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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
AMENDMENT NO. 1
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED JANUARY 2, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
COMMISSION FILE NUMBER 33-64140
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DAL-TILE INTERNATIONAL INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 13-3548809
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
7834 HAWN FREEWAY, DALLAS, TEXAS 75217
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(214) 398-1411
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- -------------------
COMMON STOCK, $.01 PAR VALUE NEW YORK STOCK EXCHANGE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. /X/
As of March 10, 1998, there were 53,435,101 shares of the Registrant's Common
Stock outstanding. The aggregate market value of Common Stock held by
nonaffiliates of the Registrant at March 10, 1998 was $71,917,207 (based on
the closing sale price of the Common Stock on March 10, 1998). This calculation
does not reflect a determination that persons are affiliates for any other
purposes.
DOCUMENTS INCORPORATED BY REFERENCE
DOCUMENT PART OF FORM 10-K
-------- INTO WHICH INCORPORATED
PROXY STATEMENT FOR 1998 ------------------------
ANNUAL MEETING OF STOCKHOLDERS PART III
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
On December 29, 1995, the Company completed its acquisition of American Olean
(the "AO Acquisition"). Following the acquisition, the Company was engaged in
the complex task of integrating the information systems of Dal-Tile and American
Olean. Delays in the systems integration affected many areas of the Company,
ultimately impacting customer service. The systems integration was
substantially completed during the fiscal year ended January 2, 1998. Due to
the unexpected timetable for conversion, the Company incurred additional costs
associated with the completion of this project, and the delays negatively
impacted revenues. During 1998, the Company will continue to establish and
enhance interfaces between individual accounting and reporting systems modules.
For the fiscal year ended January 2, 1998, the Company's earnings were
negatively impacted due to the previously discussed conversion of its management
systems, costs to consolidate eleven distribution centers to three
mega-distribution centers and overall restructuring and consolidation of
manufacturing and corporate functions. In an effort to manage inventories and
improve customer service, the Company incurred higher transportation costs
throughout the year related to movements of inventory between distribution
centers and sales centers. During the second half of the year, higher per unit
manufacturing costs were incurred as production levels were decreased in order
to reduce inventories to provide better alignment with sales.
During the second and third quarters of 1997, the Company recorded charges of
$24.7 million and $65.4 million, respectively. These charges were principally
for the write-down of obsolete and slow-moving inventories, uncollectible trade
accounts receivable, other non-productive assets and costs for restructuring of
manufacturing, store operations and corporate administrative functions. The
charges are comprised of $36.5 million in cost of sales, $3.5 million in
transportation expenses and $50.1 million in selling, general and administrative
expenses.
The write-down of uncollectible trade accounts receivable related to
increases in receivables balances arising principally as a result of earlier
sales initiatives that included, among other things, extended credit terms
and efforts to expand the Company's customer base, and operational and
systems integration issues that resulted in limited access by sales center
personnel to certain account information. In addition, in an effort to
improve customer service, authority to extend credit was decentralized and
assigned to management at the retail sales centers. Sales resulting from
these initiatives were a result of products being shipped under defined terms
to customers, with the full expectation of invoiced amounts being paid in
full within the terms of the sale. In response to deterioration in the aging
of the Company's accounts receivable, primarily as a result of the sales
initiatives and operational and systems integration issues, the Company
increased collection efforts and undertook detailed reviews of
collectibility, and subsequently recorded increases in the reserve for
doubtful accounts of $7.6 million in the second quarter of fiscal year 1997,
and $13.7 million as of the third quarter of fiscal year 1997. The sales
initiatives, which began in the fourth quarter of fiscal year 1996, were
discontinued by the end of the second quarter of fiscal year 1997. In
addition, by the end of the second quarter of fiscal year 1997, the Company
moved to a more centralized credit approval process and implemented more
stringent credit policies.
At the end of the second quarter of fiscal year 1997, the Company also
extensively reviewed its finished product inventories, including the various
patterns, shapes and sizes of finished product inventories. Based on this
analysis, an adjustment of approximately $8.4 million was recorded as of the
end of the second quarter of fiscal year 1997 to reflect the write-down of
inventory believed to be slow moving and/or obsolete, or out of balance with
other related products. Management believes that delays in systems
integration resulted in impaired inventory management, and, in particular,
resulted in an imbalance in inventory mix. During the third quarter of
fiscal year 1997, the Company's new management undertook an additional study
of the business and its operations and determined that it would reduce the
number of SKU's offered for sale by the Company and would discontinue
additional patterns. These actions, coupled with the results of physical
inventories and the delay in systems integration, resulted in a need to
record additional inventory provisions of $28.1 million consisting of
$14.2 million related to results of physical inventories, $7.3 million of
additional write-down for obsolete inventory, $4.5 million write-down for
certain other inventory accounts and $2.1 million write-down for raw materials.
Management believes that progress in its systems integration resulted in
substantially improved inventory management by the end of the third quarter
of fiscal year 1997.
The balance of the charges recorded in the second quarter of fiscal year 1997
consisted of $2.5 million in respect of terminated employees and $6.2 million
in respect of other charges, primarily related to liabilities incurred for
lease terminations, executive search fees, and other items. The balance of
the charges recorded in the third quarter of fiscal year 1997 consisted of
$4.2 million in respect of terminated employees, $8.5 million in respect of
accrued expenses, primarily related to freight and insurance, $5.3 million in
respect of fixed asset impairment and $5.6 million in respect of other
charges, primarily related to write-down of notes, non-trade receivables and
certain other assets.
The Company believes it has taken adequate charges for the expected costs
associated with its realignment efforts but can give no assurance that
additional charges will not be incurred.
The second half of 1997 was marked by significant challenges and a period of
transition as the Company focused on improving cash flows and overall customer
service. In addition, the Company has strengthened its management team and taken
steps to cut costs and streamline the organizational structure. The Company has
made progress toward its goals with substantial increases to cash flows as
accounts receivable collections increased and improved inventory management
procedures were implemented. Additionally, the quality of customer service has
been enhanced through substantial completion of the systems integration. Costs
savings have been realized through improved internal controls and organizational
changes.
-1-
The following is a discussion of the results of operations for the fiscal year
ended January 2, 1998 compared with the fiscal year ended January 3, 1997. Due
to the Company's 52/53 week accounting cycle, the year end for fiscal year 1997
was January 2, 1998 and for fiscal year 1996 was January 3, 1997.
Operating results for fiscal years 1997 and 1996 reflect the results of
operations of AO which was acquired on December 29, 1995. Because results for
the year ended December 31, 1995 do not reflect the AO Acquisition, results for
that period are not directly comparable.
RESULTS OF OPERATIONS
The following table sets forth certain operating data as a percentage of net
sales for the periods indicated:
YEAR ENDED
-----------------------------------------------------
JANUARY 2, 1998 JANUARY 3, 1997 DECEMBER 31, 1995
--------------- --------------- -----------------
Net sales . . . . . . . . . . . . . . . . . . 100.0% 100.0% 100.0%
Cost of goods sold. . . . . . . . . . . . . . 59.8 51.3 47.5
----- ----- -----
Gross profit. . . . . . . . . . . . . . . . . 40.2 48.7 52.5
Operating expenses. . . . . . . . . . . . . . 50.5 33.9 36.3
----- ----- -----
(10.3) 14.8 16.2
Non-recurring charges:
Provision for merger integration charges. . . - 1.2 4.7
----- ----- -----
Operating income (loss) . . . . . . . . . . . (10.3) 13.6 11.5
Interest expense (net). . . . . . . . . . . . 6.0 6.2 11.4
Other income. . . . . . . . . . . . . . . . . 0.2 - 0.6
----- ----- -----
Income (loss) before income taxes and
extraordinary item. . . . . . . . . . . . . (16.1) 7.4 0.7
Income tax provision. . . . . . . . . . . . . 0.2 2.6 0.2
----- ----- -----
Income (loss) before extraordinary item . . . (16.3) 4.8 0.5
Extraordinary item, net of taxes. . . . . . . - (4.1) -
----- ----- -----
Net income (loss) . . . . . . . . . . . . . . (16.3)% 0.7% 0.5%
----- ----- -----
----- ----- -----
-2-
YEAR ENDED JANUARY 2, 1998 COMPARED TO YEAR ENDED JANUARY 3, 1997
NET SALES
Net sales decreased $43.6 million, or 6.1%, to $676.6 million for fiscal year
1997 from $720.2 million for fiscal year 1996. The decrease in net sales was
due principally to the negative impact on the Company-operated sales centers
caused by the delay in systems integration and the consolidation throughout
1996 and into 1997 of redundant sales centers from the AO Acquisition. Sales
within the home center services channel decreased approximately 10% compared
to 1996 due to price concessions and certain large customers working down
their warehouse inventories. Additionally, net sales were negatively impacted
by one less week in fiscal year 1997 as compared to fiscal year 1996. These
decreases were offset by a 4% increase in same store sales in the
Company-operated sales centers and a 10% increase in sales within the
independent distributor channel due to the addition of 16 distributor
locations.
During the year, the Company completed its sales center consolidation and
substantially completed its information systems integration. The Company
believes that continued improvements in supply chain management will provide
improved product availibility and allow for sales growth opportunities.
GROSS PROFIT
Gross profit decreased $78.6 million, or 22.4%, to $271.9 million in fiscal
year 1997 from $350.5 million in fiscal year 1996. The decrease in gross
profit was due in part to the 1997 second and third quarter charges for
obsolete and slow moving inventories. Sales declines and decreases in
production levels also adversely impacted gross profit.
Gross margin (excluding the 1997 second and third quarter charges) decreased
to 45.6% for fiscal year 1997 from 48.7% for fiscal year 1996. During the
first half of 1997, gross margin (excluding charges) was 48.4% and decreased
to 42.7% in the second half of 1997 primarily as a result of higher per unit
manufacturing costs associated with reduced production levels. Additionally
during 1997, gross margin decreased as a result of a higher percentage mix of
sales within the independent distributor business unit. Sales through this
channel carry lower gross margins than sales made through the Company's sales
service centers, but due to lower operating expense levels comparable
operating margins are achieved.
EXPENSES
Expenses increased $88.9 million, or 35.2%, to $341.5 million in fiscal year
1997 from $252.6 million in fiscal year 1996. The increase was due primarily
to the second and third quarter charges, increased freight cost associated
with the consolidation of eleven distribution centers to three
mega-distribution centers, higher fixed costs for information technology and
additional expenses to complete the American Olean integration.
Expenses as a percent of sales (excluding 1997 second and third quarter
charges and the 1996 merger integration charge) increased to 42.6% in fiscal
year 1997 from 33.9% in fiscal year 1996. These increases were the result of
lower sales and the increased expenses described above.
During the fourth quarter of 1997, the Company issued stock units under a
stock appreciation rights agreement to certain executives which permit the
holders, upon the satisfaction of certain conditions, to receive value in
excess of the base price of the unit at the date of grant. Payment of the
excess will be in cash, stock, or a combination of cash and stock at the
discretion of the Board of Directors. In connection with this agreement,
non-cash expense of $5.9 million was recorded in the fourth quarter of 1997.
-3-
OPERATING INCOME (LOSS)
Operating income (loss) decreased $167.5 million to a loss of $69.6 million
in fiscal year 1997 from income of $97.9 million in fiscal year 1996.
Operating margin (excluding 1997 second and third quarter charges and the
1996 merger integration charge) decreased to 3.0% from 14.8% for the previous
fiscal period due primarily to reduced sales, decreased production levels and
increased expenses.
INTEREST EXPENSE (NET)
Interest expense (net) decreased $4.3 million, or 9.6%, to $40.4 million in
fiscal year 1997 from $44.7 million in fiscal year 1996. Interest expense
(net) decreased due to interest savings from the refinancing of debt
concurrent with the Company's initial public offering in the third quarter of
1996. The decrease was partially offset by increases in debt levels and
borrowing rates related to the second quarter amendment of the existing
credit agreement and increases in fees and higher borrowing rates related to
the third quarter 1997 amendment.
