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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: September 30, 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.
(DEBTOR-IN-POSSESSION)
(Exact name of registrant as specified in its charter)
Delaware 57-0998387
-------- ----------
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification Number)
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 [X] No [ ]
Indicate by check mark whether the registrant has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
As of October 30, 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.
(DEBTOR-IN-POSSESSION)
QUARTER ENDED SEPTEMBER 30, 1997
INDEX
Page
No.
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PART I- FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of September 30, 1997
and December 31, 1996.............................................. 4
Condensed Consolidated Statements of Operations for the three
months ended September 30, 1997 and 1996........................... 5
Condensed Consolidated Statements of Operations for the nine
months ended September 30, 1997 and 1996........................... 6
Condensed Consolidated Statement of Stockholders' Equity (Deficiency)
for the nine months ended September 30, 1997....................... 7
Condensed Consolidated Statements of Cash Flows for the nine months
ended September 30, 1997 and 1996.................................. 8
Notes to Condensed Consolidated Financial Statements (Unaudited)......... 9
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................................ 12
PART II - OTHER INFORMATION
Item 1. Legal Proceedings........................................................ 18
Item 2. Changes in Securities.................................................... 18
Item 3. Defaults Upon Senior Securities.......................................... 18
Item 4. Submission of Matters to a Vote of Security Holders...................... 18
Item 5. Other information........................................................ 18
Item 6. Exhibits and Reports on Form 8-K......................................... 18
Signature Page.................................................................... 19
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
DECORATIVE HOME ACCENTS, INC.
(DEBTOR-IN-POSSESSION)
CONDENSED CONSOLIDATED BALANCE SHEETS (In Thousands)
(Unaudited)
================================================================================
September 30, December 31,
1997 (1) 1996 (2)
-------------- ------------
ASSETS (Note 7)
CURRENT ASSETS:
Cash and cash equivalents $ 657 $ 1,980
Accounts receivable - net of
allowance for doubtful accounts
of $4,032 at September 30, 1997 and $7,014 at December 31, 1996 31,673 25,800
Income taxes receivable 183 498
Inventories (Note 3) 42,388 32,565
Other current assets 1,373 1,212
------------ ------------
Total current assets 76,274 62,055
PROPERTY, PLANT AND EQUIPMENT, NET (Note 3) 30,347 32,262
OTHER ASSETS 8,248 7,946
INTANGIBLE ASSETS, NET 12,649 13,783
------------ ------------
TOTAL ASSETS $ 127,518 $ 116,046
============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
LIABILITIES NOT SUBJECT TO COMPROMISE:
CURRENT LIABILITIES:
Current portion of long-term debt $ 20,554 124,830
Accounts payable (Note 7) 16,991 17,231
Accrued liabilities 6,182 6,176
Accrued interest 253 --
------------ ------------
Total current liabilities 43,980 148,237
LONG-TERM DEBT (Note 5) 37,437 34,100
------------ ------------
TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE 81,417 182,337
------------ ------------
LIABILITIES SUBJECT TO COMPROMISE (Note 7) 129,607 --
REDEEMABLE PREFERRED STOCK SUBJECT TO COMPROMISE (Note 7) 55,678 49,351
REDEEMABLE COMMON STOCK SUBJECT TO COMPROMISE (Note 7) 3,375 2,476
STOCKHOLDERS' EQUITY (DEFICIENCY):
Common stocks 9 9
Additional paid-in capital -- 6,685
Reduction of certain equity
interest to predecessor basis (6,209) (6,209)
Accumulated deficit (136,359) (118,603)
------------ ------------
Total stockholders' equity (deficiency) (142,559) (118,118)
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY) $ 127,518 $ 116,046
============ ===========
(1) Debtor-In-Possession.
(2) 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.
(DEBTOR-IN-POSSESSION)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In Thousands)
(Unaudited)
================================================================================
Three Months Ended September 30,
-----------------------------------
1997 (1) 1996
------------ ------------
SALES (Note 8) $ 40,768 47,441
COST OF GOODS SOLD 32,700 34,830
---------- -----------
GROSS PROFIT 8,068 12,611
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES 9,848 11,850
---------- -----------
INCOME (LOSS) FROM OPERATIONS (1,780) 761
INTEREST EXPENSE, NET (5,864) (4,962)
DEBT RESTRUCTURING FEES
AND EXPENSES (Note 7) (2,381) --
---------- -----------
LOSS BEFORE PROVISION
FOR INCOME TAXES (Note 4) (10,025) (4,201)
INCOME TAX PROVISION (Note 4) -- (2,720)
---------- -----------
NET LOSS $ (10,025) $ (6,921)
========== ===========
(1) Debtor-In-Possession.
