UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the thirteen week period ended November 28, 1998
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 333-44969-01
DESA HOLDINGS CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 22-2940760
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
2701 Industrial Drive, Bowling Green, KY 42101
(Address of principal executive offices) (Zip Code)
(502) 781-9600
(Registrant's telephone number, including area code)
Indicate by check 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 [ ]
As of January 4, 1999, there were 15,548,692 shares of Registrant's Common
Stock, $.01 par value per share, and 90,604 shares of the Registrant's Nonvoting
Common Stock, $.01 par value per share, outstanding.
DESA HOLDINGS CORPORATION
FORM 10-Q
November 28, 1998
INDEX
Page
PART I Financial Information
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets - November 28, 1998 and February 28, 3
1998
Consolidated Statements of Income - Thirteen Weeks and Thirty-nine 4
Weeks ended November 28, 1998 and November 29, 1997
Consolidated Statements of Stockholders' Equity (Deficit) 5
Consolidated Statements of Cash Flows - Thirty-nine Weeks ended 6
November 28, 1998 and November 29, 1997
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and 16
Results of Operations
PART II Other Information
Item 6. Exhibits and Reports on Form 8-K 23
Signatures 24
DESA Holdings Corporation
Consolidated Balance Sheets
(in thousands, except number of shares)
November 28 February 28
1998 1998
--------------------------
(unaudited)
Assets
Current assets:
Cash and cash equivalents $ 582 $ 794
Accounts receivable, net 80,961 20,838
Inventories:
Raw materials 1,036 1,257
Work-in-process 8,549 8,908
Finished goods 42,350 30,191
----------------------
51,935 40,356
Deferred tax assets 4,156 3,730
Other current assets 2,127 1,440
----------------------
Total current assets 139,761 67,158
Property, plant and equipment:
Land 390 390
Buildings and improvements 5,339 5,241
Machinery and equipment 34,473 29,891
Furniture and fixtures 781 630
----------------------
40,983 36,152
Less accumulated depreciation 25,535 22,593
----------------------
15,448 13,559
Goodwill, net 82,999 63,430
Other assets 26,162 11,489
----------------------
Total assets $ 264,370 $ 155,636
======================
Liabilities and stockholders' deficit Current liabilities:
Accounts payable $ 40,536 $ 15,035
Accrued interest 6,739 5,725
Other accrued liabilities 15,994 14,004
Income taxes payable 2,808 49
Current portion of long-term debt 39,437 5,250
----------------------
Total current liabilities 105,514 40,063
Long-term debt 287,910 261,105
Deferred tax liabilities 1,962 1,781
Other liabilities 579 433
----------------------
Total liabilities 395,965 303,382
Commitments
Series C redeemable preferred stock, $.01 par value; authorized--
40,000 shares; issued and outstanding-- 17,600 shares at February 28, 1998
and 18,850 shares at November 28, 1998 16,002 14,661
Stockholders' deficit:
Common stock, $.01 par value; authorized--50,000,000 shares; issued and
outstanding-- 13,688,015 shares February 28, 1998 and 15,548,692 155 137
shares at November 28, 1998
Nonvoting common stock, $.01 par value; authorized--2,000,000 shares;
issued and outstanding-- 90,604 shares at February 28, 1998
and November 28, 1998 1 1
Capital in excess of par value 97,984 85,926
Carryover predecessor basis adjustment (32,309) (32,309)
Accumulated deficit (212,458) (215,598)
Cumulative other comprehensive loss (970) (564)
----------------------
Total stockholders' deficit (147,597) (162,407)
----------------------
Total liabilities and stockholders' deficit $ 264,370 $ 155,636
======================
See accompanying notes
3
DESA Holdings Corporation
Consolidated Statements of Income
(in thousands)
(Unaudited)
Thirteen Weeks Ended Thirty-nine Weeks Ended
November 28 November 29 November 28 November 29
1998 1997 1998 1997
-------------------------- --------------------------
Net sales $134,679 $103,015 $250,849 $193,404
Cost of sales 87,055 65,185 166,996 123,243
----------------------- -----------------------
Gross profit 47,624 37,830 83,853 70,161
Operating costs and expenses:
Selling 19,570 13,277 40,323 27,165
General and administrative 3,762 3,770 9,726 8,312
Other 1,712 410 3,850 2,082
----------------------- -----------------------
25,044 17,457 53,899 37,559
----------------------- -----------------------
Operating Profit 22,580 20,373 29,954 32,602
Interest expense 7,559 4,159 20,796 11,321
----------------------- -----------------------
Income before provision for income taxes 15,021 16,214 9,158 21,281
Provision for income taxes 6,808 6,639 4,188 8,769
----------------------- -----------------------
Income before extraordinary loss 8,213 9,575 4,970 12,512
Extraordinary loss, net of income taxes of $1,495 0 2,308 0 2,308
----------------------- -----------------------
Net income 8,213 7,267 4,970 10,204
Less dividends on preferred stock 564 17 1,642 17
----------------------- -----------------------
Income available for common stockholders $ 7,649 $ 7,250 $ 3,328 $ 10,187
======================= =======================
See accompanying notes
4
DESA Holdings Corporation
Consolidated Statements of Stockholders' Deficit
Cumulative
Nonvoting Capital in Carryover Other Total
Common Common Excess of Predecssor Accumulated Comprehensive Stockholders'
Stock Stock Par Value Adjustment Deficit Loss Deficit
-------------------------------------------------------------------------------------------------------
Balance at
February 28, 1998 $137 $1 $85,926 ($32,309) ($215,598) ($564) ($162,407)
Comprehensive income:
Net Income 4,970 4,970
Foreign currency
translation adjustment (406) (406)
-----------
Comprehensive income 4,564
-----------
Accretion of preferred stock (188) (188)
Dividends on preferred stock (1,642) (1,642)
Issuance of common stock 18 12,058 12,076
-------------------------------------------------------------------------------- -----------
Balance at
November 28, 1998 $155 $1 $97,984 ($32,309) ($212,458) ($970) ($147,597)
================================================================================ ===========
See accompanying notes
5
DESA Holdings Corporation
Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)
