UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2001
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 1-9917
------
CATALINA LIGHTING, INC.
-----------------------
(Exact name of registrant as specified in its chapter)
FLORIDA
-------
(State or other jurisdiction of incorporation or organization)
59-1548266
----------
(I.R.S. Employer Identification Number)
18191 NW 68th Avenue, Miami, Florida 33015
------------------------------------------
(Address of principal executive offices) (Zip Code)
(305) 558-4777
--------------
Registrant's telephone number, including area code
----------------------------------------------------------------------
Former name, former address and former fiscal year, if changed
since last report.
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 ___
APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding
of each of the issuer's classes of common stock, as of the latest practicable
date. Outstanding on August 10, 2001: 15,878,247 shares.
-------------------------------------------------
CATALINA LIGHTING, INC. AND SUBSIDIARIES
INDEX
PART I FINANCIAL INFORMATION PAGE NO.
--------
ITEM 1 - Financial Statements:
Condensed consolidated balance sheets -
June 30, 2001 and September 30, 2000................................................. 3
Condensed consolidated statements of operations -
Three and nine months ended June 30, 2001 and 2000.................................. 5
Condensed consolidated statements of cash flows -
Three and nine months ended June 30, 2001 and 2000.................................. 6
Notes to condensed consolidated financial statements................................. 8
ITEM 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................................ 22
ITEM 3 - Quantitative and Qualitative Disclosures About Market Risk................ 38
PART II OTHER INFORMATION
ITEM 1 Legal Proceedings............................................................ 39
ITEM 4 Submission of Matters to a Vote of Security Holders.......................... 39
ITEM 6 Exhibits and Reports on Form 8-K............................................. 39
2
CATALINA LIGHTING, INC. AND SUBSIDIARIES
PART I - FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets
(In thousands)
June 30, September 30,
Assets 2001 2000
------ ---------------------- ---------------------
(Unaudited) *
Current assets
Cash and cash equivalents $ 2,632 $ 2,309
Restricted cash equivalents and short-term investments 1,527 727
Accounts receivable, net of allowance for doubtful accounts
of $1,271 and $772, respectively 28,106 36,632
Inventories 43,162 52,780
Other current assets 5,243 7,343
---------------------- ---------------------
Total current assets 80,670 99,791
Property and equipment, net 30,850 29,932
Goodwill, net 29,327 30,663
Other assets 8,974 7,585
---------------------- ----------------------
$ 149,821 $ 167,971
====================== =====================
(continued on page 4)
3
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets (continued)
(In thousands)
June 30, September 30,
Liabilities and Stockholders' Equity 2001 2000
------------------------------------ ------------------- -----------------
(Unaudited) *
Current liabilities
Accounts and letters of credit payable $ 30,121 $ 36,310
Credit lines 27,803 22,786
Term loans 25,371 28,415
Current maturities of bonds payable-real estate related 900 900
Current maturities of other long-term debt 1,041 1,339
Other current liabilities 11,425 15,647
------------------ -----------------
Total current liabilities 96,661 105,397
Bonds payable - real estate related 4,200 5,100
Other long-term debt 1,238 1,788
Other liabilities 4,425 3,782
------------------ -----------------
Total liabilities 106,524 116,067
Minority interest 1,027 1,075
Stockholders' equity
Common stock, issued 8,000 shares 80 80
Additional paid-in capital 28,560 28,560
Retained earnings 17,427 25,111
Accumulated other comprehensive loss (1,336) (461)
Treasury stock, 642 shares (2,461) (2,461)
------------------ -----------------
Total stockholders' equity 42,270 50,829
------------------ -----------------
$ 149,821 $ 167,971
================== =================
*Condensed from audited financial statements
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(Unaudited)
(In thousands, except per share data)
Three Months Ended Nine Months Ended
June 30, June 30,
--------------------------------- ----------------------------------
2001 2000 2001 2000
--------------- --------------- --------------- ----------------
Net sales $ 60,548 $ 46,705 $ 180,945 $ 131,946
Cost of sales 52,488 37,798 154,715 106,143
-------------- -------------- -------------- ---------------
Gross profit 8,060 8,907 26,230 25,803
Selling, general & administrative expenses 9,774 6,769 31,023 21,034
-------------- -------------- -------------- ---------------
Operating income (loss) (1,714) 2,138 (4,793) 4,769
-------------- -------------- -------------- ---------------
Other income (expenses):
Interest expense (1,313) (456) (4,238) (1,564)
Other income (expenses) (19) 54 (334) 426
-------------- -------------- -------------- ---------------
Total other income (expenses) 1,332 (402) (4,572) (1,138)
-------------- -------------- -------------- ---------------
Income (loss) before income taxes (3,046) 1,736 (9,365) 3,631
Income tax provision (benefit) (629) 656 (1,681) 1,262
-------------- -------------- -------------- ---------------
Net income (loss) $ (2,417) $ 1,080 $ (7,684) $ 2,369
============== ============== ============== ===============
Weighted average number of
shares outstanding
Basic 7,358 7,163 7,358 7,022
Diluted 7,358 8,409 7,358 8,674
Earnings (loss) per share
Basic $ (0.33) $ 0.15 $ (1.04) $ 0.34
Diluted $ (0.33) $ 0.14 $ (1.04) $ 0.30
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)
Nine Months Ended
June 30,
-----------------------------------------
2001 2000
------------------- -----------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (7,684) $ 2,369
Adjustments for non-cash items 3,644 4,130
Change in assets and liabilities 9,641 7,159
------------------- -----------------
Net cash provided by (used in) operating activities 5,601 13,658
------------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (4,204) (2,301)
Proceeds from sale of property and equipment 95 -
Purchase of minority interest (1,029) -
Increase in Ring acquisition costs (119) -
Decrease (increase) in restricted cash equivalents and
short-term investments (144) 738
------------------- -----------------
Net cash provided by (used in) investing activities (5,401) (1,563)
------------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock - 1,005
Payments to repurchase common stock - (1,108)
Proceeds from other long-term debt 323 -
Payments on other long-term debt (1,125) (478)
Payments on bonds payable (900) (2,210)
Proceeds from credit lines 33,739 31,900
Payments on credit lines (28,833) (37,544)
Proceeds from note payable - other - 1,402
Payments on term loans (2,459) -
Payment on convertible subordinated notes - (6,867)
Sinking fund payments on bonds payable (655) (653)
------------------- -----------------
Net cash provided by (used in) financing activities 90 (14,553)
------------------- -----------------
Effect of exchange rate changes on cash 33 (35)
Net increase (decrease) in cash and cash equivalents 323 (2,493)
Cash and cash equivalents at beginning of period 2,309 7,253
------------------- -----------------
Cash and cash equivalents at end of period $ 2,632 $ 4,760
=================== =================
(continued on page 7)
6
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (continued)
(Unaudited)
Supplemental Cash Flow Information
Nine Months Ended
June 30,
-----------------------------------
2001 2000
---------------- ---------------
(In thousands)
Cash paid (received) for:
Interest $ 3,738 $ 1,656
Income taxes $ 1,589 $ (382)
The accompanying notes are an integral part of these condensed consolidated
financial statements.
