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 August 28, 1999
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)
(270) 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 October 12, 1999, there were 15,552,547 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
August 28, 1999
INDEX
PART I Financial Information Page
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets - August 28, 1999 and February 27, 1999 3
Consolidated Statements of Operations - Thirteen and Twenty-six Weeks
ended August 28, 1999 and August 29, 1998 4
Consolidated Statements of Stockholders' Equity (Deficit) 5
Consolidated Statements of Cash Flows - Twenty-six Weeks
ended August 28, 1999 and August 29, 1998 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk 18
PART II Other Information
Item 2. Changes in Securities and Use of Proceeds 19
Item 6. Exhibits and Reports on Form 8-K 19
Signatures 20
2
DESA HOLDINGS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
August 28, February 27,
1999 1999
------------ ------------
(in thousands) (in thousands)
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents $ 1,277 $ 888
Accounts receivable, net 64,271 30,390
Inventories:
Raw materials 835 986
Work-in-process 11,008 6,376
Finished goods 60,952 37,891
--------- ---------
72,795 45,253
Deferred tax assets 2,137 2,137
Other current assets 2,132 1,321
--------- ---------
Total current assets 142,612 79,989
Property, plant and equipment:
Land 390 390
Buildings and improvements 6,137 6,173
Machinery and equipment 36,901 34,527
Furniture and fixtures 685 725
--------- ---------
44,113 41,815
Less accumulated depreciation 27,867 26,182
--------- ---------
16,246 15,633
Goodwill, net 80,878 81,882
Deferred tax assets 598 598
Other assets 24,082 25,250
--------- ---------
Total assets $ 264,416 $ 203,352
========= =========
Liabilities and stockholders' equity (deficit)
Current liabilities:
Accounts payable $ 46,569 $ 25,232
Accrued interest 3,563 3,075
Other accrued liabilities 14,443 10,732
Current portion of long-term debt 47,112 13,307
--------- ---------
Total current liabilities 111,687 52,346
Long-term debt 288,404 285,138
Other liabilities 775 599
--------- ---------
Total liabilities 400,866 338,083
Commitments
Series C redeemable preferred stock, $.01 par value; authorized--
40,000 shares; issued and outstanding-- 21,180 shares at August 28,
1999 and 19,990 shares at February 27, 1999 (liquidation preference--
$21,590,000 at August 28, 1999 and $20,371,000 at February 27, 1999) 18,526 17,207
Stockholders' equity (deficit):
Common stock, $.01 par value; authorized-- 50,000,000 shares; issued and
outstanding-- 15,552,547 shares at August 28, 1999 and 15,548,692 shares 155 155
at February 28, 1999
Nonvoting common stock, $.01 par value; authorized-- 2,000,000 shares;
issued and outstanding-- 90,604 shares at August 28, 1999
and February 27, 1999 1 1
Capital in excess of par value 98,009 97,984
Carryover predecessor basis adjustment (32,309) (32,309)
Accumulated deficit (219,503) (216,742)
Accumulated other comprehensive loss (1,329) (1,027)
--------- ---------
Total stockholders' equity (deficit) (154,976) (151,938)
--------- ---------
Total liabilities and stockholders' equity (deficit) $ 264,416 $ 203,352
========= =========
See accompanying notes
3
DESA HOLDINGS CORPORATION
Consolidated Statements of Operations
(in thousands)
(Unaudited)
Thirteen Weeks Ended Twenty-six Weeks Ended
Aug 28, Aug 29, Aug 28, Aug 29,
1999 1998 1999 1998
--------- --------- --------- ---------
Net sales $ 97,924 $ 75,416 $ 160,717 $ 116,170
Cost of sales 65,349 50,332 109,800 79,941
--------- --------- --------- ---------
Gross profit 32,575 25,084 50,917 36,229
Operating costs and expenses:
Selling 16,559 11,970 29,194 20,753
General and administrative 3,446 3,096 7,048 5,964
Other 1,540 1,272 3,064 2,138
--------- --------- --------- ---------
21,545 16,338 39,306 28,855
--------- --------- --------- ---------
Operating profit 11,030 8,746 11,611 7,374
Interest expense 7,334 6,745 13,962 13,237
--------- --------- --------- ---------
Income (loss) before provision (benefit) for income taxes 3,696 2,001 (2,351) (5,863)
Provision (benefit) for income taxes 1,720 878 (939) (2,620)
--------- --------- --------- ---------
Net Income (loss) 1,976 1,123 (1,412) (3,243)
Less dividends and accretion on preferred stock 685 613 1,348 1,203
