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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended: March 31, 1997
[ ] 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: 33-96794
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DECORATIVE HOME ACCENTS, INC.
(Exact name of registrant as specified in its charter)
Delaware 57-0998387
- ------------------------------- -----------------------------------
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
Industrial Park Drive, Abbeville, South Carolina 29620
------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (864) 446-2123
Indicate by check mark whether the registrant 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).
Yes [ ] No [X]
Indicate by check mark whether the registrant has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
As of September 15, 1997, there were 109,737 shares outstanding of the
Registrant's Class A Common Stock ($0.01 par value), 1,756,126 shares
outstanding of the Registrant's Class B Non-Voting Common Stock ($0.01 par
value), 386,040 shares outstanding of the Registrant's Class C Common Stock
($0.01 par value), 808,333 shares outstanding of the Registrant's Class D
Common Stock ($0.01 par value), 118,100 shares outstanding of the Registrant's
Class F Common Stock and 60,100 shares outstanding of the Registrant's 14%
Cumulative Redeemable Preferred Stock ($0.01 par value).
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DECORATIVE HOME ACCENTS, INC.
QUARTER ENDED MARCH 31, 1997
INDEX
Page
No.
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of
March 31, 1997 and December 31, 1996................ 3
Condensed Consolidated Statements of Operations
for the three months ended March 31, 1997
and 1996............................................ 4
Condensed Consolidated Statement of Stockholders'
Equity (Deficiency) for the three months ended
March 31, 1997...................................... 5
Condensed Consolidated Statements of Cash Flows
for the three months ended March 31, 1997
and 1996............................................ 6
Notes to Condensed Consolidated Financial
Statements (Unaudited).............................. 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations....... 12
PART II - OTHER INFORMATION
Item 1. Legal Proceedings...................................... 16
Item 2. Changes in Securities.................................. 16
Item 3. Defaults Upon Senior Securities........................ 16
Item 4. Submission of Matters to a Vote of Security Holders.... 16
Item 5. Other information...................................... 16
Item 6. Exhibits and Reports on Form 8-K....................... 16
Signature Page.................................................. 17
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DECORATIVE HOME ACCENTS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
(UNAUDITED)
- --------------------------------------------------------------------------------
March 31, December 31,
1997 1996 (1)
----------- ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,453 $ 1,980
Accounts receivable - net of allowance for doubtful accounts of
$5,194 at March 31, 1997 and $7,014 at December 31, 1996 27,060 25,800
Income taxes receivable 164 498
Inventories (Note 3) 35,599 32,565
Other current assets 1,830 1,212
---------- ----------
Total current assets 66,106 62,055
PROPERTY, PLANT AND EQUIPMENT, NET (Note 3) 31,906 32,262
OTHER ASSETS 7,769 7,946
INTANGIBLE ASSETS, NET 13,404 13,783
---------- ----------
TOTAL ASSETS $ 119,185 $ 116,046
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
CURRENT LIABILITIES:
Current portion of long-term debt (Note 5) $ 117,930 124,830
Accounts payable 13,739 17,231
Accrued liabilities 5,638 6,176
Accrued interest 4,062 --
---------- ----------
Total current liabilities 141,369 148,237
LONG-TERM DEBT (Note 5) 43,317 34,100
REDEEMABLE PREFERRED STOCK 51,453 49,351
REDEEMABLE COMMON STOCK 2,749 2,476
STOCKHOLDERS' EQUITY (DEFICIENCY):
Common stock 9 9
Additional paid-in capital 4,311 6,685
Reduction of certain equity interest to predecessor basis (6,209) (6,209)
Accumulated deficit (117,814) (118,603)
---------- ----------
Total stockholders' equity (deficiency) (119,703) (118,118)
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY) $ 119,185 $ 116,046
========== ==========
(1) Derived from December 31, 1996 audited consolidated financial statements.
See notes to condensed consolidated financial statements (unaudited).
