Cal-Maine Foods, Inc. (CALM) - Description of business

Company Description
Our Business Cal-Maine Foods, Inc. (“we”, “us”, “our”, or the “Company”) is the largest producer and marketer of shell eggs in the United States. In fiscal 2006, we sold approximately 683 million dozen shell eggs, which represented about 15.9% of domestic shell egg consumption in the United States. Our total flock of approximately 23 million layers and 6 million pullets and breeders is the largest in the United States. Layers are mature female chickens, pullets are young female chickens usually under 20 weeks of age, and breeders are male or female chickens used to produce fertile eggs to be hatched for egg production flocks. Our primary business is the production, grading, packaging, marketing and distribution of shell eggs. We sell most of our shell eggs in 29 states, primarily in the southwestern, southeastern, mid-western and mid-Atlantic regions of the United States. We market our shell eggs through our extensive distribution network to a diverse group of customers, including national and regional grocery store chains, club stores, foodservice distributors and egg product manufacturers. The strength of our position is evidenced by the fact that we have the largest market share in the grocery segment for shell eggs, and we sell shell eggs to a majority of the largest food retailers in the United States. We are also one of the largest producers and marketers of value-added specialty shell eggs in the United States. Specialty shell eggs include reduced cholesterol, cage free and organic eggs and are a rapidly growing segment of the market. In fiscal 2006, specialty shell eggs represented approximately 14% of our shell egg dollar sales. Retail prices for specialty eggs are higher than standard shell eggs due to consumer willingness to pay for the increased benefits from those products. We market our specialty shell eggs under two distinct brands: Egg-Land's Best ( TM ) and Farmhouse ( TM ).   We own a 25.7% equity interest in Egg-Land's Best, Inc., which markets the leading brand in the specialty shell egg segment. We have exclusive license agreements to market and distribute Egg-Land's Best(TM) specialty shell eggs in major metropolitan areas, including New York City, and a number of states in the southeast and southwest. We market cage free eggs under our trademarked Farmhouse brand and distribute those shell eggs across the southeast and southwest regions of the United States. We also produce market and distribute private label specialty shell eggs to several customers. Sales of specialty shell eggs accounted for approximately 6.6% of our total shell egg dozen volume in fiscal 2006. We are also a leader in industry consolidation. Since 1989, we have completed eleven acquisitions ranging in size from 600,000 layers to 7.5 million layers. Despite a market that has been characterized by increasing consolidation, the shell egg production industry remains highly fragmented. There currently are 65 producers who each own more than one million layers and the ten largest producers own approximately 41% of total industry layers. We believe industry consolidation will continue and we plan to capitalize on opportunities as they arise. Hillandale Acquisition We entered into an Agreement to Form a Limited Liability Company, Transfer Assets Thereto, and Purchase Units of Membership Therein, dated July 28, 2005, with Hillandale Farms, Inc. and Hillandale Farms of Florida, Inc. (together, “Hillandale”), and the Hillandale shareholders (the “Agreement”). Under the terms of the Agreement, we acquired 51% of the units of membership in Hillandale, LLC for cash of approximately $27 million on October 12, 2005. The remaining 49% of the units of membership in Hillandale, LLC will be acquired in essentially equal annual installments over a four-year period, with the purchase price of the units equal to their book value at the time of purchases as calculated in accordance with the terms of the Agreement. The total preliminary purchase price is estimated to be as follows (in thousands): Cash consideration paid to seller for 51% of       Hillandale, LLC's membership units   $ 27,006   Obligation to acquire 49% of         Hillandale, LLC's membership units     25,947         52,953   Less discount of preliminary purchase price to the         present value as of July 28, 2005     (3,556 ) Total preliminary purchase price   $ 49,397   The preliminary purchase price was allocated based upon the fair value of the assets acquired and liabilities assumed as follows (in thousands): Assets acquired:       Cash and cash equivalents   $ 3,918   Receivables     7,181   Inventories     11,330   Prepaid and other assets     2,798   Property, plant and equipment     49,531   Total assets acquired     74,758             Liabilities assumed:         Accounts payable and accrued expenses     3,567   Notes payable and long-term debt     21,794   Total liabilities assumed     25,361             Net assets acquired   $ 49,397   In October 2005, we paid substantially all of Hillandale, LLC notes payable and long-term debt and obtained a new $28 million term loan from an insurance company. The loan is secured by substantially all of the property, plant and equipment of Hillandale, LLC, and requires monthly principal payments of $150,000 plus interest beginning in January 2007 through November 2020. The obligation to acquire 49% of Hillandale, LLC is recorded at its present value of $23.6 million as of June 3, 2006, of which $6.9 million is included in current liabilities and $16.7 million is included in other non-current liabilities in the accompanying consolidated balance sheet. We will purchase an additional 13% of Hillandale LLC based on the value of LLC membership units as of July 29, 2006. We gained effective control of the Hillandale operations upon signing of the Agreement. Accordingly, the acquisition date for accounting purposes is July 28, 2005. The operations of Hillandale, LLC have been consolidated with our operations beginning July 29, 2005. Prior to the acquisition, we had a 44% membership interest in American Egg Products, LLC (“AEP”) and Hillandale, LLC had a 