Executive Officer, affiliates of Jeffrey Michael, a director of the Company, and affiliates of two private equity investment firms. For further information, please see our reports on Form 8-K filed on December 22, 2000 and March 8, 2001, which are incorporated herein by reference.

The Egg Products Division, comprised of M. G. Waldbaum Company ("Waldbaum") and Papetti's Hygrade Egg Products, Inc. ("Papetti's"), produces, processes and distributes numerous egg products and shell eggs. Collectively the two subsidiaries are also known as the Michael Foods Egg Products Company. We believe that the Egg Products Division is the largest egg products producer in the United States and is believed to be the third largest egg producer in the United States. Principal value-added egg products are ultrapasteurized, extended shelf-life liquid eggs ("Easy Eggs®" and "Table Ready™"), egg white-based egg substitutes ("Better 'n Eggs™", "Table Ready™", and "All Whites™"), hardcooked and pre-cooked egg products. Other egg products include frozen, liquid and dried egg whites, yolks and whole eggs. The Division is the largest supplier of extended shelf-life liquid eggs, precooked egg patties

and omelets, dried, and hardcooked eggs in the United States and is a leading supplier of frozen and liquid whole eggs, whites and yolks. The Division distributes its egg products to food processors and foodservice customers primarily throughout the United States with some international sales in the Far East and Europe. The largest selling product line within the Division, extended shelf-life liquid eggs, and other egg products are marketed nationally to a wide variety of foodservice and industrial customers. The Division also is a leading supplier of egg white-based egg substitutes sold in the U. S. retail and foodservice markets. Most of the Division's annual shell egg sales are made to the Company's Refrigerated Distribution Division, which, in turn, distributes them throughout its 30 state territory.

In 2000, the Division derived approximately 97% of net sales from egg products, with 3% of net sales coming from shell eggs. Pricing for shell eggs and certain egg products in the United States reflects levels reported by Urner Barry Spot Egg Market Quotations ("Urner Barry"), a recognized industry publication. Prices of certain valued-added products, such as extended shelf-life liquid eggs, egg substitutes, and hardcooked and pre-cooked egg products, typically are not significantly affected by Urner Barry quoted price levels. Such products accounted for approximately 60% of the Division's 2000 sales. Prices for the Division's other products, including frozen, short shelf-life liquid, certain dried products and, particularly, shell eggs, are significantly affected by frequently changing market levels as reported by Urner Barry.

In 2000, approximately 35% of the Division's egg needs were satisfied by production from Company-owned hens, with the balance being purchased under grower contracts and in the spot market. The cost of eggs from Company-owned facilities is largely dependent upon the cost of feed. Additionally, for an increasing proportion of eggs purchased under grower contracts, the egg cost is determined largely by the cost of feed. For a larger proportion of eggs purchased under grower contracts, plus eggs purchased in the spot market, the egg cost is determined by normal market forces. Such costs are largely determined by reference to Urner Barry quotations. Historically, feed costs have generally been less volatile than have egg market prices and internally produced eggs generally are lower in cost than are externally sourced eggs. Key feed costs, such as corn and soybean meal, are partially hedged through the use of futures and other purchase contracts. There is no market mechanism for hedging egg prices.

The Division has endeavored to moderate the effects of egg market commodity factors through an emphasis on value-added products and the internal production of eggs, where the egg cost is somewhat controllable. Further, the Division attempts to match market-affected egg sourcing with the production of egg products whose selling prices are also market-affected, and cost-affected egg sourcing, as best can be managed, with higher value-added products priced over longer terms, generally 6-12 months. The former allows the Division to typically realize a modest processing margin on such sales, even though there are notable commodity influences on both the egg sourcing cost and the egg products pricing, with each changing as frequently as daily. Shell eggs are essentially a commodity and are sold based upon reported egg prices. Egg prices are significantly influenced by modest shifts in supply and demand. Pricing of shell eggs is also typically affected by seasonal demand related to increased consumption during holiday periods.

The Division's principal egg processing plants are located in New Jersey, Minnesota, Nebraska, Pennsylvania and Iowa. Certain of the Division's facilities are fully integrated from the production and maintenance of laying flocks through the processing of egg products. Fully automated laying barns, housing approximately 14,000,000 producing hens, are located in Nebraska and Minnesota, of which approximately 1,600,000 are housed in contract facilities. Major laying facilities also maintain their own grain and feed storage facilities. Further, the production of approximately 5,000,000 hens is under long-term supply agreements, with an additional 26,500,000 hens under shorter-term agreements. The Division also maintains facilities with approximately 2,800,000 pullets located in Nebraska and Minnesota.

The Refrigerated Distribution Division, comprised of Crystal Farms Refrigerated Distribution Company ("Crystal Farms") and Wisco Farm Cooperative, distributes a wide range of refrigerated grocery products directly to retailers and to wholesale warehouses. The Division believes that its strategy of offering quality branded products at a good value relative to national brands has contributed to its growth. These distributed refrigerated products, which consist principally of cheese, eggs, bagels, butter, margarine, muffins, potato products, juice and ethnic foods, are supplied by vendors, or other divisions of the Company, to the Division's specifications. Cheese accounts for approximately 58% of divisional annual sales. We operate a cheese packaging facility in Lake Mills, Wisconsin, which processes and wraps various cheese products for its Crystal Farms brand cheese business and for private label customers.

