Michael Foods, Inc.

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Michael Foods, Inc.

Suite 324, Park National Bank Building
5353 Wayzata Boulevard
Minneapolis, Minnesota 55416
(612) 546-1500
Fax: (612) 546-3711
Web site: http://www.michaelfoods.com

Public Company
Employees: 3,900
Sales: $956 million
Stock Exchanges: OTH
Ticker Symbol: D.MDW
SICs: 5143 Dairy Products, Except Dried or Canned; 2037 Frozen Fruits & Vegetables; 2099 Food Preparations, Not Elsewhere Classified; 0252 Chicken Eggs; 2020 Dairy Products; 6719 Holding Companies, Not Elsewhere Classified

Michael Foods, Inc., through its Egg Products Division, is the largest producer, processor, and distributor of extended shelf-life liquid eggs and dried, hard-cooked, and frozen egg products in the United States. In addition to its domestic market, the Egg Products Division distributes its products to the Far East, Europe, and South America, The company is also a diversified producer and/or distributor of food products in three other areas: dairy products, potato products, and refrigerated distribution. The Dairy Products Division processes and distributes soft serve mix, ice cream mix, and extended shelf-life ultra-pasteurized milk and specialty dairy products to domestic fast food businesses and other foodservice markets, independent retailers, 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. The Refrigerated Distribution Division distributes a variety of refrigerated grocery products directly to supermarkets, including cheese, shell eggs, bagels, butter, margarine, muffins, potato products, juice, and ethnic foods.

1987 Spin-Off

Michael Foods, Inc. was formed out of a 1987 spin-off from North Star Universal, Inc., a St. Louis Park, Minnesota conglomerate that funds itself with the direct marketing of unrated subordinated notes. North Star was created in 1980 when James H. Michael merged Universal Marking Systems, a public company he controlled, with a St. Paul, Minnesota company called North Star Acceptance and Investment Corporation. Michael owned about 70 percent of the stock, and he frequently guaranteed the companys debt as it went about making acquisitions, according to Corporate Report Minnesota. Since the spin-off of Michael Foods, that stock remained North Stars most valuable asset.

James Michael received his undergraduate and law degrees from the University of Minnesota. Rather than entering into the practice of law, he managed the Metropolitan Building in downtown Minneapolis, one of many real estate properties held by Michaels parents. Other of his assets include real estate, a foreign trade company, and Michael/Curry Companies, Inc., which owns Knutson Construction.

At the time of the Michael Foods spin-off from North Star, the company made its initial public offering at $7.11 per share, netting $170 million. Committed to producing extended-life, value-added food products, the company offered their ultrapasteurized liquid whole-eggs for approval by the U.S. Food and Drug Administration and the U.S. Department of Agriculture. Called Easy Eggs, researchers came up with a process that killed bacteria, making the eggs salmonella and listeria negative, while allowing for a shelf life of 45 days. The longer shelf life promised to provide a savings in storage and labor costs. The company gained licensing approval, which immediately precipitated a 25-cent rise in share price. Initial shipments were made from Michael Foods pilot plant in North Carolina, a plant capable of producing 25 million pounds of product annually. They began construction on a second plant at Michael Foods Crystal Food facility in Gaylord, Minnesota, providing an additional capacity of 150 million to 200 million pounds annually. Easy Eggs were targeted for major restaurants and food service operators and were produced by the companys Morning Glory Eggs Division.

By April of 1989 the company was reporting flat profits, sending Michael Foods shares plummeting. The decline was balanced, however, by record gains earlier in the year. Some analysts began expressing the concern that most of the companys business was dependent upon highly competitive commodity food products, rather than on consumer brands that could bring brand loyalty and more consistent margins. Others had more faith in the novelty of Michael Foods concept of value-added eggs, liquid eggs that could become substitutes for eggs in omelets, scrambled eggs, and as an ingredient in baked goods. After allowing for savings on labor costs, egg breakage, storage and refrigeration savings, the company claimed that their pricing was competitive.