7
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Summary of Significant Accounting Policies
Basis of Presentation
---------------------
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with the accounting policies described in the
Company's Annual Report on Form 10-K for the fiscal year ended September 30,
2000 and should be read in conjunction with the consolidated financial
statements and notes which appear in that report. These statements do not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements.
In the opinion of management, the condensed consolidated financial
statements include all adjustments (which consist mostly of normal, recurring
accruals) considered necessary for a fair presentation. The results of
operations for the three months and nine months ended June 30, 2001 may not
necessarily be indicative of operating results to be expected for the full
fiscal year due to seasonal fluctuations in the Company's business, changes in
economic conditions and other factors.
Certain amounts previously presented in the financial statements of
prior periods have been reclassified to conform to the current period's
presentation.
Going Concern
-------------
The accompanying condensed consolidated financial statements as of and
for the three and nine months ended June 30, 2001 have been prepared on a going
concern basis, which contemplates the realization of assets and the satisfaction
of liabilities in the normal course of business.
The Company's continuation as a going concern is dependent upon its
ability to comply with the terms and covenants of its $75 million credit
facility and to obtain additional financing or refinancing as may be required.
As of June 30, 2001, the Company was not in compliance with the terms of this
credit facility and was operating under a forbearance agreement. Effective July
23, 2001 the Company renegotiated the terms of its $75 million credit facility
and obtained a capital infusion. See Notes 4, 7 and 10 of Notes to Condensed
Consolidated Financial Statements.
Accounts Receivable
-------------------
The Company provides allowances against accounts receivable for sales
deductions, returns and doubtful accounts. The Company's agreements with its
major customers provide for various sales allowances (i.e., deductions given the
customer from purchases made from the Company), the most common of which are for
volume discounts, consumer product returns, and cooperative advertising. These
allowances are usually defined as a percentage of the gross sales price, and are
recognized as a reduction of gross sales revenue at the time the related sales
are recorded. If the customer agreement does not provide for the deduction of
the allowance amount directly from the amount invoiced the customer at time of
billing, the Company records an accrual for the amounts due. These accrued sales
allowances are settled periodically either by subsequent deduction from the
accounts receivable from the customer or by cash payment. For financial
statement presentation purposes, these sales allowances are netted against
accounts receivable, and amounted to $10,159,000 and $11,703,000 at June 30,
2001 and September 30, 2000, respectively.
8
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)
Derivative Instruments and Hedging Activities
---------------------------------------------
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133") was issued in June
1998. SFAS 133 establishes standards for the accounting and reporting of
derivative instruments embedded in other contracts (collectively referred to as
derivatives) and of hedging activities. It requires that an entity recognize all
derivatives as either assets or liabilities in the balance sheet and measure
those instruments at fair value. Derivatives that are not hedges must be
adjusted to fair value through income. If the derivative is a hedge, depending
on the nature of the hedge, changes in the fair value of derivatives are either
offset against the change in fair value of assets, liabilities, or firm
commitments through earnings or recognized in other comprehensive income (loss)
until the hedged item is recognized in earnings. The ineffective portion of a
derivative's change in fair value will be immediately recognized in earnings.
The Company adopted SFAS 133 on October 1, 2000 and the cumulative
effect on the accumulated comprehensive loss on such date was income of $153,000
(net of $86,000 in income taxes). The fair value of the derivative instrument on
June 30, 2001 was $42,000 (net of $24,000 in income taxes).
All derivatives are recognized on the balance sheet at their fair
value. On the date the derivative contract is entered into, the Company
designates the derivative as (1) a hedge of the fair value of a recognized asset
or liability or of an unrecognized firm commitment ("fair value" hedge), (2) a
hedge of a forecasted transaction or of the variability of cash flows to be
received or paid related to a recognized asset or liability ("cash flow" hedge),
(3) a foreign-currency fair-value or cash-flow hedge ("foreign currency" hedge),
or (4) a hedge of a net investment in a foreign operation. Changes in the fair
value of a derivative that is highly effective as - and that is designated and
qualifies as - a fair-value hedge, along with the loss or gain on the hedged
asset or liability that is attributable to the hedged risk (including losses or
gains on firm commitments), are recorded in current-period earnings. Changes in
the fair value of a derivative that is highly effective as - and that is
designated and qualifies as - a cash-flow hedge are recorded in other
comprehensive income, until earnings are affected by the variability of cash
flows (e.g., when periodic settlements on a variable-rate asset or liability are
recorded in earnings).
Changes in fair value of derivatives that are highly effective as - and
that are designated and qualify as - foreign-currency hedges are recorded in
either current-period earnings or other comprehensive income, depending on
whether the hedge transaction is a fair-value hedge (e.g., a hedge of a firm
commitment that is to be settled in a foreign currency) or a cash-flow hedge
(e.g., a foreign-currency-denominated forecasted transaction). If, however, a
derivative is used as a hedge of a net investment in a foreign operation, its
changes in fair value, to the extent effective as a hedge, are recorded in the
cumulative translation adjustments account within equity.
The Company formally documents all relationships between hedging
instruments and hedged items, as well as its risk-management objective and
strategy for undertaking various hedge transactions. This process includes
linking all derivatives that are designated as fair-value, cash-flow, or
foreign-currency hedges to specific assets and liabilities on the balance sheet
or to specific firm commitments or forecasted transactions. The Company also
formally assesses, both at the hedge's inception and on an ongoing basis,
whether the derivatives that are used in hedging transactions are highly
effective in offsetting changes in fair values or cash flows of hedged items. If
it is determined that a derivative is not highly effective as a hedge or that it
has ceased to be a highly effective hedge, the Company will discontinue hedge
accounting prospectively. See also Note 8 of Notes to Condensed Consolidated
Financial Statements.
Revenue Recognition
-------------------
The Company manufactures and sells its products pursuant to purchase
orders received from customers and recognizes revenue at the time its products
are delivered to the customer or the customer's carrier. Any shipping, handling
or other costs incurred by the Company associated with the sale are expensed as
cost of sales at the time of sale recognition.