See notes to condensed consolidated financial statements (unaudited).
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DECORATIVE HOME ACCENTS, INC.
(DEBTOR-IN-POSSESSION)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In Thousands)
(Unaudited)
================================================================================
Nine Months Ended September 30,
-------------------------------
1997 (1) 1996
------------- ------------
SALES (Note 8) $ 114,294 129,213
COST OF GOODS SOLD 89,750 95,440
----------- -----------
GROSS PROFIT 24,544 33,773
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES 28,793 35,948
----------- -----------
LOSS FROM OPERATIONS (4,249) (2,175)
OTHER INCOME (Note 6) 3,748 --
INTEREST EXPENSE, NET (16,285) (14,484)
DEBT RESTRUCTURING FEES
AND EXPENSES (Note 7) (3,985) --
----------- -----------
LOSS BEFORE BENEFIT FOR INCOME TAXES
AND EXTRAORDINARY ITEM (20,771) (16,659)
INCOME TAX BENEFIT (Note 4) -- 1,387
----------- -----------)
LOSS BEFORE EXTRAORDINARY ITEM (20,771) (15,272)
EXTRAORDINARY GAIN FROM FORGIVENESS OF DEBT,
NET OF TAXES (Note 6) 3,556 --
----------- -----------
NET LOSS $ (17,215) $ (15,272)
=========== ============
(1) Debtor-In Possession
See notes to condensed consolidated financial statements (unaudited)
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DECORATIVE HOME ACCENTS, INC.
(DEBTOR-IN-POSSESSION)
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIENCY)
(In Thousands)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 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
nine months ended September 30, 1997 (899) (899)
Accretion of redeemable preferred stock for the
nine months ended September 30, 1997 (701) (701)
Preferred stock dividends accrued in-kind
for the nine months ended September, 30, 1997 (5,085) (541) (5,626)
Net loss for the nine months ended
September 30, 1997 (17,215) (17,215)
----------- ------------ ------------- ----------- ---------------
Balances at September 30, 1997 (1) $ 9 $ - $ 6,209 $ (136,359) $ (142,559)
=========== ============ ============= ============ ===============
(1) Debtor-In-Possession.
See notes to condensed consolidated financial statements (unaudited).
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DECORATIVE HOME ACCENTS, INC.
(DEBTOR-IN-POSSESSION)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands)
(Unaudited)
================================================================================
Nine Months Ended September 30,
1997 (1) 1996
------------ -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (17,215) $ (15,272)
Adjustment to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 4,698 7,394
Deferred tax benefit -- (1,818)
Retirement of related party debt (Note 6) (3,344) --
Extraordinary gain from retirement of debt (Note 6) (3,556)
Changes in operating assets and liabilities:
Accounts receivable (5,873) (7,862)
Inventories (9,823) (1,435)
Income tax receivable 315 2,258
Other current assets (161) (2,220)
Accounts payable (240) 1,037
Accrued liabilities 6 (3,853)
Accrued interest 11,988 (3,464)
------------ -----------
Net cash used in operating activities (23,205) (25,235)
------------ -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (1,649) (4,073)
Other long-term assets (302) 564
------------ -----------
Net cash used in investing activities (1,951) (3,509)
------------ -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings under revolving line of
credit and other debt obligations 3,833 31,282
Net borrowings under bridge loan 20,000 --
Redeemable preferred stock dividends paid -- (1,750)
------------ -----------
Net cash provided by financing activities 23,833 29,532
------------ -----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,323) 788
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,980 169
------------ -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 657 $ 957
============ ===========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $ 4,297 1,405
Non-cash activities:
Forgiveness of debt (Note 6) $ 6,900 --
(1) Debtor-In-Possession.
See notes to condensed consolidated financial statements (unaudited).