--------- --------- --------- ---------
Income (loss) applicable to common stockholders $ 1,291 $ 510 $ (2,760) $ (4,446)
========= ========= ========= =========
See accompanying notes
4
DESA Holdings Corporation
Consolidated Statements of Stockholders' Deficit
($000's)
Carryover Cumulative
Nonvoting Capital in Predecessor Other Total
Common Common Excess of Basis Accumulated Comprehensive Stockholders'
Stock Stock Par Value Adjustment Deficit Loss Deficit
-------------------------------------------------------------------------------------------------------
Balance at
February 27, 1999 $155 $1 $97,984 ($32,309) ($216,742) ($1,027) ($151,938)
Comprehensive loss:
Net Loss (1,412) (1,412)
Foreign currency
translation adjustment (302) (302)
----------
Comprehensive loss (1,714)
----------
Accretion of preferred stock (129) (129)
Dividends on preferred stock (1,219) (1,219)
Issuance of common stock 25 25
-------------------------------------------------------------------------------- ----------
Balance at
August 28, 1999 $155 $1 $98,009 ($32,309) ($219,503) ($1,329) ($154,976)
================================================================================ ==========
See accompanying notes
5
DESA HOLDINGS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
Twenty-six Weeks Ended
Aug 28, Aug 29,
1999 1998
---------- -----------
Cash flows from operating activities
Net loss $ (1,412) $ (3,243)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation 2,305 1,512
Amortization 2,980 1,945
Deferred income taxes 0 (15)
Equity in undistributed earnings of joint venture (119) (78)
(Increase) decrease in operating assets:
Accounts receivable, net (33,881) (28,436)
Inventories (27,542) (14,558)
Other current assets (811) (529)
Increase (decrease) in operating liabilities:
Accounts payable 21,337 22,290
Accrued interest 568 (1,789)
Other accrued liabilities 4,592 (5,391)
Income taxes payable (910) (3,831)
Other liabilities 176 208
---------- -----------
Net cash used in operating activities $ (32,717) $ (31,915)
---------- -----------
Investing activities
Capital expenditures (2,918) (2,806)
Dividends received from joint venture 106 83
Net cash paid for acquisition of businesses 0 (39,635)
Other (390) (672)
---------- -----------
Net cash used in investing activities $ (3,202) $ (43,030)
---------- -----------
Financing activities
Increase in working capital loan 38,930 33,722
Decrease in note payable (64) 0
Principal payments of term loans (1,875) (1,125)
Issuance of common stock 25 12,076
Increase in acquisition loans 0 30,000
Payment of debt financing costs (703) 0
---------- -----------
Net cash provided by financing activities 36,313 74,673
Effect of exchange rates on cash (5) (5)
---------- -----------
Increase (decrease) in cash and cash equivalents for the period 389 (277)
Cash and cash equivalents at beginning of period 888 794
========== ===========
Cash and cash equivalents at end of period $ $1,277 $ 517
========== ===========
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" or "Holdings"), 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 including inventory levels, accounts receivable
levels and debt levels during the year.
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 27, 1999, 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 Annual Report
on Form 10-K.
2. Summary of Significant Accounting Policies
Consolidation
The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiary, DESA International, Inc. ("DESA") and
all of its wholly-owned subsidiaries, including DESA Industries of Canada, Inc.,
DESA Europe BV, 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.
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.
7
DESA HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Summarized Financial Information of DESA International, Inc
DESA International, Inc. is the issuer of the 9 7/8% Senior Subordinated Notes.
The Company has not presented separate financial statements and other
disclosures concerning DESA International, Inc. because management has
determined that such information is not material to holders of the Senior
Subordinated Notes.
The following summarized consolidated financial information is being provided
for DESA International, Inc. as of August 28, 1999 and February 27, 1999 and for
the thirteen and twenty-six weeks ended August 28, 1999, and August 29, 1998.