9
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)
Comprehensive Income (loss)
---------------------------
Comprehensive income (loss) consisted of the following:
Three Months Ended June 30, Nine Months Ended June 30,
-------------------------------- ---------------------------------
2001 2000 2001 2000
-------------- ------------- ------------- ------------
(In thousands) (In thousands)
Net income (loss) $ (2,417) $ 1,080 $ (7,684) $ 2,369
Foreign currency translation gain (loss)
(98) - (833) -
Change in unrealized loss on derivative
instrument, net of taxes
10 - (42) -
-------------- ------------- ------------- ------------
Total comprehensive income (loss) $ (2,505) $ 1,080 $ (8,559) $ 2,369
============== ============= ============= ============
New Accounting Pronouncements
-----------------------------
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101") which summarizes certain of the staff's
view in applying generally accepted accounting principles to revenue recognition
in financial statements. The effective date of SAB 101 for the Company is the
quarter ending September 30, 2001. The Company has evaluated the impact that SAB
101 will have on the timing of revenue recognition in future periods and
believes SAB 101 will not have a material impact on its financial position or
results of operations.
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 141 ("SFAS 141") "Business
Combinations". SFAS 141 addresses financial accounting and reporting for
business combinations and supercedes Accounting Principles Board Opinion No. 16,
"Business Combinations and Statement of Financial Accounting No. 38 "Accounting
for Preacquisition Contingencies of Purchased Enterprises". All business
combinations in the scope of SFAS 141 are to be accounted for under the
purchased method. SFAS 141 is effective June 30, 2001. The Company does not
expect the adoption of SFAS 141 to have an impact on its financial position,
results of operations or cash flows.
In July 2001, the FASB also issued Statement of Financial Accounting
Standards No. 142 "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 142
addresses financial accounting and reporting for intangible assets acquired
individually or with a group of other assets (but not those acquired in a
business combination) at acquisition. SFAS 142 also addresses financial and
accounting and reporting for goodwill and other intangible assets subsequent to
their acquisition. With the adoption of SFAS 142, goodwill is no longer subject
to amortization. Rather, goodwill will be subject to at least an annual
assessment for impairment by applying a fair-value based test. The impairment
loss is the amount, if any, by which the implied fair value of goodwill is less
than carrying or book value. SFAS 142 is effective for fiscal years beginning
after December 15, 2001. Impairment loss for goodwill arising from the initial
application of SFAS 142 is to be reported as resulting from a change in
accounting principle. As of June 30, 2001, the Company has not assessed the
impact of adopting SFAS 142.
2. Inventories
Inventories consisted of the following:
June 30, September 30,
2001 2000
--------------- ---------------
(In thousands)
Raw materials $ 3,121 $ 6,700
Work-in-progress
917 1,159
Finished goods
39,124 44,921
--------------- ---------------
Total inventories $ 43,162 $ 52,780
=============== ===============
10
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)
3. Property and Equipment, net
In September 2000, the Company's wholly owned Hong Kong subsidiary, Go-
Gro Industries ("Go-Gro") made a deposit of approximately $1 million to purchase
its joint venture partner's interest in Go-Gro's Chinese cooperative joint
venture manufacturing subsidiary, Shenzhen Jiadianbao Electrical Products Co.,
Ltd. ("SJE"). This purchase was finalized in December 2000. During the quarter
ended March 31, 2001, SJE was converted under Chinese law from a cooperative
joint venture to a wholly owned foreign entity and its name changed to
Jiadianbao Electrical Products (Shenzhen) Co., Ltd. ("JES").
JES obtained non-transferable land use rights for the land on which its
primary manufacturing facilities were constructed under a Land Use Agreement
dated April 11, 1995 between SJE and the Bureau of National Land Planning Bao-An
Branch of Shenzhen City. This agreement provides JES with the right to use this
land until January 18, 2042 and required SJE to construct approximately 500,000
square feet of factory buildings and 211,000 square feet of dormitories and
offices. This construction is complete and total costs aggregated $15.8 million.
In connection with the settlement with Go-Gro's former joint venture
partner in SJE, JES acquired the land use rights for a parcel of land adjoining
its primary manufacturing facilities. Under the separate land use agreement for
this parcel, JES has the right to use the land through March 19, 2051 and is
obligated to complete new construction on the land (estimated to cost
approximately $1.3 million) by March 20, 2002. If this construction is not
completed by that date JES is subject to fines, and if the construction is not
completed by March 20, 2004, the local municipal planning and state land bureau
may take back the land use rights for the parcel without compensation and
confiscate the structures and attachments.
4. Credit Lines
The Company has a $75 million credit facility which funded the
Company's acquisition of Ring Plc ("Ring") and that provides funds through
revolving facilities for the Company's U.S. and U.K. operations. The credit
facility agreement required that the Company meet certain financial covenants
and obtain certain statutory declarations and associated independent auditors'
report relating to the acquisition of Ring.
The Company obtained amendments to the credit facility on December 22,
2000 and February 9, 2001, without which the Company would not have been in
compliance with the credit facility's financial covenants for the quarters ended
September 30, 2000 and December 31, 2001. On March 30, 2001, the Company
obtained an amendment extending the deadline for obtaining the statutory
declarations and related auditors' report to May 31, 2001.
As a result of the net loss for the quarter ended March 31, 2001, the
Company was not in compliance with a financial covenant under its $75 million
credit facility for that quarter, and would not have been able to obtain the
statutory declarations and related auditors' report by May 31, 2001 as required
by the credit facility. On May 15, 2001 the Company obtained a forbearance
agreement, which waived and deferred until June 15, 2001, the lenders' ability
to exercise their rights and remedies for the event of default under the credit
facility resulting from the failure to meet the financial covenant. This
forbearance agreement also extended for the same period the deadline for
obtaining the statutory declarations and related auditors' report. The Company
subsequently obtained two amendments to the forbearance agreement that extended
its terms through July 31, 2001.
11
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)
On July 23, 2001 the Company obtained $11.8 million in additional
funding from the closing of a transaction with a new investor and other parties.
The Company amended and restructured its $75 million credit facility in
connection with this transaction. The net proceeds from the transaction
amounting to $8.4 million were applied against the revolving loans and term
loans under this credit facility. Borrowings under this facility now bear
interest, payable monthly at the Company's option of either the prime rate plus
an applicable margin or the LIBOR rate plus an applicable margin. Under the
amended facility, the Company is required to meet minimum levels of adjusted
quarterly earnings beginning with the quarter ending September 30, 2001 and
revised quarterly leverage and fixed charge ratios beginning with the quarter
ending December 31, 2002. Annual capital expenditures are limited under the
amendment to $3.75 million. The term loans are now repayable in installments
aggregating (i) $200,000 on each of September 30, 2001, December 31, 2001, March
31, 2002, June 30, 2002 and September 30, 2002; (ii) $750,000 on each of
December 31, 2002, March 31, 2003, June 30, 2003, and September 30, 2003, and;
(iii) $20,842,000 on December 31, 2003. The revolving loans under the facility
mature December 31, 2003. The amendment eliminated (as an event of default under
the facility) the requirement that the Company obtain the statutory declarations
and associated independent auditors' report. However, if such statutory
declarations and auditors' report are not obtained by December 31, 2001, 50
basis points will be added to the facility's effective interest rate. The bank
syndication group's fee for the amendment consisted of the right to obtain
warrants to purchase 329,149 shares of common stock at a price of $.01 per
share. See also Notes 7 and 10 of Notes to Condensed Consolidated Financial
Statements.