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DECORATIVE HOME ACCENTS, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
SEPTEMBER 30, 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
September 30, 1997 and the results of its operations and its cash flows
for the nine months ended September 30, 1997 and 1996 have been included.
Operating results for the three and nine months ended September 30, 1997
are not necessarily indicative of the results that may be expected for
the year ending December 31, 1997. Certain information and footnote
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 for the
year ended December 31, 1996 and the notes thereto.
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
petition under Chapter 11 of the United States Bankruptcy Code.
Simultaneous with the filing, the Company filed a proposed plan of
reorganization (the "Proposed Plan") and a related disclosure statement.
The Proposed Plan makes provision for the conversion of all of the
Company's 13% Senior Notes (the "Senior Notes") and its 14% Redeemable
Preferred Stock (the "Preferred Stock") to common stock and the full
payment in cash of all pre-petition general unsecured claims. The
financial statements of the Company have been 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
the event that a restructuring and the related exit financing are not
consummated, the ability of the Company to continue as a going concern is
doubtful.
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 of a plan of reorganization, 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), the 14% Redeemable Preferred Stock
and the Redeemable Common Stock are classified on the condensed
consolidated balance sheet as subject to compromise. These liabilities
are recorded at the amounts expected to be allowed as claims in the
Chapter 11 case rather than as estimates of the amounts for which those
allowed claims may be settled as a result of the capital restructuring
plan described in Note 7.
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
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to identifiable assets." As a result of the adoption of "fresh start"
reporting, the Company's post-emergence ("successor") financial statements
will not be comparable with its pre-emergence ("predecessor") financial
statements including the historical financial statements included in this
quarterly report.
The accompanying statements of operations reflect certain restructuring
fees and expenses consisting of professional fees and expenses directly
related to the debt restructuring and reorganization. Interest expense on
the Senior Notes has been reported to September 29, 1997, the petition
date. Such interest expense was not reported subsequent to that date
because it will not be paid during the bankruptcy case and will not be an
allowed claim under the capital restructuring plan. The difference
between the reported interest expense and stated contractual interest
expense is insignificant for the one-day period until September 30, 1997.
2. ORGANIZATION
The accompanying interim consolidated financial statements as of
September 30, 1997, include the accounts of Decorative Home Accents, Inc.
("DHA" or the "Company") and its wholly-owned subsidiaries, The Rug Barn,
Inc. (the "Rug Barn") and Home Innovations, Inc. (and its wholly owned
subsidiaries).
All significant intercompany transactions and accounts have been
eliminated.
3. BALANCE SHEET COMPONENTS
Inventories are summarized as follows (in $000's):
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
Raw materials $ 19,025 $ 13,964
Work-in-process 3,411 2,654
Finished goods 19,952 15,947
------------- ------------
$ 42,388 $ 32,565
============= ============
Property, plant and equipment is summarized as follows (in $000's):
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
Land $ 862 $ 862
Buildings, and improvements 17,035 16,782
Furniture and fixtures 6,064 5,296
Machinery and equipment 16,169 15,536
------------- ------------
40,130 38,476
Accumulated depreciation (11,158) (7,594)
------------- ------------
28,972 30,882
Construction in progress 1,375 1,380
------------- ------------
$ 30,347 $ 32,262
============= ============
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4. INCOME TAXES
The Company's income tax benefit for the nine months ended September 30,
1997 was calculated at an effective rate of 38%. Such tax benefit has
been fully offset by an increase in the tax valuation allowance because
management of the Company cannot be assured that the net deferred income
tax asset will be realized.
4. LONG-TERM DEBT
On November 12, 1996, the Company and certain subsidiaries entered into a
Loan and Security Agreement (the "Agreement") providing 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 to the Company's prior lender. Borrowings under the
$50 million Revolving Credit Facility bear interest, at the Company's
discretion, at a rate of 5/8% per annum in excess of the Prime Rate or
3-1/4% 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. In accordance with the
Agreement, the Company is required to maintain a minimum adjusted
tangible net worth, as defined, the payment of cash dividends on the
Company's common stock is prohibited and 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 pursuant to which the lender made supplemental loans
("Supplemental Loans") of $5 million. The Supplemental Loans 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.