Thirty-nine Weeks Ended
November 28 November 29
1998 1997
-------------------------
Operating activities
Net income $ 4,970 $ 10,204
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation 2,957 2,363
Amortization 3,511 1,570
Deferred income taxes (15) 28
Equity in undistributed earnings of joint venture (117) (124)
Extraordinary loss 0 2,308
Increase in operating assets, net of effects of acquisitions:
Accounts receivable, net (58,457) (52,520)
Inventories (7,674) (11,386)
Other current assets (570) (599)
Increase (decrease) in operating liabilities, net of effects of acquisitions:
Accounts payable 23,896 7,117
Accrued interest 1,074 (957)
Other accrued liabilities (272) 2,564
Income taxes payable 2,759 3,834
Other liabilities 146 105
----------------------
Net cash used in operating activities (27,792) (35,493)
----------------------
Investing activities
Capital expenditures (3,645) (3,690)
Dividends received from joint venture 123 124
Net cash paid for acquisition of businesses (39,635)
Other (986) 270
----------------------
Net cash used in investing activities (44,143) (3,296)
----------------------
Financing activities Recapitalization transactions:
Proceeds from Working Capital Loan 0 35,500
Proceeds from Term Loans 0 100,000
Proceeds from issuance of Senior Subordinated Notes 0 130,000
Proceeds from issuance of Series C Redeemable Preferred Stock 0 14,598
Proceeds from issuance of warrants 0 3,002
Proceeds from issuance of common stock 0 73,815
Exercise of options 0 150
Repurchase of common stock 0 (156,587)
Repayment of Term Loans 0 (183,095)
Payment of expenses 0 (16,772)
Increase in revolving loan 0 43,000
Increase (decrease) in Working Capital Loan 32,657 (2,645)
Proceeds from issuance of common stock 12,076 0
Principal payments of Term Loans (1,725) (6,855)
Payments for repurchase of common stock 0 (30)
Exercise of stock options 0 5
Increase in Acquisition Loans 30,000 0
Payment of debt financings costs in connection with debt issuance (1,193) 0
Payment of expenses related to issuance of preferred stock (96) 0
----------------------
Net cash provided by financing activities 71,719 34,086
Effect of exchange rates on cash 4 (154)
----------------------
Decrease in cash and cash equivalents for the period (212) (4,857)
Cash and cash equivalents at beginning of period 794 5,058
----------------------
Cash and cash equivalents at end of period $ 582 $ 201
======================
See accompanying notes
6
DESA HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The interim consolidated financial statements for the periods presented
herein have not been audited by independent public accountants. In the opinion
of management of DESA Holdings Corporation (the "Company"), all adjustments
(consisting only of normal recurring accruals) considered necessary to present
fairly the results of operations for the periods have been included. Interim
results are not necessarily indicative of results for a full year. Sales of the
Company's zone heating products follow seasonal patterns that affect the
Company's results of operations.
The unaudited consolidated financial statements have been prepared by
the Company in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X. Certain information and footnote disclosures normally
included in the financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
rules and regulations.
The consolidated balance sheet presented as of February 28, 1998, has
been derived from the consolidated financial statements that have been audited
by the Company's independent auditors. The consolidated financial statements and
notes thereto included herein should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company's
Registration Statement on Form S-4 (SEC File No. 333-44969-01).
Other than a small amount of goodwill and a $2.06 million note payable,
the Company has no assets, operations or cash flows independent of DESA
International, Inc. ("Desa") and, accordingly, separate financial statements for
Desa have not been provided as management believes that such financial
statements are not material to an investor.
2. Summary of Significant Accounting Policies
Consolidation
The accompanying consolidated financial statements include the accounts
of the Company and its wholly-owned subsidiary, Desa, and all of its
wholly-owned subsidiaries, including Desa Industries of Canada, Inc., Desa
Europe B.V., DESA Industries of V.I., Inc., and Heath Company Limited. All
significant intercompany accounts and transactions have been eliminated. Desa's
50% interest in a joint venture is accounted for using the equity method.
7
DESA HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the reported
period. Actual results can differ from those estimates.
Impact of Recently Issued Accounting Pronouncements
In February 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits ("FAS 132"). FAS 132 is
effective for fiscal years beginning after December 15, 1997, and will be
adopted by the Company in conjunction with its 1999 year-end reporting. The
overall objective of FAS 132 is to improve and standardize disclosures about
pensions and other postretirement benefits and to make the required information
easier to prepare and more understandable. Management does not anticipate that
FAS 132 will have a significant effect on the Company's consolidated financial
statements.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("FAS 133"). FAS 133 must first be applied
in the first quarter of fiscal years that begin after June 15, 1999. FAS 133
will require the Company to recognize all derivatives on the balance sheet at
fair value. Derivatives that are not hedges must be adjusted to fair value
through income. If the derivative is a hedge, depending on the nature of the
hedge, changes in the fair value of derivatives will either be offset against
the change in fair value of the hedged assets, liabilities or firm commitments
through earnings or recognized in other comprehensive income until the hedged
item is recognized in earnings. The ineffective portion of a derivatives change
in fair value will immediately be recognized in earnings. Management has not yet
determined what the effect of FAS 133 will be on the earnings and financial
position of the Company.