The Company's Canadian subsidiary has a credit facility with a Canadian
bank which provides 5.5 million Canadian dollars or U.S. equivalent
(approximately U.S. $3.6 million) in revolving demand credit. Canadian dollar
advances bear interest at the Canadian prime rate plus .5% (6.75% at June 30,
2001) and U.S. dollar advances bear interest at the U.S. base rate of the bank
(7.25% at June 30, 2001). The credit facility is secured by substantially all of
the assets of the Company's Canadian subsidiary. The agreement contains certain
minimum covenants to be met by the Canadian subsidiary, prohibits the payment of
dividends, and limits advances by the bank to a borrowing base calculated based
upon receivables and inventory. At September 30, 2000, $2.5 million in net
assets of the Company's Canadian subsidiary were restricted under the credit
facility and could not be transferred to the parent Company. This facility is
payable upon demand and is subject to an annual review by the bank. The Company
pays a monthly commitment fee of .25% based on the unused portion of the
facility. At June 30, 2001, U.S. $274,000 was available under the borrowing base
calculation. On August 13, 2001, the Company received verbal notification from
the bank of their intention to demand repayment by December 31, 2001.
12
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)
5. Segment Information
Information on operating segments and a reconciliation to income (loss)
before income taxes for the three and nine months ended June 30, 2001 and 2000
are as follows (in thousands):
Three Months Ended June 30,
---------------------------------------------------------------------------------------------
Net Sales 2001 2000
--------------------------------------------- ---------------------------------------------
by Operating Segment: External External
Customers Intersegment Total Customers Intersegment Total
--------------------------------------------- ---------------------------------------------
United States $ 24,864 $ 137 $ 25,001 $ 31,726 $ 166 $ 31,892
China 5,756 26,317 32,073 7,927 30,578 38,505
United Kingdom 24,415 - 24,415 - - -
Other segments 5,513 35 5,548 7,052 48 7,100
Eliminations - (26,489) (26,489) - (30,792) (30,792)
--------------------------------------------- ---------------------------------------------
$ 60,548 $ - $ 60,548 $ 46,705 $ - $ 46,705
============================================= =============================================
Nine Months Ended June 30,
---------------------------------------------------------------------------------------------
2001 2000
External External
Customers Intersegment Total Customers Intersegment Total
--------------------------------------------- ---------------------------------------------
United States $ 60,044 $ 547 $ 60,591 $ 88,359 $ 716 $ 89,075
China 19,030 66,553 85,583 20,329 82,594 102,923
United Kingdom 80,453 - 80,453 - - -
Other segments 21,418 309 21,727 23,258 169 23,427
Eliminations - (67,409) (67,409) - (83,479) (83,479)
--------------------------------------------- ---------------------------------------------
$180,945 $ - $180,945 $ 131,946 $ - $ 131,946
============================================= ==============================================
13
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)
Net Sales by Location Three Months Ended Nine Months Ended
of External Customers: June 30, June 30,
----------------------------- ----------------------------
2001 2000 2001 2000
------------ ----------- ------------ ------------
United States $ 25,031 $ 31,735 $ 60,425 $ 88,474
United Kingdom 24,099 - 77,877 -
Canada 4,550 5,954 18,544 19,646
Other countries 6,868 9,016 24,099 23,826
------------ ----------- ------------ ------------
$ 60,548 $ 46,705 $ 180,945 $ 131,946
============ =========== ============ ============
Segment Contribution (Loss): Three Months Ended Nine Months Ended
June 30, June 30,
----------------------------- ----------------------------
2001 2000 2001 2000
------------ ----------- ------------ ------------
United States $ (437) $ 792 $ (1,831) $ 3,023
China 1,650 2,957 4,684 7,176
United Kingdom (773) - (3,273) -
Other segments (948) 148 (1,348) 922
------------ ----------- ------------ ------------
Subtotal for segments (508) 3,897 (1,768) 11,121
Executive management reorganization - - - (788)
Parent/administrative expenses (2,538) (2,161) (7,597) (6,702)
------------ ----------- ------------ ------------
Income (loss) before income taxes $ (3,046) $ 1,736 $ (9,365) $ 3,631
============ =========== ============ ============
Interest Expense (Income) (1): Three Months Ended Nine Months Ended
June 30, June 30,
----------------------------- ----------------------------
2001 2000 2001 2000
------------ ----------- ------------ ------------
United States $ (168) $ 58 $ (381) $ 330
China (7) 40 (120) 233
United Kingdom 920 - 3,053 -
Other segments 81 86 324 355
------------ ----------- ------------ ------------
Subtotal for segments 826 184 2,876 918
Parent interest expense 487 272 1,362 646
------------ ----------- ------------ ------------
Total interest expense $ 1,313 $ 456 $ 4,238 $ 1,564
============ =========== ============ ============
Total Assets (2): June 30, September 30,
2001 2000
-------------------- -------------------
United States $ 56,174 $ 64,263
China 48,830 53,170
United Kingdom 68,083 75,505
Other segments 10,222 14,252
Eliminations (33,488) (39,219)
-------------------- -------------------
Total assets $ 149,821 $ 167,971
==================== ===================
14
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)
Long-Lived Assets (3):
June 30, September 30,
2001 2000
------------- ---------------
United States $ 11,183 $ 12,156
China 15,495 12,516
United Kingdom 4,070 5,125
Other segments 102 135
------------ --------------
Total long-lived assets $ 30,850 $ 29,932
============ ==============
Expenditures for Additions to Long-Lived Assets:
Nine Months Ended June 30,
------------------------------------
2001 2000
--------------- ---------------
United States $ 102 $ 537
China 3,754 1,862
United Kingdom 335 -
Other segments 13 81
--------------- ---------------
Total expenditures $ 4,204 $ 2,480
=============== ===============
(1) The interest expense shown for each segment includes interest paid
or earned on inter-segment advances.
(2) Total assets for United States include parent/administrative
assets.
(3) Represents property and equipment, net.
Major Customers
---------------
During the three months ended June 30, 2001 and 2000 one customer with
U.S. and Canadian operations accounted for 13.9% and 30.8%, respectively, of the
Company's net sales and during the nine months ended June 30, 2001 and 2000,
accounted for 12.8% and 29.5%, respectively, of the Company's net sales. Another
customer with locations in the U.S., Canada and Mexico accounted for 12.2% and
9.4%, respectively, of the Company's net sales during the three months ended
June 30, 2001 and 2000. During the three and nine months ended June 30, 2001 one
other customer (included in United Kingdom - based operations) accounted for
16.9% and 17.1%, respectively, of the Company's net sales.