At September 30, 1997, the Company's aggregate outstanding borrowings
under the Revolving Credit totaled approximately $34.7 million. There
were no Events of Default (as defined) under the Agreement, as amended,
at September 30, 1997. In connection with the Chapter 11 filing by the
Company and its subsidiaries, the Agreement was amended to provide for
the availability of Loans and Letters of Credit to the Company as
debtor-in-possession under Chapter 11. See Note 7 - Capital
Restructuring Plan.
The Company did not make the scheduled interest payment of approximately
$7.7 million on its Senior Notes due on June 30, 1997. See Note 7 -
Capital Restructuring Plan.
In March 1997, $6.9 million of the Company's Senior Notes were returned
to the Company. See Note 6 - Related Party Transaction.
Pursuant to the restructuring discussed in Note 7 - Capital Restructuring
Plan, an institutional investor provided the Company with a secured term
loan facility of up to $20 million (the "Secured Term Loan Facility") of
which $15 million was advanced to the Company on May 23, 1997 and the
balance was advanced to the Company on July 9, 1997.
On October 3, 1997, an institutional investor provided the Company with a
$3.75 million term loan. See Note 7 - Capital Restructuring Plan.
6. RELATED PARTY TRANSACTION
During 1996, two of the Company's officers, who also were members of the
Board of Directors, resigned. Subsequent to their resignation, certain
allegations concerning wrongful acts were made by the
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Company and certain stockholders. On March 11, 1997, in consideration of
the release and discharge from all claims, damages, and causes of action,
the two former officers/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. During the first quarter of 1997, the Company recorded
approximately $3.7 million as other income and approximately $3.6 million
as an extraordinary gain as a result of this settlement and forgiveness
of debt.
7. CAPITAL RESTRUCTURING PLAN
On May 15, 1997, the Company reached an agreement in principle for a
comprehensive capital restructuring plan with 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 advisory clients in their respective accounts at
Magten ("Magten"), and CIGNA. The restructuring plan, if effective, will,
among other things, (i) convert the $118.1 million outstanding principal
amount of Senior Notes, plus all accrued and unpaid interest thereon, into
92.5% of the Company's common stock to be outstanding following the
restructuring (the "New Common Stock"), (ii) exchange all of the
Redeemable Preferred Stock for 7.5% of the New Common Stock along with a 5
year warrant to purchase up to 7.5% of the New Common Stock on a fully
diluted basis and, (iii) exchange all of the remaining classes of common
stock for a 5 year warrant to purchase up to 2.5% of the New Common Stock
on a fully diluted basis. In connection with the capital restructuring
plan, the Company did not pay interest on the Senior Notes due on June 30,
1997.
Pursuant to the capital restructuring plan, Magten provided the Company
with a secured term loan facility of up to $20 million (the "Secured Term
Loan Facility") of which $15 million was advanced to the Company on May
23, 1997 and the balance 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; the Company has not recorded a liability for
such closing fee. Additionally, the indenture that governs the Senior
Notes was modified to permit the Company to incur the Secured Term Loan
Facility. Pursuant to the Proposed Plan, the Secured Term Loan Facility
is to be repaid with the proceeds of a rights offering of Common Stock.
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 were 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 Plan and
the Exercise Agreements are subject to various conditions.
The Company and its subsidiaries, on September 29, 1997, filed voluntary
petitions under the provisions of Chapter 11 of the United States
Bankruptcy Code the Proposal in order to effect the Proposed Plan.
Concurrent therewith, the Company filed the Proposed Plan with the United
States Bankruptcy Court for the Southern District of New York (the
"Bankruptcy Court"). The Proposed Plan provides for the payment in full
of all pre-petition general unsecured claims following the confirmation
of the Proposed Plan. The Company is prohibited from making payment on
any pre-petition obligations during the course of the Chapter 11 cases.
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 Chapter 11 filing, the Company (with approval of
the Bankruptcy Court) has entered into a debtor-in-possession term loan
agreement ("Term Loan") with Magten. On October 3, 1997, the Term Loan
provided $3.75 million of borrowings. The Term Loan is secured by all of
the
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assets of the Company and its subsidiaries and the common stock of the
Company's subsidiaries. Magten also earned a $937,500 closing fee,
which will be waived under certain conditions set forth in the credit
agreement with respect to the Term Loan; the Company has not recorded a
liability for such closing fee. Pursuant to the Proposed Plan, any
amounts outstanding on the Term Loan as of the effective date of the
Proposed Plan are to 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. The Company has
commenced discussions with Magten regarding alternative methods of
funding this $7.5 million cash requirement.