27.5% membership interest in AEP. Prior to the acquisition of Hillandale, LLC, our membership was accounted for by the equity method. Effective with our acquisition of Hillandale, LLC, we own a majority of the membership interest in AEP and, accordingly, the financial statements of AEP have been consolidated with our financial statements effective July 29, 2005. AEP, located in Georgia, processes shell eggs into liquid and frozen egg products that are sold primarily to food manufacturers and to the food service industry. AEP has contract shell egg production for approximately 50% of shell egg requirements and purchases the balance from regional egg markets. Hillandale, LLC’s production facilities are principally located in Florida. Hillandale, LLC is a fully integrated shell egg producer with its own feed mills, hatchery, production, processing and distribution facilities. The Hillandale acquisition increased our current egg production capacity by approximately 30%. As of July 28, 2005, Hillandale, LLC owned a 50% ownership interest in Hillandale Farms, LLC that was accounted for by the equity method. On October 5, 2005, Hillandale, LLC acquired the other 50% interest in Hillandale Farms, LLC for $1.0 million. The purchase price was allocated to the assets acquired and liabilities assumed and resulted in approximately $900,000 of goodwill. Hillandale Farms, LLC is engaged in the production, processing and distribution of shell eggs.  Our Corporate Information We were incorporated in Delaware in 1969. Our principal executive office is located at 3320 Woodrow Wilson Drive, Jackson, Mississippi 39209. The telephone number of our principal executive office is (601) 948-6813. We maintain a website at where general information about our business is available. The information contained in our website is not a part of this document. Our annual reports on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K, Forms 3 and 4, and all amendments to those reports are available, free of charge, through our web site as soon as reasonably practicable after they are filed with the SEC. Information concerning corporate governance matters is also available on the website. Our Common Stock is listed on The NASDAQ Stock Market LLC (“NASDAQ”) under the symbol “CALM”.   On June 2, 2006, the last sale price of our Common Stock on NASDAQ was $7.19 per share . Our fiscal year 2006 ended June 3, 2006 and the first three fiscal quarters of fiscal 2006 ended August 27, 2005, November 26, 2005 and February 25, 2006. All references herein to a fiscal year means our fiscal year and all references to a year mean a calendar year.  We have adopted a Code of Conduct and Ethics for Directors, Officers and Employees, including the chief executive and principal financial and accounting officers of the Company. We will provide a copy of the code free of charge to any person that requests a copy by writing to: Cal-Maine Foods, Inc. P.O. Box 2960 Jackson, Mississippi 39207 Attn.: Investor Relations Requests can be made by phone at (601) 948-6813 A copy is also available at our website . Information contained on our website is not a part of this report. IMPORTANT FACTORS RELATING TO FORWARD-LOOKING STATEMENTS This report contains numerous forward-looking statements relating to the Company's shell egg business, including estimated production data, expected operating schedules, expected capital costs and other operating data. Such forward-looking statements are identified by the use of words such as "believes," "intends," "expects," "hopes," "may," "should," "plan," "projected," "contemplates," "anticipates" or similar words. Actual production, operating schedules, results of operations and other projections and estimates could differ materially from those projected in the forward-looking statements. The factors that could cause actual results to differ materially from those projected in the forward-looking statements include (i) the risk factors set forth below under the following Item 1A, (ii) the risks and hazards inherent in the shell egg business (including disease, pests, and weather conditions), (iii) changes in the market prices of shell eggs, and (iv) changes that could result from the Company's future acquisition of new flocks or businesses. Readers are cautioned not to put undue reliance on forward-looking statements. The Company disclaims any intent or obligation to update publicly these forward-looking statements, whether as a result of new information, future events or otherwise.   Industry Background  The United States Department of Agriculture reported that in 2003 the wholesale shell egg industry was a $4.5 billion market. Shell eggs are a staple food product and 94% of US homes buy shell eggs according to the 2003 Progressive Grocer Consumer Expenditure Study. Based on historical consumption trends, demand for shell eggs increases in line with overall population growth, averaging an increase of about 1% per year. According to U.S. Department of Agriculture reports, since 2000, annual per capita consumption in the United States has varied between 252 and 256 eggs. In 2005, per capita consumption in the United States was 254 eggs, or approximately five eggs per person per week. Prices for Shell Eggs Shell egg prices are a critical component of profitability in the industry. Over 90% of all shell eggs sold in the United States in the retail and foodservice channels are sold at prices related to the Urner Barry wholesale quotation for shell eggs. For fiscal 2006, wholesale shell egg prices averaged 75.1 cents per dozen compared to an average of 85.2 cents per dozen for fiscal years 2003 to 2005. The current price environment is weak due to seasonal factors and a slight oversupply of eggs. Factors currently influencing demand: - industry advertising campaigns successfully promoting the health benefits of eggs; - positive announcements from the medical community highlighting eggs as a good source of protein; - increased consumption resulting from the factors noted above as well as the reduced level of cholesterol in eggs; and - increased demand from the foodservice channel. Factors currently influencing supply: - living space for newly