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DECORATIVE HOME ACCENTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS)
(UNAUDITED)
- --------------------------------------------------------------------------------
Three Months Ended March 31,
------------------------------------
1997 1996
--------------- ------------
SALES (Note 8) $ 35,897 38,783
COST OF GOODS SOLD 27,826 28,836
-------------- -------------
GROSS PROFIT 8,071 9,947
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 9,390 11,736
-------------- -------------
LOSS FROM OPERATIONS (1,319) (1,789)
OTHER INCOME (Note 6) 3,748 --
INTEREST EXPENSE, NET (5,196) (4,605)
-------------- -------------
LOSS BEFORE PROVISION FOR INCOME TAXES
AND EXTRAORDINARY ITEM (2,767) (6,394)
INCOME TAX BENEFIT -- 2,106
-------------- -------------
NET INCOME (LOSS) BEFORE EXTRAORDINARY ITEM (2,767) (4,288)
EXTRAORDINARY GAIN FROM FORGIVENESS OF DEBT,
NET OF TAXES 3,556 --
-------------- -------------
NET INCOME (LOSS) $ 789 $ (4,288)
=============== =============
See notes to condensed consolidated financial statements (unaudited).
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DECORATIVE HOME ACCENTS, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIENCY) (IN THOUSANDS)
FOR THE THREE MONTHS ENDED MARCH 31, 1997
(UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------------------------
Reduction of
Certain Equity
Interest to Total
Common Additional Predecessor Accumulated Stockholder's
Stocks Paid-in Capital Basis Deficiency Equity (Deficiency)
------- ---------------- -------------- ------------ ------------------
Balances at December 31, 1996 $ 9 $ 6,685 $ (6,209) $ (118,603) $ (118,118)
Accretion of redeemable common stock for the
three months ended March 31, 1997 (273) (273)
Accretion of redeemable preferred stock for the
three months ended March 31, 1997 (227) (227)
Preferred stock dividends paid in-kind for the
three months ended March 31, 1997 (1,874) (1,874)
Net income for the three months ended
March 31, 1997 789 789
------ ----------- ----------- ----------- -------------
Balances at March 31, 1997 $ 9 $ 4,311 $ (6,209) $ (117,814) $ (119,703)
====== =========== =========== =========== =============
See notes to condensed consolidated financial statements (unaudited).
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DECORATIVE HOME ACCENTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
(UNAUDITED)
- --------------------------------------------------------------------------------
Three Months Ended March 31,
1997 1996
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 789 $ (4,288)
Adjustment to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 1,470 2,328
Deferred tax (benefit) provision -- (2,143)
Retirement of related party debt (Note 6) (6,900) --
Changes in operating assets and liabilities:
Accounts receivable (1,260) (2,273)
Inventories (3,034) (3,992)
Income tax receivable 334 (774)
Other current assets (618) (479)
Accounts payable (3,492) (766)
Accrued liabilities (538) (1,009)
Accrued interest 4,062 (3,516)
-------------- ------------
Net cash used in operating activities (9,187) (16,912)
-------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (734) (857)
Other long-term assets 177 (524)
-------------- ------------
Net cash used in investing activities (557) (1,381)
-------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings under revolving line of credit 9,217 19,874
Redeemable preferred stock dividends paid -- (1,750)
-------------- ------------
Net cash provided by financing activities 9,217 18,124
-------------- ------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENT (527) (169)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,980 169
-------------- ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,453 $ --
============== ============
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $ 1,134 9,875
Non-cash activities:
Forgiveness of debt (Note 6) $ 6,900 --
See notes to condensed consolidated financial statements (unaudited).
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DECORATIVE HOME ACCENTS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 1997 AND 1996
- -------------------------------------------------------------------------------
1. BASIS OF INTERIM PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting
principles for interim financial information and the instructions of
Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for
complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered
necessary to present fairly the Company's financial position as of March
31, 1997 and the results of its operations and its cash flows for the
three months ended March 31, 1997 have been included. Operating results
for the three months ended March 31, 1997 are not necessarily indicative
of the results that may be expected for the year ending December 31,
1997. Certain information and note disclosures normally included in
annual financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to
the Securities and Exchange Commission's rules and regulations. The
condensed financial statements should be read in conjunction with the
Company's audited financial statements and notes thereto for the year
ended December 31, 1996.
For interim reporting, the Company's subsidiary, Home Innovations. Inc.
("HII") uses an estimated gross profit based on information provided by
its accounting and financial systems. At year-end, inventories of the
Company are stated at the lower of cost, determined using the first-in,
first-out ("FIFO") method, or market.
As discussed in Note 7, on September 29, 1997, the Company filed a
pre-negotiated filing under the provisions of Chapter 11 of the United
States Bankruptcy code in order to effect a financial reorganization of
the Company. The plan of reorganization makes provision for the payment
of all pre-petition trade debt following the confirmation of the plan.