INCOME TAXES
The income tax provision for fiscal year 1997 represents amounts related to
income from Mexican operations. Due to the significant loss in fiscal year
1997 and prior year tax loss carryforwards, a valuation allowance has been
recorded against the net Federal and State deferred tax asset. This
valuation allowance will be reassessed in future reporting periods.
INCOME (LOSS) BEFORE EXTRAORDINARY ITEM
Income (loss) before extraordinary item decreased $144.6 million to a loss of
$110.2 million in fiscal year 1997 from income of $34.4 million in fiscal
year 1996. The decrease was due primarily to the second and third quarter
charges and reductions in operating income offset by lower interest and
income tax expense.
PESO-U.S. DOLLAR EXCHANGE RATE
The Company's Mexican facility is primarily a provider of ceramic tile to the
Company's U.S. operations and in addition sells ceramic tile in Mexico. In
fiscal year 1997, domestic sales in Mexico represented approximately 3% of
consolidated net sales. These sales are peso-denominated and the majority of
the Mexican facility's cost of sales and operating expenses are
peso-denominated. In fiscal year 1997, peso-denominated cost of sales and
operating expenses represented approximately 7% of the Company's consolidated
cost of sales and expenses. Exposure to exchange rate changes is favorable
to operating results when the peso devalues against the U.S. dollar, since
peso costs exceed peso revenues. As the peso appreciates against the U.S.
dollar, the effect is unfavorable to operating results. In addition to the
effect of exchange rate changes on operating results, foreign currency
transaction gains or losses are recognized in other income and expense.
During fiscal year 1997, the Company recorded a transaction gain of
approximately $0.6 million. Except for peso transactions, management
utilizes foreign currency forward contracts to offset exposure to exchange
rate changes, although the number and amount of such contracts are not
significant. Since the exposure to exchange rate change is favorable when
the peso devalues against the U.S. dollar and management does not expect the
peso to appreciate significantly against the U.S. dollar in the near term,
management has not entered into peso currency forward contracts during fiscal
years 1997 and 1996.
-4-
YEAR ENDED JANUARY 3, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1995
NET SALES
Net sales for fiscal year 1996 increased $245.4 million, or 51.7%, to $720.2
million from $474.8 million in 1995. The increase in net sales was due
principally to the inclusion of AO's operations in fiscal year 1996 and
increased shipments to independent distributors and home center retailers.
During fiscal year 1996, a primary focus of management was to gain
marketplace acceptance of the Company's three principal brand names, DALTILE,
AMERICAN OLEAN and HOME SOURCE. During the year, the Company concentrated on
integrating the 61 sales centers acquired as part of the AO Acquisition. A
total of 51 sales centers were consolidated into existing sales centers.
Domestic sales in Mexico decreased to $17.9 million in fiscal year 1996 from
$23.0 million in 1995. Sales decreased due to a larger allocation of Mexican
production to distribution in the United States.
GROSS PROFIT
Gross profit increased $101.1 million, or 40.5%, to $350.5 million in fiscal
year 1996 from $249.4 million in 1995. The increase in gross profit was
principally the result of the increase in net sales. Gross margin decreased
to 48.7% in fiscal year 1996 from 52.5% in 1995. The decrease in gross
margin was primarily due to production earlier in the year at higher cost
facilities acquired as part of the AO Acquisition. These facilities were
closed in March 1996 and production shifted to lower cost manufacturing
plants. This higher cost production negatively impacted gross margins as the
inventory was sold in the second quarter and to a lesser extent in the third
quarter. During the first half of fiscal year 1996, gross margins were 47.8%
and increased to 49.5% in the second half of fiscal year 1996 primarily as a
result of shifting production to lower cost manufacturing plants. Gross
margins also decreased in fiscal year 1996 as the Company significantly
increased its presence in the independent distributor channel, as a result of
the AO Acquisition, and increased sales to home centers. Sales through these
channels carry lower gross margins than sales made through sales service
centers, but due to lower operating expense levels comparable operating
margins are achieved.
EXPENSES
Expenses increased to $252.6 million in fiscal year 1996 from $194.9 million in
1995, primarily as a result of the inclusion of AO's operations. Expenses in
fiscal years 1996 and 1995 include, respectively, a $9.0 million and $22.4
million merger integration charge. Expenses, excluding merger integration
charges, as a percentage of sales, decreased to 33.9% in fiscal year 1996 from
36.3% in 1995. The decrease in expenses as a percentage of sales, excluding
merger integration charges, was due to consolidation savings achieved by
integrating sales forces, closing duplicative sales service centers and
consolidating administrative functions. These savings were offset in part by
increased transportation costs, increased advertising and sample costs to
increase brand name recognition and increased information systems costs
resulting from the system integration after the AO Acquisition. Additionally,
sales made to independent distributors and home center retailers require lower
operating expense levels which offset the lower gross margins generated through
this distribution channel.
MERGER INTEGRATION CHARGES
In the first quarter of fiscal year 1996, a pre-tax merger integration charge of
$9.0 million was recorded for the closings of duplicative sales centers,
duplicative distribution centers and certain manufacturing facilities, as well
as incurrence of severance costs associated with the elimination of overlapping
positions. The majority of the $9.0 million is a cash charge related to lease
commitments on closed facilities and severance costs.
-5-
The 1995 merger integration charge represents a $22.4 million pre-tax merger
integration charge in the fourth quarter of 1995 associated with the revaluation
of certain assets in connection with the AO Acquisition. The majority of the
$22.4 million was a non-cash charge to write-down less efficient and duplicative
equipment not needed in the combined Company.
OPERATING INCOME
Operating income increased to $97.9 million in fiscal year 1996 from $54.5
million in 1995. Operating income, excluding merger integration charges,
increased as a result of the AO Acquisition and related cost savings, but was
offset in part by lower gross margins. The operating margin, excluding
merger integration charges, decreased to 14.8% in fiscal year 1996 as
compared to 16.2% in 1995 due to the decrease in gross margins as a result of
the higher cost manufacturing facilities.
INTEREST EXPENSE (NET)
Interest expense (net) decreased $9.5 million to $44.7 million in fiscal year
1996 from $54.2 million in 1995. The decrease was due to reduced debt levels
as a result of the third quarter public offering and private placement whose
proceeds were used to reduce debt. Interest expense (net) also decreased as
a result of lower borrowing rates from the refinancing.
INCOME TAXES
The income tax provision reflects an effective tax rate of 35.5% for fiscal
years 1996 (prior to the extraordinary charge) and 1995.
EXTRAORDINARY ITEM
In connection with the refinancing and early extinguishment of debt, an
extraordinary charge of $44.8 million ($29.1 million, net of tax) was
recorded during the third quarter of 1996. This charge consists of
prepayment premiums on certain debt repaid, the write-off of existing
deferred financing fees and a termination fee paid in connection with the
termination of the Company's management agreement with AEA Investors.
PESO-U.S. DOLLAR EXCHANGE RATE
In fiscal year 1996, domestic sales in Mexico represented approximately 3% of
the Company's consolidated net sales. In fiscal year 1996, peso-denominated
cost of sales and operating expenses represented approximately 9% of the
Company's consolidated cost of sales and expenses. During fiscal year 1996,
the Company recorded a transaction loss of approximately $0.1 million.
LIQUIDITY AND CAPITAL RESOURCES
Funds available under the Company's bank credit agreement (the "Credit
Facility") provided liquidity and capital resources for working capital
requirements, capital expenditures, expansion and debt service. Cash used in
operating activities was $52.8 million in fiscal year 1997 and $18.7 million in
fiscal year 1996. For fiscal year 1997, cash was used primarily to fund
increases in inventory, trade accounts receivable and capital expenditures.
Trade accounts receivable, prior to charges, increased earlier in 1997 as a
result of extended terms granted to customers and limited access by sales center
personnel to certain account information. Trade accounts receivable decreased
during the second half of 1997 due to improved collection efforts and the
write-down of uncollectible accounts. The Company has implemented more
stringent collection policies and a combination of centralized and decentralized
collection responsibilities. Inventories increased earlier in 1997 due to
delays in systems integration which impaired the management of inventories.
Inventories
-6-
declined during the second half of 1997 due to temporary reductions in
production levels and the write-down of slow-moving or obsolete inventories.
The second half of 1997 showed marked improvements in inventory management
due to completion of the conversion to one fully integrated inventory system
and increased management focus.
During the second quarter of 1997, the Company completed a new $125 million
Term B loan facility ("Term B Loan") which made certain modifications to its
then existing Credit Facility (as amended, the "Amended Credit Facility").
The proceeds of the Term B Loan were used to repay $50 million of the Term A
loan and $72 million of the existing revolving Credit Facility. The Company
is required to make annual amortization payments in respect to the Term B
Loan starting in the first quarter of 1998 with final maturity on December
31, 2003. The Amended Credit Facility is collateralized by certain assets of
the Company.
During the third quarter of 1997, certain financial covenants were amended to
provide increased flexibility under the Amended Credit Facility (as amended,
the "Second Amended Credit Facility"). In connection with the Second Amended
Credit Facility, the borrowing rate was increased 50 basis points over the
previously existing rates (which now range from 2 to 2-1/2 over LIBOR). The
borrowing rate is based on a pricing grid which provides for reduced
borrowing rates as certain financial ratios improve. The Company is
required, among other things, to maintain certain financial covenants and has
restrictions on incurring additional debt and limitations on cash dividends.
The Company is required to make quarterly amortization payments on the
remaining portion of the $275 million Term A loan through December 31, 2002,
at various scheduled amounts. Borrowings under the $250 million revolving
Credit Facility are payable in full December 31, 2002.
The Company periodically uses interest rate swap agreements to manage
exposure to fluctuations in interest rates. These agreements involve the
exchange of interest obligations on fixed and floating interest rate debt
without the exchange of the underlying principal amounts. The differential
paid or received on the agreements is recognized as an adjustment to interest
expense over the term of the underlying swap agreement. The book value of
the interest rate swap agreements represents the differential receivable or
payable with a swap counterparty since the last settlement date. The
underlying notional amount on which the Company has interest rate swap
agreements outstanding was $300,000,000 at January 9, 1998. These agreements
are in effect for a term of two years at an interest rate of approximately
5.7%. There were no interest rate swap agreements at or during fiscal years
1997 or 1996.
Expenditures for property, plant and equipment were $40.1 million for fiscal
year 1997. The expenditures were used to fund expansion in floor tile
production, routine capital improvements and the integration of management
information systems. The Company's ability to improve and expand
manufacturing facilities in the future will be dependent on cash generated
from operations and borrowings under the revolving credit facility. During
fiscal year 1998, the Company plans to expend approximately $15-20 million to
complete its Dallas plant expansion and fund routine capital improvements.
Total availability as of January 2, 1998 on the revolving portion of the
Second Amended Credit Facility was $48.6 million. The Company believes cash
flow from operating activities, together with borrowings available under the
Second Amended Credit Facility, will be sufficient to fund future working
capital needs, capital expenditures and debt service requirements. Given its
capital needs and debt service and other obligations under its Credit
Facility, the Company expects to seek to refinance its debt in 1999, although
there can be no assurance that the Company will be able to do so. Cash
provided by financing activities was $90.5 million for fiscal year 1997,
which reflects borrowings under the revolving credit facility and the $125
million Term B debt facility.
The peso devaluation and economic uncertainties in Mexico are not expected to
have a significant impact on liquidity. Since the Company has no peso-based
borrowings, high interest rates in Mexico are not
-7-
expected to directly affect the Company.
The Company is involved in various proceedings relating to environmental
matters. The Company is currently engaged in environmental investigation and
remediation programs at certain sites. The Company has provided reserves for
remedial investigation and cleanup activities that the Company has determined
to be both probable and reasonably estimable. The Company is entitled to
indemnification with respect to certain expenditures incurred in connection
with such environmental matters and does not expect that the ultimate
liability with respect to such investigation and remediation activities will
have a material effect on the Company's liquidity and financial condition.