The Division has expanded its market area using both company-owned and leased resources and independent distributors. The Division's market area includes 30 states primarily in the central U. S. Retail locations carrying the Division's products approximate 4,300 stores, though a majority are served via customers' warehouses. In 2000, sales to the warehouse operations of a major national food wholesaler, and to its owned and franchised stores, represented approximately 45% of divisional sales. The Division maintains a fleet of refrigerated tractor-trailers to deliver products daily to its retail customers from ten distribution centers located centrally in its key marketing areas.

The Dairy Products Division, comprised of Kohler Mix Specialties, Inc. ("Kohler"), processes and sells soft serve mix, ice cream mix, frozen yogurt mix, creamers, milk and specialty dairy products, many of which are ultra-high temperature ("UHT") pasteurized products. The Division sells its products throughout much of the United States from processing facilities in Minnesota, Texas and Connecticut.

UHT processing is designed to produce bacteria-free products with delicate flavors, such as milk, ice cream mixes and specialty dairy products such as coffee creamers, whipping cream, half and half and cordials. Many of the Division's products have an extended shelf-life of up to ninety days, which extends the trade territory which can be effectively served by the Division to include most of the United States.

Soft serve, frozen yogurt and ice cream mixes are made to customers' specifications. Currently, the Division produces approximately 100 different formulations. The Division believes that the customization of high quality products and high customer service levels are critical to their business.

The Division has approximately 325 customers, including branded ice cream manufacturers, quick service restaurants, other foodservice outlets and independent ice cream retailers. The Division's top five customers represented approximately 53% of 2000 divisional sales volume. Most of the Division's sales are to customers who purchase products on a cost-plus basis. This includes sales to most of the large quick-service restaurant chains operating in its market areas. Sales of soft serve, milk shake, and ice cream mixes are more seasonal than the Company's other products, with higher sales volume occurring between April and October. The addition of other specialty dairy products in recent years, such as non-refrigerated dairy creamers and cartoned items, has somewhat offset the impact on the Division's sales and earnings from this seasonality.

Refrigerated potato products are produced and sold by Northern Star Co. ("Northern Star") and Farm Fresh Foods, Inc. ("Farm Fresh") to both the foodservice and retail markets. Products consist of shredded hash browns and diced, sliced, mashed, and other specialty potato products. In 2000,

approximately 66% of the Potato Products Division's net sales were to the foodservice market, with the balance to the retail market.

The Division maintains its main processing facility in Minnesota, with a smaller facility located in Nevada. The Division typically purchases approximately 90%-95% of its annual potato requirements from contract producers. The balance of potato requirements are purchased on the spot market. The Division maintains a high percentage of its contracted supply from irrigated fields and also has geographical diversification of its potato sources. However, weather remains an important factor in determining raw potato prices and quality. Variations in the purchase price and/or quality of potatoes can effect the Potato Products Division's operating results.

Each of our four divisions has developed a marketing strategy, which emphasizes high quality products and customer service. Michael Foods Sales, an internal sales group, coordinates the sales of Waldbaum, Papetti's, Kohler and Northern Star, primarily for national and regional accounts, and is supported by a centralized order entry and customer service staff. The consolidations of the historically distinct egg products sales groups, and related customer service groups, were completed in February 2001. A group of foodservice brokers is used by Michael Foods Sales to supplement its internal sales efforts. Further, the Egg Products Division utilizes a separate broker group for the retail market and maintains a small sales group which handles certain industrial egg product sales. The Company has a small marketing staff, which executes marketing plans in the foodservice market, with additional resources available from outside agencies and consultants as needed.

The Refrigerated Distribution Division's internal and external sales personnel obtain orders from retail stores which are usually placed no more than one day ahead of the requested delivery date. The Division's marketing efforts are primarily focused on in-store and co-op advertising programs, which are executed with grocers on a market-by-market basis. During 2000, Crystal Farms increased its consumer support programs, with largely favorable sales volume results. Also, the Egg Products Division has a consumer support program to support various of its egg products sold in the retail market.

We have made acquisitions in prior years and anticipate that we will continue to make acquisitions as part of our strategic plan. In 2000, we acquired Ingredient Supply, LLC, a hardcooked egg products processor located in Cokato, Minnesota. Ingredient Supply's annual sales were approximately $10 million.

All aspects of our businesses are extremely competitive. In general, food products are price sensitive and affected by many factors beyond our control, including changes in consumer tastes, fluctuating commodity prices, changes in supply due to weather, production variances and feed costs.