3. Financing Arrangements
The Company entered into a new credit agreement on November 26, 1997
with NationsBank, N.A., UBS Securities LLC and Nationsbanc Montgomery
Securities, Inc., which was amended in May 1998, that consists of a Working
Capital Loan Commitment of up to $75,000,000 (which includes a Swing-Line Loan
Commitment of up to $5,000,000 and provides that the Company can use Letters of
Credit up to $10,000,000 under the Working Capital Loan Commitment), a Term A
Loan Commitment ("Term A Loan") of $50,000,000, a Term B Loan Commitment ("Term
B Loan") of $50,000,000, an Acquisition Loan Commitment of up to $20,000,000 and
an Acquisition Loan Commitment B of up to $30,000,000 (collectively, the "Credit
Facility").
8
DESA HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Outstanding borrowings consist of the following (in thousands):
November 28, February 28,
1998 1998
------------ ------------
9 7/8% Senior Subordinated Notes Due 2007 (A) $130,000 $130,000
Term A Loan (B) 47,900 49,125
Term B Loan (C) 49,250 49,750
Working Capital Loan Commitment (D) 48,137 15,480
Acquisition Loan (E) 20,000 20,000
Acquisition Loan B (F) 30,000 --
Note payable related to acquisition of Heath/Zenith (G) 2,060 2,000
-------- --------
Total outstanding borrowings $327,347 $266,355
Less current portion of long-term debt 39,437 5,250
-------- --------
Total long-term debt $287,910 $261,105
======== ========
<FN>
(A) The Senior Subordinated Notes are payable on December 15, 2007 and
accrue interest at a rate of 9.875% per annum. Interest is payable
semi-annually on June 15 and December 15. The Senior Notes can be
redeemed prior to the mandatory redemption date based upon the
occurrence of certain events, as defined. Desa is the issuer of the
Senior Subordinated Notes, which are fully and unconditionally
guaranteed by the Company.
(B) The Term A Loan is payable in quarterly installments through November
26, 2003, and accrues interest at the prime rate plus 1.50% or LIBOR
plus 2.50% at the option of the Company. Interest is payable on a
quarterly basis under the prime rate option or at the end of each LIBOR
period. Once repaid, the Term A Loan may not be reborrowed.
(C) The Term B Loan is payable in quarterly installments through November
26, 2004, and accrues interest at the prime rate plus 1.875% or LIBOR
plus 2.875% at the option of the Company. Interest is payable on a
quarterly basis under the prime rate option or at the end of each LIBOR
period. Once repaid, the Term B Loan may not be reborrowed.
(D) The Working Capital Loan Commitment is payable at any time at the
option of the Company prior to November 26, 2003, and accrues interest
at the prime rate plus 1.50% or LIBOR plus 2.50%, at the option of the
Company. Interest is payable on a quarterly basis under the prime rate
option or at the end of each LIBOR period. As of November 28, 1998,
letters of credit of $2,614,371 were outstanding under the Working
Capital Loan Commitment. Borrowings are generally limited to specific
percentages of eligible trade receivables and inventory. The Credit
Facility requires a Clean-Up Period, as defined under the Working
Capital Loan
9
DESA HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Commitment, for a period of 30 consecutive days occurring between
January 1 and May 30. During each Clean-Up Period, the sum of Working
Capital advances, Letter of Credit advances and Swing Line loan
advances outstanding may not exceed $15,000,000. As of November 28,
1998, approximately $33 million of working capital borrowings have been
classified as current, reflecting the Company's intention to pay down
such advances in order to comply with the Clean-Up Period requirements.
Such amount may be reborrowed after compliance with the Clean-Up Period
requirements.
(E) The Acquisition Loan is payable in quarterly installments commencing in
February 2000 and extending through November 26, 2003, and accrues
interest, which is payable quarterly, at the prime rate plus 1.875% or
LIBOR plus 2.875% at the option of the Company. Once repaid, the
Acquisition Loan may not be reborrowed.
(F) The Acquisition Loan B is payable in quarterly installments commencing
in February 2000 and extending through November 26, 2003, and accrues
interest, which is payable quarterly, at the prime rate plus 1.875% or
LIBOR plus 2.875% at the option of the Company. Once repaid, the
Acquisition B Loan may not be reborrowed. On August 19, 1998, the
Acquisition B Loan was drawn on to fund the Fireplace Manufacturers,
Inc. and Universal Heating, Inc. acquisitions. $30,000,000 was
borrowed, of which $4,423,170 was used to pay down the Working Capital
Loan.
(G) The note payable is due on December 31, 2008 and accrues interest,
which is payable semi-annually, at a rate of 7.5% per annum. The
Company may elect, upon written notice, to defer any interest payments,
in which event such interest payments shall effectively convert to
principal and accrue interest at a rate of 7.5% per annum.
</FN>
In accordance with the terms of the Working Capital Loan
Commitment, the ability of the Company to incur additional indebtedness
is limited, as defined. At November 28, 1998, the Company had the
ability to incur additional indebtedness of $24.2 million.
On October 1, 1998, Desa entered into a binding agreement with
NationsBank for an interest rate swap. The terms of the swap
transaction have an effective date of November 27, 1998 and terminate
on November 29, 1999 and obligate the Company to pay a fixed rate of
4.75% on $75,000,000 and NationsBank to pay a floating rate based on
LIBOR on $75,000,000.