Following the companys announcement that 1989 earnings would be lower than expected, stocks took a major dive. In October of 1989 two disgruntled shareholders filed a lawsuit against Michael Foods, alleging that the company violated securities laws by giving investors false and misleading information concerning expected demand for its Easy Eggs product. One of the complaints stated, The statements to the effect that there was almost unlimited demand for Easy Eggs were materially misleading in that defendants did not have a reasonable basis for their statements about existing or projected demand. Michael Foods attributed the lower earnings to slower-than-anticipated sales of their new product. Legally, the company could not be held accountable since it could not be proved that Michael Foods had misled investors intentionally.

Michael Foods acquired four companies, including the first half of M.G. Waldbaum Company, a producer of egg products. The company also bought Drallos Potato Company of Detroit and Farm Fresh Foods of Los Angelestwo companies that produced and sold fresh refrigerated potato products, which were important products for Michael Foods potato processing subsidiary, Northern Star Co. Michael Foods was hoping to strengthen its position in the potato product category by increasing its market share in Eastern markets and extending its coverage to the West Coast.

Reduced Cholesterol Liquid Whole Eggs Introduced in 1992

Michael Foods began investing heavily in the research of the decholesterolization of eggs, in response to public concern about heart disease and a trend toward decreasing the level of artery-clogging dietary cholesterol. During this period, it was reported that a small Pennsylvania company called C.R. Eggs, Inc. would introduce to the United States eggs laid by kelp-fed chickens. Already marketed in Japan, the kelp-fed chickens supposedly produced eggs capable of lowering human blood cholesterol levels. Some worried that the C.R. Eggs product would seriously threaten sales of Michael Foods low-cholesterol egg alternative, a product still being tested. By 1991 the government had ordered C.R. Eggs to stop selling their eggs because the iodine levels in their product were considered prohibitively high. Several other egg-substitute products were already on the market, but they did not contain yolk, which is where most of the eggs cholesterol resides. A New Jersey company, Papetti Hy-Grade Egg Products, Inc., another rival in the egg business, also announced that it had plans to introduce a cholesterol-stripped egg.

The process that Michael Foods was proposing removed about 80 percent of an eggs cholesterol, which was extracted from the yolks, then recombined with whites in a liquefied, pasteurized product. Their process was developed by a German company, SKW Natures Products, Inc., a unit of Viag AG, which had formed a $30 million joint venture with Michael Foods. Their process involved encapsulating cholesterol molecules with a starch substance known as beta-cyclodextrin. The yolk then would be centrifuged and the enrobed cholesterol removed. Michael Foods planned to call their product Simply Eggs. The eggs still contained fat, another concern for potential consumers, many of whom had felt the need to eliminate eggs from their diets altogether. The company intended to sell Simply Eggs to food manufacturers, restaurants, and other food-service customers and the retail market. According to Richard Gibson of the Wall Street Journal, The company intends to market the product even if it hasnt received Food and Drug Administration approval of the process by which cholesterol is removed from yolks. If the FDA later decides the processing substance, beta-cyclodextrin, isnt safe, it could order the product recalled. Whether or not Simply Eggs contributed to better nutrition was the question considered criticalby many outsidersto the success or failure of the product.

In July of 1992 Cargill, Inc. challenged the validity of four patents underlying the processing of egg products made by Michael Foods. Cargill contended that Michael Foods and North Carolina State University, which licensed the processes to the food company, knew that the invention (the pasteurization process that kills salmonella and other bacteria) was not original but withheld that information from the U.S. Patent and Trademark Office. By this time Simply Eggs was in retail tests in several Midwestern markets. The Wall Street Journal reported, Cargills lawsuit may have been preemptory. Its complaint says the defendants have engaged in a course of conduct that suggests Cargill would be sued over the egg-processing patents. Sunny Fresh Foods, a Cargill unit, is a relative newcomer in the production of extended shelf-life egg products, although Cargill stated in their complaint that they had abandoned the patented processes and used another procedure.