Our Egg Products Division is considered the largest egg products processor and the third largest egg producer in the United States. The Egg Products Division competes with many suppliers of egg products and eggs. While the shell egg industry is highly fragmented, and the egg products sector is fairly fragmented, there has been a trend toward consolidation in recent years and further consolidation in the industry is expected. Other major egg producers include Cal-Maine Foods, Inc. and Rose Acre Farms, Inc. We believe our Egg Products Division is among the lowest cost egg producers in the United States. We believe that Easy Eggs'® and Table Ready's™ salmonella-negative aspects, extended shelf-lives and ease of use are significant competitive advantages in the foodservice and industrial food markets for eggs. We also believe our largest competitor in egg products is the Sunny Fresh Foods, Inc. subsidiary of Cargill, Inc.

Our Refrigerated Distribution Division competes with the refrigerated products of other suppliers such as Beatrice Companies, Inc. (a subsidiary of ConAgra Foods, Inc.), Kraft Foods, Inc., Land O' Lakes, Inc., and Sargento Cheese Company, Incorporated. The Division believes that its emphasis on a high level of service and lower-priced branded products has enabled it to compete effectively in its market area with larger national brand companies.

We believe the Dairy Products Division provides the majority of the soft serve mix, and a significant percentage of ice cream mix, sold in Minnesota and Wisconsin. Kohler also has a large percentage of the UHT soft serve mix and UHT fluid milk business with quick service restaurant chains in the central United States. Competitors include local dairies utilizing conventional pasteurization and regional dairies with UHT products.

The Potato Products Division has a leading market share in refrigerated potato products sold in the United States foodservice and retail markets, where competitors are generally smaller, local or regional companies. One refrigerated potato products competitor, Reser's Fine Foods, Inc., has a national presence. Certain companies in the frozen potato products business, such as Ore-Ida Foods, Inc. (a subsidiary of H. J. Heinz Co.) and Lamb-Weston, Inc. (a subsidiary of ConAgra, Inc.), also sell frozen versions of potato products which are sold by the Division in refrigerated form.

We use a combination of patent, trademark and trade secrets laws to protect the intellectual property for our products. We own proprietary patents, and we have exclusive license agreements for several patents and technologies. In 1988, we entered into an exclusive license agreement to use patented processes developed and owned by North Carolina State University involving the ultra-pasteurization of liquid eggs. The patents licensed to us under this agreement expire between 2006 and 2010. In addition, as a result of our acquisition of Papetti's, we also acquired an exclusive sublicense to use a patented process for the electro-heating of liquid eggs owned by Raztek Corporation. The patent licensed to us under this sublicense expires in 2005. Our license to use each of these patents will continue until the expiration of the patents. These patented processes produce liquid eggs that are salmonella and listeria-negative, as defined by federal law, and extend the shelf-life of liquid eggs from less than two weeks to over ten weeks.

We also own an exclusive license to use a patented process, owned and developed by the University of Missouri, to eliminate salmonella from shell eggs. This patent is set to expire in 2016. Our license to use this patent will also continue until the expiration of the patent. We currently use this technology for processing in-shell pasteurized eggs sold through our refrigerated distribution division. We also have acquired licenses to other patents and technology from other third parties, including the University of Nebraska.

We believe that certain of our competitors infringe upon some of our patents and the patents licensed to us. Along with North Carolina State University, we have initiated litigation against several processors of competing liquid egg products claiming infringement of the original and subsequent related process patents licensed to us by North Carolina State University with respect to ultra-pasteurized liquid egg production. In 1992, a jury for the United States District Court for the Middle District of Florida found the original patent to be valid and that a processor, Bartow Food Co., willfully and deliberately infringed one of the patents. In another action, the United States District Court for the District of New Jersey found in 1992 and 1993 that Papetti's had infringed certain of the patents and that the licensed patents are valid and enforceable. In 1994, the Court of Appeals for the Federal Circuit upheld this judgment. In 1993, Nulaid Foods, Inc. sought a declaratory judgment that the licensed patents are invalid. This action was subsequently settled, and Nulaid Foods entered into an agreement with us for the sublicense of the patents. In 1996, reissue and reexamination proceedings were initiated by us and our competitors with the U.S. Patent and Trademark Office, or PTO, seeking

to determine the scope and validity of some of the patents that we license from North Carolina State University. We have recently received a notice of allowance from the PTO that the claims in the licensed patents are valid and in full force and effect. In 2000, Sunny Fresh Foods, Inc., a division of Cargill, Inc., filed an action seeking declaratory judgment that Sunny Fresh Foods does not infringe upon the licensed patents and that the licensed patents are invalid. We have counter claimed alleging that Sunny Fresh Foods has infringed the patents. For more information, see Item 3—Legal Proceedings.

Although we actively pursue patent infringement litigation, we do not believe that the expiration of these patents will have a material adverse affect on our business or market share within these product segments because of our strong market position combined with the fact that we believe our largest competitor is currently infringing on this patent.

The egg products division maintains numerous trademarks and/or trade names for its products, including "Logan Valley," "Wakefield," "Sunny Side Up," "Michael Foods," "Deep Chill," "MGW," "Simply Eggs Brand," "Better 'n Eggs," "All Whites," "Chef's Omelet Brand," "Express Eggs," "Quaker State Farms," and "Broke N' Ready." Ultra-pasteurized liquid eggs are marketed using the "Easy Eggs" and "Table Ready" trade names.