Summarized consolidated balance sheet information (in thousands):
August 28, February 27,
1999 1999
--------------------------------
Assets
Current assets $ 250,554 $ 187,892
Net fixed assets 16,246 15,633
Goodwill, net 79,757 80,744
Deferred tax assets 598 598
Other assets 24,082 25,250
-----------------------------
$ 371,237 $ 310,117
Liabilities and stockholders' deficit
Current liabilities $ 111,250 $ 51,939
Long-term debt 156,250 153,000
9 7/8% Senior Subordinated Notes 130,000 130,000
Other liabilities 775 599
Stockholders' deficit (27,038) (25,421)
-----------------------------
$ 371,237 $ 310,117
Summarized consolidated statements of operations information (in thousands):
Thirteen Weeks Ended Twenty-six Weeks Ended
August 28, August 29, August 28, August 29,
1999 1998 1999 1998
------------------------- ----------------------------
Net Sales $ 97,924 $ 75,416 $ 160,717 $ 116,170
Income (loss) before income taxes 3,745 2,094 (2,254) (5,762)
Net income (loss) 2,025 1,216 (1,315) (3,142)
8
DESA HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Impact of Recently Issued Accounting Pronouncements
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, 2000. FAS 133 will require
Holdings to recognize all derivatives on the consolidated balance sheets 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
determined that FAS 133 will not have a significant effect on the earnings and
financial position of the Company.
3. Financing Arrangements
Outstanding borrowings consist of the following (in thousands):
August 28, February 27,
1999 1999
--------------------------------------
9 7/8% Senior Subordinated Notes due 2007 (A) $ 130,000 $ 130,000
NationsBank and various banks Term A Loan (B) 43,250 44,875
NationsBank and various banks Term B Loan (C) 48,500 48,750
NationsBank and various banks Working Capital Loan 61,612 22,682
Commitment (D)
NationsBank and various banks Acquisition Loan (E) 20,000 20,000
NationsBank and various banks Acquisition B Loan (F) 30,000 30,000
Note payable related to acquisition of Heath (G) 2,154 2,138
--------------------------------------
Total outstanding borrowings 335,516 298,445
Less current portion of long-term debt 47,112 13,307
--------------------------------------
Total long-term debt $ 288,404 $ 285,138
<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,
commencing on June 15, 1998. 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
Holdings.
(B) The Term A Loan is payable in quarterly installments through November 26, 2003, and
accrues interest at the prime rate plus 2.25% or LIBOR plus 3.25% at the option of the
Holdings. 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 2.50% or LIBOR plus 3.50% at the option of
Holdings. 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.
9
DESA HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(D) The Working Capital Loan Commitment is payable at any time at the option of Holdings prior
to November 26, 2003, and accrues interest at the prime rate plus 2.25% or LIBOR plus
3.25%, at the option of Holdings. Interest is payable on a quarterly basis under the prime
rate option or at the end of each LIBOR period. Holdings can utilize letters of credit
under the Working Capital Loan Commitment up to $10 million. As of August 28, 1999,
letters of credit of $5,813,000 are outstanding under the Working Capital Loan Commitment.
Borrowings are generally limited to specific percentages of eligible trade receivables and
inventory. Holdings pays commitment fees of 1/2of 1% per annum on the daily unutilized
Working Capital Loan Commitment.
(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 2.50% or LIBOR plus 3.50% at the option of Holdings. Once repaid, the
Acquisition Loan may not be reborrowed.
(F) The Acquisition B 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 2.50% or LIBOR plus 3.50% at the option of Holdings. Once repaid,
the Acquisition B Loan may not be reborrowed.
(G) The note payable is due on December 31, 2008 and accrues interest, which is payable
semi-annually beginning June 30, 1998, at a rate of 7.5% per annum. Holdings 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. In
fiscal 2000, $80,000 of interest payments were deferred and were converted into
principal.
</FN>
In accordance with the terms of the Credit Facility, the ability of DESA to
incur additional indebtedness is limited, as defined. At August 28, 1999, DESA
can incur additional indebtedness of $7.6 million.
4. Comprehensive Income
Comprehensive loss consisted of the following (in thousands):
Thirteen Weeks Ended Twenty-six Weeks Ended
August 28, August 29, August 28, August 29,
1999 1998 1999 1998
-----------------------------------------------------
Net income (loss) $ 1,976 $ 1,123 $ (1,412) $ (3,243)
Net change in foreign currency
translation adjustment (84) (404) (302) (537)
----------- ---------------------------------------
Comprehensive income (loss) $ 1,892 $ 719 $ (1,714) $ (3,780)
===================================================
As of August 28, 1999 and August 29, 1998 the cumulative other comprehensive
loss consisted solely of the Company's foreign currency translation adjustment.