The financial statements of the Company are prepared on a going concern
basis which contemplates continuity of operations, realization of assets
and satisfaction of liabilities in the ordinary course of business.
In accordance with Statement of Position 90-7, "Financial Reporting by
Entities in Reorganization Under the Bankruptcy Code" issued by the
American Institute of Certified Public Accountants ("SOP 90-7"),
subsequent to the September 29, 1997 Chapter 11 filing and until the
confirmation date, all pre-petition liabilities that are subject to
compromise under the plan of reorganization (the $118.1 million principal
amount of 13% Senior Notes plus all accrued and unpaid interest on the
Senior Notes and the 14% Redeemable Preferred Stock) will be classified
on the condensed balance sheets as liabilities subject to compromise.
As of the effective date of the plan of reorganization, the Company will
adopt "fresh start" reporting as defined in SOP 90-7. In accordance with
"fresh start" reporting, the reorganization value of the Company will be
allocated to the emerging entity's specific tangible and identifiable
intangible assets. Any excess reorganization value will be reported as
"reorganization value in excess of amounts allocable to identifiable
assets." As a result of the adoption of such "fresh start" reporting,
the Company's post-emergence financial statements ("successor") will not
be comparable with its pre emergence financial statements ("predecessor")
including the historical financial statements included in this quarterly
report.
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2. ORGANIZATION
The accompanying interim consolidated financial statements as of March
31, 1997, include the accounts of Decorative Home Accents, Inc. ("DHA" or
the "Company") and its wholly-owned subsidiaries, The Rug Barn, Inc.
("Rug Barn") and Home Innovations, Inc.
All significant intercompany transactions and accounts have been
eliminated.
3. BALANCE SHEET COMPONENTS
Inventories are summarized as follows (in $000's):
MARCH 31, DECEMBER 31,
1997 1996
---------- -----------
Raw materials $ 14,068 $ 13,964
work-in-process 3,002 2,654
Finished goods 18,529 15,947
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$ 35,599 $ 32,565
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Property, plant and equipment is summarized as follows (in $000's):
MARCH 31, DECEMBER 31,
1997 1996
---------- -----------
Land $ 862 $ 862
Buildings and improvements 16,971 16,782
Furniture and fixtures 5,308 5,296
Machinery and equipment 15,687 15,536
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38,828 38,476
Accumulated depreciation (8,771) (7,594)
---------- -----------
30,057 30,882
Construction in progress 1,849 1,380
---------- -----------
$ 31,906 $ 32,262
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4. INCOME TAXES
The Company's income tax benefit for the three months ended March 31,
1997 was calculated at an effective rate of 38% before being offset by an
increase in the tax valuation allowance. Management of the Company
cannot be assured that the net deferred income tax asset will be
realized, therefore the deferred tax asset has been fully reserved.
5. LONG-TERM DEBT
On November 12, 1996, the Company and certain subsidiaries entered into a
Loan and Security Agreement (the "Agreement") with a revolving credit
facility to provide for revolving loans ("Loans") and letters of credit
("Letters of Credit") in an aggregate principal amount of up to $50
million, subject to borrowing limitations, for a three year period. The
Agreement may be renewed from year to year thereafter at the mutual
agreement of the parties. The initial borrowing of $35.4 million on
November 12, 1996 was utilized to repay amounts owed the prior lender
under the Company's former Revolving
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Credit Facility. Borrowings under the $50 million Revolving Credit
Facility bear interest, at the Company's discretion, at a rate of 5/8%
percent per annum in excess of the Prime Rate or 3-1/4% percent per annum
in excess of the Eurodollar Rate. The borrowings are secured by a first
priority lien on the accounts receivable and inventories of the Company's
subsidiaries. The Company is required to maintain a minimum adjusted
tangible net worth, as defined, and the payment of cash dividends on the
Company's common stock is prohibited in accordance with the Agreement.
Further, there are limitations on the ability of the Company to incur
additional indebtedness and make loans, advances and investments.
On March 1, 1997, the Agreement was amended to provide for a line of
credit ("Supplemental Facility") pursuant to which the lender made
supplemental loans ("Supplemental Loans") of $5 million. At March 31,
1997, the Company's outstanding borrowings under the Revolving Credit
Facility and the Supplemental Facility totaled approximately $38.2
million.