Within the potato products division, Northern Star Co. markets its refrigerated potato products to foodservice customers under a variety of brands, including "Northern Star," "Farm Fresh" and "Quality Farms." The "Simply Potatoes" and "Diner's Choice" brands are used for retail refrigerated products.

Within the dairy products division, "Kohler" and "Midwest Mix, Inc." are the two primary trade names.

Refrigerated distribution division products are marketed principally under the "Crystal Farms" trade name.

All of our divisions are subject to federal, state and local government regulations relating to grading, quality control, product branding and labeling, waste disposal and other aspects of their operations. Our divisions are also subject to USDA and FDA regulation regarding grading, quality, labeling and sanitary control. The processing plants of our egg products division that break eggs, and some of our other egg processing operations, are subject to continuous on-site USDA inspection. All of our other processing plants are subject to periodic inspections by the USDA, FDA and state regulatory authorities.

Crystal Farms cheese and butter products and the dairy products division's mix products are affected by milk price supports established by the USDA. The support price serves as an artificial minimum price for these products, which may not be indicative of market conditions that would prevail if such supports were abolished.

In November 2000, Crystal Farms initiated a recall of a small quantity of two cheese products manufactured by a co-packer due to possible contamination of listeria. Crystal Farms worked with the United States Food and Drug Administration to coordinate the recall, which involved several other companies and many brands of cheese. No illnesses were reported related to the recall and the impact on Crystal Farms' operations was minimal.

A substantial portion of the egg production operations of our Egg Products Division are located in the State of Nebraska. With certain exceptions, a provision of the Nebraska constitution generally prohibits corporations from engaging in farming or ranching in Nebraska. Although the constitutional provision contains an exemption for agricultural land operated by a corporation for the purpose of raising poultry, the Nebraska Attorney General has, in written opinions, taken the position that

facilities devoted primarily to the production of eggs do not fall within such exemption and therefore are subject to the restrictions contained in the constitutional provision. We believe that our egg production facilities in Nebraska are part of integrated facilities for the production, processing and distribution of egg products, and therefore, that any agricultural land presently owned by us in Nebraska is being used for non-farming and non-ranching purposes.

The constitution empowers the Nebraska Attorney General, or if the Attorney General fails to act, a Nebraska citizen, to obtain a court order to, among other things, force a divestiture of land held in violation of this constitutional provision. If land subject to such a court order is not divested within a two-year period, the constitutional provision directs the court to declare the land escheated, or forfeited, to the State of Nebraska. We are not aware of any proceedings under this 70 year-old constitutional provision pending or threatened against us or any other companies engaging in farming or ranching activities in Nebraska. We believe that we have adequate contingency arrangements in place in the event a determination is made that we engage in farming and/or ranching activities proscribed by the Nebraska constitution. Until the scope of such provision has been clarified by further judicial, legislative, or executive action, there can be no assurance as to the effect, if any, that it may have on our egg products division.

We are subject to federal, state and local environmental regulations and requirements, including those governing discharges to air and water, the management of hazardous substances, the disposal of solid and hazardous wastes and the remediation of contamination.

We have an ongoing relationship with an environmental consulting firm who helps us comply with environmental requirements. In addition, a review was conducted by independent environmental consultants in connection with the acquisition, and, as a result, we believe we are currently in material compliance with all environmental regulations and requirements. Nonetheless, as is the case with any business, if we do not fully comply with environmental regulations, or if a release of hazardous substances occurs at or from one of our facilities, we may be subject to penalties and/or held liable for the cost of remedying the condition.

Many of our facilities discharge wastewater pursuant to wastewater discharge permits. We dispose of our waste from our internal egg production primarily by providing it to farmers for use as fertilizer. We dispose of our solid waste from potato processing by selling the waste to a processor who converts it to animal feed.

We have made, and will continue to make, expenditures to comply with environmental requirements. We recently upgraded the wastewater treatment system at our Klingerstown, Pennsylvania facility and agreed to pay the city of Lenox, Iowa the cost to construct and operate a wastewater treatment plant used by our facility located there. Although our plants in Klingerstown and Lenox have exceeded their permitted wastewater discharge levels in the past, we believe that these expenditures will reduce the risk of future wastewater violations at these facilities. In addition, we are reviewing the adequacy of our wastewater treatment systems at the egg products division's facilities in Gaylord, Minnesota and Bloomfield, Nebraska and the dairy products division's facility in White Bear Lake, Minnesota. We may elect to upgrade the wastewater controls at these facilities or we may be required to upgrade such controls at these or other facilities in the future. However, we do not anticipate making any material capital expenditures for environmental controls for the foreseeable future.

At December 31, 2000, we had approximately 4,100 employees. Of this total, the Egg Products Division employed approximately 2,750 full-time and 265 part-time employees, none of whom are represented by a union. The Potato Products Division employed approximately 290 persons, approximately 195 of which were represented by the Bakery, Laundry, Allied Sales Drivers and Warehousemen Union, which is affiliated with the Teamsters. The Dairy Products Division employed approximately 220 people, approximately 65 of which were represented by the Milk Drivers and Dairy Employees Union. The Refrigerated Distribution Division employed approximately 460 employees, none of whom are represented by a union. The Michael Foods corporate, sales, distribution and customer service and information systems groups collectively employed approximately 120 people at December 31, 2000.