10
DESA HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
5. 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. Operational results and
other financial data for the two business segments for the periods ended August
28, 1999 and August 29, 1998 are presented below (in thousands):
Zone Heating Specialty General
Products Products Corporate Total
--------------------------------------------------------------------
Thirteen weeks ended August 28, 1999
Net sales $ 50,204 $ 47,720 -- $ 97,924
Operating profit (loss) 6,086 6,009 $ (1,065) 11,030
Depreciation and amortization 1,759 667 419 2,845
Identifiable assets 141,201 108,277 14,938 264,416
Capital expenditures 1,051 263 -- 1,314
Thirteen weeks ended August 29, 1998
Net sales 42,479 32,937 -- 75,416
Operating profit (loss) 5,873 3,863 (990) 8,746
Depreciation and amortization 1,396 465 385 2,246
Identifiable assets 136,639 88,343 16,811 241,793
Capital expenditures 1,228 132 48 1,408
Zone Heating Specialty General
Products Products Corporate Total
--------------------------------------------------------------------
Twenty-six weeks ended August 28, 1999
Net sales $ 70,868 $ 89,849 -- $160,717
Operating profit (loss) 3,782 9,973 $ (2,144) 11,611
Depreciation and amortization 2,864 1,602 819 5,285
Identifiable assets 141,201 108,277 14,938 264,416
Capital expenditures 2,025 865 28 2,918
Twenty-six weeks ended August 29, 1998
Net sales 52,148 64,022 -- 116,170
Operating profit (loss) 3,043 6,334 (2,003) 7,374
Depreciation and amortization 1,778 926 753 3,457
Identifiable assets 136,639 88,343 16,811 241,793
Capital expenditures 2,491 249 66 2,806
11
DESA HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
6. Prior Period Acquisitions
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 $25,805,000. The
purchase price includes non-compete agreements with certain executives of FMI
covering a three year period for aggregate payments of $3,050,000. The Company
also acquired certain of the assets of Universal Heating, Inc. ("UHI") through
Desa U. S. Inc., which then merged into DESA, for a cash purchase price of
$12,634,000, including non-compete payments of $1,998,000. The Company financed
the two acquisitions through borrowings of $26,363,500 under the Credit Facility
(Term Loan B) and the issuance of Common Stock for $12,075,500.
The Company accounted for such acquisition using the purchase method. As of
August 28, 1999, there are unresolved contingencies related to the FMI
acquisition, the resolution of which could result in adjustments to the purchase
price for the FMI acquisition. 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 $ 4,450
Property, plant and equipment 1,201
Other assets 15,734
Goodwill 20,114
Current liabilities (3,060)
--------
$ 38,439
The following supplemental pro forma information is presented as if the
acquisition had been completed as of February 28, 1999 and March 1, 1998:
Twenty-six weeks ended
August 28, 1999 August 29, 1998
-----------------------------------
(dollars in thousand)
Net sales $ 160,717 $ 128,877
Income from operations before 11,611 8,446
extraordinary item
Loss before extraordinary item (1,412) (5,880)
Net loss (1,412) (3,647)
12
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 that 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 twenty-six week periods ended August 28, 1999,
and August 29, 1998, 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 27, 1999, included in the Company's
Annual Report on Form 10-K.
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
Company's fiscal operating profit have also been historically highest during the
Company's fiscal 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 higher inventory carryover by the
Company's customers. Last winter was unusually warm and, consequently, net sales
and operating profit of zone heating products were below normal levels; however
net sales and operating profits of zone heating products were above the prior
year results.
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.
13
Results of Operations
Thirteen Week Period Ended August 28, 1999, Compared to the Thirteen Week Period
Ended August 29, 1998
Net sales. Net sales in the thirteen weeks ended August 28, 1999, ("second
quarter 2000") were $97.9 million, an increase of 30% or $22.5 million compared
to the thirteen weeks ended August 29, 1998 ("second quarter 1999"). Zone
heating products had net sales of $50.2 million in second quarter 2000, an
increase of 18% or $7.7 million from the second quarter 1999. This increase is
primarily in hearth product sales due to the acquisition of FMI and increased
fireplace product demand in the propane marketer/natural gas utility
distribution channel.
Specialty products had net sales of $47.7 million in the second quarter 2000, an
increase of 45% or $14.8 million over second quarter 1999, due to an increased
market demand for generators related to the concern of year 2000 computer
problems and sales for the electric pole saw.