The United States is a party to the General Agreement on Tariffs and Trade
("GATT"). Under GATT, the United States currently imposes import duties on
ceramic tile from non-North American countries at 17% to be reduced ratably
to 10% by 2005. Accordingly, GATT may stimulate competition from non-North
American manufacturers who now export, or who may seek to export, ceramic tile
to the United States. The Company cannot predict with certainty the effect
that GATT may have on the Company's operations.
EFFECTS OF INFLATION
The Company believes it has generally been able to enhance productivity to
offset increases in costs resulting from inflation in the U.S. and Mexico.
Inflation has not had a material impact on the results of operations for
fiscal years 1997, 1996 and 1995. Approximately 84% of inventory is valued
using the LIFO inventory accounting method. Therefore, current costs are
reflected in cost of sales rather than in inventory balances. The impact of
inflation in Mexico has not had a significant impact on fiscal years 1997,
1996 and 1995 operating results; however, the future impact is uncertain at
this time.
IMPACT OF YEAR 2000
Some of the Company's computer programs were written using two digits rather
than four to define the applicable year. As a result, those computer
programs have time-sensitive software that recognize a date using "00" as the
year 1900 rather than the year 2000. This could cause a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or
engage in similar normal business activities.
The Company has completed an assessment and will have to modify or replace
portions of its software so that its computer systems will function properly
with respect to dates in the year 2000 and thereafter. The total Year 2000
project cost is estimated at approximately $7.0 million that will be expensed
as incurred. To date, the Company has incurred minimal expenses, primarily
for assessment of the Year 2000 issue and the development of a modification
plan.
The project is estimated to be completed no later than April 2, 1999, which
is prior to any anticipated impact on the Company's operating systems. The
Company believes that with modifications to existing software and conversions
to new software, the Year 2000 issue will not pose significant operational
problems for its computer systems. However, if such modifications and
conversions are not made, or are not completed timely, the Year 2000 issue
could have a material impact on operations.
The costs of the project and the date which the Company believes it will
complete the Year 2000 modifications are based on management's best
estimates, which were derived utilizing numerous assumptions of future
events, including the continued availability of certain resources and other
factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those anticipated.
Specific factors that might cause such material differences include, but are
not limited to, the availability and cost of personnel trained in this area,
the ability to locate and
-8-
correct all relevant computer codes, and similar uncertainties.
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
Certain statements contained in this filing are "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995.
Such statements are subject to risks, uncertainties and other factors which
could cause actual results to differ materially from future results expressed
or implied by such forward-looking statements. Potential risks and
uncertainties include, but are not limited to, the impact of competitive
pressures and changing economic conditions on the Company's business and its
dependence on residential and commercial construction activity, the fact that
the Company is highly leveraged, currency fluctuations and other factors
relating to the Company's foreign manufacturing operations, the impact of
pending reductions in tariffs and custom duties and environmental laws and
other regulations.
-9-
PART IV
ITEM 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES AND REPORTS
ON FORM 8-K
(a) DOCUMENTS TO BE FILED AS PART OF THIS REPORT:
1. Financial statements under Item 8:
See Index to Consolidated Financial Statements and Financial Statement
Schedule included on page F-1 below in this report.
2. Financial Statement Schedule filed herewith:
See Index to Consolidated Financial Statements and Financial Statement
Schedule included on page F-1 below in this report.
All other schedules are omitted either because they are not required or
because the required information is included in the financial statements and
notes thereto included herein. See Index to Consolidated Financial
Statements and Financial Statement Schedule included on page F-1 below in
this report.
3. List of Exhibits. Each management contract or compensatory plan
or arrangement required to be filed as an Exhibit to this Form
10-K pursuant to Item 14(c) of this report is identified with an
asterisk (*).
EXHIBIT
NO.
- -------
2.1 Stock Purchase Agreement, dated as of December 21, 1995, by and among
Dal-Tile International Inc., Armstrong Enterprises, Inc., Armstrong
Cork Finance Corporation and Armstrong World Industries, Inc. (Filed
as Exhibit 2 to the Registrant's Current Report on Form 8-K filed on
January 16, 1996 and incorporated herein by reference.)
2.2 Agreement and Plan of Merger among Dal-Tile International Inc., DTI
Investors LLC and DTI Merger Company, dated as of August 7, 1996
(Filed as Exhibit 2.1 to the Registrant's Form 10-Q filed on
November 7, 1996 and incorporated herein by reference.)
-10-
EXHIBIT
NO.
- -------
3.1 Second Amended and Restated Certificate of Incorporation of the
Company. (Filed as Exhibit 3.1 to the Registrant's Form 10-Q filed on
November 7, 1996 and incorporated herein by reference).
3.2 Amended and Restated By-laws of the Company. (Filed as Exhibit 3.2 to
the Registrant's Registration Statement on Form S-1 (No. 333-5069) and
incorporated herein by reference.)
4.1 Specimen form of certificate for Common Stock. (Filed as Exhibit 4.1
to the Registrant's Registration Statement on Form S-1 (No. 333-5069)
and incorporated herein by reference.)
10.1 Dal-Tile International Inc. 1996 Amended and Restated Stock Option
Plan. (Filed as Exhibit 10.1 to the Registrant's Registration
Statement on Form S-1 (No. 333-5069) and incorporated herein by
reference.)
*10.2 Consulting Agreement dated as of August 1, 1995, among Harold L. Turk,
Dal-Tile International Inc., Dal-Tile Corporation, DTM/CM Holdings
Inc., Dal-Minerals Company, Ceramica Regiomontana S.A. de C.V. and
Materiales Ceramicos, S.A. de C.V. (Filed as Exhibit 10.2 to the
Registrant's Registration Statement on Form S-1 (No. 333-5069) and
incorporated herein by reference.)
*10.3 Amended and Restated Employment Agreement, dated June 7, 1993, between
Dal-Tile Corporation and Harold G. Turk. (Filed as Exhibit 10.2.3 to
the Registrant's Registration Statement on Form S-1 (No. 33-64140) and
incorporated herein by reference.)
*10.4 Employment Agreement, dated February 5, 1990, between Dal-Tile
Corporation and Carlos E. Sala. (Filed as Exhibit 10.2.4 to the
Registrant's Registration Statement on Form S-1 (No. 33-64140) and
incorporated herein by reference.)
*10.5 Employment Agreement, dated April 15, 1994, between Dal-Tile
Corporation and Howard I. Bull. (Filed as Exhibit 10.2.5 to the
Registrant's Annual Report on Form 10-K for the year ended December
31, 1994 and incorporated herein by reference.)
10.6 Indenture dated as of August 11, 1993, between Dal-Tile International
Inc. and Citibank, N.A., as trustee relating to the Zero Coupon Notes.
(Filed as Exhibit 4.1 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1993 and incorporated herein by
reference.)
+10.7 First Supplemental Indenture dated as of August 1, 1996 between
Dal-Tile International Inc. and Citibank, N.A., as trustee, relating
to the Zero Coupon Notes.
10.8 Credit and Guarantee Agreement, dated August 14, 1996 among Dal-Tile
International Inc., Dal-Tile Group Inc., the several banks, financial
institutions and other entities from time-to-time party thereto,
Credit Suisse, as Documentation Agent, Goldman Sachs Credit Partners
L.P., as Syndication Agent, and The Chase Manhattan Bank, as
Administrative Agent. (Filed as Exhibit 10.1 to the Registrant's Form
10-Q filed on November 7, 1996 and incorporated herein by reference.)
-11-
EXHIBIT
NO.
- -------
10.9 Pledge Agreement dated as of October 4, 1996, made by Dal-Tile Group
Inc. in favor of The Chase Manhattan Bank, as Administrative Agent,
relating to the pledge of Common Stock of Dal-Tile Mexico, S.A. de
C.V. (Filed as Exhibit 10.2 to the Registrant's Form 10-Q filed on
November 7, 1996 and incorporated herein by reference.)
10.10 Pledge Agreement dated as of August 14, 1996, made by Dal-Tile
International Inc. in favor of The Chase Manhattan Bank, as
Administrative Agent, relating to the pledge of common stock of
Dal-Tile Group Inc. (Filed as Exhibit 10.3 to the Registrant's Form
10-Q filed on November 7, 1996 and incorporated herein by reference.)
10.11 Pledge Agreement dated as of August 14, 1996 made by Dal-Tile Group
Inc. in favor of The Chase Manhattan Bank, as Administrative Agent,
relating to the pledge of common stock of Dal-Tile Corporation (Filed
as Exhibit 10.4 to the Registrant's Form 10-Q filed on November 7,
1996 and incorporated herein by reference.)
10.12 Pledge Agreement dated as of October 4, 1996, made by Dal-Tile Group
Inc. in favor of The Chase Manhattan Bank, as Administrative Agent,
relating to the pledge of common stock of Dal-Tile Mexico, S.A. de
C.V. (Filed as Exhibit 10.2 to the Registrant's Form 10-Q filed on
November 7, 1996 and incorporated herein by reference.)
10.13 Form of Indemnification Agreement between Dal-Tile International
Inc. and its directors and officers. (Filed as Exhibit 10.4 to the
Registrant's Registration Statement on Form S-1 (No. 33-64140) and
incorporated herein by reference.)
10.14 Settlement Agreement dated as of May 20, 1993, among AEA Investors
Inc., DTM Investors Inc., Dal-Tile Group Inc., Dal-Tile Corporation,
Dal-Minerals Company and Robert M. Brittingham and John G.
Brittingham. (Filed as Exhibit 10.5 to the Registrant's Registration
Statement on Form S-1 (No. 33-64140) and incorporated herein by
reference.)
10.15 Stockholders Agreement, dated December 29, 1995, among Dal-Tile
International Inc., AEA Investors Inc., Armstrong World Industries,
Inc., Armstrong Enterprises, Inc. and Armstrong Cork Finance
Corporation. (Filed as Exhibit 10.6 to the Registrant's Annual Report
on Form 10-K for the year ended December 31, 1995 and incorporated
herein by reference.)
10.16 Agreement, dated July 15, 1996, among Dal-Tile International Inc., AEA
Investors Inc., DTI Investors LLC, Armstrong World Industries, Inc.,
Armstrong Enterprises, Inc. and Armstrong Cork Finance Corporation.
(Filed as Exhibit 10.17 to the Registrant's Registration Statement on
Form S-1 (No. 333-5069) and incorporated herein by reference.)
+*10.17 Employment Agreement, dated as of June 13, 1997, and amended as of
October 10,1997 between Dal-Tile International Inc. and Jacques R.
Sardas.
+*10.18 Employment Agreement, dated as of August 25, 1997, and amended October
10, 1997, between Dal-Tile International Inc. and William C. Wellborn.
+*10.19 Stock Appreciation Rights Agreements, dated as of October 10, 1997,
and amended February 20, 1998, between Dal-Tile International Inc. and
each of Jacques R. Sardas, William C.
-12-
EXHIBIT
NO.
- -------
Wellborn, Dan L. Cooke, Marc Powell, and David F. Finnigan.
10.20 First Amendment, dated as of June 19, 1997, to the Credit and
Guarantee Agreement (filed as Exhibit 10.1 to the Registrant's Form
10-Q filed on November 17, 1997 and incorporated herein by reference).
10.21 Second Amendment, dated as of September 30, 1997, to the Credit and
Guarantee Agreement (filed as Exhibit 10.2 to the Registrant's Form
10-Q filed on November 17, 1997 and incorporated herein by reference).
+10.22 Collateral Agreement, dated as of June 19, 1997, made by Dal-Tile
Group Inc. and certain of its subsidiaries in favor of the Chase
Manhattan Bank, as Administration Agent.
+10.23 Dal-Tile International Inc. 1997 Amended and Restated Stock Option
Plan
+21.1 List of subsidiaries of Dal-Tile International Inc.
23.1 Consent of Ernst & Young LLP
+27.1 Financial Data Schedule
+ Previously filed.