4. Comprehensive Income
As of March 2, 1997, the Company adopted Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("FAS 130"). FAS 130 established new rules for the reporting
and display of comprehensive income and its components; however, the
10
DESA HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
adoption of FAS 130 has had no effect on the Company's net income or
stockholders' deficit. FAS 130 requires the Company's foreign currency
translation adjustment, which prior to adoption was reported separately
in stockholders' deficit, to be included in other comprehensive income.
Amounts reported in prior year financial statements have been
reclassified to conform with the requirements of FAS 130. As of
November 28, 1998 the cumulative other comprehensive loss consisted
solely of the Company's foreign currency translation adjustment.
Comprehensive income consisted of the following (in thousands):
Thirteen Weeks Ended Thirty-nine Weeks Ended
November November November November
28, 1998 29, 1997 28, 1998 29, 1997
Net income $ 8,213 $ 7,267 $ 4,970 $ 10,204
Net change in foreign
currency translation
adjustment 131 (56) (406) (154)
-------- -------- -------- --------
Comprehensive income $ 8,344 $ 7,211 $ 4,564 $ 10,050
======== ======== ======== ========
5. Stockholders' Deficit
Effective in March 1998, the Company established the 1998 Stock Option
Plan. The plan terminates in ten years and provides for the issuance of
incentive options or nonqualified stock options for up to 1,462,222
shares of common stock, $.01 par value per share, of the Company
("Common Stock"). The stock options may be granted to key employees or
eligible non-employees as defined, as determined by the Compensation
Committee of the Board of Directors, and the term of the options cannot
exceed ten years from the grant date, except for employees who own
stock possessing more than 10% of the combined voting power of all
classes of stock of the Company, for whom the term of the options is
five years. The exercise price of the incentive options must be equal
to or greater than the fair market value of the Common Stock on the
date of grant, except for employees who own stock possessing more than
10% of the combined voting power of all classes of stock, for whom the
exercise price cannot be less than 110% of the fair market value of the
Common Stock on the date of grant. The exercise price of the
nonqualified options is determined by the Compensation Committee of the
Board of Directors.
11
DESA HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
5. Stockholders' Deficit (continued)
Effective in March and July of 1998, the Compensation Committee awarded
incentive stock options to purchase an aggregate of 187,750 shares of Common
Stock to certain key employees at an exercise price of $6.50 per share. These
options vest as follows: 5% at the end of year one, 10% at the end of year two,
60% at the end of year three, 80% at the end of year four and 100% at the end of
year five.
In September 1998, the Compensation Committee awarded incentive stock
options to purchase an aggregate of 1,179,777 shares of Common Stock to certain
key employees at an option price of $6.50 per share. These options vest upon the
attainment of certain performance goals.
6. Segment Information
The Company is organized into two primary product categories: (a) zone
heating products, which include indoor room heaters, hearth products and outdoor
heaters, and (b) specialty products, which include specialty tools and home
security products.
Corporate expenses include corporate headquarters staff, a modest
portion of the cost of certain support functions, including accounting,
management information systems, human resources and treasury and the
amortization of deferred financing costs.
Identifiable assets are those assets of the Company that are identified
with the operations in each product segment. Corporate assets include primarily
cash, deferred income taxes and deferred financing costs.
12
DESA HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Operational results and other financial data for the two business
segments for the periods ended November 28, 1998 and November 29, 1997 are
presented below (in thousands):
Zone
Heating Specialty General
Products Products Corporate Total
-------- -------- --------- -----
Thirteen weeks ended November 28, 1998
Net sales $ 95,852 $ 38,827 -- $134,679
Operating profit 17,776 6,047 (1,243) 22,580
Depreciation and amortization 2,113 432 466 3,011
Identifiable assets 153,978 93,345 17,047 264,370
Capital expenditures 568 268 3 839
Thirteen weeks ended November 29, 1997
Net sales 90,650 12,365 -- 103,015
Operating profit 19,644 1,669 (940) 20,373
Depreciation and amortization 1,231 45 254 1,530
Identifiable assets 119,086 25,841 12,853 157,780
Capital expenditures 716 111 3 830
Zone
Heating Specialty General
Products Products Corporate Total
-------- -------- --------- -----
Thirty-nine weeks ended November 28, 1998
Net sales $148,000 $102,849 -- $250,849
Operating profit 20,819 12,381 (3,246) 29,954
Depreciation and amortization 3,891 1,358 1,219 6,468
Identifiable assets 153,978 93,345 17,047 264,370
Capital expenditures 3,059 517 69 3,645
Thirty-nine weeks ended November 29, 1997
Net sales 158,144 35,260 -- 193,404
Operating profit 30,841 4,731 (2,970) 32,602
Depreciation and amortization 2,925 246 762 3,933
Identifiable assets 119,086 25,841 12,853 157,780
Capital expenditures 3,364 323 3 3,690
13
DESA HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
7. Prior Period Acquisitions
On February 4, 1998, the Company purchased all of the issued and
outstanding stock of Heath Holding Corp. ("Heath/Zenith") for an aggregate
purchase price of $42,365,000. The purchase price consisted of $40,365,000 in
cash and a $2,000,000 junior subordinated note payable. Heath/Zenith is engaged
in the manufacturing and distribution of motion-sensor lighting products and
wireless home-controlled devices, all of which are included in the Specialty
Products segment of the Company. The Company accounted for such acquisition
using the purchase method. The fair value of the assets acquired and liabilities
assumed at February 4, 1998 is summarized as follows (in thousands):
Current assets $25,757
Property, plant and equipment 458
Other assets 2,370
Goodwill 23,769
Current liabilities (9,989)
-------
$42,365
This allocation is preliminary and will be adjusted as necessary based
upon our further analysis of the acquisition of Heath/Zenith.