hatched layers will increase 20% by 2008 according to guidelines put in place by the United Egg Producers, in conjunction with the Food Marketing Institute, both industry trade associations; and -  the process to bring new shell egg production capacity online has become more complex than in the past, increasing the time it takes to bring new capacity to market . Feed Costs for Shell Egg Production Feed is a primary cost component in the production of shell eggs and represents over one-half of industry production costs. Most shell egg processors are vertically integrated; manufacturing the majority of the feed they require themselves. Although feed ingredients, primarily corn and soybean meal, are available from a number of sources, prices for ingredients can fluctuate and can be affected by weather and by various supply and demand factors. Current feed prices are about the same as a year ago. Forecasts vary widely for prices for the next years, with some dry conditions reported in the Midwest and a stronger demand for corn from ethanol plants. Growth Strategy and Acquisitions For many years, we have pursued a growth strategy focused on the acquisition of existing shell egg production and processing facilities, as well as the construction of new and more efficient facilities. Since the beginning of fiscal 1989, we have completed eleven acquisitions. In addition, we have built seven new “in-line” shell egg production and processing facilities and one pullet growing facility which added 8 million layers and 1.5 million growing pullets to our capacity. Each of the new shell egg production facilities generally provide for the processing of approximately 400 cases of shell eggs or 12,000 dozen eggs, per hour. These increases in capacity have been accompanied by the retirement of older and less efficient facilities and a reduction in eggs produced by contract producers. The “in-line” facilities result in the gathering, grading and packaging of shell eggs by less labor-intensive, more efficient, mechanical means. As a result of our strategy, our total flock, including pullets, layers and breeders, has increased from approximately 6.8 million at May 28, 1988 to an average of approximately 24.8 million for the past five fiscal years. Also, the number of dozens of shell eggs sold has increased from approximately 117 million in the fiscal year ended May 28, 1988 to an average of approximately 599.2 million over the past five fiscal years. Net sales amounted to $477.6 million in fiscal 2006 compared to net sales of $69.9 million in fiscal 1988.  We propose to continue to pursue opportunities for the acquisition of other companies engaged in the production and sale of shell eggs. We will continue to evaluate and selectively pursue acquisitions that will expand our shell egg production capabilities in existing markets and broaden our geographic reach. We have extensive experience identifying, valuing, executing and integrating acquisitions and we intend to leverage that experience in the evaluation and execution of future acquisitions. We will seek to acquire regional shell egg businesses that have significant market share and long-standing customer relationships. We believe that enhancing our national presence will help us further strengthen our relationships with existing customers which have operations across the United States. Through exclusive license agreements with Egg-Land's Best, Inc. in several key territories and our trademarked Farmhouse brand, we are one of the leading producers and marketers of value-added specialty shell eggs. We also produce, market and distribute private label specialty shell eggs to several customers. Since selling prices of specialty shell eggs are not related to the generic shell egg market, we believe that growing our specialty eggs business will enhance the stability of our margins. We expect that the price of specialty eggs will remain at a premium to regular shell eggs. We intend to pursue acquisitions that may expand our specialty shell egg production. Federal anti-trust laws require regulatory approval of acquisitions that exceed certain threshold levels of significance. Also, we are subject to federal and state laws generally prohibiting anti-competitive conduct. Because the shell egg production and distribution industry is so fragmented, we believe that our sales of shell eggs during its last fiscal year represented only approximately 15.9% of domestic shell egg sales notwithstanding that we are the largest producer and distributor of shell eggs in the United States based on independently prepared industry statistics. We believe that regulatory approval of any future acquisitions either will not be required, or, if required, that such approvals will be obtained. The construction of new, more efficient production and processing facilities is an integral part of our growth strategy. Any such construction will require compliance with applicable environmental laws and regulations, including the receipt of permits that could cause schedule delays, although we have not experienced any significant delays in the past. Shell Eggs Production . Our operations are fully integrated. At our facilities, we hatch chicks, grow pullets, manufacture feed and produce and distribute shell eggs. Company-owned facilities accounted for approximately 89% of our total fiscal 2006 egg production, with the balance attributable to contract producers used by us. Under arrangements with our contract producers, we own the entire flock, furnish all feed and supplies, own the shell eggs produced and assume all market risks. The contract producers own their facilities and are paid a fee based on production with incentives for performance. The commercial production of shell eggs requires a source of baby chicks for laying flock replacement. We produce approximately 96% of our chicks in our own hatcheries and obtain the balance from commercial sources. We own breeder facilities producing 15.5 million pullet chicks per year in a computer-controlled environment. These pullets are distributed to 28 state-of-the-art laying operations around the southwestern, southeastern, mid-western and mid-Atlantic regions of the