Cost of Sales. For second quarter 2000, cost of sales was $65.3 million, an
increase of $15.0 million or 30% from second quarter 1999, attributable to the
higher net sales for the period. Cost of sales was 67% of net sales in second
quarter 2000 compared to 67% for second quarter 1999. Period to period costs are
comparable because of a product mix with proportionately lower sales growth of
zone heating products (which are sold at higher margins compared to specialty
products) being offset by lower manufacturing overhead per unit of zone heating
products. Manufacturing overhead per unit is lower as a result of higher second
quarter production levels this year compared to a year ago.
Selling, General and Administrative Expenses. For second quarter 2000, selling,
general and administrative expenses were $21.5 million, an increase of $5.2
million or 32% from second quarter 1999, primarily attributable to the net sales
increase. As a percentage of net sales, selling, general and administrative
expenses were 22% for second quarter 2000 compared to 22% in first quarter 1999.
This comparable level is associated with increased sales, which absorbed more of
the fixed expenses in the engineering and administration areas, offset by
increased shipping costs associated with the setup of a new distribution
facility and higher customer sales program costs.
Operating Profit. Operating profit was $11.0 million for second quarter 2000
compared to an operating profit of $8.7 million for second quarter 1999, an
improvement of $2.3 million or 26%. Operating profit attributable to zone
heating products was $6.1 million for second quarter 2000, an increase of $.2
million or 4% from second quarter 1999. This is a result of the increased sales
and higher factory overhead absorption offset by higher selling costs and
shipping costs associated with the sales increase. Specialty products operating
profit was $6.0 million for the second quarter 2000, an increase of $2.1 million
or 56% over second quarter 1999. This increase is attributable to the higher
level of specialty products sales and their related contribution margins.
EBITDA. EBITDA for the second quarter 2000 was $13.9 million, an increase of
$2.9 million or 26% from second quarter 1999. 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 second quarter 2000 was $7.3 million, an
increase of $.6 million or 9% compared to second quarter 1999. The increase is
associated with higher levels of borrowing and increased interest rates in
conjunction with Amendment and Waiver No. 4 made to the Credit Facility on May
25, 1999.
Income Tax. The income tax rate was 47% for second quarter 2000, an increase of
3% from the second quarter 1999 rate of 44%. The increase is attributable to
differences in the mix of foreign and domestic source income and their
corresponding tax rates.
Net Income. Net income was $2.0 million for second quarter 2000 compared to net
income of $1.1 million for second quarter 1999, an improvement of $.9 million.
This improvement is attributable to higher sales volume in both Zone heating and
Specialty products.
14
Twenty-six Week Period Ended August 28, 1999, Compared to the Twenty-six Week
Period Ended August 29, 1998
Net sales. Net sales in the twenty-six weeks ended August 28, 1999, ("year to
date 2000") were $160.7 million, an increase of 38% or $44.5 million compared to
the twenty-six weeks ended August 29, 1998 ("year to date 1999"). Zone heating
products had net sales of $70.9 million in year to date 2000, an increase of 36%
or $18.7 million from the year to date 1999. This increase is primarily in
hearth product sales due to the acquisition of FMI and increased fireplace
product demand in the propane marketer / natural gas utility distribution
channel.
Specialty products had net sales of $89.8 million in year to date 2000, an
increase of 40% or $25.8 million over year to date 1999, due to an increased
market demand for generators related to the fear of year 2000 computer problems
and sales for the electric pole saw.
Cost of Sales. For year to date 2000, cost of sales was $109.8 million, an
increase of $29.9 million or 37% from year to date 1999, attributable to the
higher net sales for the period. Cost of sales was 68% of net sales in year to
date 2000 compared to 69% for year to date 1999. This decrease is because of
lower manufacturing overhead per unit of zone heating products, as a result of
higher year to date production levels this year compared to a year ago.
Selling, General and Administrative Expenses. For year to date 2000, selling,
general and administrative expenses were $39.3 million, an increase of $10.5
million or 36% from year to date 1999, primarily attributable to the net sales
increase. As a percentage of net sales, selling, general and administrative
expenses were 24% for year to date 2000 compared to 25% in year to date 1999.
This lower level is associated with increased sales, which absorbed more of the
fixed expenses in the engineering and administration areas, offset by costs
associated with the set-up of a new distribution facility for zone heating
products.