On August 19, 1998, the Company consummated two acquisitions. The
Company acquired all of the outstanding stock of Fireplace Manufacturers, Inc.
("FMI"), which then merged into Desa, for a net cash purchase price of
$21,984,798. The Company also entered into non-compete agreements with certain
executives of FMI covering a three-year period for aggregate payments of
$3,050,000. The Company also acquired the worldwide rights (except in China) to
distribute Universal Heating, Inc.'s and its affiliates ("UHI") indoor heating
products, through Desa U.S. Inc., which then merged into Desa, for a cash
purchase price of $12,332,548, including non-compete payments of $1,998,000. The
Company financed the two acquisitions through borrowings of $25,891,500 under
the Credit Facility (Acquisition Loan B) and the issuance of 1,860,677 shares of
Common Stock to existing stockholders for $12,075,500. The cash purchase prices
set forth above exclude an aggregate of $600,000 in fees and expenses incurred
in connection with both acquisitions and approximately $1,200,000 in debt
financing fees paid to obtain Acquisition Loan B.
14
DESA HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The Company accounted for such acquisitions using the purchase method,
and, accordingly, the results of operations of such acquisitions have been
included in the Company's results of operations from the acquisition dates. The
following summarizes the fair value of the assets acquired and liabilities
assumed at August 19, 1998, for the two acquisitions (in thousands):
Current assets $ 5,080
Property, plant and equipment 1,202
Other assets 10,385
Non-compete agreements 5,048
Goodwill 18,837
Current liabilities (2,585)
-------
$37,967
This allocation is preliminary and will be adjusted as necessary based
upon our further analysis of both acquisitions.
The following supplemental pro forma information is presented as if the
acquisitions of Heath/Zenith, FMI and UHI had been completed as of March 1,
1998, and as of March 2, 1997:
Thirty-nine weeks ended
November 28, 1998 November 29, 1997
----------------- -----------------
(dollars in thousands)
Net sales $263,556 $275,330
Income from operations before extraordinary item $ 30,050 $ 35,984
Income before extraordinary item $ 5,211 $ 9,426
Net income $ 4,754 $ 7,118
15
DESA HOLDINGS CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION
This quarterly report on Form 10-Q of Desa Holdings Corporation (the
"Company," which includes its consolidated subsidiaries unless the context
indicates otherwise contains statements which constitute forward looking
statements within the meaning of Section 21E of the Securities Exchange Act of
1934, as amended. Those statements appear in a number of places in this report
and include statements regarding the strategies, plans, beliefs or current
expectations of the Company and its management and other statements that are not
historical facts. Readers are cautioned that any such forward looking statements
are not guaranties of future performance and involve risks and uncertainties,
and that actual results may differ materially from those set forth in such
forward looking statements as a result of various factors. Such factors include,
but are not limited to, the Company's vulnerability to adverse general economic
and industry conditions because of its leverage, the Company's ability to obtain
future financing on acceptable terms, the Company's ability to integrate
acquired companies and to complete acquisitions on satisfactory terms, the
demand and price for the Company's products relative to production costs, the
seasonality of the Company's business and uncertainties regarding the resolution
of Year 2000 problems. The Company undertakes no obligation to release publicly
the results of any revisions to these forward looking statements that may be
made to reflect errors or circumstances that occur after the date hereof.
The following discussion of the Company's results of operations and
financial condition for the thirteen and thirty-nine week periods ending
November 28, 1998, and November 29, 1997, should be read in conjunction with the
consolidated financial statements of the Company and the notes thereto contained
herein, as well as for the fiscal year ended February 28, 1998, included in the
Company's Registration Statement on Form S-4 (SEC File No. 333-44969-01).
Overview
The Company is organized into two primary product categories: (a) zone
heating products, which include indoor room heaters, hearth products and outdoor
heaters, and (b) specialty products, which include specialty tools and home
security products. The Company records sales upon shipment of products to its
customers. Net sales constitute gross sales net of an accrual for returns and
allowances and cash discounts.
Sales of the Company's zone heating products follow seasonal patterns
that affect the Company's results of operations. Demand for the Company's zone
heating products has been historically highest in the third quarter, as
consumers prepare for winter. Consequently, the Company's net sales and
operating profit have also been historically highest during the third quarter.
Management believes that the Company's results of operations will continue to
follow this pattern; there can be no assurance, however, that third quarter
results will always surpass those of the first and second quarters, or that any
improvement shown will be as great as that shown in previous years. In
particular, unusually warm weather in the fall may reduce demand for zone
heating products.
The Company's net sales and operating profit of zone heating products
in its current fiscal year may be adversely affected by warm weather during the
preceding winter, which can result in inventory carryover by the Company's
customers. Last winter and this fall were unusually warm
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and, consequently, net sales and operating profit of zone heating products for
the first three quarters of the current fiscal year were lower than in similar
periods in the previous fiscal year.
Sales of the Company's specialty products do not follow a significant
seasonal pattern and are not affected by weather patterns. Historically, these
sales have followed a relatively level quarterly pattern.