The Supplemental Loans under the Supplemental Facility were repaid on May
27, 1997. Additionally, on May 23, 1997, the Agreement was amended for,
among other things, changes in certain covenants including the tangible
net worth calculation. There were no Events of Default (as defined)
under the Agreement, as amended, at March 31, 1997. In connection with
the pre-negotiated Chapter 11 filing by the Company and its subsidiaries,
the Agreement was amended. See Note 7 - Subsequent Events.
The Company's did not make the scheduled interest payment of
approximately $7.7 million on its Senior Notes due on June 30, 1997. As
a result the Company has reclassified $118.1 million of long-term debt as
a current liability. See Note 7 regarding the Company's planned
financial reorganization.
On March 11, 1997, $6.9 million of the Company's Senior Notes were
retired. See Note 6 - Related Party Transaction.
6. RELATED PARTY TRANSACTION
During 1996, two of the Company's officers who were members of the Board
of Directors resigned. Subsequent to their resignation, certain
allegations concerning wrongful acts were made by the Company and certain
stockholders. On March 11, 1997, in consideration of the release and
discharge from all claims, damages, and all causes of action, the two
former officers and members of the Board of Directors returned to the
Company 965,101 shares of the Company's Class A Common Stock, 6,900
shares of the Company's Class F Common Stock, $6.9 million of the
Company's Senior Notes and $448,000 in cash. The Company recorded
approximately $3.7 million as other income and approximately $3.6 million
as an extraordinary gain in the first quarter of 1997, as a result of
this settlement and forgiveness of debt.
7. SUBSEQUENT EVENTS
On May 15, 1997, the Company reached an agreement in principle with
certain of the Company's bond holders and equity holders providing for a
comprehensive capital restructuring plan. The restructuring agreement
was entered into by the Company's preferred stockholder, TCW Special
Credits Fund V - The Principal Fund ("Fund V") and the beneficial owners
of approximately 76% of the principal amount of the Senior Notes, Magten
Asset Management Corp., solely as agent for various of its investment
advisor clients in their respective accounts at Magten ("Magten"), and
CIGNA. The restructuring plan will, among other things, (i) convert the
$118.1 million principal amount still outstanding on the 13% Senior Notes
plus all accrued and unpaid interest on the Senior Notes into 92.5% of
the Company's common equity, (ii) exchange all the Company's 14%
redeemable preferred stock into 7.5% of the common equity along with a
5-year warrant to purchase up to 7.5% of the fully diluted common equity
and, (iii) exchange all of the classes of common stock into a 5-year
warrant to purchase up to 2.5% of the fully diluted equity. In
connection with the Company's capital restructuring plan, the Company did
not pay interest on the Senior Notes due on June 30, 1997.
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Pursuant to the restructuring plan, Magten provided the Company with a
secured term loan facility of up to $20 million (the "Secured Term Loan
Facility") ($15 million was advanced to the Company on May 23, 1997 and
an additional $5 million was advanced to the Company on July 9, 1997).
Magten also earned a $5 million closing fee which will be waived under
certain conditions set forth in the credit agreement with respect to the
Secured Term Loan Facility. Additionally, the indenture that governs the
Senior Notes was modified to permit the Company to incur the Secured Term
Loan Facility. It is contemplated that the Secured Term Loan Facility
will be repaid with the proceeds of a rights offering to purchase
additional shares of the Company's common stock upon a consummation of
the restructuring. Pursuant to certain agreements, dated September 26,
1997 (the "Exercise Agreements"), Magten and Fund V each agreed to
exercise all rights and/or oversubscription options issued to them in the
rights offering so that the Company will receive sufficient proceeds from
the rights offering to enable it to pay in full in cash all of the
indebtedness under the Secured Term Loan Facility. A portion of the
proceeds from the Secured Term Loan Facility was used to retire the
Supplemental Facility described in Note 5. In connection with the
Secured Term Loan Facility provided by Magten, the Company's existing
working capital lender and Magten entered into an inter-creditor
agreement. The proposed restructuring plan and the Exercise Agreements
are subject to various conditions.
On September 29, 1997, a pre-negotiated filing under the provisions of
Chapter 11 of the United States Bankruptcy Code was made by the Company
and its subsidiaries in order to effect the restructuring plan.
Concurrent therewith, the Company filed its plan of reorganization with
the United States Bankruptcy Court for the Southern District of New York
(the "Bankruptcy Court") that reflects the proposed restructuring plan
described above. The plan of reorganization provides for the payment in
full of all unpaid pre-petition trade debt following the consummation of
the plan. The Company is prohibited from making payment on any
pre-petition obligations during the course of the Chapter 11 filing. In
the event that a restructuring is not consummated, management of the
Company believes that the Company's inability to pay all of the current
obligations and service its debt as required raises substantial doubt
about the Company's ability to continue as a going concern.