(b) Reports on Form 8-K:
None.
(c) Exhibits:
See Item 14(a) above.
(d) Financial Statement Schedule
See Item 14(a) above.
-13-
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) THE SECURITIES EXCHANGE
ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS
BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, ON THE 23rd Day of June
1998.
DAL-TILE INTERNATIONAL INC.
By: /s/ Jacques R. Sardas
------------------------------------------
JACQUES R. SARDAS
President, Chief Executive Officer and
Chairman of the Board of Directors
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS IN THE CAPACITIES AND
ON THE DATES INDICATED.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Jacques R. Sardas President, Chief Executive June 23, 1998
- --------------------------- Officer and Chairman of
JACQUES R. SARDAS the Board of Directors
/s/ William C. Wellborn Executive Vice President, June 23, 1998
- --------------------------- Chief Financial Officer,
WILLIAM C. WELLBORN Treasurer and Assistant
Secretary (Principal
Financial and Accounting
Officer)
/s/ John M. Goldsmith Director June 23, 1998
- ---------------------------
JOHN M. GOLDSMITH
/s/ Charles J. Pilliod, Jr. Director June 23, 1998
- ---------------------------
CHARLES J. PILLIOD, JR.
/s/ Henry F. Skelsey Director June 23, 1998
- ---------------------------
HENRY F. SKELSEY
-14-
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Douglas D. Danforth Director June 23, 1998
- ---------------------------
DOUGLAS D. DANFORTH
/s/ Vincent A. Mai Director June 23, 1998
- ---------------------------
VINCENT A. MAI
/s/ Norman E. Wells, Jr. Director June 23, 1998
- ---------------------------
NORMAN E. WELLS, JR.
-15-
DAL-TILE INTERNATIONAL INC.
ITEM 14(A)-INDEX TO CONSOLIDATED FINANCIAL
STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
YEARS ENDED JANUARY 2, 1998, JANUARY 3, 1997 AND DECEMBER 31, 1995
CONTENTS
Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . . .F-2
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets at January 2, 1998 and January 3, 1997 . . . . .F-3
Consolidated Statements of Operations for each of the
three years in the period ended January 2, 1998. . . . . . . . . . . . . . .F-4
Consolidated Statements of Stockholders' Equity for each of
the three years in the period ended January 2, 1998. . . . . . . . . . . . .F-5
Consolidated Statements of Cash Flows for each of the three
years in the period ended January 2, 1998. . . . . . . . . . . . . . . . . .F-6
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . .F-7
CONSOLIDATED FINANCIAL STATEMENT SCHEDULE
Schedule II-Valuation and Qualifying Accounts. . . . . . . . . . . . . . . .S-1
All other schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and therefore have been omitted.
F-1
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
Dal-Tile International Inc.
We have audited the accompanying consolidated balance sheets of Dal-Tile
International Inc. as of January 2, 1998 and January 3, 1997, and the related
consolidated statements of operations, stockholders' equity and cash flows
for each of the three years in the period ended January 2, 1998. Our audits
also included the financial statement schedule listed in the Index at Item
14(a). These financial statements and schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Dal-Tile International Inc. at January 2, 1998 and January 3, 1997, and
the consolidated results of its operations and its cash flows for each of the
three years in the period ended January 2, 1998, in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
/s/ ERNST & YOUNG LLP
Dallas, Texas
February 16, 1998
F-2
DAL-TILE INTERNATIONAL INC.
CONSOLIDATED BALANCE SHEETS
JANUARY 2, JANUARY 3,
1998 1997
---------- ----------
(IN THOUSANDS)
ASSETS
Current assets:
Cash. . . . . . . . . . . . . . . . . . . . . . . $ 7,488 $ 9,999
Trade accounts receivable . . . . . . . . . . . . 96,296 123,586
Inventories . . . . . . . . . . . . . . . . . . . 130,747 142,413
Prepaid expenses. . . . . . . . . . . . . . . . . 3,120 3,186
Other current assets. . . . . . . . . . . . . . . 18,438 15,132
--------- ---------
Total current assets. . . . . . . . . . . . . 256,089 294,316
Property, plant and equipment, at cost:
Land. . . . . . . . . . . . . . . . . . . . . . . 17,205 17,403
Leasehold improvements. . . . . . . . . . . . . . 11,067 10,347
Buildings . . . . . . . . . . . . . . . . . . . . 75,134 78,360
Machinery and equipment . . . . . . . . . . . . . 183,806 126,830
Construction in process . . . . . . . . . . . . . 12,020 29,036
--------- ---------
299,232 261,976
Accumulated depreciation. . . . . . . . . . . . . . 71,547 58,350
--------- ---------
227,685 203,626
Goodwill, net of amortization . . . . . . . . . . . 152,560 157,251
Finance costs, net of amortization. . . . . . . . . 6,599 3,683
Tradename and other assets. . . . . . . . . . . . . 29,136 29,621
--------- ---------
Total assets. . . . . . . . . . . . . . . . . $ 672,069 $ 688,497
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable. . . . . . . . . . . . . . $ 18,231 $ 38,827
Accrued expenses. . . . . . . . . . . . . . . . . 55,043 27,809
Accrued interest payable. . . . . . . . . . . . . 2,287 3,293
Current portion of long-term debt . . . . . . . . 19,261 32,823
Income taxes payable. . . . . . . . . . . . . . . 801 2,342
Deferred income taxes . . . . . . . . . . . . . . 863 1,367
Other current liabilities . . . . . . . . . . . . 4,715 7,036
--------- ---------
Total current liabilities . . . . . . . . . . 101,201 113,497
Long-term debt. . . . . . . . . . . . . . . . . . . 537,830 433,035
Other long-term liabilities . . . . . . . . . . . . 27,230 24,369
Deferred income taxes . . . . . . . . . . . . . . . 1,888 2,027
Commitments and contingencies
Stockholders' equity:
Common stock. . . . . . . . . . . . . . . . . . . 534 534
Additional paid-in capital. . . . . . . . . . . . 436,100 436,100
Accumulated deficit . . . . . . . . . . . . . . . (370,886) (260,650)
Currency translation adjustment . . . . . . . . . (61,828) (60,415)
--------- ---------
Total stockholders' equity. . . . . . . . . . 3,920 115,569
--------- ---------
Total liabilities and stockholders' equity. . $ 672,069 $ 688,497
--------- ---------
--------- ---------
See accompanying notes.
F-3
DAL-TILE INTERNATIONAL INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED
--------------------------------------
JANUARY 2, JANUARY 3, DECEMBER 31,
1998 1997 1995
----------- ---------- ------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net sales . . . . . . . . . . . . . . . . . . . . . $ 676,637 $720,236 $474,812
Cost of goods sold. . . . . . . . . . . . . . . . . 404,728 369,731 225,364
--------- -------- --------
271,909 350,505 249,448
Operating expenses:
Transportation. . . . . . . . . . . . . . . . . . 58,425 47,125 33,535
Selling, general and administrative . . . . . . . 277,515 190,911 134,193
Provision for merger integration charges. . . . . - 9,000 22,430
Amortization of goodwill and tradename. . . . . . 5,605 5,605 4,765
--------- -------- --------
Total expenses. . . . . . . . . . . . . . . . . . . 341,545 252,641 194,923
--------- -------- --------
Operating income (loss) . . . . . . . . . . . . . . (69,636) 97,864 54,525
Interest expense. . . . . . . . . . . . . . . . . . 40,649 46,338 55,453
Interest income . . . . . . . . . . . . . . . . . . 268 1,685 1,250
Other income. . . . . . . . . . . . . . . . . . . . 1,220 129 2,994
--------- -------- --------
Income (loss) before income taxes
and extraordinary item. . . . . . . . . . . . . . (108,797) 53,340 3,316
Income tax provision. . . . . . . . . . . . . . . . 1,439 18,914 1,176
--------- -------- --------
Income (loss) before extraordinary item . . . . . . (110,236) 34,426 2,140
Extraordinary item - loss on early
retirement of debt, net of taxes. . . . . . . . . - (29,072) -
--------- -------- --------
Net income (loss) . . . . . . . . . . . . . . . . . $(110,236) $ 5,354 $ 2,140
--------- -------- --------
--------- -------- --------
BASIC EARNINGS PER SHARE
Income (loss) before extraordinary item
per common share. . . . . . . . . . . . . . . . . $ (2.06) $ 0.71 $ 0.07
Extraordinary item. . . . . . . . . . . . . . . . . - (0.60) -
--------- -------- --------
Net income (loss) per common share. . . . . . . . . $ (2.06) $ 0.11 $ 0.07
--------- -------- --------
--------- -------- --------
Average outstanding common shares . . . . . . . . . 53,435 48,473 28,743
--------- -------- --------
--------- -------- --------
DILUTED EARNINGS PER SHARE
Income (loss) before extraordinary item
per common share. . . . . . . . . . . . . . . . . $ (2.06) $ 0.69 $ 0.07
Extraordinary item. . . . . . . . . . . . . . . . . - (0.58) -
--------- -------- --------
Net income (loss) per common share. . . . . . . . . $ (2.06) $ 0.11 $ 0.07
--------- -------- --------
--------- -------- --------
Average outstanding common and equivalent shares. . 53,435 50,053 29,668
--------- -------- --------
--------- -------- --------
See accompanying notes.
F-4
DAL-TILE INTERNATIONAL INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
COMMON STOCK
--------------------------------------------------------------
CONVERTED
CLASS CLASS CLASS CLASS CLASS CLASS COMMON
A B C D E F STOCK
----- ----- ----- ----- ----- ----- ---------
Balance at December 31, 1994................. $ 10 $ - $ 3 $ 10 $ 1 $ 1 $ -
Net income................................... - - - - - - -
Stock issued in connection with
the AO Acquisition......................... 6 - 2 6 1 1 -
Currency translation adjustment.............. - - - - - - -
--- --- --- --- --- --- ----
Balance at December 31, 1995................. 16 - 5 16 2 2 -
Net income................................... - - - - - - -
Stock conversion............................. (16) - (5) (16) (2) (2) 454
Proceeds from AWI in connection
with the AO Acquisition.................... - - - - - - -
Stock issued in connection with the
Initial Public Offering................... - - - - - - 80
Currency translation adjustment.............. - - - - - - -
--- --- --- --- --- --- ----
Balance at January 3, 1997................... - - - - - - 534
Net loss..................................... - - - - - - -
Currency translation adjustment.............. - - - - - - -
--- --- --- --- --- --- ----
Balance at January 2, 1998................... $ - $ - $ - $ - $ - $ - $534
--- --- --- --- --- --- ----
--- --- --- --- --- --- ----
ADDITIONAL CURRENCY
PAID-IN ACCUMULATED TRANSLATION
CAPITAL DEFICIT ADJUSTMENT TOTAL
---------- ----------- ----------- ---------
Balance at December 31, 1994................. $200,475 $(268,144) $(36,179) $(103,823)
Net income................................... - 2,140 - 2,140
Stock issued in connection with the
AO Acquisition............................. 133,560 - - 133,576
Currency translation adjustment.............. - - (22,254) (22,254)
-------- --------- -------- ---------
Balance at December 31, 1995................. 334,035 (266,004) (58,433) 9,639
Net income................................... - 5,354 - 5,354
Stock conversion............................. (413) - - -
Proceeds from AWI in connection
with the AO Acquisition.................... 650 - - 650
Stock issued in connection with the
Initial Public Offering...................... 101,828 - - 101,908
Currency translation adjustment.............. - - (1,982) (1,982)
-------- --------- -------- ---------
Balance at January 3, 1997................... 436,100 (260,650) (60,415) 115,569
Net loss..................................... - (110,236) - (110,236)
Currency translation adjustment.............. - - (1,413) (1,413)
-------- --------- -------- ---------
Balance at January 2, 1998................... $436,100 $(370,886) $(61,828) $ 3,920
-------- --------- -------- ---------
-------- --------- -------- ---------
See accompanying notes.