Company Perspectives:

Our strategic thrust is to further transition Michael Foods into a value-added food products company by being a leader in the food industry in introducing innovative food technology and customer solutions. The key to this strategy is value-added, whether that is in the product, the distribution channel or in the service we provide to our customers.

Michael Foods filed patent infringement suits against two other rivals, Papetti Hy-Grade Egg Products, Inc. and Bartow Food Company. News of the flurry of lawsuits caused Michael Foods stock to fall. Federal Court rulings favored Michael Foods in both of the patent-infringement suits. In 1994 the U.S. Federal Court of Appeals upheld the validity of the patents subject to the license agreement. Subsequently, a patent examiner at the U.S. Patent and Trademark Office rejected the patents. The company appealed the decision; during the appeal process, the patents remained valid.

1993 Restructuring

At the end of 1993 the company announced that it would be abandoning its reduced-cholesterol egg product and that it would be taking a restructuring charge of $23 million, against then-current quarter earnings. Higher-than-expected production costs and lower than expected sales prompted the decision. In conjunction with that news, the companys president and chief executive officer, Richard G. Olson, announced that he would retire at years end. His designated successor was Gregg A. Ostrander.

Michael Foods continued to increase resources devoted to the research and development of new food products, through internal food scientists, and externally, through the sponsorship of research projects at American universities. The Potato Products Division introduced special recipe mashed potatoes marketed to the food service industry. For the retail market they introduced Country Mashed Potatoes, made with skins and butter, under their Simply Potatoes brand, which was well received. In early 1994 Simply Eggs was re-introduced into the retail and food service markets as a cholesterol and fat-reduced scrambled egg mix. Consumer Reports rated Simply Eggs, the best tasting egg substitute of the 13 tested, but by 1995 Simply Eggs and Brand Scrambled Egg Mix were discontinued in the retail market. Management concluded that the consumer support costs to grow the sales would be too high relative to the products longer-term profit margin potentialalthough the products remained available in the foodservice market.

In late 1995 Michael Foods entered into an agreement with North Star Universal, Inc. to enter into a tax-free business combination of the two companies, in which Michael Foods would be the surviving company. The company repurchased and retired a portion of North Stars Michael Foods stock holdings (approximately 38 percent of Michael Foods common stock), at a discount to the market price of Michael Foods stock prior to closing, by assuming North Stars debt. Michael Foods assumed debt of $25-$38 million, and North Stars other assets and liabilities were transferred to a new company and distributed to its stockholders.

The companys Crystal Farms Division introduced 26 new products in 1995, including a line of bagel spreads, cracker toppers spreadable cheese, and two new flavors of cheese sauce. The companys retail sales and broker network was combined with the sales group of the Crystal Farms Division, providing a more unified sales presence and better access to other geographic areas. In the Dairy Products Division, a similar consolidation of sales groups occurred, adding to the presence of Kohlers specialty dairy products, including no chill creamers, targeted to the foodservice market.

The company reported sales growth of 15 percent for 1996, with the Refrigerated Distribution and Dairy Products divisions leading in profits. The Egg Products and Potato Products divisions were buffeted by raw material cost pressures and other operating difficulties, according to company reports. Excepting the refrigerated potato products wholesale and retail markets, Michael Foods found it increasingly difficult to operate the frozen line profitably and announced that they would exit that business. The value-added line of egg products performed satisfactorily, although below-average corn and soybean crops from the fall of 1995 caused a rise in chicken feed pricespushing feed prices up 50 percent from the previous year.