In connection with the pre-negotiated Chapter 11 filing, the Company
(with the approval of the Bankruptcy Court) has entered into a
debtor-in-possession post-petition term loan agreement ("Term Loan") with
Magten. The Term Loan provided $3.75 million of borrowings and is
secured by all of the assets of the Company and its subsidiaries and the
common stock of the Company's subsidiaries. Any amounts outstanding under
the Term Loan agreement as of the effective date of the restructuring
will be repaid with the proceeds from a new secured term loan of up to
$7.5 million to be funded by Magten. Funding of this $7.5 million term
loan is subject to various conditions.
Subsequent to the Chapter 11 bankruptcy filing, the Company (with the
approval of the Bankruptcy Court) entered into a debtor-in-possession
financing agreement with Congress Financial Corporation which has amended
the pre-petition Agreement. The form of this financing substantially
conforms with the Company's previous Agreement with Congress.
In connection with the restructuring, the Company entered into employment
retention agreements with certain key management personnel. The
agreements provide for, among other things, a guaranteed bonus payment in
March 1998 if the individual is employed by the Company on that date.
The maximum obligation to the Company for payments under these agreements
is $1.1 million. During the three months ended March 31, 1997 a charge
of $256,000 was recorded for these retention agreements. On February 28,
1997, the Company also entered into amended and restated employment and
non-competition agreements with certain officers. Each of such
agreements provides that if the applicable officer's employment is
terminated within 90 days following a change of control of the Company,
by (i) the Company without good cause, (ii) a successor to the Company
without good cause or (iii) the officer, then the Company shall pay the
officer an amount in cash, which amount for all such officers aggregates
approximately $2.5 million.
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In connection with the restructuring plan discussed elsewhere herein, the
original license with Calvin Klein, Inc. was terminated on April 26, 1997
and on April 27, 1997, Calvin Klein and DHA Home, Inc. entered into
interim license agreement (the "Interim License Agreement") with similar
terms and conditions. As part of the Interim License Agreement, the
Company changed the name of Calvin Klein Home, Inc. to DHA Home, Inc.
The Interim License Agreement expires upon the earlier of April 30, 1998,
or the completion of the restructuring plan. Upon the consummation of
the restructuring, the Company believes that Calvin Klein has committed
to enter into a new multiple year license agreement on similar terms and
conditions that would extend through the year 2004. DHA Home also
believes that it has a good relationship with Calvin Klein and continues
to work with Calvin Klein on long-range plans for Calvin Klein license
products. Notwithstanding DHA Home's belief, Calvin Kelin has asserted
that (i) no assurances can be given that any such license will be entered
into and (ii) Calvin Klein has not committed to enter into any such
long-term license. At March 31, 1997, the carrying amount of the Calvin
Klein license agreement is $8,087,000, which is calculated based on the
original contract period ending in 2004. If the above described
restructuring is not completed, Calvin Klein, Inc. may not renew its
license agreement with the Company. Failure to renew the license
agreement on a long-term basis would result in a charge to earnings for
the unamortized balance of the license agreement and may otherwise have a
material adverse effect on the Company's future results of operations.
8. THE RUG BARN, INC. SALES DECLINE
Through September 1997, the Company has experienced a significant decline
in sales at The Rug Barn, Inc. Demand for the Rug Barn's core product of
two and three-layer cotton throws has continued to decline in the
giftware distribution channel served by the Rug Barn. Through September
1997, order bookings have declined approximately 50% compared to the same
period in 1996. Management of the Company is addressing the sales
decline through reductions in fixed overhead costs and planned expanded
product offerings. The fixed overhead reductions are expected to be
completed by December 31, 1997. The new product offerings will include
both internally manufactured and outsourced products targeted at the
giftware distribution channel Management does not expect that the new
product offerings will favorably impact 1997 operating results and
expects that the operations at the Rug Barn will incur an operating loss
through December 31, 1997.