Corporate. We maintain leased space for our corporate headquarters, customer service office, sales office and information services group in suburban Minneapolis, Minnesota.

Egg Products Division. The following table summarizes information relating to the primary facilities of our egg products division:

Location	Principal Use	Size (square feet)	Owned/ Leased
Elizabeth, New Jersey	Processing	75,000	Leased
Elizabeth, New Jersey	Processing	125,000	Leased
Bloomfield, Nebraska	Processing	80,000	Owned
LeSueur, Minnesota	Processing	29,000	Owned
Wakefield, Nebraska	Processing	380,000	Owned
Klingerstown, Pennsylvania	Processing and Distribution	139,000	Leased
Klingerstown, Pennsylvania	Processing and Distribution	19,000	Leased
Lenox, Iowa	Processing and Distribution	143,000	Owned
Gaylord, Minnesota	Processing and Distribution	190,000	Owned
Elizabeth, New Jersey	Sales and Distribution	80,000	Leased
Bloomfield, Nebraska	Egg Production	619,000	Owned
Wakefield, Nebraska	Egg Production	658,000	Owned
LeSueur, Minnesota	Egg Production	345,000	Owned
Gaylord, Minnesota	Egg Production	349,000	Owned
Gaylord, Minnesota	Pullet Houses	130,000	Owned
Wakefield, Nebraska	Pullet Houses	432,000	Owned
Plainview, Nebraska	Pullet Houses	112,000	Owned

The Egg Products Division leases office space for its headquarters, financial and administrative services staff in suburban Minneapolis and owns or leases, primarily for egg production operations, approximately 1,600 acres of land in Nebraska and Minnesota.

Potato Products Division. The Potato Products Division owns a processing plant and land located in Minneapolis, Minnesota, consisting of approximately 175,000 square feet of production area. The

division leases one building in North Las Vegas, Nevada as of March 2001, consisting of approximately 31,000 square feet.

Dairy Products Division. The Dairy Products Division's facilities in White Bear Lake, Minnesota, consist of three owned buildings, with the main plant measuring approximately 95,000 square feet. It also leases a dairy plant in Sulphur Springs, Texas, which is approximately 40,000 square feet, and a dairy plant in Newington, Connecticut, which is approximately 70,000 square feet.

Refrigerated Distribution Division. The Refrigerated Distribution Division leases administrative and sales offices in suburban Minneapolis and several small warehouses across the United States. It owns a distribution center located near LeSueur, Minnesota, which is approximately 33,000 square feet. The refrigerated distribution division also owns and operates a 48,200 square foot refrigerated warehouse and a 19,000 square foot cheese packaging facility on a 19 acre site in Lake Mills, Wisconsin.

The total annual base rent of the facilities described above is approximately $7.4 million. The leases for these facilities have varying length terms ranging from month-to-month to September 2024. We believe that our owned and leased facilities, together with budgeted capital projects in each of our four operating divisions, are adequate to meet anticipated requirements for our current lines of business for the foreseeable future.

Four patents for ultrapasteurizing liquid eggs licensed to us by North Carolina State University were involved in proceedings before the PTO. In 1996, an examiner rejected certain claims under these patents as a result of challenges from competitors. We and North Carolina State University appealed this rejection to the PTO's Board of Patent Appeals and Interferences, or the PTO Board. In September 1999, we and North Carolina State University received a favorable ruling whereby the PTO Board reversed the examiner's rejection of 57 process claims made under the patents. As a result of these proceedings, process claims of all four patents continue to be valid and in full force and effect. We have recently received a notice of allowance from the PTO with regard to new product claims under the fourth patent. The patents will be re-issued once standard allowance fees are paid. In connection with a renegotiation in 1999 of our arrangements with respect to the patents that we license from North Carolina State University, we reduced the license fees we pay in exchange for agreeing to assume 50% of the costs relating to the defense of these patents in proceedings before the PTO and all other civil proceedings.

On September 13, 2000, Sunny Fresh Foods, Inc., a division of Cargill Inc., filed a declaratory judgment action in the United States District Court for the District of Minnesota requesting the adjudication of the unenforceability and invalidity of those patents exclusively licensed to us by North Carolina State University. We have filed a counter-claim against Sunny Fresh Foods, claiming willful infringement by Sunny Fresh Foods of these patents. This litigation is still in its preliminary stages.

Macartney Farms, a Canadian company that formerly distributed our egg products to the Canadian market, has filed a complaint against us and our Canadian joint venture Trilogy Egg Products, Inc., seeking $23.7 million (Canadian), or approximately $15.5 million, in damages asserting wrongful termination of its alleged exclusive marketing and distribution rights of Easy Eggs, intentional interference with economic relations, breach of fiduciary duty and recoupment of monies invested for the benefit of Michael Foods. Macartney also seeks an injunction against both Michael Foods and Trilogy from soliciting Macartney's customers. The litigation, which is pending in the Ontario Superior Court in Ottawa, is still in its preliminary stages.