Acquisitions
On August 19, 1998, the Company consummated the acquisitions of FMI and
the worldwide rights (except in China) to distribute UHI's indoor heating
products. FMI is a Santa Ana, California based manufacturer of wood-burning
metal fireplaces, decorative gas appliances with refractory-lined fireboxes,
direct vent gas fireplaces, and related chimney flues. UHI, based in Yorba
Linda, California, is a privately held manufacturer of indoor gas heating
products. The aggregate purchase price for the acquisitions was $37,967,346
including non-compete payments. These acquisitions were accounted for under the
purchase method of accounting.
The Company financed these acquisitions with the proceeds of a
$25,891,500 advance under its senior credit facility and $12,075,500 of the
proceeds from the issuance of approximately 1,860,677 additional shares of the
Common Stock by the Company. The additional equity was sold to existing
stockholders of the Company at a per-share price of approximately $6.50.
In August 1998, the Company became party to an agreement to negotiate
in good faith for the purpose of entering into a joint venture to manufacture
various products in China. Pursuant to the terms of the joint venture under
negotiation, UHI intends to contribute manufacturing facilities located in China
in exchange for a 60% interest in the joint venture and a preferred interest in
an additional $7 million of profits of the joint venture. The Company intends to
contribute $3 million in cash for a 40% interest in the joint venture, which
will be subordinate to UHI's $7 million preferred interest in profits. The
Company intends to finance its $3 million contribution to the joint venture
through indebtedness under the Credit Facility. There can be no assurance that
the joint venture will be formed or, if formed, formed on the terms described
above.
Results of Operations
Thirteen Week Period Ended November 28, 1998, Compared to the
Thirteen Week Period Ended November 29, 1997
Net sales. Net sales in the thirteen weeks ended November 28, 1998,
("third quarter 1999") were $134.7 million, an increase of 31% or $31.7 million
compared to the thirteen weeks ended November 29, 1997 ("third quarter 1998").
Zone heating products had net sales of $95.9 million in third quarter 1999, an
increase of 6% or $5.2 million from third quarter 1998. This increase reflects
primarily the effects of the previously discussed FMI and UHI acquisitions on
indoor and hearth heating product sales. Specialty products had net sales of
$38.8 million in the third quarter 1999, an increase of 214% or $26.5 million
over third quarter 1998, primarily attributable to the acquisition of
Heath/Zenith and its line of home security products in February 1998 and a 38%
growth in the traditional tool business over third quarter 1998.
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Cost of Sales. For third quarter 1999, cost of sales was $87.1 million,
an increase of $21.9 million or 34% from third quarter 1998, attributable to the
higher net sales for the period. Cost of sales was 65% of net sales in third
quarter 1999 compared to 63% for third quarter 1998. This increase is because of
(i) product mix with proportionately higher sales of acquired business products,
which are sold at lower margins, and (ii) higher manufacturing overhead per unit
of zone heating products, which resulted from the weather-related reduction in
production of heating products along with an increase of $.4 million in
depreciation expense over third quarter 1998.
Selling, General and Administrative Expenses. For third quarter 1999,
selling, general and administrative expenses were $25.0 million, an increase of
$7.6 million or 43% from third quarter 1998, primarily attributable to the net
sales increase. As a percentage of net sales, selling, general and
administrative expenses were 19% for third quarter 1999 compared to 17% in third
quarter 1998. This higher level is associated with an increase in selling
expenses of 1.6% for higher freight, advertising and warranty expenses
associated with the sales increase to the major home centers and higher
amortization expenses of 0.7% associated with the November 1997 recapitalization
and the acquisitions of Heath/Zenith, FMI and UHI.
Operating Profit. Operating profit was $22.6 million for third quarter
1999 compared to $20.4 million for third quarter 1998, an increase of 11%.
Operating profit attributable to zone heating products was $17.8 million for
third quarter 1999, down $1.9 million from third quarter 1998. This decline is
attributable to the increased cost of goods sold associated with under absorbed
factory overhead and higher selling costs associated with sales increase to
major home centers. Specialty products operating profit was $6.0 million for the
third quarter 1999, an increase of $4.4 million over third quarter 1998. This
increase is attributable to increased net sales of specialty products related
primarily to the acquisition of Heath/Zenith and a 74% increase in the
traditional tool business over third quarter 1998.
EBITDA for the third quarter 1999 was $25.6 million, an increase of
$3.7 million or 17% over the third quarter 1998 which was $21.9 million. EBITDA
is defined as income before income taxes plus interest expense and depreciation
as well as amortization expense associated with intangibles and deferred
charges. EBITDA is presented because it is a widely accepted financial indicator
of a leveraged company's ability to service and/or incur indebtedness and
because management believes that EBITDA is a relevant measure of the Company's
ability to generate cash without regard to the Company's capital structure or
working capital needs. However, EBITDA should not be considered as an
alternative to net income as a measure of a company's operating results or to
cash flows from operating activities as a measure of liquidity as defined by
generally accepted accounting principles.
Interest Expense. Interest expense for third quarter 1999 was $7.6
million, an increase of $3.4 million or 82%, reflecting the November 1997
recapitalization and the financing of the acquisitions of Heath/Zenith, FMI, and
UHI.
Income Tax. The provision for income taxes was 45% for third quarter
1999, above the 41% rate for third quarter 1998. This increase is because of the
nondeductibility of the higher goodwill amortization charges.
Net Income. Net income was $8.2 million for third quarter 1999 compared
to net income of $7.3 million for third quarter 1998, an increase of 13%. This
increase is attributable to the writeoff
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of the extraordinary item associated with the November, 1997 recapitalization.