F-5
DAL-TILE INTERNATIONAL INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED
----------------------------------------
JANUARY 2, JANUARY 3, DECEMBER 31,
1998 1997 1995
---------- ---------- ------------
(IN THOUSANDS)
OPERATING ACTIVITIES
Net income (loss).................................. $(110,236) $ 5,354 $ 2,140
Adjustments to reconcile net income
(loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization.................... 24,543 24,017 17,164
Extraordinary loss............................... - 29,072 -
Provision for losses on accounts receivable ..... 27,805 5,781 5,111
Merger integration reserve....................... - - 22,430
Foreign exchange transaction (gain) loss......... 339 (59) (6,067)
Zero coupon notes interest expense............... - - 10,899
Deferred income tax provision (benefit).......... (475) 13,539 (3,088)
Changes in operating assets and
liabilities, net of assets and
liabilities of business acquired:
Trade accounts receivable...................... (688) (25,752) 3,470
Inventories.................................... 10,845 (39,607) (3,580)
Other assets................................... (7,420) 217 (5,754)
Trade accounts payable and accrued expenses ... 4,442 6,854 12,371
Accrued interest payable....................... (1,004) (14,105) 354
Other liabilities.............................. (958) (23,995) (14,787)
--------- --------- --------
Net cash provided by (used in)
operating activities.............................. (52,807) (18,684) 40,663
INVESTING ACTIVITIES
Expenditures for property,
plant and equipment, net.......................... (40,074) (42,039) (29,392)
FINANCING ACTIVITIES
Borrowings under long-term debt.................... 111,007 451,000 -
Borrowings under Term B loan....................... 125,000 - -
Borrowings under previous
bank credit facility.............................. - 63,723 46,702
Repayment of long-term debt........................ (19,968) (576,679) (22,538)
Repayment of long-term debt
from Term B loan.................................. (122,000) - -
Fees and expenses associated
with debt refinancing............................. (3,576) (42,765) -
Proceeds from issuance of
common stock...................................... - 102,558 27,575
--------- --------- --------
Net cash provided by (used in)
financing activities.............................. 90,463 (2,163) 51,739
Effect of exchange rate changes on cash............ (93) (80) (3,022)
--------- --------- --------
Net increase (decrease) in cash.................... (2,511) (62,966) 59,988
Cash at beginning of year.......................... 9,999 72,965 12,977
--------- --------- --------
Cash at end of year................................ $ 7,488 $ 9,999 $ 72,965
--------- --------- --------
--------- --------- --------
See accompanying notes.
F-6
DAL-TILE INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JANUARY 2, 1998
1. ORGANIZATION
Dal-Tile International Inc. (the "Company"), a holding company, owns the
outstanding capital stock of its sole direct subsidiary, Dal-Tile Group Inc.
(the "Group"), and conducts its operations through the Group. The Group also
conducts substantially all of its operations through its subsidiaries.
Dal-Tile International Inc., as a stand-alone holding company, has no
operations (see Note 17).
The Group is a multinational manufacturing and distribution company operating
in the United States, Mexico and Canada. The Group offers a full range of
glazed and unglazed ceramic tile products and accessories. The Group's
products are sold principally through its extensive network of
Company-operated sales centers. The Group also distributes products through
independent distributors and sells to home center retailers and flooring
dealers.
ACQUISITION
On December 29, 1995, the Company completed the acquisition of all of the
issued and outstanding stock of American Olean Tile Company, Inc. ("AO"), a
wholly owned subsidiary of Armstrong World Industries, Inc. ("AWI"), and
certain related assets of the Ceramic Tile Operations of AWI (the "AO
Acquisition"). The AO Acquisition was accounted for under the purchase
method of accounting. The statement of operations excludes the results of
operations of AO for the year ended December 31, 1995, as the acquisition
occurred on December 29, 1995.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements reflect the consolidation of all
accounts of the Company, which includes the Group and the Group's wholly
owned subsidiaries:
FORM OF ENTITY
--------------
Dal-Tile Group Inc. . . . . . . . . U.S. Corporation
Dal-Tile Corporation. . . . . . . . U.S. Corporation
Tileways, Inc.. . . . . . . . . . . U.S. Corporation
DTM/CM Holdings, Inc. . . . . . . . U.S. Corporation
R&M Supplies, Inc.. . . . . . . . . U.S. Corporation
Dal-Minerals Company. . . . . . . . U.S. Corporation
Dal-Tile Mexico,
S.A. de C.V. ("Dal-Tile Mexico"). Mexican Corporation
Materiales Ceramicos,
S.A. de C.V. ("Materiales") . . . Mexican Corporation
Dal-Tile of Canada Inc. . . . . . . Canadian Corporation
Significant intercompany transactions and balances have been eliminated in
consolidation.
F-7
DAL-TILE INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with maturities of three
months or less to be cash equivalents.
INVENTORIES
U.S. finished products inventories are valued at the lower of cost (last-in,
first-out ("LIFO")) or market, while U.S. raw materials and goods-in-process
inventories are valued at the lower of cost (first-in, first-out ("FIFO")) or
market. Mexican and Canadian inventories are valued at the lower of cost
(FIFO) or market.
DEPRECIATION
Depreciation for financial reporting purposes is determined using the
straight-line method. Estimated useful lives are as follows:
YEARS
-------------
Leasehold improvements . . . . . . Life of lease
Buildings. . . . . . . . . . . . . 20-30
Machinery and equipment. . . . . . 3-20
GOODWILL
Goodwill, which represents the excess cost over the fair value of net assets
acquired, is amortized on a straight-line basis over the expected period to
be benefited of 40 years. Accumulated amortization at January 2, 1998 and
January 3, 1997 was $61,890,000 and $57,125,000, respectively. The carrying
value of goodwill and other long-lived assets is reviewed periodically to
determine whether it may be impaired. If an impairment exists, the
impairment loss is measured by comparing the fair value of the business
unit's long-lived assets to their carrying amount.
FINANCE COSTS
Finance costs incurred in connection with financings are being amortized over
the term of the related debt on a straight-line basis. Accumulated
amortization at January 2, 1998 and January 3, 1997 was approximately
$1,112,000 and $205,000, respectively.
F-8
DAL-TILE INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ADVERTISING EXPENSES
Advertising and promotion expenses are charged to income during the period in
which they are incurred. Advertising and promotion expenses incurred for the
years ended January 2, 1998, January 3, 1997 and December 31, 1995 amounted
to $16,722,000, $14,627,000 and $7,566,000, respectively.
STOCK OPTIONS
The Company grants stock options for a fixed number of shares to employees
with an exercise price equal to the fair value of the underlying common stock
at the date of grant. The Company has elected to follow Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25"), and related interpretations in accounting for its employee stock
options because the alternative fair value accounting provided for under
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"), requires use of option valuation
models that were not developed for use in valuing employee stock options.
Under APB 25, no compensation expense is recognized because the exercise
price of the Company's employee stock options equals the market price of the
underlying stock on the date of grant.
RETIREMENT PLANS
The Company maintains a defined contribution 401(k) plan for eligible
employees. A participant may contribute up to 15% of his total annual
compensation (annual base pay for union participants) to the plan.
Contributions by the Company to the plan are at the discretion of its Board
of Directors. Currently, the Company matches 50% of any non-union
participant's contribution to the plan up to 6% of the employee's total
annual compensation. Dal-Tile Mexico and Materiales maintain defined benefit
plans for eligible employees with funding policies based on local statutes.
FOREIGN CURRENCY TRANSLATION
The Company's Mexican operations use the Mexican peso as their functional
currency. Assets and liabilities are translated from the functional currency
into the U.S. dollar using the period-end exchange rates. Income and expense
accounts are translated from the functional currency into the U.S. dollar
using the average exchange rate for the period. Translation gains or losses
are included as a component of stockholders' equity. Gains and losses
resulting from foreign currency transactions are reflected currently in the
consolidated statements of operations. The Company experienced foreign
currency transaction gains (losses) of $558,000, ($80,000) and $4,100,000 for
the years ended January 2, 1998, January 3, 1997 and December 31, 1995,
respectively.
CONCENTRATIONS OF CREDIT RISK
The Company is engaged in the manufacturing and distribution of glazed and
unglazed ceramic tile products and accessories in the United States and
Mexico and the distribution of such manufactured products in Canada. The
Company grants credit to customers, substantially all of whom are dependent
upon the construction economic sector. The Company continuously evaluates
its customers' financial condition and periodically requires payments to its
customers to be issued on behalf of the customer and the Company. In
addition, the Company frequently obtains liens on property to secure accounts
receivable.
F-9
DAL-TILE INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Trade accounts receivable are net of an allowance for losses from
uncollectible accounts of $13,160,000 and $12,750,000 at January 2, 1998 and
January 3, 1997, respectively.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the 1997
presentation.
NET INCOME (LOSS) PER SHARE
In 1997, the Financial Accounting Standards Board ("FASB") issued Statement
No. 128, "Earnings Per Share" ("SFAS 128"). SFAS 128 replaced the
calculation of primary and fully diluted earnings per share with basic and
diluted earnings per share. Unlike primary earnings per share, basic
earnings per share excludes any diluted effects of options, warrants and
convertible securities. Diluted earnings per share is very similar to the
previously reported fully diluted earnings per share. All earnings per share
amounts for all periods have been presented, and where appropriate, restated
to conform to SFAS 128 requirements.
Options to purchase 6,597,371 shares of common stock at prices ranging from
$9.01 to $13.75 per share were outstanding at January 2, 1998, but were not
included in the computation of earnings per share for 1997. Due to the
Company's net loss for the year, these options would have had an antidilutive
effect on earnings per share.
FOR THE YEAR ENDED JANUARY 3, 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)
----------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
BASIC EARNINGS PER SHARE
Income before extraordinary item
available to common stockholders. . . $34,426 48,473 $0.71
EFFECT OF DILUTIVE SECURITIES
Stock options . . . . . . . . . . . . - 1,580 -
------- ------ -----
DILUTED EARNINGS PER SHARE
Income available to common stockholders
plus assumed conversion . . . . . . . $34,426 50,053 $0.69
------- ------ -----
------- ------ -----
Options to purchase 50,000 shares of common stock at $19.75 per share were
outstanding during the fourth quarter of 1996 but were not included in the
computation of diluted earnings per share because the options' exercise price
was greater than the average market price of the common shares. The options,
which expire January 2, 2007, were still outstanding at the end of 1996.
F-10
DAL-TILE INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 1995
(IN THOUSANDS, EXCEPT PER SHARE DATA)
--------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
BASIC EARNINGS PER SHARE
Income before extraordinary item
available to common stockholders. . . . $2,140 28,743 $0.07
EFFECT OF DILUTIVE SECURITIES
Stock options . . . . . . . . . . . . . - 925 -
------ ------ -----
DILUTED EARNINGS PER SHARE
Income available to common stockholders
plus assumed conversion . . . . . . . . $2,140 29,668 $0.07
------ ------ -----
------ ------ -----
NEW ACCOUNTING STANDARDS
In June 1997, the FASB issued Statement No. 130, "Reporting Comprehensive
Income," which establishes rules for reporting and displaying comprehensive
income. The Company intends to adopt this statement, as required, for fiscal
year 1998. When adopted, the Company has elected to display comprehensive
income and its components in the Statement of Stockholders' Equity. Adoption
of this statement is not expected to have an effect on the financal
statements.
3. INVENTORIES
Inventories consist of the following:
JANUARY 2, JANUARY 3,
1998 1997
---------- ----------
(IN THOUSANDS)
Finished products in U.S. . . . . . . . $110,323 $118,823
Finished products in Mexico . . . . . . 4,307 3,690
Finished products in Canada . . . . . . 2,266 3,724
Goods-in-process. . . . . . . . . . . . 3,960 3,516
Raw materials . . . . . . . . . . . . . 9,891 12,660
-------- --------
Total inventories . . . . . . . . . . . $130,747 $142,413
-------- --------
-------- --------
If U.S. finished products inventories were shown at current costs
(approximating the FIFO method) rather than at LIFO values, inventories would
have been $2,200,000 higher and $8,200,000 lower than reported at January 2,
1998 and January 3, 1997, respectively.