In addition, we are from time to time party to litigation, administrative proceedings and union grievances that arise in the ordinary course of our business. We do not have pending any litigation that,

separately or in the aggregate, would, in our opinion, have a material adverse effect on our results of operations or financial condition.

Item 5—Market for Registrant's Common Equity and Related Stockholder Matters

Michael Foods common stock is traded on the Nasdaq National Market System under the symbol "MIKL." The following table sets forth the high and low reported sale prices of Michael Foods common stock for each quarter of 2000 and 1999.

1999	High	Low
First Quarter	28³/4	16¹¹/16
Second Quarter	25	18¹/4
Third Quarter	28¹/16	21³/8
Fourth Quarter	27⁷/16	22¹/2

2000	Low	High
First Quarter	25³/4	19¹/8
Second Quarter	25⁹/16	19³/8
Third Quarter	26³/4	21⁷/16
Fourth Quarter	31	22

The following table sets forth the regular quarterly cash dividends per share paid on Michael Foods common stock in 2000 and 1999.

	2000		1999
First Quarter	$	0.07	$	0.06
Second Quarter		0.08		0.07
Third Quarter		0.08		0.07
Fourth Quarter		0.08		0.07

At year end 2000, we had 358 common shareholders of record and an estimated 4,000 beneficial owners whose shares were held by nominees or broker dealers.

The following sets forth selected historical financial data with respect to the Company and its subsidiaries. The data given below as of and for the five years ended December 31, 2000 has been derived for the Company's Consolidated Financial Statements audited by Grant Thornton, LLP, independent certified public accounts. Such data should be read in conjunction with the Company's Consolidated Financial Statements and Notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations", included elsewhere herein, in thousands, except per share data.

Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the Company's consolidated financial statements and the notes to those statements appearing elsewhere in this Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Actual results may differ materially from those indicated in forward-looking statements.

Michael Foods is a diversified producer and distributor of specialty egg, potato and dairy products to the foodservice, retail and industrial ingredient markets. We also distribute refrigerated grocery items, primarily cheese and other dairy products, to the retail grocery market in the central United States. The following table summarizes certain historical results of the Company and its operating divisions and such data as a percentage of total net sales for the periods indicated and was derived from the Company's consolidated financial statements included elsewhere in this document (dollars in thousands):

Net Sales. Net sales for the year ended December 31, 2000 increased $27.3 million, or 2.6%, to $1,080.6 million from $1,053.3 million for the year ended December 31, 1999. This increase was primarily attributable to an increase in net sales from the egg products division of $16.7 million and an increase in net sales from the Company's refrigerated distribution division of $10.8 million, partially offset by reduced net sales of $3.5 million from the dairy products division.

Egg Products Division Sales. Egg products division sales for the year ended December 31, 2000 increased $16.7 million, or 2.7%, to $637.4 million from $620.7 million for the year ended December 31, 1999. The increase was primarily attributable to a 6.5% unit sales growth for all higher value-added products, such as extended shelf-life liquid, pre-cooked, hard cooked and low/no cholesterol liquid eggs. This sales growth more than offset price declines on certain products, including frozen and dried eggs. During 2000, shell egg prices dropped to a 15 year low, which for a variety of reasons (most notably supply and demand imbalances), resulted in narrow margins for frozen, short-shelf life liquid and dried eggs. As a result, the Company limited sales volumes for these products because of the adverse pricing environment. Sales of higher value-added egg products represented approximately 60% of the egg product division's sales in 2000, up from 58% in 1999.

Potato Products Division Sales. Potato products division sales for the year ended December 31, 2000 increased $3.3 million, or 5.9%, to $60.7 million from $57.4 million for the year ended December 31, 1999. This increase was primarily attributable to a strong unit sales growth for retail refrigerated potato products, which increased 12% from 1999. Sales to new customers, growth in sales to existing customers and new product introductions all contributed to the increase in sales as well.

Dairy Products Division Sales. Dairy products division sales for the year ended December 31, 2000 decreased by $3.5 million, or (2.4)%, to $141.4 million from $144.9 million for the year ended December 31, 1999. This decrease was primarily attributable to lower unit sales volumes for certain packaged mixes and the loss of its industrial ingredient customer in late 1999, as a result of problems related to a product recall which accounted for $15 million of our sales in 1999. These declines were offset by increased volumes as a result of the Company's acquisition of a Connecticut dairy facility in May 1999, which expanded the division' geographic coverage, continued growth in non-refrigerated dairy creamers as a result of product line extensions and customer additions and a recovery in cartoned specialty products, one year after the 1999 recall. In early 1999, the Company recalled milk carton products which may have been contaminated. Sales in 2000 were adversely impacted as a result of volume declines and operating inefficiencies associated with the recall. In response, the Company has upgraded its facilities and equipment, implemented improved quality control, testing and operating procedures and added new divisional management.