Operating Profit. Operating profit was $11.6 million for year to date 2000
compared to $7.4 million for year to date 1999, an improvement of $4.2 million
or 57%. Operating profit attributable to zone heating products was $3.8 million
for year to date 2000, favorable by $.7 million from year to date 1999. This is
a result of the increased sales and higher factory overhead absorption offset by
higher selling costs and shipping costs associated with the sales increase.
Specialty products operating profit was $10.0 million for year to date 2000, an
increase of $3.6 million or 57% over year to date 1999. This increase is
attributable to increased sales of specialty products and their related
contribution margins.
EBITDA. EBITDA for year to date 2000 was $16.9 million, an increase of $6.1
million or 56% over year to date 1999 of $10.8 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 year to date 2000 was $13.9 million, an
increase of $.7 million or 5% compared to second quarter 1999. The increase is
associated with higher levels of borrowing and increased interest rates in
conjunction with Amendment and Waiver No. 4 made to the Credit Facility on May
25, 1999.
Income Tax. The income tax rate was 40% for year to date 2000, below the rate
for year to date 1999 of 45%. The decrease is attributable to differences in the
mix of foreign and domestic source income and their corresponding tax rates.
Net Income. Net loss was $1.4 million for year to date 2000 compared to a net
loss of $3.2 million for year to date 1999, an improvement of $1.8 million. This
improvement is attributable to higher sales volume in both Zone heating and
Specialty products.
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
15
number of factors, including the level of retail sales for heating products
during the prior winter and current fall 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 2000 was $32.7
million compared to net cash used of $31.9 million for the year to date 1999.
This increase in cash used of $.8 million reflects the higher accounts
receivable balance of $64.3 million and higher inventory balance of $72.8
million, offset by higher accounts payable balance of $46.6 million.
Net cash used in investing activities was $3.2 million for the year to date
2000, compared to $43.0 million for the year to date 1999. This lower cash used
for investing activities reflects the acquisition of UHI and FMI in year to date
1999. Net cash provided by financing activities for the year to date 2000 was
$36.3 million, compared to $74.7 million for the year to date 1999. The
difference reflects a decrease in the working capital loan and the prior year
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
$216.8 million. Borrowings outstanding under the Credit Facility were $203.4
million on August 28, 1999. Outstanding letters of credit and foreign currency
contracts established to facilitate merchandise purchases were $5.8 million and
$3.1 million, respectively, on August 28, 1999. The Company had the ability to
incur additional indebtedness of $7.6 million at August 28, 1999 under the
Credit Facility. The Company is in compliance with all its covenants under the
Credit Facility.
The Company expects that capital expenditures during fiscal 2000 will be
approximately $5.5 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. Additionally, the Company reviews potential acquisitions and
relationships from time to time and may be required to seek additional debt to
fund any acquisition. The Company's ability to fund its operations, make planned
capital expenditures, make scheduled debt payments, make desired acquisitions,
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 has completed the process of reviewing its computer and operational
systems to identify and determine the extent to which any such systems were
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
presented several potential 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 has written all of its internal management information systems
("MIS") applications, rather than buying applications from vendors, and chose to
modify those applications internally to appropriately address the Year 2000
problem. Management believes that the Company's' MIS staff was able to modify
all such applications prior to March 1, 1999, and the appropriate system testing
has been performed. No embedded systems used in manufacturing required any
modification for Year 2000 compliance. Review of embedded systems used for
quality control was 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 has already been spent, exclusive of staff
time.
The Company has identified critical parts and materials suppliers and has
completed a program to contact such suppliers and evaluate the extent of the
Year 2000 risk to the Company's' continued timely receipt of parts and
16
materials deliveries. Management believes, based upon supplier input, that the
risk of significant parts or materials shortages is unlikely. Management is,
however, monitoring the situation and will seek to find alternative suppliers or
to order sufficient quantities of critical parts and materials prior to the Year
2000 as adverse situations are identified 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 have been or 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 volume.