During 1997, inventory quantities in three of the Company's LIFO pools were
reduced. This reduction resulted in the liquidation of LIFO inventory
quantities carried at higher costs prevailing in prior years as compared with
the 1997 costs, the effect of which decreased net income by approximately
$691,000, or $0.01 per share (basic and diluted).
F-11
DAL-TILE INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During 1996, inventory quantities in three of the Company's LIFO pools were
reduced. This reduction resulted in the liquidation of LIFO inventory
quantities carried at lower costs prevailing in prior years as compared with
the 1996 costs, the effect of which increased net income by approximately
$493,000, or $0.01 per share (basic and diluted).
4. INITIAL PUBLIC OFFERING
During the third quarter of 1996, the Company completed an initial public
offering (the "Offering") of its common stock and a concurrent private
placement of its common stock to a subsidiary of AWI (the "Private
Placement"). The Offering of 7,316,343 shares of common stock, including the
underwriter over allotment, raised $102,428,802 of gross proceeds with net
proceeds, after underwriting commission and expenses, amounting to
$92,557,930. The Private Placement of 714,286 shares of common stock raised
$10,000,000 of proceeds with total net proceeds from the Offering and Private
Placement amounting to $102,557,930. In connection with the Offering and
Private Placement, the Company effected a recapitalization of its capital
stock. Pursuant to a common stock conversion, all of the classes of the
Company's previously outstanding common stock were converted into 45,404,472
shares of a single class of common stock. In addition, all outstanding
options to purchase Dal-Tile's capital stock were converted into options to
purchase 4,204,747 shares of Common Stock.
5. LONG-TERM DEBT
Long-term debt consists of the following:
JANUARY 2, JANUARY 3,
1998 1997
---------- ----------
(IN THOUSANDS)
Term A Loan, interest due quarterly at LIBOR plus 2%
(approximately 7.8% at January 2, 1998), principal
due in variable quarterly installments through
December 31, 2002, collateralized by certain assets
of the Company . . . . . . . . . . . . . . . . . . . . . $217,500 $275,000
Term B Loan, interest due quarterly at LIBOR plus 2-1/2%
(approximately 8.3% at January 2, 1998), principal due
in variable quarterly installments through December 31,
2003, collateralized by certain assets of the
Company. . . . . . . . . . . . . . . . . . . . . . . . . 125,000 --
Revolving line of credit, interest due quarterly at LIBOR
plus 2% (approximately 7.8% at January 2, 1998),
principal due December 31, 2002, collateralized by
certain assets of the Company. . . . . . . . . . . . . . 190,000 176,000
Other, principally borrowings to fund capital
additions. . . . . . . . . . . . . . . . . . . . . . . . 24,591 14,858
-------- --------
557,091 465,858
Less current portion. . . . . . . . . . . . . . . . . . . 19,261 32,823
-------- --------
$537,830 $433,035
-------- --------
-------- --------
F-12
DAL-TILE INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Concurrent with the Offering, the Company entered into a new bank credit
agreement (the "New Bank Credit Agreement") which, along with the proceeds
from the Offering and Private Placement, were used to repay substantially all
of the Company's debt. The New Bank Credit Agreement included a term loan of
$275,000,000 ("Term A Loan") and a revolving line of credit of $250,000,000.
During the second quarter of 1997, the Company completed a new $125,000,000
Term B loan facility which made certain modifications to the New Bank Credit
Agreement (the "Amended Credit Facility"). The proceeds of the Term B loan
were used to repay $50,000,000 of the Term A Loan and $72,000,000 of the
existing revolving line of credit. The Amended Credit Facility did not
modify the Term A Loan amortization schedule.
During the third quarter of 1997, the Company amended certain financial
covenants to provide increased flexibility under the Amended Credit Facility
(as amended, the "Second Amended Credit Facility"). In connection with the
Second Amended Credit Facility, the Company's borrowing rate was increased 50
basis points over the previously existing rates (which now range from 2 to
2-1/2 over LIBOR). Under the Second Amended Credit Facility, the Company is
required, among other things, to maintain certain financial covenants and has
restrictions on incurring additional debt and limitations on cash dividends.
The Company was in compliance with such covenants at January 2, 1998. A
commitment fee at a rate per annum based on a pricing grid is payable
quarterly.
As of January 2, 1998, the Company had availability of approximately
$48,600,000 on the revolving line of credit. The availability is net of
$11,448,526 in letters of credit for foreign inventory purchases and
industrial revenue bond financing transactions.
The Company periodically uses interest rate swap agreements to manage exposure
to fluctuations in interest rates. These agreements involve the exchange of
interest obligations on fixed and floating interest rate debt without the
exchange of the underlying principal amounts. The differential paid or
received on the agreements is recognized as an adjustment to interest expense
over the term of the underlying swap agreement. The book value of the
interest rate swap agreements represents the differential receivable or
payable with a swap counterparty since the last settlement date. The
underlying notional amounts on which the Company has interest rate swap
agreements outstanding was $300,000,000 at January 9, 1998. These agreements
are in effect for a term of two years at an interest rate of approximately 5.7%.
There were no interest rate swap agreements at or during the years ended
January 2, 1998 or January 3, 1997.
Aggregate maturities of long-term debt for the five years subsequent to
January 2, 1998 (in thousands) are:
1998 . . . . . . . . . . . . . . . . . . . $ 19,261
1999 . . . . . . . . . . . . . . . . . . . 46,144
2000 . . . . . . . . . . . . . . . . . . . 56,148
2001 . . . . . . . . . . . . . . . . . . . 55,684
2002 . . . . . . . . . . . . . . . . . . . 258,615
F-13
DAL-TILE INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Total interest cost incurred for the years ended January 2, 1998, January 3,
1997 and December 31, 1995 amounted to approximately $41,817,000, $47,706,000
and $56,699,000, respectively, of which approximately $1,168,000, $1,368,000
and $1,246,000, respectively, was capitalized to property, plant and
equipment. Total interest paid, net of interest received, was $41,899,000,
$52,857,000 and $43,460,000 for the years ended January 2, 1998, January 3,
1997 and December 31, 1995, respectively.
6. EXTRAORDINARY ITEM
In connection with the refinancing and early extinguishment of debt during
the year ended January 3, 1997, the Company recorded an extraordinary charge
of $44,800,000 ($29,072,000, net of tax) for prepayment premiums on certain
debt repaid, the write-off of existing deferred financing fees and a
termination fee paid in connection with the termination of the Company's
management agreement with AEA Investors.
7. CAPITAL STRUCTURE
Common stock consists of the following:
JANUARY 2, JANUARY 3,
1998 1997
---------- ----------
(IN THOUSANDS)
Common stock, $0.01 par value--authorized shares--
200,000,000, issued and outstanding shares--53,435,101 at
January 2, 1998 and January 3, 1997 . . . . . . . . . . . . . . $534 $534
---- ----
---- ----
At January 2, 1998, the Company has authorized 11,100,000 shares of preferred
stock, none of which were outstanding. Holders of common stock are entitled
to one vote per share on all matters to be voted upon by the stockholders,
including the election of directors. Holders of common stock do not have
cumulative voting rights and, therefore, holders of a majority of the shares
voting for the election of directors can elect all the directors. In such
event, the holders of the remaining shares will not be able to elect any
directors.
Holders of common stock are entitled to receive such dividends as may be
declared from time to time by the Board of Directors out of funds legally
available therefor, after payment of dividends required to be paid on
outstanding preferred stock, if any, and subject to the terms of the
agreements governing the Company's long-term debt. In the event of the
liquidation, dissolution or winding up of the Company, the holders of common
stock are entitled to share pro rata in all assets remaining after payment of
liabilities, subject to prior distribution rights of preferred stock then
outstanding, if any. The common stock has no preemptive, conversion or
redemption rights and is not subject to further calls or assessments by the
Company.
8. PROVISION FOR MERGER INTEGRATION CHARGE -- YEAR ENDED JANUARY 3, 1997
In the first quarter of 1996, the Company recorded an integration charge of
$9,000,000 in connection with the AO Acquisition and the Company's merger
integration plan. The charge was for closings of duplicative sales centers,
duplicative distribution centers, elimination of overlapping positions and the
closing of a manufacturing facility. The Company completed these actions during
1997. The primary components of the charge were $7,400,000 for lease
commitments, $1,300,000 for severance and
F-14
DAL-TILE INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
employee contracts and $300,000 for shut down costs of the closed facilities.
The leases were primarily associated with sales centers that closed during
the first half of 1997 and expire over the next two to four years.
9. PROVISION FOR MERGER INTEGRATION CHARGES -- YEAR ENDED DECEMBER 31, 1995
In the fourth quarter of 1995, the Company recorded a pre-tax charge of
$22,430,000 for the revaluation of certain assets in connection with the AO
Acquisition and the Company's merger integration plan. The primary component
of the charge was a write-down of duplicate management information systems,
including future lease commitments on system hardware of $15,750,000. As a
result of the AO Acquisition, the Company has combined two independent
systems into one system. The operating leases related to such software will
expire over the next two years. In addition, the Company has recorded a
charge of $5,400,000 for inventory revaluation as a result of the elimination
of product lines discontinued as a result of the AO Acquisition, as well as a
general stock keeping unit reduction that occurred in 1996. The Company
recorded a charge of $1,280,000 in connection with the closure of certain
duplicative sales service centers. The Company completed its sales centers
consolidation during the first half of 1997. The noncash portion of the
charge, $20,200,000, represents the write-down of certain equipment and the
revaluation of inventory. The cash portion of the merger integration charge
is $2,230,000 which primarily consists of leasehold commitments on equipment.