Refrigerated Distribution Division Sales. Refrigerated distribution division sales for the year ended December 31, 2000 increased $10.8 million, or 4.7%, to $241.1 million from $230.3 million for the year ended December 31, 1999. This increase was primarily attributable to strong unit sales growth in cheese, which increased 10.9% from 1999, and butter, which increased 15.1% from 1999. Strong volume growth resulted from sales to new customers, particularly in new territories, promotional activity and increased consumer advertising.

Gross Profit. Gross profit for the year ended December 31, 2000 decreased $1.5 million, or approximately (0.8)%, to $191.5 million from $193.0 million for the year ended December 31, 1999. The Company's gross profit margin was 17.7% of net sales for 2000, as compared to 18.3% of net sales for 1999. The decrease in gross profit was mainly attributable to a $14.9 million decrease in gross profit from lower value-added egg products resulting from a decrease in margins, as discussed above, and $0.8 million from the loss of the industrial dairy mix customer in late 1999 as a result of problems

related to the product recall, partially offset by increased gross profit from our higher value-added egg products, refrigerated case items and specialty potato products.

Selling, General and Administrative Expenses. Selling, general and administrative expenses for the year ended December 31, 2000 decreased $2.0 million, or (1.9)%, to $104.7 million from $106.7 million for the year ended December 31, 1999. Selling, general and administrative expenses declined as a percent of sales in 2000, as compared to the results in 1999. Expenses decreased due to reductions in costs associated with the Company's information systems upgrade project, the majority of which was completed in the third quarter of 2000, as compared to peak expense levels on this project in 1999 and reduced payments under the executive incentive plan from 1999 levels. The Company also benefited from effective expense controls in other areas of the business and the favorable impact of reduced egg products royalty payments arising from a renegotiation of these payments in exchange for the assumption by us of certain administrative expenses, including any expenses related to litigation or other disputes in connection with some of the patents that we license. These benefits more than offset increases in bad debt expense resulting from a foodservice distributor's bankruptcy filing and additional marketing efforts.

Operating Profit. Operating profit for the year ended December 31, 2000 increased $0.5 million, or approximately 0.6%, to $86.8 million from $86.3 million for the year ended December 31, 1999. This increase is primarily attributable to increased operating profits in the potato products and refrigerated distribution divisions, which were partially offset by a decline in operating profits of the egg products and dairy products divisions.

Egg Products Division Operating Profit. Egg products division operating profit for the year ended December 31, 2000 decreased $5.8 million, or (8.0)%, to $67.7 million from $73.5 million for the year ended December 31, 1999. Operating profit for higher value-added egg products increased by $6.2 million, or 10.4%, from 1999, while operating profit from other egg products declined by 98% to approximately break-even levels. As discussed above, operating profits for our industrial ingredient egg products declined by $14.0 million in 2000 as a result of a decrease in margins. The operating profit for the entire egg products division was impacted by a $4.6 million increase in depreciation as a result of substantial capital expenditures made throughout the division in 1999.

Potato Products Division Operating Profit. Potato products division operating profit for the year ended December 31, 2000 increased $0.9 million, or 13.3%, to $7.7 million from $6.8 million for the year ended December 31, 1999. This increase reflects benefits from volume growth and continuing improvements in plant operations, which were partially offset by increased marketing spending.

Dairy Products Division Operating Profit. Dairy products division operating profit for the year ended December 31, 2000 decreased $2.5 million, or (64.7)%, to $1.3 million from $3.8 million for the year ended December 31, 1999. Divisional operating profit declined in 2000 as a result of the loss of its major industrial customer, increased bad debt expense resulting from a foodservice distributor's bankruptcy filing, higher overhead expenses, continued above average operating expenses as a result of the 1999 product recall and increased amortization related to the acquisition of a dairy facility in Connecticut.

Refrigerated Distribution Division Operating Profit. Refrigerated distribution division operating profit for the year ended December 31, 2000 increased $5.3 million, or 50.1%, to $16.0 million from $10.7 million for the year ended December 31, 1999. Strong unit sales growth, along with a reduction in cheese supply costs without a commensurate reduction in selling prices, resulted in increases in margins during 2000.

Net Sales. Net sales for the year ended December 31, 1999 increased $32.8 million, or 3.2%, to $1,053.3 million from $1,020.5 million for the year ended December 31, 1998. The increase was attributable to sales growth across all four operating divisions.

Egg Products Division Sales. Egg products division sales for the year ended December 31, 1999 increased $13.0 million, or 2.1%, to $620.7 million from $607.7 million for the year ended December 31, 1998. The increase was primarily attributable to sales in higher value-added product lines, such as pre-cooked patties and omelets, which increased 5.1% from 1998, and sales of other egg products, such as dried eggs, which increased 1.5% from 1998. Sales of higher value-added egg products represented approximately 58% of the egg product division's sales in 1999 compared to approximately 57% in 1998.

Potato Products Division Sales. Potato products division sales for the year ended December 31, 1999 increased $5.0 million, or 9.6%, to $57.4 million from $52.4 million for the year ended December 31, 1998. This increase was primarily attributable to higher unit sales in 1999 compared to 1998. Foodservice unit sales were particularly strong in 1999, up 7.5% from 1998, with mashed potatoes, which showed significant sales increases, and new foodservice products contributing to the sales increase. Sales volume for retail items also increased in 1999, up 10.2% from 1998.