17
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risks relating to the Company's operations result primarily from changes
in interest rates. The Company also has limited foreign currency risk associated
with its Canadian, European, and Hong Kong operations. A portion of the
Company's operations consists of purchasing and sales activities in foreign
jurisdictions. The Company manufactures its products in the United States,
purchases products in Europe, China, and Japan and sells the products primarily
in the United States, Canada, and Europe. As a result, the Company's financial
results could be affected by factors such as changes in foreign currency
exchange rates or weak economic conditions in the foreign markets in which the
Company operates. The Company employs established policies and procedures to
manage its exposure to fluctuations in interest rates and the value of the
foreign currencies. Interest rate and foreign currency transactions are used
only to the extent considered necessary to meet the Company's objectives. The
Company does not utilize derivative financial instruments for trading or other
speculative purposes. There have been no material changes in the market risk to
which the Company is exposed since the end of the Company's preceding fiscal
year.
Interest Rate Risk
The Company's interest rate risk management objective is to limit the impact of
interest rate changes on its earnings and cash flow and to lower its overall
borrowing cost. To achieve its objectives, the Company regularly evaluates the
amount of its variable rate debt as a percentage of its aggregate debt. The
Company manages its exposure to interest rate fluctuations in its variable rate
debt through interest rate swap agreements. These agreements effectively convert
interest rate exposure from variable rates to fixed rates of interest without
the exchange of the underlying principal amounts. In fiscal 1999, the Company
entered into interest rate swap agreements with Nations Bank to manage its
exposure to interest rate fluctuations. The interest rate swap agreements
provide for payment by the Company of fixed rates of interest based on three
month LIBOR (4.75% at February 27, 1999). Notional principal amounts of these
agreements total $125 million, of which $75 million terminates in November 1999
and $50 million terminates in August 2001. The agreements terminating in August
2001 may be canceled at the option of Nations Bank in February 2000. The
notional amounts are used to measure the interest to be paid or received and do
not represent the amount of exposure to credit loss. Net proceeds to the Company
of $100,000 were recorded as adjustments to interest expense in fiscal 1999.
The following table summarizes the carrying amounts and estimated fair values
the Company's remaining financial instruments at February 27, 1999 and February
28, 1998 (bracketed amount represents an asset):
February 27, 1999 February 28, 1998
Carrying Fair Value Carrying Fair Value
Amount Amount
(in thousands)
Bank debt $166,307 $166,307 $134,355 $134,355
Senior subordinated notes 130,000 102,700 130,000 135,525
Note payable 2,138 2,138 2,000 2,000
Interest rate swap agreements -- (438) -- --
Based on the average outstanding amount of variable rate indebtedness of the
Company in FY 1999 a one percentage point change in the interest rates for the
Company's variable rate debt would have impacted the Company's FY 1999 interest
expense by an aggregate of approximately $1.6 million, after giving effect to
the Company's interest rate swap agreements.
Foreign Currency Exchange Rate Risk
The Company does not conduct a significant portion of its manufacturing or sales
activity in foreign markets. The Company's reported financial results could be
affected, however, by factors such as changes in foreign currency exchange rates
in the markets where it operates. When the U.S. dollar strengthens against such
foreign currencies, the reported U.S. dollar value of local currency operating
profits generally decreases; when the U.S. dollar weakens against such foreign
currencies, the reported U.S. dollar value of local currency operating profits
generally increases. The Company utilizes foreign exchange forward contracts to
mitigate the short-term effect of movements in currency exchange rates on the
Company's foreign currency based inventory purchases. The Company regularly
hedges by entering into foreign exchange forward contracts, approximately 85% to
95% of its budgeted (future) net foreign currency purchase transactions over a
period of 4 quarters. Gains and losses related to qualifying hedges of foreign
currency risk exposure are recorded when the related inventory is purchased.
Because the Company does not have significant foreign operations, the Company
does not believe it is necessary to enter into any other derivative financial
instruments to reduce its exposure to foreign currency exchange rate risk.
18
PART II Other Information
Item 2. Changes in Securities and Use of Proceeds
On March 19, 1999 and July 19, 1999, options representing 3,817 common shares
and 38 common shares, respectively, were exercised and shares were issued to
employees at an aggregate sale price of $24,773 and $247, respectively. These
shares are exempt from registration under Section 4(2) of the Securities Act.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27 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.
19
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: October 12, 1999 /s/ Terry G. Scariot
Terry G. Scariot
Chief Executive Officer and President
Dated: October 12, 1999 /s/ Edward G. Patrick
Edward G. Patrick
Vice President of Finance and Treasurer
(Principal Financial Officer)
Dated: October 12, 1999 /s/ Scott M. Nehm
Scott M. Nehm
Vice President and Controller
(Chief Accounting Officer)
20