10. INCOME TAXES
Income (loss) before income taxes and extraordinary items relating to
operations is as follows:
YEAR ENDED
-------------------------------------------
JANUARY 2, JANUARY 3, DECEMBER 31,
1998 1997 1995
----------- --------- ------------
(IN THOUSANDS)
UNITED STATES . . . . . . . . $ (116,249) $ 45,812 $ (4,100)
MEXICO. . . . . . . . . . . . 7,879 7,603 7,754
OTHER . . . . . . . . . . . . (427) (75) (338)
----------- --------- --------
$ (108,797) $ 53,340 $ 3,316
----------- --------- --------
----------- --------- --------
F-15
DAL-TILE INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of the provision for income taxes include the following:
YEAR ENDED
-------------------------------------
JANUARY 2, JANUARY 3, DECEMBER 31,
1998 1997 1995
---------- ---------- ------------
(IN THOUSANDS)
U.S. state - current . . . . . . . . . $ - $ 3,060 $ 2,179
U.S. deferred. . . . . . . . . . . . . - (1,590) -
------ ------- -------
- 1,470 2,179
Mexico - current . . . . . . . . . . . 2,082 1,716 1,471
Mexico - deferred. . . . . . . . . . . (643) - (2,474)
------ ------- -------
1,439 1,716 (1,003)
------ ------- -------
Total with extraordinary item. . . . . 1,439 3,186 1,176
Tax effect of extraordinary item . . . - 15,728 -
------ ------- -------
Total before extraordinary item. . $1,439 $18,914 $ 1,176
------ ------- -------
------ ------- -------
Principal reconciling items from income tax provision (benefit) computed at
the U.S. statutory rate of 35% and the provision for income taxes for the
years ended January 2, 1998, January 3, 1997 and December 31, 1995 are as
follows:
YEAR ENDED
-------------------------------------
JANUARY 2, JANUARY 3, DECEMBER 31,
1998 1997 1995
---------- ---------- ------------
(IN THOUSANDS)
Provision (benefit) at
statutory rate . . . . . . . . . . . $(37,958) $ 2,989 $ 1,161
Amortization of goodwill . . . . . . . 1,668 1,668 1,668
State income tax . . . . . . . . . . . (5,489) 3,751 1,416
Foreign loss not benefited . . . . . . 149 26 1,436
Difference between U.S. and Mexico
statutory rate . . . . . . . . . . . (1,319) (945) (4,106)
Valuation allowance. . . . . . . . . . 44,107 (10,134) -
Non-Permanently reinvested
foreign earnings . . . . . . . . . . - 5,571 -
Other. . . . . . . . . . . . . . . . . 281 260 (399)
-------- -------- -------
$ 1,439 $ 3,186 $ 1,176
-------- -------- -------
-------- -------- -------
F-16
DAL-TILE INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of the Company's deferred tax liabilities are as follows:
JANUARY 2, JANUARY 3,
1998 1997
---------- ----------
(IN THOUSANDS)
Deferred tax liabilities:
Book basis of property, plant and
equipment over tax . . . . . . . . . . . $ 18,707 $ 16,324
Book basis of inventories over tax . . . . -- 1,367
Book basis of other assets over tax. . . . 10,640 14,513
Other, net . . . . . . . . . . . . . . . . 6,983 7,055
-------- --------
Total deferred tax liabilities. . . . . 36,330 39,259
-------- --------
Deferred tax assets:
Tax basis of inventories over book . . . . 5,519 --
Tax basis of other assets over book. . . . 1,325 210
Net operating loss carryforwards . . . . . 52,518 23,465
Expenses not yet deductible for tax. . . . 18,324 12,190
-------- --------
Total deferred tax assets . . . . . . . 77,686 35,865
Valuation allowance for
deferred tax assets. . . . . . . . . . . (44,107) --
-------- --------
Net deferred tax assets. . . . . . . . . . 33,579 35,865
-------- --------
Net deferred tax liabilities . . . . . . . $ 2,751 $ 3,394
-------- --------
-------- --------
Total income tax payments, net of refunds received, during the years ended
January 2, 1998, January 3, 1997 and December 31, 1995 were $3,206,000,
$1,989,000 and $6,145,000, respectively. The Company has U.S. net operating
loss carryforwards of approximately $138,000,000 which expire in the years
2008 - 2012. The net operating loss carryforwards will be available to
offset regular U.S. taxable income during the carryforward period.
Deferred tax assets are required to be reduced by a valuation allowance if it
is more likely than not that some portion or all of the deferred tax assets
will not be realized. Realization of the future benefits related to the
deferred tax assets is dependent on many factors, including the Company's
ability to generate U.S. taxable income within the near to medium term.
Management has considered these factors in determining the valuation
allowance recorded in 1997.
U.S. tax rules impose limitations on the use of net operating loss
carryforwards following certain changes in ownership. If such a change were
to occur with respect to the Company, the limitation could reduce the amount
of deductions that would be available to offset future taxable income each
year, starting with the year of the ownership change.
A company operating in Mexico is generally required by law to contribute 10%
of pre-tax profits (subject to certain adjustments) directly to employees.
These mandatory charges were not deductible for Mexican income tax purposes
during the fiscal years ended January 2, 1998, January 3, 1997 and December
31, 1995 and, for financial statement presentation purposes, have been
classified as components of income tax expense. Total tax provision amounts
accrued by Dal-Tile Mexico and Materiales for this obligation
F-17
DAL-TILE INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
amounted to approximately $327,000, $390,000 and $1,500,000 for the years
ended January 2, 1998, January 3, 1997 and December 31, 1995, respectively.
11. RELATED PARTY TRANSACTIONS
AEA Investors Inc., a majority stockholder, previously provided management,
consulting and financial services to the Company for fees and expenses. The
Company incurred fees and expenses for such services of $485,000 and $991,000
for the years ended January 3, 1997 and December 31, 1995, respectively.
Such services included, but were not necessarily limited to, advice and
assistance concerning the strategy, planning and financing of the Company, as
needed from time to time. The management arrangement was terminated during
1996, and AEA Investors was paid a termination fee of $4,000,000 in
connection therewith. Certain directors and officers of the Company also
serve as officers of AEA Investors Inc.
During 1996, the Company entered into an agreement with AWI to provide
mainframe data processing services. The agreement expires on May 31, 1999.
Payments made under this agreement were $6,147,000 and $2,549,000 for the
years ended January 2, 1998 and January 3, 1997, respectively.
12. STOCK PLANS
The Company has a stock option plan (the "Plan") that provides for the
granting of options for up to 7,836,425 shares of its common stock to key
employees of the Company. Options granted under the Plan prior to January 1,
1996 vest 20% at the date of the grant and 20% on each successive anniversary
of the date of the grant until fully vested. Options granted on or after
January 1, 1996 vest 25% at the date of the grant and 25% on each successive
anniversary of the date of the grant until fully vested. In each case, the
options expire on the tenth anniversary of the date of the grant; however,
these terms may be modified on an individual grant basis at the discretion of
the Company's Board of Directors.
Stock option activity under the Plan is summarized as follows (option data shown
below is after giving effect to the Company's options conversion):
WEIGHTED AVERAGE
NUMBER OF SHARES TOTAL OPTION PRICE EXERCISE PRICE
---------------- ------------------ ----------------
Outstanding at December 31, 1994. . 3,021,120 $27,217,300 $ 9.01
Granted. . . . . . . . . . . . . 61,050 550,000 9.01
Canceled . . . . . . . . . . . . (486,823) (4,385,800) 9.01
---------- ----------- --------
Outstanding at December 31, 1995. . 2,595,347 23,381,500 9.01
Granted. . . . . . . . . . . . . 1,695,535 17,294,604 10.20
Canceled . . . . . . . . . . . . (185,048) (1,667,100) 9.01
---------- ----------- --------
Outstanding at January 3, 1997. . . 4,105,834 39,009,004 9.50
Granted. . . . . . . . . . . . . 3,215,174 43,123,573 13.41
Canceled . . . . . . . . . . . . (723,637) (7,556,083) 10.44
---------- ----------- --------
Outstanding at January 2, 1998. . . 6,597,371 $74,576,494 $ 11.30
---------- ----------- --------
---------- ----------- --------
The Company has reserved 7,836,425 shares of common stock for options,
1,239,054 of which are ungranted at January 2, 1998 and are for future
issuance under the Plan.
F-18
DAL-TILE INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At January 2, 1998, January 3, 1997 and December 31, 1995, there were
4,200,159 options exercisable at a weighted average exercise price of $10.07,
2,986,372 options exercisable at a weighted average exercise price of $9.30
and 2,128,436 options exercisable at a weighted average exercise price of
$9.01, respectively.
The following table summarizes information with regard to stock options
outstanding at January 2, 1998:
WEIGHTED AVERAGE
EXERCISE OPTIONS REMAINING
PRICE OUTSTANDING CONTRACTUAL LIFE
- -------- ----------- ----------------
$9.01 . . . . . . . . . . . . . . . . . 2,441,202 3.56 years
9.91 . . . . . . . . . . . . . . . . . 1,113,169 8.00 years
12.63 . . . . . . . . . . . . . . . . . 106,000 9.95 years
13.69 . . . . . . . . . . . . . . . . . 2,837,000 9.78 years
13.75 . . . . . . . . . . . . . . . . . 100,000 9.30 years
In accordance with the provisions of SFAS 123, the Company applies APB 25 and
related interpretations in accounting for its stock option plan, and,
accordingly, does not recognize compensation cost. If the Company had
elected to recognize compensation cost based on the fair value of the options
granted at grant date as prescribed by SFAS 123, net income (loss) and
earnings (loss) per share would have been reduced to the pro forma amounts
indicated in the table below (in thousands, except per share data):
YEAR ENDED
---------------------------------------
JANUARY 2, JANUARY 3, DECEMBER 31,
1998 1997 1995
---------- --------- ------------
Net income (loss) -- as reported . . . . $(110,236) $5,354 $2,140
Net income (loss) -- pro forma . . . . . (112,150) 3,827 2,088
Earnings (loss) per share (basic
and diluted) -- as reported . . . . . . (2.06) 0.11 0.07
Earnings (loss) per share (basic
and diluted) -- pro forma . . . . . . . (2.10) 0.08 0.07
The pro forma effects on net income (loss) for the years ended January 2,
1998, January 3, 1997 and December 31, 1995 are not representative of the pro
forma effect on net income (loss) in future years because they do not take
into consideration pro forma compensation expense related to grants made
prior to 1995.
The weighted average fair value at date of grant for options granted during
the years ended January 2, 1998, January 3, 1997 and December 31, 1995 was
$5.62, $2.93 and $3.38 per option, respectively. The
F-19
DAL-TILE INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
fair value of the options at the date of grant was estimated using the
binomial model with the following weighted average assumptions:
YEAR ENDED
----------------------------------------
JANUARY 2, JANUARY 3, DECEMBER 31,
1998 1997 1995
---------- ---------- ------------
Expected life (years). . . . . 3 3 4
Interest rate. . . . . . . . . 5.96% 5.08% 7.52%
Volatility . . . . . . . . . . 53.5% 33.6% 33.6%
Dividend yield . . . . . . . . 0.00% 0.00% 0.00%
The Company has issued stock units under a stock appreciation rights
agreement to certain executives which permit the holders to receive value in
excess of the base price of the unit at the date of grant. Payment of the
excess will be in cash, stock or a combination of cash and stock at the
discretion of the Board of Directors. The total value to be received is
subject to a ceiling. During the fourth quarter of 1997, the Company granted
2,710,000 stock units at a base price of $9.01 per unit. These stock units
vest at various dates through fiscal year 2000 provided certain conditions
are met. The Company has recorded compensation expense of approximately
$5,900,000 during the fourth quarter of 1997 in respect of these stock units.
13. COMMITMENTS AND CONTINGENCIES
The Company leases substantially all of its sales service centers and various
distribution, manufacturing and transportation equipment under terms of
noncancelable operating leases. Certain leases contain escalation charges.
The minimum aggregate annual lease payments subsequent to January 2, 1998 are
as follows (in thousands):
1998. . . . . . . . . . . . . . . . . . . . . $27,797
1999. . . . . . . . . . . . . . . . . . . . . 21,769
2000. . . . . . . . . . . . . . . . . . . . . 14,379
2001. . . . . . . . . . . . . . . . . . . . . 10,679
2002. . . . . . . . . . . . . . . . . . . . . 8,141
Thereafter. . . . . . . . . . . . . . . . . . 17,119
-------
$99,884
-------
-------
Rental expense amounted to approximately $31,075,000, $24,166,000 and
$16,427,000 for the years ended January 2, 1998, January 3, 1997 and December
31, 1995, respectively.
The Company is subject to federal, state, local and foreign laws and
regulations relating to the environment and to work places. Laws that affect
or could affect the Group's United States operations include, among others,
the Clean Air Act, the Clean Water Act, the Resource Conservation and
Recovery Act and the Occupational Safety and Health Act. The Company
believes that it is currently in substantial compliance with such laws and
the regulations promulgated thereunder.
The Company is involved in various proceedings relating to environmental
matters. The Company, in the past, has disposed or arranged for the disposal
of substances which are now characterized as hazardous
F-20
DAL-TILE INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
and currently is engaged in the cleanup of hazardous substances at certain
sites. It is the Company's policy to accrue liabilities for remedial
investigations and cleanup activities when it is probable that such
liabilities have been incurred and when they can be reasonably estimated.
The Company has provided reserves which management believes are adequate to
cover probable and estimable liabilities of the Company with respect to such
investigations and cleanup activities, taking into account currently
available information and the Company's contractual rights of
indemnification. However, estimates of future response costs are necessarily
imprecise due to, among other things, the possible identification of
presently unknown sites, the scope of contamination of such sites, the
allocation of costs among other potentially responsible parties with respect
to any such sites and the ability of such parties to satisfy their share of
liability. Accordingly, there can be no assurance that the Company will not
become involved in future litigation or other proceedings or, if the Company
were found to be responsible or liable in any litigation or proceeding, that
such costs would not be material to the Company.