15
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)
6. Commitments and Contingencies
Westinghouse License
--------------------
On April 26, 1996, the Company entered into a license agreement with
Westinghouse Electric Corporation to market and distribute a full range of
lighting fixtures, lamps and other lighting products under the Westinghouse
brand name in exchange for royalty payments. Subject to the minimum sales
conditions discussed below, the agreement terminates on September 30, 2002 with
the Company having options to extend the agreement for two additional five-year
terms. The royalty payments are due quarterly and are based on a percent of the
value of the Company's net shipments of Westinghouse branded products, subject
to annual minimum net shipments. Either party has the right to terminate the
agreement if the Company does not meet the minimum net shipments of $30 million
for fiscal 2001 and $60 million for fiscal 2002. Net sales of Westinghouse
branded products amounted to $13.3 million and $20.0 million for the nine months
ended June 30, 2001 and 2000, respectively.
Litigation
----------
During the past few years the Company received a number of claims
relating to halogen torchieres sold by the Company to various retailers. After
January 1, 1999, the Company is self-insuring up to $10,000 per incident. Based
upon its experience, the Company is presently accruing for this self-insurance
provision and has accrued $230,000 for this contingency as of June 30, 2001.
Management does not believe that this self-insurance provision will have a
material adverse impact on the Company's financial position or annual results of
operations. However, no assurance can be given that the number of claims will
not exceed historical experience or that claims will not exceed available
insurance coverage or that the Company will be able to maintain the same level
of insurance.
On September 15, 1999, the Company filed a complaint entitled Catalina
Lighting, Inc. v. Lamps Plus, Civil Action 99-7200, in the U.S. District Court
for the Southern District of Florida. The lawsuit requested declaratory relief
regarding claims of trade dress and patent infringement made by Lamps Plus
against a major customer of the Company. Lamps Plus filed an Answer and
Counterclaim against the Company and its customer on October 6, 1999 alleging
patent infringement and trade dress. The trade dress claim was dismissed with
prejudice before trial in March 2001. In April 2001, a jury returned a verdict
finding liability against the Company on the patent infringement claim and in
June 2001 the Court entered a judgment of approximately $1.8 million for damages
and interest thereon. The Company plans to appeal the judgment entered by the
Court and to obtain the necessary surety bond for the appeal. Based upon advice
of counsel, the Company believes that it ultimately will not be found liable for
patent infringement in this case. Accordingly, no provision for loss has been
recorded in the accompanying June 30, 2001 Condensed Consolidated Financial
Statements for this matter.
NYSE Listing
------------
On August 9, 1999 the New York Stock Exchange ("NYSE") notified the
Company that it had changed its rules regarding continued listing for companies
which have shares traded on the NYSE. The new rules changed and increased the
requirements to maintain a NYSE listing. Through March 31, 2001, the Company did
not meet the new rules, which required a total market capitalization of $50
million and the maintenance of minimum total stockholders' equity of $50
million. On April 5, 2001 the NYSE announced that it had determined that the
common stock of the Company should be removed from the list of companies trading
on the NYSE. The Company decided not to appeal the NYSE's decision. On May 21,
2001 the Company's common stock began trading on the NASDAQ Over-the-Counter
Bulletin Board under the symbol "CALA.OB".
16
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)
Pension Plan
------------
The Company's U.K. subsidiary, Ring Limited ("Ring") has a defined
benefit pension plan which covers 29 current employees and over 1,000 other
members formerly associated with Ring. The plan is administered externally and
the assets are held separately by professional investment managers. The plan is
funded by contributions at rates recommended by an actuary. The Company is
reviewing the plan and believes that in the future it may terminate the plan. It
is anticipated that a termination will require payment of a lump sum equal to
the "Minimum Funding Requirement ("MFR") shortfall. The most recent estimate as
of January 2001 placed the MFR shortfall at approximately $2.0 million. The U.K.
Government announced in its March 2001 budget that it intends to abolish the MFR
and to replace it with funding standards individually tailored to the
circumstances of plans and employers. Based on current information, it appears
that this change is not likely to occur before April 2003, and should the
Company not terminate its U.K. pension plan prior to that date, the cost to
terminate the Company's U.K. plan under the new rules is likely to be much
greater than the current $2 million deficit under the MFR method.
7. Going Concern
The accompanying financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the satisfaction
of liabilities in the normal course of business. As discussed in Note 4, the
Company has significant borrowings obtained through a $75 million credit
facility which required, among other things, compliance with financial
covenants, including a leverage ratio and a fixed charge coverage ratio, on a
quarterly basis. The Company obtained amendments to the credit facility on
December 22, 2000 and February 9, 2001, without which the Company would not have
been in compliance with the credit facility's financial covenants for the
quarters ended September 30, 2000 and December 31, 2000. Due to the sales and
profitability declines the Company experienced for the quarter ended March 31,
2001 the Company was not in compliance with one of the amended financial
covenants of the credit facility for the quarter ended March 31, 2001. On May
15, 2001 the Company obtained a forbearance agreement, which waived and deferred
through June 15, 2001 the lenders' ability to exercise their rights and remedies
for the event of default under the credit facility resulting from the failure to
meet the financial covenant for the quarter ended March 31, 2001.
In addition to requiring the Company to meet financial covenants, the
$75 million credit facility required the Company to complete a "whitewash
procedure" by obtaining certain statutory declarations and an associated
auditors' report prescribed under English law, relating to the acquisition of
Ring.
The February 9, 2001 amendment of the $75 million credit facility
included a requirement that the Company procure the statutory declarations and
independent auditors' report thereon by March 31, 2001. On March 30, 2001, the
Company obtained an amendment to the credit facility extending this deadline to
May 31, 2001 and on May 15, 2001 the Company obtained a forbearance agreement
from its lenders which extended this deadline to June 15, 2001.
The forbearance agreement obtained by the Company on May 15, 2001 was
amended and extended on June 15, 2001 and again on July 16, 2001, with the
second amendment extending the terms of the forbearance agreement through July
31, 2001.
On July 23, 2001 the Company obtained $11.8 million in additional
funding as a result of closing a transaction (the "Sun transaction") with Sun
Catalina Holdings LLC (SCH), an affiliate of Sun Capital Partners, Inc. (a
merchant banking firm based in Boca Raton, Florida) and other parties. See Note
10 of Notes to Condensed Consolidated Financial Statements.