Net income before extraordinary loss for third quarter 1999 was $8.2 million
compared to net income before extraordinary loss for third quarter 1998 of $9.6
million, a decrease of 14%. This decline is attributable to the lower operating
profit and higher interest expense.
Thirty-nine Week Period Ended November 28, 1998 Compared to the Thirty-nine Week
Period Ended November 29, 1997
Net Sales. Net sales for the thirty-nine weeks ended November 28, 1998
("year to date 1999") were $250.8 million, an increase of $57.4 million or 30%
compared to the thirty-nine weeks ended November 29, 1997 ("year to date 1998").
Zone heating products had net sales of $148.0 million for the year to date 1999,
a decrease of 6% or $10.1 million from the year to date 1998. This decline
primarily reflects the effects of last winter's and this fall's unusually warm
weather and the related customer carryover inventory on heating products
particularly, outdoor heating products. Specialty products had net sales of
$102.8 million for the year to date 1999, an increase of 192% or $67.6 million
from the year to date 1998, primarily attributable to the acquisition of
Heath/Zenith in February 1998 and a 24% increase in the traditional tool
business over year to date 1998.
Cost of Sales. For the year to date 1999, cost of sales was $167.0
million, an increase of $43.8 million or 36% from the year to date 1998,
reflecting the higher sales. Cost of sales was 67% of net sales during the year
to date 1999 compared to 64% for the year to date 1998. This increase is because
of (i) product mix with proportionately higher sales of acquired business
products, which are sold at lower margins, and (ii) higher manufacturing
overhead per unit of zone heating products, which resulted from the
weather-related reduction in production of heating products primarily during the
first half of the year and an increase in depreciation expense of $0.6 million
over year to date 1998.
Selling, General and Administrative Expenses. For the year to date
1999, selling, general and administrative expenses were $53.9 million, an
increase of $16.3 million or 44% over the year to date 1998, primarily
attributable to the net sales increase. As a percentage of net sales, selling
general and administrative expenses were 21% for the year to date 1999 compared
to 19% for the year to date 1998. This higher level is associated with an
increase in selling expenses for higher freight, advertising and warranty
expenses associated with the sales increase to the major home centers and higher
amortization expenses of $2 million or 0.8% of sales associated with the
November 1997 recapitalization and the acquisitions of Heath/Zenith, FMI and
UHI.
Operating Profit. Operating profit was $30.0 million for the year to
date 1999 as compared to $32.6 million for the year to date 1998, a decline of
8% attributable to a $2.5 million increase in depreciation and amortization
expense. Operating profit attributable to zone heating products was $20.8
million for the year to date 1999, down $10.0 million from the year to date
1998. This decline is attributable to the decline in net sales of zone heating
products and the increased cost of goods sold as discussed above. Operating
profit attributable to specialty products was $12.4 million for the year to date
1999, an increase of $7.7 million over the year to date 1998. This increase is
attributable to increased net sales of specialty products related primarily to
the acquisition of Heath/Zenith and the growth of the traditional tool business
over year to date 1998.
EBITDA for the year to date 1999 was $36.4 million, in line with the
year to date 1998 of $36.5 million. EBITDA is defined as income before income
taxes plus interest expense and
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depreciation as well as amortization expense associated with intangibles and
deferred charges. EBITDA is presented because it is a widely accepted financial
indicator of a leveraged company's ability to service and/or incur indebtedness
and because management believes that EBITDA is a relevant measure of the
Company's ability to generate cash without regard to the Company's capital
structure or working capital needs. However, EBITDA should not be considered as
an alternative to net income as a measure of a company's operating results or to
cash flows from operating activities as a measure of liquidity as defined by
generally accepted accounting principles.
Interest Expense. Interest expense for the year to date 1999 was $20.8
million, an increase of $9.5 million from the year to date 1998, reflecting the
November 1997 recapitalization and the financing of the acquisitions of
Heath/Zenith, FMI, and UHI.
Income Tax. The provision for income taxes was 46% for the year to date
1999, above the rate of 41% for the year to date 1998. This increase is because
of the nondeductibility of the higher goodwill amortization charges.
Net Income. Net income for the year to date 1999 was $5.0 million
compared to $10.2 million for the year to date 1998, a decline of 51%. This
decline is attributable to the lower operating profit and higher interest
expense.
Liquidity and Capital Resources
The Company's primary cash needs have been for working capital, capital
expenditures and debt service requirements. The Company's sources of liquidity
have been cash flows from operations and borrowings under its revolving credit
facilities. The Company's business is subject to a pattern of seasonal
fluctuation. The Company's needs for working capital and the corresponding debt
levels tend to peak in the second and third fiscal quarters. The amount of sales
generated during the second and third fiscal quarters generally depends upon a
number of factors, including the level of retail sales for heating products
during the prior year's fall and winter, weather conditions affecting the level
of sales of heating products, general economic conditions, and other factors
beyond the Company's control.
Net cash used in operating activities for the year to date 1999 was
$27.8 million compared to net cash used of $35.5 million for the year to date
1998. This positive reduction of $7.7 million reflects the lower inventory build
up associated with the reduced production of zone heating products and a higher
accounts payable balance of $15.9 million.
Net cash used in investing activities was $44.1 million for the year to
date 1999, compared to $3.3 million for the year to date 1998. This higher cash
used for investing activities reflects the acquisition of UHI and FMI. Net cash
provided by financing activities for the year to date 1999 was $71.7 million,
compared to $34.1 million for the year to date 1998 due to the issuance of
Common Stock and bank loans associated with the acquisitions of UHI and FMI.