The Company is also a defendant in various lawsuits arising from normal
business activities. In the opinion of management, the ultimate liability
likely to result from the contingencies described above is not expected to
have a material adverse effect on the Company's consolidated financial
condition, results of operations or liquidity.
14. GEOGRAPHIC AREA OPERATIONS
The Company currently conducts its business in one industry segment, engaging
in the manufacturing and distribution of glazed and unglazed ceramic tile
products and accessories. The Company operates manufacturing facilities in
the United States and Mexico and distributes products through wholly owned
sales service centers in the United States and Canada and nonaffiliated
distributors in the United States and Mexico. Intercompany sales between
geographic areas are accounted for at amounts that are generally above cost
and in compliance with rules and regulations of governing tax authorities.
Such intercompany sales are eliminated in the consolidated financial
statements.
F-21
DAL-TILE INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Financial information by geographical area is summarized below:
YEAR ENDED
-------------------------------------
JANUARY 2, JANUARY 3, DECEMBER 31,
1998 1997 1995
---------- ---------- ------------
(IN THOUSANDS)
Consolidated revenue:
Unaffiliated customers:
United States. . . . . . . . . . . . . . $648,529 $695,532 $446,323
Mexico . . . . . . . . . . . . . . . . . 18,533 17,927 23,012
Other. . . . . . . . . . . . . . . . . . 9,575 6,777 5,477
-------- -------- --------
Total consolidated revenues from
unaffiliated customers . . . . . . . 676,637 720,236 474,812
-------- -------- --------
Intercompany revenue:
United States. . . . . . . . . . . . . . 4,348 4,057 3,174
Mexico . . . . . . . . . . . . . . . . . 71,802 61,526 43,109
Eliminations . . . . . . . . . . . . . . (76,150) (65,583) (46,283)
-------- -------- --------
Total consolidated revenue . . . . . . $676,637 $720,236 $474,812
-------- -------- --------
-------- -------- --------
Consolidated operating income (loss):
United States. . . . . . . . . . . . . . $(76,686) $ 90,175 $ 48,874
Mexico . . . . . . . . . . . . . . . . . 7,508 7,339 6,120
Eliminations/other . . . . . . . . . . . (458) 350 (469)
-------- -------- --------
Total consolidated operating
income (loss). . . . . . . . . . . . $(69,636) $ 97,864 $ 54,525
-------- -------- --------
-------- -------- --------
Consolidated identifiable assets:
United States. . . . . . . . . . . . . . $613,882 $623,444 $618,328
Mexico . . . . . . . . . . . . . . . . . 53,637 54,889 38,585
Eliminations/other . . . . . . . . . . . 4,550 10,164 15,480
-------- -------- --------
Total consolidated identifiable
assets . . . . . . . . . . . . . . . $672,069 $688,497 $672,393
-------- -------- --------
-------- -------- --------
15. FINANCIAL INSTRUMENTS
The carrying amounts of cash, trade accounts receivable and trade accounts
payable approximate fair value because of the short maturity of those
instruments. The carrying amount of the Company's long-term debt
approximates its fair value, which the Company estimates based on incremental
rates of comparable borrowing arrangements.
16. CHANGE IN FISCAL YEAR
During 1996, the Company changed its fiscal year end from December 31 to a 52
or 53 week year ending on the Friday nearest December 31. Accordingly, the
1996 fiscal year ended on January 3, 1997 (and included 53 weeks) whereas the
previous fiscal year ended on December 31 (and included 52 weeks). The
change was made to help facilitate the financial closing process. The effect
of the change was to increase net sales for 1996 by approximately $6,000,000.
The impact of the change on net income for fiscal year 1996 was not material.
F-22
DAL-TILE INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
17. CONDENSED UNCONSOLIDATED FINANCIAL STATEMENTS
Provided below are the condensed unconsolidated financial statements of
Dal-Tile International Inc.:
JANUARY 2, JANUARY 3,
1998 1997
---------- ----------
(IN THOUSANDS)
Condensed balance sheets:
Cash. . . . . . . . . . . . . . . . . . $ 59 $ 97
Other assets. . . . . . . . . . . . . . 9,151 8,286
Investment in Dal-Tile Group Inc.,
net of accumulated losses . . . . . . - 108,507
------ --------
$9,210 $116,890
------ --------
------ --------
Senior secured zero coupon notes. . . . . . $ 157 $ 140
Other liabilities . . . . . . . . . . . . . 1,232 1,181
Accumulated losses, net of investment
in Dal-Tile Group Inc.. . . . . . . . . . . 3,901 -
Stockholders' equity. . . . . . . . . . . . 3,920 115,569
------ --------
$9,210 $116,890
------ --------
------ --------
YEAR ENDED
----------------------------------------
JANUARY 2, JANUARY 3, DECEMBER 31,
1998 1997 1995
---------- ---------- ------------
(IN THOUSANDS)
Condensed statements of operations:
Equity in net income (loss)
of Dal-Tile Group Inc. . . . . . . . $(110,739) $ 11,841 $14,125
Other expense (income). . . . . . . . . (520) (511) 450
Interest income . . . . . . . . . . . . -- 921 142
Interest expense . . . . . . . . . . . 17 7,919 11,677
--------- -------- -------
Net income (loss) . . . . . . . . . . . $(110,236) $ 5,354 $ 2,140
--------- -------- -------
--------- -------- -------
Condensed statements of cash flows:
Cash flow used in operating
activities . . . . . . . . . . . . . . $ (129) $ (6,303) $ (687)
Financing activities:
Proceeds from sale of stock and
equity infusion . . . . . . . . . . . -- 102,558 27,575
Investment in Dal-Tile Group Inc. . . . 91 (18,134) --
Fees and expenses incurred in debt
refinancing. . . . . . . . . . . . . . -- (9,457) --
Repayment of long-term debt at time of
refinancing. . . . . . . . . . . . . . -- (98,938) --
--------- -------- -------
Net increase (decrease) in cash . . . . (38) (30,274) 26,888
Cash at beginning of period . . . . . . 97 30,371 3,483
--------- -------- -------
Cash at end of period . . . . . . . . $ 59 $ 97 $30,371
--------- -------- -------
--------- -------- -------
F-23
DAL-TILE INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
18. SUMMARY OF QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a tabulation of the unaudited quarterly results of
operations for the years ended January 2, 1998 and January 3, 1997:
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Year ended January 2, 1998:
Net sales . . . . . . . . . . . . . . . . . . $167,409 $173,742 $177,731 $157,755
Gross profit . . . . . . . . . . . . . . . . . 83,188 73,609 46,270 68,842
Operating income (loss) . . . . . . . . . . . 17,303 (11,891) (64,675) (10,373)
Net income (loss) . . . . . . . . . . . . . . 6,527 (13,803) (80,939) (22,021)
Per share:
Net income (loss) - basic . . . . . . . . 0.12 (0.25) (1.51) (0.41)
- assuming dilution. . . 0.12 (0.25) (1.51) (0.41)
Year ended January 3, 1997
Net sales. . . . . . . . . . . . . . . . . . . $170,674 $180,849 $184,386 $184,327
Gross profit . . . . . . . . . . . . . . . . . 82,734 85,334 90,602 91,835
Operating income . . . . . . . . . . . . . . . 14,224 21,927 31,072 30,641
Income before extraordinary item . . . . . . . 930 4,889 13,175 15,432
Extraordinary item . . . . . . . . . . . . . . - - (29,072) -
Net income (loss). . . . . . . . . . . . . . . 930 4,889 (15,897) 15,432
Per share:
Income before extraordinary
item - basic . . . . . . . . 0.02 0.11 0.27 0.29
- assuming dilution. . . 0.02 0.10 0.26 0.28
Extraordinary item - basic. . . . . . . . . - - (0.59) -
- assuming dilution. . . - - (0.57) -
Net income (loss) - basic. . . . . . . . . 0.02 0.11 (0.32) 0.29
- assuming dilution. . . 0.02 0.10 (0.31) 0.28
The 1996 and first three quarters of 1997 earnings per share amounts have
been restated to comply with SFAS 128.
The sum of quarterly per share amounts does not necessarily equal the annual
amount reported, as per share amounts are computed separately for each
quarter and the full year based on respective weighted average of common and
common equivalent shares outstanding. Share amounts used in the calculation
of net income (loss) per share amounts above are after giving effect to the
Company's common stock conversion in August 1996.
During the second quarter of 1997, the Company recorded charges of
$24,700,000 primarily for the write-down of trade accounts receivable and
inventories. The charge is comprised of $8,400,000 in cost of sales and
$16,300,000 in selling, general and administrative expenses.
During the third quarter of 1997, the Company recorded charges of $65,400,000
primarily for the write-down of obsolete and slow-moving inventories,
uncollectible trade accounts receivable, other non-productive assets and
costs for restructuring manufacturing, store operations and corporate
administrative functions. The charge is comprised of $28,100,000 in cost of
sales, $3,500,000 in transportation expense and $33,800,000 in selling,
general and administrative expenses.
The write-down of uncollectible trade accounts receivable related to
increases in receivables balances arising principally as a result of earlier
sales initiatives that included, among other things, extended credit terms
and efforts to expand the Company's customer base, and operational and
systems integration issues that resulted in limited access by sales center
personnel to certain account information. In addition, in an effort to
improve customer service, authority to extend credit was decentralized and
assigned to management at the retail sales centers. Sales resulting from
these initiatives were a result of products being shipped under defined terms
to customers, with the full expectation of invoiced amounts being paid in
full within the terms of the sale. In response to deterioration in the aging
of the Company's accounts receivable, primarily as a result of the sales
initiatives and operational and systems integration issues, the Company
increased collection efforts and undertook detailed reviews of
collectibility, and subsequently recorded increases in the reserve for
doubtful accounts of $7,600,000 in the second quarter of fiscal year 1997,
and $13,700,000 as of the third quarter of fiscal year 1997. The sales
initiatives, which began in the fourth quarter of fiscal year 1996, were
discontinued by the end of the second quarter of fiscal year 1997. In
addition, by the end of the second quarter of fiscal year 1997, the Company
moved to a more centralized credit approval process and implemented more
stringent credit policies.
At the end of the second quarter of fiscal year 1997, the Company also
extensively reviewed its finished product inventories, including the various
patterns, shapes and sizes of finished product inventories. Based on this
analysis, an adjustment of approximately $8,400,000 was recorded as of the
end of the second quarter of fiscal year 1997 to reflect the write-down of
inventory believed to be slow moving and/or obsolete, or out of balance with
other related products. Management believes that delays in systems
integration resulted in impaired inventory management, and, in particular,
resulted in an imbalance in inventory mix. During the third quarter of
fiscal year 1997, the Company's new management undertook an additional study
of the business and its operations and determined that it would reduce the
number of SKU's offered for sale by the Company and would discontinue
additional patterns. These actions, coupled with the results of physical
inventories and the delay in systems integration, resulted in a need to
record additional inventory provisions of $28,100,000 consisting of
$14,200,000 related to results of physical inventories, $7,300,000 of
additional write-down for obsolete inventory, $4,500,000 write-down for
certain other inventory accounts and $2,100,000 write-down for raw materials.
Management believes that progress in its systems integration resulted in
substantially improved inventory management by the end of the third quarter
of fiscal year 1997.
The balance of the charges recorded in the second quarter of fiscal year 1997
consisted of $2,500,000 in respect of terminated employees and $6,200,000
in respect of other charges, primarily related to liabilities incurred for
lease terminations, executive search fees, and other items. The balance of
the charges recorded in the third quarter of fiscal year 1997 consisted of
$4,200,000 in respect of terminated employees, $8,500,000 in respect of
accrued expenses, primarily related to freight and insurance, $5,300,000 in
respect of fixed asset impairment and $5,600,000 in respect of other
charges, primarily related to write-down of notes, non-trade receivables and
certain other assets.
F-24