9. LEGAL PROCEEDINGS
On July 29, 1997, a fixture supplier of the Company filed suit seeking
$1.9 million in damages, against the Company claiming that the Company
failed to fulfill its obligations under a supply arrangement. Management
of the Company intends to vigorously defend against the suit. Further,
management expects to contest the claim during the course of its Chapter
11 case. Management does not expect that the ultimate settlement of the
claim will have a material adverse impact on the Company.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
INTRODUCTION
The following discussion provides management's assessment of the results
of operations and liquidity and capital resources of DHA. This
discussion should be read in conjunction with the respective unaudited
condensed consolidated financial statements of DHA and the notes thereto
included elsewhere in this Form 10-Q and the audited consolidated
financial statement of DHA and the notes thereto for the year ended
December 31, 1996 reported on Form 10-K with the Securities and Exchange
Commission.
RESULTS OF OPERATIONS
Comparison of Three Months Ended March 31, 1997 with Three Months Ended
March 31, 1996
NET SALES
Net sales for the three months ended March 31, 1997 decreased by
approximately $2.9 million, or 7.4%, to $35.9 million from $38.8 million
for the three months ended March 31, 1996. The Company experienced
significantly weakened sales during the first quarter of 1997 in its gift
division (The Rug Barn, Inc.). Sales from the gift division decreased
approximately $2.8 million, or 34%, during the first quarter of 1997
compared to the gift division sales during the first quarter of 1996. As
discussed in Note 8 to the Condensed Consolidated Financial Statements,
order bookings for the gift division through September 1997 have declined
approximately 50% from the comparable 1996 period. Accordingly, the
Company expects to experience continued weakening in sales from the gift
division during 1997. In addition, the gift division was negatively
impacted by delivery problems for product offerings sourced from other
manufacturers. The liquidity shortages faced by the Company in the three
months ended March 31, 1997 and to date have also significantly impacted
the Company's ability to service its customer base. Given the limited
resources, the Company attempted to service its most significant
customers. Sales from the Company's bath division decreased as a result
of the Company's inability to procure piece goods as a result of
liquidity issues and industry-wide towel blank availability limitations.
These declines were partially offset by increased sales from the
Company's Calvin Klein Home Collection product line.
GROSS PROFIT
Gross profit decreased approximately $1.9 million, or 18.9%, to $8.1
million for the three months ended March 31, 1997 from $9.9 million for
the three months ended March 31, 1996. Gross profit margin decreased to
22.5% for the three months ended March 31, 1997 from 25.6% for the three
months ended March 31, 1996. This decrease primarily resulted from
decreased sales in the Company's gift division which accounted for
approximately $1.5 million of the decrease in gross profit. Historically,
gross profit margins achieved on products in the gift division have been
higher than those earned on the Company's other product lines. The
Company also experienced efficiency losses in its cut-and-sew plants as a
result of liquidity constraints negatively impacting raw material
purchases.
SELLING, GENERAL & ADMINISTRATIVE EXPENSES
Selling, general and administrative ("SG&A") expenses decreased
approximately $2.3 million, or 20%, to $9.4 million for the three months
ended March 31, 1997 from $11.7 million for the three months ended March
31, 1996. SG&A expenses decreased as a percentage of sales to 26.2% for
the three months ended March 31, 1997 from 30.3% million for the three
months ended March 31, 1996. Favorably impacting the 1997 results was a
decrease of approximately $700,000 in salary and benefit costs as a
result of headcount reductions made throughout 1996. Additionally, the
1996 results included approximately $1.1 million of goodwill
amortization. As discussed below, the Company wrote-off its unamortized
goodwill at December 31, 1996 and accordingly, there was no goodwill
amortization in 1997.
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Prior to the fourth quarter of 1996, the Company evaluated the
recoverability of goodwill by determining whether the amortization of the
goodwill balance over its remaining amortization period could be
recovered through undiscounted future operating cash flows of the
acquired operations. In the fourth quarter of 1996, the Company changed
its method for evaluating the recoverabilty of goodwill to a method
whereby the carrying amount is compared to its estimated fair value, and
any excess carrying amount is determined to be impaired. Based on an
evaluation of the recoverability of goodwill at December 31, 1996, the
Company concluded that its unamortized balance of goodwill, $79.7
million, was impaired and recorded a pre-tax charge for such amount in
the 1996 consolidated statement of operations.