17
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)
The Company amended and restructured its $75 million credit facility
with its bank syndicate group in connection with the Sun transaction. The net
proceeds from the transaction amounting to $8.4 million were applied against the
revolving loans and term loans under this credit facility. Borrowings under the
facility bear interest, payable monthly at the Company's option of either the
prime rate plus 1.75% or the LIBOR rate plus 2.75% and thereafter at the rate of
prime plus 2% or LIBOR plus 4.75%. Under the amended facility, the Company is
required to meet minimum levels of adjusted quarterly earnings beginning with
the quarter ending September 30, 2001 and revised quarterly debt to adjusted
earnings and fixed charge ratios beginning with the quarter ending December 31,
2002. Annual capital expenditures are limited under the amendment to $3.75
million. The term loans are now repayable in installments aggregating (i)
$200,000 on September 30, 2001, December 31, 2001, March 31, 2002, June 30, 2002
and September 30, 2002; (ii) $750,000 on December 31, 2002, March 31, 2003, June
30, 2003, and September 30, 2003, and; (iii) $20,842,000 on December 31, 2003.
The revolving loans under the facility mature December 31, 2003. The amendment
eliminated (as an event of default under the facility) the requirement that the
Company obtain the statutory declarations and associated independent auditors'
report. However, if such statutory declarations and auditors' report are not
obtained by December 31, 2001, 50 basis points will be added to the facility's
effective interest rate. The bank syndication group's fee for the amendment
consisted of the right to obtain warrants to purchase 329,149 shares of common
stock at a price of $.01 per share.
The Company utilizes the revolving portions of its $75 million credit
facility to support its operations in the U.S. and U.K. The Company's U.S.
operations are also supported to a limited extent by cash flows from the
Company's China operations. Due to an inability to transfer funds from the U.K.
to the U.S. until the whitewash procedure is completed, all payments on the
Company's term loans must presently be made by the Company's U.S. operations. As
of August 10, 2001, the Company had approximately $13.9 million available under
its revolving facilities to support U.S. and U.K. operations. Should its
operating losses continue, or should its cash needs in the future exceed its
available borrowings under the revolving facilities, the Company may be required
to obtain either a modification of the $75 million credit facility or funding
from other sources to continue to support its operations.
The Company's ability to satisfy the terms of its $75 million credit
facility in future quarters depends on business and economic conditions,
including demand for the Company's products. The Company's continuation as a
going concern is dependent upon its ability to successfully maintain the
necessary financing arrangements and to comply with the terms of its $75 million
credit facility.
8. Derivative Instruments and Hedging Activities
The Company sells its products in Europe and the United Kingdom and
maintains major capital investments in manufacturing facilities in China,
administrative offices in Hong Kong, and sales and distribution operations in
the United Kingdom. The Company also has subsidiaries in Canada and Mexico and
sells its products in these foreign countries. Of the Company's revenues for the
nine months ended June 30, 2001, 67% were generated from international
customers. The Company's activities expose it to a variety of market risks,
including the effects of changes in foreign-currency exchange rates. These
foreign currency exposures are monitored and managed by the Company. The
Company's foreign-currency risk-management program focuses on the
unpredictability of foreign currency exchange rate movements and seeks to reduce
the potentially adverse effects that the volatility of these movements may have
on its operating results.
The Company maintains a foreign-currency risk-management strategy that
uses derivative instruments to protect its interests from unanticipated
fluctuations in earnings and cash flows caused by volatility in currency
exchange rates. Movements in foreign-currency exchange rates pose a risk to the
Company's operations and competitive position, since exchange-rate changes may
affect profitability, cash flows, and business and/or pricing strategies. The
Company uses foreign-currency forward-exchange contracts to partially hedge
these risks.
By using derivative financial instruments to hedge exposures to changes
in exchange rates, the Company exposes itself to credit risk and market risk.
Credit risk is the failure of the counterparty to perform under the terms of the
derivative contract. When the fair value of a derivative contract is positive,
the counterparty owes the Company, which creates repayment risk for the Company.
When the fair value of a derivative contract is negative, the Company owes the
counterparty and, therefore, it does not possess repayment risk. The Company
minimizes the credit (or repayment) risk in derivative instruments by entering
into transactions with high-quality counterparties.
18
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)
The Company's derivatives activities are subject to the management,
direction and control of the Foreign Currency Risk Management Committee (FCRMC).
The FCRMC is composed of the chief executive officer, the chief financial
officer, and other officers of the Company. The FCRMC reports to the board of
directors on the scope of its derivatives activities. The FCRMC (1) sets forth
risk-management philosophy and objectives through a corporate policy, (2)
provides guidelines for derivative-instrument usage, and (3) establishes
procedures for control and valuation, counterparty credit approval, and the
monitoring and reporting of derivative activity.
Fair-Value Hedges
-----------------
As of June 30, 2001 and for the nine months then ended, the Company's
U.K. subsidiary, Ring, entered into forward-exchange contracts to hedge the
foreign-currency exposure of its firm commitments to purchase certain
inventories from China and Europe in currencies other than the British pound.
The forward contracts used in this program mature in three months or less,
consistent with the related purchase commitments.
Cash Flow Hedge
---------------
The Company uses an interest-rate swap to convert the variable rate
bonds payable related to its U.S. warehouse facility into a fixed rate of 5.52%.
The fair value of this cash-flow hedge of $42,000 (loss, net of tax benefit) at
June 30, 2001 is included in stockholders' equity as part of the accumulated
comprehensive loss.
9. Restructuring Charge
In September 2000, the Company's United States (Catalina Industries)
business segment finalized plans to consolidate the functions of its Boston
office into the Miami headquarters. A $500,000 charge comprised of employee
severance costs ($422,000), property write-downs ($56,000) and lease termination
costs ($22,000) was recorded in September 2000 for the Boston office closure.
The closing of the Boston office resulted in the termination of two
vice-presidents and eight customer support and administrative personnel. The
non-cash property write-down consisted of the net book value of leasehold
improvements and the office furniture and other equipment not suitable for use
by the Miami headquarters or the Company's Canadian operations. The charge for
lease termination costs represented the remaining aggregate contractual lease
obligation for the Boston office subsequent to the date of its closure, net of
projected sublease income. Catalina Industries continued to incur and expense
normal payroll, depreciation, lease and other operating costs for its Boston
office through March 31, 2001, amounting to approximately $400,000, until the
office was closed in December 2000 and certain remaining employees ceased
working for the Company in March 2001. In addition, due to a continuing
inability to sublease the Boston office space, Catalina Industries increased its
provision for lease termination costs by $100,000 and $150,000 during the three
and nine months ended June 30, 2001, respectively. Operating costs for the
Boston office were approximately $247,000 and $786,000 for the three and nine
months ended June 30, 2000, respectively.
10. Recent Developments
On July 23, 2001 the Company obtained $11.8 million in additional
funding as a result of closing a transaction (the "Sun transaction") with Sun
Catalina Holdings LLC (SCH), an affiliate of Sun Capital Partners, Inc. (a
merchant banking firm based in Boca Raton, Florida) and other parties.