The Credit Facility provides for commitments in an aggregate amount of
up to $225.0 million. Borrowings outstanding under the Credit Facility were
$195.3 million on November 28, 1998. Outstanding letters of credit and foreign
currency contracts established to facilitate merchandise purchases were $2.6
million and $2.7 million, respectively, on November 28, 1998.
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The Company had the ability to incur additional indebtedness of $24.2 million at
November 28, 1998 under the Credit Facility.
The Company expects that capital expenditures during fiscal 1999 will
be approximately $4.2 million. Capital expenditures are expected to be funded
from internally generated cash flows and by borrowings under the Credit
Facility.
Management believes that cash flow from operations and availability
under the Credit Facility will provide adequate funds for the Company's
foreseeable working capital needs, planned capital expenditures and debt service
obligations. The Credit Facility requires a Clean-Up Period, as defined, under
the Working Capital Loan Commitment, for a period of 30 consecutive days
occurring between January 1 and May 30 in each calendar year commencing January
1, 1998. During the Clean-Up Period, the sum of Working Capital advances, Letter
of Credit advances and Swing Line loan advances outstanding shall not exceed
$15,000,000 for any Clean-Up Period. As of November 28, 1998, approximately $33
million of working capital borrowings have been classified as current as a
result of the Clean-Up requirement. Such amount may be reborrowed after
compliance of the Clean-Up Period The Company's ability to fund its operations,
make planned capital expenditures, make scheduled debt payments, finance
indebtedness and remain in compliance with all of the financial covenants under
its debt agreements depends on its future operating performance and cash flow,
which in turn, are subject to prevailing economic conditions and to financial,
business and other factors, some of which are beyond its control.
Year 2000
The Company is in the process of reviewing its computer and operational
systems to identify and determine the extent to which any such systems will be
vulnerable to potential errors and failures as a result of the "Year 2000"
problem. The Year 2000 problem is a result of computer programs being written
using two digits, rather than four digits, to identify years. The Year 2000
presents several risks to the Company: (i) that the Company's internal systems
may not function properly, (ii) that suppliers' computer systems may not
function properly and, consequently, deliveries of required parts may be
delayed, (iii) that customers' computer systems may not function properly and,
consequently, orders or payments for the Company's products may be delayed, and
(iv) that the Company's bank's computer systems could malfunction, disrupting
the Company's orderly posting of deposits, funds transfers and payments. The
occurrence of any one or more of these events could have a material adverse
effect on the Company's financial condition and results of operations. The
Company does not have any contingency plans to address the Year 2000 problem if
the efforts described below are not successful.
The Company has written all of its internal management information
systems ("MIS") applications, rather than buying applications from vendors, and
is in the process of modifying those applications to appropriately address the
Year 2000 problem. Such modifications are approximately 80% complete. Management
believes that the Company's MIS staff will be able to modify all such
applications prior to March 1, 1999, although there can be no assurances that
such modifications will be timely completed. No embedded systems used in
manufacturing require any modification for Year 2000 compliance. Review of
embedded systems used for quality control is expected to be completed in January
1999. The expenses of the Company's efforts to identify and address any Year
2000 problems are not expected to exceed $100,000, of which $37,000 have already
been spent, exclusive of staff time.
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The Company has identified critical parts and materials suppliers and
is beginning a program to contact such suppliers to evaluate the extent of the
Year 2000 risk to the Company's continued timely receipt of parts and materials
deliveries. Management believes that such efforts will allow the Company to
identify any risk of parts or materials shortages and either to find alternative
suppliers or to order sufficient quantities of critical parts and materials
prior to the Year 2000 so as to avoid adverse effects on the Company's financial
condition and results of operations, although there can be no assurances that
such efforts will be successful.
The Company is also engaged in discussions with certain major customers
to ensure that electronic data interchange ("EDI") formats function properly
notwithstanding the advent of the Year 2000. EDI is the primary method by which
customers place orders for the Company's products. Such discussions are
completed, in the case of the Company's major home center customers, and are
well advanced with other major customers using EDI, and management believes that
transmission of orders from these major customers will not be significantly
affected by the advent of the Year 2000, although there can be no assurances in
this regard. Management does not, however, have sufficient information regarding
the internal systems of all of its customers to form an opinion as to whether
such customers will be able to timely place such orders or to timely pay for
products. The purchasing patterns of existing and potential customers may be
affected by Year 2000 problems that could cause unexpected fluctuations in the
Company's sales volumes.
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PART II Other Information
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.1 Desa Holdings Corporation Amended and Restated
Stockholders Agreement dated as of October 9, 1998
among the Company and the persons named therein
10.2 Desa Holdings Corporation Purchase Agreement dated as
of October 9, 1998 among the Company and the persons
named therein
10.3 Preferred Stock Tagalong Agreement dated as of
October 9, 1998 among the Company and the persons
named therein
10.4 Form of Warrant
27.1 Financial Data Schedule
(b) Reports on Form 8-K
The Company filed no reports on Form 8-K during the period for
which this report is made.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DESA HOLDINGS CORPORATION
By:
Dated: January 11, 1999 /s/ Robert H. Elman
Robert H. Elman
Chairman and Chief Executive Officer
Dated: January 11, 1999 /s/ Edward G. Patrick
Edward G. Patrick
Vice President of Finance and Treasurer
(Principal Financial Officer)
Dated: January 11, 1999 /s/ Scott M. Nehm
Scott M. Nehm
Vice President and Controller
(Chief Accounting Officer)
24