Convenience into the Next Millennium

Michael Foods acquired Papettis Hy-Grade Egg Products, Inc., the worlds largest preeminent egg products company, and added it to the second largest, M.G. Waldbaum Company, of which the company had completed the purchase in 1990. Papettis began as a business in 1908, when the Papetti family started a store-front fresh poultry business. By the 1950s that company switched entirely to the egg products business, and operations grew to include facilities in New Jersey, Pennsylvania, and Iowa. Third- and fourth-generation Papetti family members remain active in management. Products included whole eggs, scramble mixes, reduced-cholesterol products, bakery blends, hard-cooked eggs, and precooked omelets and pattiesproducts that Michael Foods considered complementary to those produced by Waldbaum. The substantial combined volumes of the two companies would allow cost savings in the areas of plant operations, distribution/freight, egg and ingredient souring, sales force optimization, and supplies and packaging purchases. Several capital spending projects related to the egg segment were initiated in 1996, including egg laying barn renovations and capacity expansions.

In 1997 Michael Foods stocks hit an all-time high of $28.375, in part a result of the earlier North Star merger, whereby Michael Foods emerged with a reduced share base, enhancing earnings per shareand record net earnings. The egg business had grown to comprise nearly two-thirds of Michael Foods revenue. The company introduced Simply Omelet in 1998, a precooked meal that can be heated in a microwave oven. Approximately 22 percent of Michael Foods yearly sales came from refrigerated distribution services. The company started shipping several new types of packaged cheese and refrigerated bread sticks with the Crystal Farms brand name. The dairy products segment made up 11 percent of sales, while the refrigerated potato products accounted for the remaining seven percent of Michael Foods revenue.

A fresh ad campaign was begun in 1998 and aimed at increasing awareness that Michael Foods is the umbrella company for the brand-name products offered by each of the companys divisions. The ads promoted the companys food innovations and how those products could be used at foodservice companies. In one of the ads for M.G. Waldbaum, an egg is pictured with a zipper, with a headline reading, Excuse me while we slip eggs into something more practical.

According to Pachuta in Investors Business Daily, Three years ago, Michael Foods set three goals to be achieved by 2000: $1 billion in yearly sales; earnings growth of 12 to 15 percent a year; and return on equity of 13 to 15 percent. The companys sales should easily surpass $1 billion this year, analysts say.

Principal Subsidiaries

Crystal Farms Refrigerated Distribution Company; Farm Fresh Foods, Inc.; Kohler Mix Specialties, Inc.; M.G. Waldbaum Company; Northern Star Co.; Papettis Hy-Grade Egg Products, Inc.; Wisco Farm Cooperative.

Principal Divisions

Refrigerated Distribution Division; Dairy Products Division; Egg Products Division; Potato Products Division.

Further Reading

Cargill Challenges Michael Foods Patents on Egg Processing, Wall Street Journal, July 10, 1992, p. B-6.

Ex-Chief at Pillsbury Named Head of Unit at Michael Foods, Inc., Wall Street Journal, August 1, 1989, p. B-6.

Gibson, Richard, Michael Foods Draws Analysts Long-Term Bet, Wall Street Journal, March 2, 1992, B-6H.

, Strip Cholesterol from Whole Eggs, Wall Street Journal, February 19, 1992.

Johnson, Tim, Michael Foods Hatches First Branding Eggs, City Business, May 29, 1998, p. 3.

Marcotty, Josephine, Disappointed Shareholders Sue Michael Foods, Minneapolis Star Tribune, October 13, 1989, p. 02D.

Michael Foods Buys Potato Firm, Minneapolis Star Tribune, October 6, 1989, p. 02D.

Michael Foods, Inc., Wall Street Journal, November 16, 1992, p. B-4.

Norris, Floyd, Behind Interest in Michael Foods, New York Times, April 25, 1989, p. IV, 10:3.

Pachuta, Michael, Michael Foods Cracks Open New Processed-Food Markets, Investors Business Daily, May 27, 1998, p. A3.

Stoppage of Egg Product Leads to $23 Million Charge, Wall Street Journal, December 16, 1993, p. B-4.

The Wealthiest Minnesotans, Corporate Report of Minnesota, May, 1991, p. 56.

Terri Mozzone

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Michael Foods, Inc.

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