In exchange for the $11.8 million, the Company issued SCH 8,489,932
shares of common stock and $4.5 million in secured subordinated notes, and
issued $4.3 million in secured subordinated notes to another lender, SunTrust
Equity Partners (STEP). SCH and STEP also received the right to obtain warrants
exercisable immediately upon receipt at $.01 per share to purchase an additional
3,904,838 and 1,652,636 shares, respectively, of the Company's common stock.
Immediately after the Sun transaction, SCH owned approximately 53% of the
Company's outstanding common shares. In connection with the Sun transaction the
Company redeemed its shareholders rights plan. SCH entered into a ten-year
management services agreement with the Company at an annual fee of $500,000 at
the time of closing.
19
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)
The secured subordinated notes are due in full on July 23, 2006. These
notes bear interest at 12%, compounded quarterly. Interest on the notes is
payable quarterly in arrears in cash commencing March 31, 2003. Interest for
quarters prior to the quarter ending March 31, 2003 will be added to the
principal amount of the notes. Interest and principal on the notes are
prepayable subject to a premium equal to an additional 5% of the principal
amount of the note. SCH and STEP are also entitled to additional warrants to
purchase common shares at $.01 per share for the quarters during which interest
on the notes is not paid in cash. Such additional warrants would total 1,078,441
shares of common stock, assuming interest payments do not commence until March
31, 2003.
The Company amended and restructured its $75 million credit facility
with its bank syndicate group in connection with the Sun transaction. The net
proceeds from the transaction, amounting to $8.4 million, were applied against
the revolving loans and term loans under this credit facility. Borrowings under
the facility bear interest, payable monthly at the Company's option of either
the prime rate plus an applicable margin or the LIBOR rate plus an applicable
margin. Under the amended facility, the Company is required to meet minimum
levels of adjusted quarterly earnings beginning with the quarter ending
September 30, 2001 and revised quarterly debt to adjusted earnings and fixed
charge ratios beginning with the quarter ending December 31, 2002. Annual
capital expenditures are limited under the amendment to $3.75 million. The term
loans are now repayable in installments aggregating (i) $200,000 on each of
September 30, 2001, December 31, 2001, March 31, 2002, June 30, 2002 and
September 30, 2002; (ii) $750,000 on each of December 31, 2002, March 31, 2003,
June 30, 2003, and September 30, 2003, and; (iii) $20,842,000 on December 31,
2003. The revolving loans under the facility mature December 31, 2003. The
amendment eliminated (as an event of default under the facility) the requirement
that the Company completed the whitewash procedure in connection with the Ring
acquisition by obtaining the statutory declarations and associated independent
auditors' report. However, if such statutory declarations and auditors' report
are not obtained by December 31, 2001, 50 basis points will be added to the
facility's effective interest rate. The bank syndication group's fee for the
amendment consisted of the right to obtain warrants to purchase 329,149 shares
of common stock at a price of $.01 per share.
The Company's employment agreements with its Chief Executive Officer,
two Executive Vice Presidents and Chief Financial Officer provided for certain
payments to these employees in the event the Company experienced a "change in
control". The Company resolved these obligations as part of the Sun transaction
by terminating the previous employment agreements and entering into settlement
agreements with these employees, which agreements provide in the aggregate for
(i) the granting of options to purchase 1,569,229 shares of common stock at a
price of $1.18 per share, subject to the increase in the Company's authorized
shares, as discussed below, and (ii) payments of approximately $198,000 each
quarter over a three-year period beginning September 1, 2001. The quarterly
payments under these settlement agreements are suspended at any time in which a
default under the Company's credit facility has occurred and is continuing.
Effective with the closing of the Sun transaction, the Company's former Chief
Executive Officer entered into a new one-year employment agreement to serve as
the Company's President, the Chief Financial Officer signed a new one-year
employment agreement, and the employment of the Company's Executive Vice
Presidents was terminated. As part of the settlement agreements the Company
obtained covenants not to compete through July 23, 2004.
Prior to the Sun transaction, 7,388,315 shares of the Company's common
stock were outstanding, and another 1,523,434 shares were issuable upon exercise
of outstanding stock options. In connection with the Sun transaction and the
amendment of the credit facility, the Company issued SCH 8,489,932 shares and,
subject to an increase in the Company's authorized shares, granted the rights to
SCH and the other parties to obtain warrants and stock options for an additional
8,784,293 shares. Because the aggregate number of shares (including shares
issuable upon exercise of options or warrants) to be issued in the transaction
would exceed the remaining available authorized shares, the Company is required
to obtain shareholder approval to increase its authorized number of shares to an
amount sufficient to provide for the additional shares contingently issuable as
a result of the transaction. If shareholder approval is not obtained and the
warrants due STEP and the bank syndication group are not issued by December 31,
2001, STEP has the right to retroactively increase the interest rate on its
subordinated note to 15%, and the bank group has the right to add 75 basis
points to the interest rate on the credit facility.
20
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)
As a result of these transactions, the Company's board of directors was
expanded to nine members, and six individuals designated by SCH became members
of the board of directors. Subsequent to the consummation of these transactions,
Eric Bescoby (formerly the president and a director of an affiliate of SCH) was
named chief executive officer of the Company. In addition, the board of
directors was expanded to ten members and Mr. Bescoby became a member of the
board of directors. On August 8, 2001 Robert Hersh, the Company's President, and
a member of the board of directors resigned from the board of directors and
terminated his employment with the Company.
The Sun transaction may constitute a change of ownership of the Company
as defined under Internal Revenue Code Section 382 ("IRC 382"). In general, IRC
382 can limit an entity's utilization of its net operating loss carryforwards
and other anticipated tax return deductions existing at the time the change in
ownership occurs. Management is presently evaluating and has not yet determined
the impact of IRC 382 on the Company arising from the Sun transaction. The
Company had $4.7 million in deferred tax assets at June 30, 2001. A portion or
all of these deferred tax assets may be required to be expensed should it
ultimately be determined that the utilization of the components of these
deferred tax assets is limited under IRC 382.
11. Income Taxes
The effective income tax rates for the nine months ended June 30, 2001 and
2000 were 17.9% and 34.8%, respectively. The lower effective tax rate for the
Company's income tax benefit in 2001 is attributable to $3.7 million in losses
for which no tax benefit has been provided. The Company's effective income tax
rate is dependent both on the total amount of pretax income generated and the
source of such income (i.e. domestic or foreign). Consequently, the Company's
effective tax rate may vary in future periods. The Company's effective income
tax rate reflects the anticipated tax benefits associated with the Company's
1999 restructuring of its international operations. Should these tax benefits
not materialize, the Company may experience an increase in its effective
consolidated income tax rate.