Subsequent to the Chapter 11 filing, the Company (with approval of the
Bankruptcy Court) entered into a debtor-in-possession financing agreement
with Congress Financial Corporation, which amended the pre-petition
Agreement. The terms of this financing substantially conform to the
Company's previous agreement with Congress.
Accounts payable included pre-petition claims of approximately $17.0
million at September 29, 1997. In accordance with the Bankruptcy Code
these pre-petition claims may not be paid until emergence from Chapter
11. Liabilities subject to compromise include the Senior Notes of
approximately $118.1 million and all accrued but unpaid interest of
approximately $11.7 million.
In connection with the capital restructuring plan, 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 of the Company for payments under
these agreements is $1.1 million. During the nine months ended September
30, 1997 a charge of $768,000 was recorded in respect of 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 a specified amount in cash; the
aggregate amount of the payments for all such officers is approximately
$2.5 million.
In connection with the restructuring plan, the original license with
Calvin Klein, Inc. was terminated on April 26, 1997 and, on April 27,
1997, Calvin Klein, Inc. and DHA Home, Inc. entered into an 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. The Company believes that
Calvin Klein, Inc. has committed upon the consummation of the
restructuring to enter into a new multiple year license agreement on
similar terms and conditions that would extend through the year 2004.
DHA Home continues to work with Calvin Klein, Inc. on long-range plans
for Calvin Klein licensed products. Notwithstanding DHA Home's belief,
Calvin Klein, Inc. has asserted that no assurances can be given that any
such license will be entered into and Calvin Klein, Inc. has not
committed to enter into any such long-term license. At September 30,
1997, the carrying amount of the Calvin Klein license agreement is
approximately $7.5 million, which is calculated based on the original
contract period ending in 2004. If the above described capital
restructuring plan 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
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bookings have declined approximately 50% compared to the same period in
1996. Management of the Company has addressed 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
have a favorable impact on 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 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 resolution 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 statements 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 SEPTEMBER 30, 1997 WITH THREE MONTHS
ENDED SEPTEMBER 30, 1996
NET SALES
Net sales decreased by approximately $6.7 million, or 14.1%, to $40.8
million for the three months ended September 30, 1997 compared to $47.4
million for the three months ended September 30, 1996. The Company
experienced weakened sales during 1997 in its gift division, The Rug
Barn, Inc. Sales of the gift division decreased by $8.3 million, or
55.8%, for the three months ended September 30, 1997 compared to the
three months ended September 30, 1996. As discussed in Note 8 to the
Condensed Consolidated Financial Statements, order bookings for the gift
division for the nine months ended 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. This decrease was partially offset by an increase
in sales of the Calvin Klein Home Collection line.
GROSS PROFIT
Gross profit decreased by approximately $4.5 million, or 36.1%, to $8.1
million for the three months ended September 30, 1997 from $12.6 million
for the three months ended September 30, 1996. Gross profit as a
percentage of net sales decreased to 19.8% for the three months ended
September 30, 1997 from 26.6% for the three months ended September 30,
1996. The decline in the gift division sales accounted for approximately
$4.7 million of the decrease in gross profit. Additionally, gross profit
margin as a percentage of sales was negatively impacted by the reduction
in gift division sales. Historically, gross profit margins achieved on
products in the gift division have been higher than those earned on the
Company's other product lines.
SELLING, GENERAL & ADMINISTRATIVE EXPENSES
Selling, general and administrative ("SG&A") expenses decreased
approximately $2.0 million, or 16.9%, to $9.8 million for the three
months ended September 30, 1997 from $11.9 million for the three months
ended September 30, 1996. SG&A expenses decreased as a percentage of net
sales decreased to 24.2% for the three months ended September 30, 1997
from 25.0% for the three months ended September 30, 1996. The decrease in
SG&A expenses was primarily due to the gift division's lower sales volume
which resulted in decreases in variable expenses. Additionally, the 1996
results included approximately $1.1 million of goodwill amortization. As
noted below, the Company wrote-off its unamortized goodwill at December
31, 1996 and accordingly, there was no goodwill amortization in 1997.