Dairy Products Division Sales. Dairy products division sales for the year ended December 31, 1999 increased by $6.0 million, or 4.3%, to $144.9 million from $138.9 million for the year ended December 31, 1998. This increase was primarily attributable to the acquisition of a Connecticut dairy facility in May 1999 and sales growth in non-refrigerated dairy creamers, partially offset by the loss of its major industrial customer at the beginning of the fourth quarter of 1999 and lower milk product sales as a result of the product recall in early 1999.

Refrigerated Distribution Division Sales. Refrigerated distribution division sales for the year ended December 31, 1999 increased $8.7 million, or 3.9%, to $230.3 million from $221.6 million for the year ended December 31, 1998. This increase was primarily attributable to strong unit sales growth in cheese products, which increased 12.0% from 1998, and butter, which increased 9.0% from 1998. Strong volume growth resulted from new customers, promotional activity and increased consumer advertising.

Gross Profit. Gross profit for the year ended December 31, 1999 increased $19.9 million, or 11.5%, to $193.0 million from $173.1 million for the year ended December 31, 1998. The Company's gross profit margin was 18.3% of net sales in 1999, as compared to 17.0% of net sales in 1998. The increase in gross profit margin in 1999 was attributable to a greater proportion of value-added product sales, which have higher margins, relative to total net sales, reduced feed and egg costs due to declines in the market prices of such raw materials and a decrease in potato products processing costs. It is the Company's strategy to increase value-added product sales as a percent of total sales over time, while decreasing the contribution of commodity-sensitive products to consolidated sales. These efforts historically have been beneficial to gross profit margins and earnings stability in most periods.

Selling, General and Administrative Expenses. Selling, general and administrative expenses

		Years Ended December 31,
		2000		1999		1998		1997		1996
STATEMENT OF OPERATIONS DATA
Net sales		$	1,080,601	$	1,053,272	$	1,020,484	$	956,223	$	616,395
Cost of sales			889,138		860,256		847,383		813,771		545,055
Product line inventory markdown			—		—		—		—		12,225

Gross profit			191,463		193,016		173,101		142,452		59,115
Selling, general and administrative expenses			104,657		106,686		93,548		76,173		44,822
Product line asset impairment			—		—		—		—		10,472

Operating profit			86,806		86,330		79,553		66,279		3,821
Interest expense, net			13,206		11,664		10,136		10,830		7,264

Earnings (loss) before income taxes			73,600		74,666		69,417		55,449		(3,443	)
Income tax expense (benefit)			28,890		30,610		29,160		23,010		(370	)

	Net earnings (loss)	$	44,710	$	44,056	$	40,257	$	32,439	$	(3,073	)

Net earnings (loss) per share
	Basic	$	2.36	$	2.15	$	1.86	$	1.53	$	(0.16	)
	Diluted		2.33		2.12		1.83		1.51		(0.16	)

Weighted average shares outstanding
	Basic		18,950		20,500		21,642		21,181		19,386
	Diluted		19,192		20,750		21,980		21,446		19,386
Dividends per common share		$	0.31	$	0.27	$	0.23	$	0.20	$	0.20
At December 31,
BALANCE SHEET DATA
Working capital		$	78,628	$	51,764	$	61,297	$	54,788	$	56,677
Total assets			612,904		597,917		551,516		503,655		364,659
Long-term debt, including current maturities			198,809		178,534		166,107		146,028		112,901
Shareholders' equity			258,733		264,599		244,149		229,246		174,042

			Years Ended December 31,
			2000				1999				1998
			$		%		$		%		$		%
Statement of operations data:
External net sales:
	Egg products division		637,355		59.0		620,719		58.9		607,688		59.6
	Potato products division		60,731		5.6		57,353		5.5		52,345		5.1
	Dairy products division		141,401		13.1		144,865		13.7		138,865		13.6
	Refrigerated distribution division		241,114		22.3		230,335		21.9		221,586		21.7

		Total net sales	1,080,601		100.0		1,053,272		100.0		1,020,484		100.0
Cost of sales			889,138		82.3		860,256		81.7		847,383		83.0

Gross profit			191,463		17.7		193,016		18.3		173,101		17.0
Selling, general and administrative expenses			104,657		9.7		106,686		10.1		93,548		9.2

Operating profit:
	Egg products division		67,658		6.2		73,531		7.0		69,295		6.8
	Potato products division		7,650		0.7		6,751		0.6		3,890		0.4
	Dairy products division		1,322		0.1		3,750		0.4		6,748		0.7
	Refrigerated distribution division		16,001		1.5		10,656		1.0		7,288		0.7
	Corporate		(5,825	)	(0.5	)	(8,358	)	(0.8	)	(7,668	)	(0.8	)

	Total operating profit		86,806		8.0		86,330		8.2		79,553		7.8

Interest expense, net			13,206		1.2		11,664		1.1		10,136		1.0