OTHER INCOME AND EXRAORDINARY ITEM
During 1996, two of the Company's officers who were members of the Board
of Directors resigned. Subsequent to their resignation, certain
allegations concerning wrongful acts were made by the Company and certain
stockholders. On March 11, 1997, in consideration of the release and
discharge from all claims, damages, and all causes of action, the two
former officers and members of the Board of Directors returned to the
Company 965,101 shares of the Company's Class A Common Stock, 6,900
shares of the Company's Class F Common Stock, $6.9 million of the
Company's Senior Notes and $448,000 in cash. The Company recorded
approximately $3.7 million as other income and approximately $3.6 million
as an extraordinary gain in the first quarter of 1997, as a result of
this settlement and forgiveness of debt.
INTEREST EXPENSE, NET
Interest expense increased approximately $591,000, or 12.8%, to $5.2
million for the three months ended March 31, 1997 compared to $4.6
million for the same period in 1996. During the first quarter of 1997
the Company incurred additional borrowings from its revolving credit
facility of approximately $9.2 million to support operating activities.
INCOME TAXES
The Company's income tax benefit for the three months ended March 31,
1997 was calculated at an effective rate of 38% before being offset by an
increase in the tax valuation allowance. Management of the Company
cannot be assured that the net deferred income tax asset will be
realized, therefore the deferred tax asset has been fully reserved.
SEASONALITY
The Company's business is seasonal in nature with its highest sales
levels historically occurring during the third and fourth fiscal
quarters, which includes the holiday selling season.
LIQUIDITY AND CAPITAL RESOURCES
During the first half of 1997, the Company experienced significant
liquidity constraints as a result of poor operating performance during
the fourth quarter of 1996 and a December 31, 1996 payment of the $8.125
million interest on the Company's Senior Notes. Additionally, the
Company experienced a significant reduction in vendor trade credit and
was forced to operate on a cash-in-advance or cash-on-delivery basis. As
a result, the Company was unable to service all of its customers. Also,
operating efficiencies of the Company's plants were negatively impacted
due to the restricted raw material purchasing ability. The comprehensive
restructuring plan discussed herein provided additional liquidity to the
Company through a $20 million secured term loan facility. Additionally,
the post-petition term loans from Magten and the DIP financing will
provide additional liquidity. Management believes that these sources of
liquidity combined with operating cash flow will be adequate to service
the working capital needs of the Company as well as
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fund operating losses at the Rug Barn which are expected to continue
through 1997. In the event that a restructuring is not consummated, the
ability of the Company to continue as a going concern is doubtful.
The Company's Revolving Credit Facility provides for a revolving loan
facility and letters of credit based on specified levels of underlying
collateral with a maximum principal amount equal to the lesser of (a) $50
million or (b) a specified borrowing base, which is based on eligible
receivables and inventory of the Company and its operating subsidiaries
("Borrowing Subsidiaries"). The Revolving Credit Facility (or a similar
credit facility) is essential for the Company's working capital needs.
The Company is required to maintain a minimum adjusted tangible net
worth, as defined, and the payment of cash dividends on the Company's
common stock is prohibited in accordance with the Revolving Credit
Facility. Further, there are limitations on the Company's ability to
incur additional indebtedness and make loans, advances and investments.
On May 23, 1997, the Revolving Credit Facility was amended for, among
other things, changes in certain covenants including the tangible net
worth calculation. There were no Events of Default (as defined) under
the Revolving Credit Facility, as amended, at March 31, 1997.
On March 31, 1997, the Company had approximately $1.5 million available
for borrowing under the Revolving Credit Facility borrowing base formula.
Borrowings under the Revolving Credit Facility are made on a daily basis
for requirements for that business day and repayments are made on a daily
basis by cash collections from trade accounts receivables.
Cash used in operating activities was approximately $9.2 million for the
three months ended March 31, 1997 compared to use of cash of $16.9
million for the three months ended March 31, 1996. The principal reason
for the change is due to the timing of the Company's $8.1 million
interest payment on its Senior Notes. The Company used approximately
$3.5 million in the three months ended March 31, 1997 to reduce trade
payables as a result of decreasing trade credit from the Company's
vendors. Accounts receivable and inventories increased approximately
$1.3 million and $3.0 million, respectively, in the three months ended
March 31, 1997.
Cash used in investing activities was approximately $557,000 for the
three months ended March 31, 1997 compared to $1.4 million used in the
three months ended March 31, 1996. The Company used approximately the
same amount of cash for property and equipment purchases in both periods.
Cash used for the purchase of long-term assets decreased by a net of
approximately $701,000 in the first quarter of 1997 compared to the first
quarter of 1996. This resulted from ongoing systems conversions programs
which were cut back in 1997 due to liquidity constraints.