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 recoverability 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.
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INTEREST EXPENSE, NET
Interest expense increased approximately $902,000, or 18.2%, to $5.9
million for the three months ended September 30, 1997, from $5.0 million
for the three months ended September 30, 1996. During the first nine
months of 1997 the Company's short-term and long-term borrowings
increased by approximately $16.9 million net of a $6.9 million reduction
for a related party transaction. See Note 6 - Related Party Transaction.
DEBT RESTRUCTURING FEES AND EXPENSES
The accompanying statements of operations reflect certain restructuring
fees and expenses consisting of professional fees and expenses directly
related to the debt restructuring and reorganization. For the three
months ended September 30, 1997 the Company incurred approximately $2.4
million in restructuring fees and expenses.
INCOME TAXES
The Company's income tax benefit for the three months ended September 30,
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.
COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 1997 WITH NINE MONTHS ENDED
SEPTEMBER 30, 1996
NET SALES
Net sales decreased approximately $14.9 million, or 11.6%, to $114.3
million for the three months ended September 30, 1997 compared to $129.2
million for the three months ended September 30, 1996. The sales decline
is attributable primarily to a $14.5 million decrease in the Company's
gift division sales for the nine months ended September 30, 1997 compared
to the nine months ended September 30, 1996. As discussed in Note 8 to
the Condensed Consolidated Financial Statements, order bookings through
September, 1997 for the gift division 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. Also, negatively impacting the sales for the 1997 period were
liquidity shortages faced by the Company. Given the limited resources,
the Company attempted to service only its most significant customers.
GROSS PROFIT
Gross profit decreased approximately $9.2 million, or 24.7%, to $24.5
million for the nine months ended September 30, 1997 compared to $33.8
million for the nine months ended September 30, 1996. Gross profit as a
percentage of sales decreased to 21.5% for the nine months ended
September 30, 1997 from 26.2% for the nine months ended September 30,
1996. The decline in the Company's gift division sales accounted for
approximately $8.1 million of the decrease in gross profit.
Additionally, gross profit margin as a percentage of sales was negatively
impacted by the reduced gift division sales. Historically, gross profit
margins achieved on products in the gift division have been higher than
those earned on the Company's other product lines.
SELLING, GENERAL & ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses decreased approximately $7.2
million, or 19.9%, to $28.8 million for the nine months ended September
30, 1997 from $35.9 million for the nine months ended September 30, 1996.
SG&A expenses decreased as a percentage of sales to 25.2% for the nine
months ended September 30, 1997 from 27.9% for the nine months ended
September 30, 1996. The decrease in SG&A expenses was partially due to
the decreased sales volume and the resulting reduction in variable
expenses. Commissions decreased $1.3 million for the nine months ended
September 30, 1997 compared to the same period in 1996. Also, salaries
and benefit expenses decreased approximately $600,000 for the nine months
ended September 30, 1997. Finally, the 1996 results included
approximately $3.2 million of goodwill amortization. As discussed above,
the Company wrote-off its unamortized goodwill at December 31, 1996 and
accordingly, there was no goodwill amortization in 1997.
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OTHER INCOME AND EXTRAORDINARY GAIN
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 (estimated fair market value of bonds) as
other income and approximately $3.6 million as an extraordinary item in
the first quarter of 1997, as a result of this settlement and
forgiveness of debt.
INTEREST EXPENSE, NET
Interest expense increased approximately $1.8 million, or 12.5%, to $16.3
million for the nine months ended September 30, 1997, from $14.5 million
for the nine months ended September 30, 1996. During the first nine
months of 1997 the Company's short-term and long-term borrowings
increased by approximately $16.9 million net of a $6.9 million reduction
for a related party transaction. See Note 6 - Related Party Transaction.
INCOME TAXES
The Company's income tax benefit for the nine months ended September 30,
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.
DEBT RESTRUCTURING FEES AND EXPENSES
The accompanying statements of operations reflect certain restructuring
fees and expenses consisting of professional fees and expense directly
related to the debt restructuring and reorganization. For the nine
months ended September 30, 1997 the Company incurred approximately $4.0
million in restructuring fees and expenses.