Cash provided by financing activities was approximately $9.2 million for
the three months ended March 31, 1997 compared to $18.1 million for the
three months ended March 31, 1996. This change is primarily due to the
timing of the Company's interest payment on its Senior Notes.
See Note 7 to the Condensed Consolidated Financial Statements.
INFLATION
Although the operations of the Company are generally influenced by
economic conditions, the Company does not believe that inflation had a
material effect on the results of operations during the three months
ended March 31, 1997 and 1996. The Company has been historically able
to mitigate the impact of the increases in the spot market prices of
cotton through fixed price purchase contracts.
EFFECT OF COMPLIANCE WITH ENVIRONMENTAL PROTECTION PROVISIONS
Compliance with Federal, State and local provisions that have been
enacted or adopted regulating the discharge of materials in the
environment, or otherwise relating to protection of the environment, has
not had, and is not expected to have, a material adverse effect on the
capital expenditures, net income or competitive position of the Company.
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PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The statements contained in this Item 2 (Management's Discussion and
Analysis of Financial Condition and Results of Operations) that are not
historical facts are forward-looking statements subject to the safe
harbor created by the Private Securities Litigation Reform Act of 1995.
The Company cautions readers of this Quarterly Report on Form 10-Q that a
number of important factors could cause the Company's actual results in
1997 and beyond to differ materially from those expressed in any such
forward-looking statements. These factors include, without limitation,
the general economic and business conditions affecting the retail
industry, the Company's ability to complete its plan of reorganization,
competition from a variety of firms ranging from small manufacturers to
large textile mills, the seasonality of the Company's sales, the
volatility of the Company's raw material cost, the Company's dependence
on key personnel and the risk of loss of a material customer or a
significant license. These and other factors are more fully described in
the Company's previous filings with the Securities and Exchange
Commission including, without limitation, the Company's Prospectus dated
November 10, 1995.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On July 29, 1997, a fixture supplier of the Company filed suit seeking
$1.9 million against the Company claiming that the Company failed to
fulfill its obligations under a supply arrangement. Prayed damages are
approximately $1.9 million. Management of the Company intends on
vigorously defending the suit. Further, management expects to contest
the claim during the course of its Chapter 11 case. Management does not
expect that the ultimate settlement of the claim will have a material
adverse impact on the Company.
As contemplated by the Company's capital restructuring plan, the Company
filed a pre-negotiated filing under the provisions of Chapter 11 of the
United States Bankruptcy on September 29, 1997. See Note 7 to the
Condensed Consolidated Financial Statements contained in Part I of this
Form 10-Q.
The Company is involved in various routine legal proceedings incidental
to the conduct of its business. Management believes that none of these
legal proceedings, except for the pre-negotiated Chapter 11 filing, could
have a material adverse impact on the financial condition or results of
operations of the Company.
ITEM 2. CHANGES IN SECURITIES
NONE
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
(a) The Company did not make a scheduled interest payment of
approximately $7.7 million on its Series B 13% Senior Notes due on
June 30, 1997. The principal amount of the Senior Notes is $118.1
million. The terms of the indenture governing the Company's Senior
Notes provide that such a failure to pay interest when due results
in an event of default on such indebtedness and as a result, the
holders of these debt securities are entitled to accelerate the debt
represented thereby. In addition, under the indenture, as a
consequence of the Chapter 11 bankruptcy filing by the Company, the
indebtedness under the Senior Notes was automatically accelerated
and became immediately due and payable.
(b) On July 15, 1997 the Company did not make a scheduled
dividend payment in kind of approximately $1.9 million on its
Redeemable Preferred Stock ($0.01 par value).
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NONE
ITEM 5. OTHER INFORMATION
NONE
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
SEE EXHIBIT INDEX.
(B) REPORTS ON FORM 8-K
NONE
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Form 10-Q to be signed on its behalf by the
undersigned thereunto duly authorized.
Decorative Home Accents, Inc.
-------------------------------------
(Registrant)
Date: November 14, 1997 /s/ Jay N. Baker
-------------------------------------
Jay N. Baker*
Chief Financial Officer
*Duly authorized to sign on behalf of the Registrant.
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EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------- --------------------------------------------------------------
2.1 Plan of Reorganization
10.1 Credit Agreement between Decorative Home Accents, Inc. and the
Lenders, as defined therein.
27 Financial data schedule
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