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 nine months of 1997, the Company experienced significant
liquidity constraints as a result of losses incurred during the first
nine months of 1997 and the fourth quarter of 1996 and the payment of the
$8.1 million, interest on the Company's 13% Senior Notes on December 31,
1996. During the first nine months of 1997, the Company experienced a
significant reduction in vendor trade credit and was forced to operate
largely 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 affected due to the
restricted raw material purchasing ability. In connection with the
capital restructuring plan discussed herein, the Company received a cash
infusion of $20 million pursuant to a secured term loan facility. Upon
filing Chapter 11, the Company obtained debtor-in-possession financing
from Congress Financial Corporation ("Congress") on terms substantially
conforming with the Company's pre-filing date revolving credit facility
("Revolving Credit Facility") with Congress, together with $3.75 million
of post-petition term loans from Magten to provide additional liquidity.
Upon successful completion of the restructuring, management believes that
a new revolving credit facility can be obtained which will be sufficient
to operate the Company's business. In the event that a restructuring and
the related exit financing are not consummated, the ability of the
Company to continue as a going concern is doubtful.
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The Revolving Credit Facility provides for revolving loans and letters
of credit up to 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.
In accordance with the Revolving Credit Facility, 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.
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 September 30, 1997.
On September 30, 1997, the Company had approximately $2.5 million
available for borrowing under the Revolving Credit Facility borrowing
base formula based on underlying collateral. Borrowings under the
Revolving Credit Facility are made on a daily basis to meet requirements
for that business day and repayments are made on a daily basis through
the application of cash collections from trade accounts receivable.
Cash used in operating activities totaled approximately $23.2 million for
the nine months ended September 30, 1997 compared to use of cash of $25.2
million for the nine months ended September 30, 1996. The Company's
inventory and accounts receivable increased approximately $9.8 million
and $5.9 million, respectively. The increased use of cash for inventory
was a result of (i) the Company's change in product mix which resulted in
longer lead times (resulting primarily from the increased sales in the
Calvin Klein Home Collection line), (ii) the loss of vendor trade credit
which has required the disbursement of cash earlier in the production
cycle and (iii) and a seasonal increase in the Company's bath division
inventory. Of the Company's $17.0 million net loss, approximately $4.0
was used to fund the debt restructuring fees and expenses. The reduction
in cash used for interest expense was due to the timing of the Company's
December 31, 1996 interest payment that was made in the first quarter of
1997. In addition, the Company did not make its scheduled interest
payment of approximately $7.9 million due on June 30, 1997 on its Senior
Notes.
Cash used in investing activities was approximately $2.0 million for the
nine months ended September 30, 1997 compared to $3.5 million used for
the nine months ended September 30, 1996. The Company used $1.6 million
for the nine months ended September 30, 1997 for purchases of property
and equipment compared to $4.1 million used for the first nine months of
1996. This reduction in capital expenditures is a result of the
Company's limited liquidity.
Cash provided by financing activities totaled approximately $23.8 million
for the nine months ended September 30, 1997 compared to $29.5 million
for the nine months ended September 30, 1996. This change is primarily
due to the operating losses for 1997 and increased working capital
requirements.
See Footnote 7 - Capital Restructuring Plan.
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 six months ended
September 30, 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
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had, and is not expected to have, a material adverse effect on the
capital expenditures, net income or competitive position of the Company.
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 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 against
the Company claiming that the Company failed to fulfill its obligations
under a supply arrangement. The alleged damages are approximately $1.9
million. Management of the Company intends to vigorously defend the
suit. Further, management expects to contest the claim during the course
of its Chapter 11 case. Management does not expect that the ultimate
resolution 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-voluntary petition under of Chapter 11 of the United States
Bankruptcy Code 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 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) On June 30, 1997 the Company failed to 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 Senior Notes were
automatically accelerated and became immediately due and payable.
(b) 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
Form 8-K filed on October 16, 1997 under Item 3 regarding the
Company's filing a pre-negotiated Chapter 11 under the United
States Bankruptcy Code.
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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: February 27, 1998 /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
- ------- -----------
10.1 Credit Agreement dated October 1, 1997 between Decorative Home
Accents, Inc. and the Lenders, defined therein.
27 Financial data schedule
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