21
CATALINA LIGHTING, INC. AND SUBSIDIARIES
ITEM II Management's Discussion and Analysis of Financial Condition and Results
of Operations
Certain statements in this Management's Discussion and Analysis of
Financial Condition and Results of Operations, including without limitation
expectations as to future sales and operating results as discussed under
"Outlook" and the discussion under "Liquidity and Capital Resources" constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995 (the "Reform Act"). Words such as "expects,"
"anticipates," "believes," "plans," "intends," "estimates," variations of such
words and similar expressions are intended to identify such forward-looking
statements. These statements involve known and unknown risks, uncertainties and
other factors which may cause the actual results, performance or achievements of
Catalina Lighting, Inc. and its subsidiaries (collectively, the "Company") to be
materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. Factors that would
cause or contribute to the inability to obtain the results or to fulfill the
other forward-looking statements include, but are not limited to, the following:
the highly competitive nature of the lighting industry; the Company's reliance
on key customers who may delay, cancel or fail to place orders; consumer demand
for lighting products; dependence on third party vendors and imports from China
which may limit the Company's margins or affect the timing of revenue and sales
recognition; general domestic and international economic conditions which may
affect consumer spending; brand awareness, the existence or absence of adverse
publicity, continued acceptance of the Company's products in the marketplace,
new products and technological changes, and changing trends in customer tastes,
each of which can effect demand and pricing for the Company's products;
pressures on product pricing and pricing inventories; cost of labor and raw
materials; the availability of capital; the ability to satisfy the terms of, and
covenants under, credit and loan agreements and the impact of increases in
borrowing costs, each of which affect the Company's short-term and long-term
liquidity and ability to operate as a going concern; the costs and other effects
of legal and administrative proceedings; foreign currency exchange rates;
changes in the Company's effective tax rate (which is dependent on the Company's
U.S. and foreign source income); and other factors referenced in this Form 10-Q
and the Company's annual report on Form 10-K for the year ended September 30,
2000. The Company will not undertake and specifically declines any obligation to
update or correct any forward-looking statements to reflect events or
circumstances after the date of such statements or to reflect the occurrence of
anticipated or unanticipated events.
In the following comparison of the results of operations, the three and
nine months ended June 30, 2001 and 2000 are referred to as 2001 and 2000,
respectively. Unless otherwise noted, U.S. dollar equivalents of foreign
currency amounts are based upon the exchange rates prevailing at June 30, 2001.
RECENT DEVELOPMENTS
On July 23, 2001 the Company obtained $11.8 million in additional funding
as a result of closing a transaction (the "Sun transaction") with Sun Catalina
Holdings LLC (SCH), an affiliate of Sun Capital Partners, Inc. (a merchant
banking firm based in Boca Raton, Florida) and other parties.
In exchange for the $11.8 million, the Company issued SCH 8,489,932 shares
of common stock and $4.5 million in secured subordinated notes, and issued $4.3
million in secured subordinated notes to another lender, SunTrust Equity
Partners (STEP). SCH and STEP also received the right to obtain warrants
exercisable immediately upon receipt at $.01 per share to purchase an additional
3,904,838 and 1,652,636 shares, respectively, of the Company's common stock.
Immediately after the Sun transaction, SCH owned approximately 53% of the
Company's outstanding common shares. SCH entered into a ten-year management
services agreement with the Company at an annual fee of $500,000 at the time of
closing.
The secured subordinated notes are due in full on July 23, 2006. These
notes bear interest at 12%, compounded quarterly. Interest on the notes is
payable quarterly in arrears in cash commencing March 31, 2003. Interest for
quarters prior to the quarter ending March 31, 2003 will be added to the
principal amount of the notes. Interest and principal on the notes are
prepayable subject to a premium equal to an additional 5% of the principal
amount of the note. SCH and STEP are also entitled to additional warrants to
purchase common shares at $.01 per share for the quarters during which interest
on the notes is not paid in cash. Such additional warrants would total 1,078,441
shares of common stock, assuming interest payments do not commence until March
31, 2003.
22
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
The Company amended and restructured its $75 million credit facility with
its bank syndicate group in connection with the Sun transaction. The net
proceeds from the transaction, amounting to $8.4 million, were applied against
the revolving loans and term loans under this credit facility. Borrowings under
the facility bear interest, payable monthly at the Company's option of either
the prime rate plus an applicable margin or the LIBOR rate plus an applicable
margin. Under the amended facility, the Company is required to meet minimum
levels of adjusted quarterly earnings beginning with the quarter ending
September 30, 2001 and revised quarterly debt to adjusted earnings and fixed
charge ratios beginning with the quarter ending December 31, 2002. Annual
capital expenditures are limited under the amendment to $3.75 million. The term
loans are now repayable in installments aggregating (i) $200,000 on each of
September 30, 2001, December 31, 2001, March 31, 2002, June 30, 2002 and
September 30, 2002; (ii) $750,000 on each of December 31, 2002, March 31, 2003,
June 30, 2003, and September 30, 2003, and; (iii) $20,842,000 on December 31,
2003. The revolving loans under the facility mature December 31, 2003. The
amendment eliminated (as an event of default under the facility) the requirement
that the Company completed the whitewash procedure in connection with the Ring
acquisition by obtaining the required statutory declarations and associated
independent auditors' report. However, if such statutory declarations and
auditors' report are not obtained by December 31, 2001, 50 basis points will be
added to the facility's effective interest rate. The bank syndication group's
fee for the amendment consisted of the right to obtain warrants to purchase
329,149 shares of common stock at a price of $.01 per share.
The Company's employment agreements with its Chief Executive Officer, two
Executive Vice Presidents and Chief Financial Officer provided for certain
payments to these employees in the event the Company experienced a "change in
control". The Company resolved these obligations as part of the Sun transaction
by terminating the previous employment agreements and entering into settlement
agreements with these employees, which agreements provide in the aggregate for
(i) the granting of options to purchase 1,569,229 shares of common stock at a
price of $1.18 per share, subject to the increase in the Company's authorized
shares, as discussed below, and (ii) payments of approximately $198,000 each
quarter over a three-year period beginning September 1, 2001. The quarterly
payments under these settlement agreements are suspended at any time in which a
default under the Company's credit facility has occurred and is continuing.
Effective with the closing of the Sun transaction, the Company's former Chief
Executive Officer entered into a new one-year employment agreement to serve as
the Company's President, the Chief Financial Officer signed a new one-year
employment agreement, and the employment of the Company's Executive Vice
Presidents was terminated. As part of the settlement agreements the Company
obtained covenants not to compete through July 23, 2004.
Prior to the Sun transaction, 7,388,315 shares of the Company's common
stock were outstanding, and another 1,523,434 shares were issuable upon exercise
of outstanding stock options. In connection with the Sun transaction and the
amendment of the credit facility, the Company issued SCH 8,489,932 shares and,
subject to an increase in the Company's authorized shares, granted the rights to
SCH and the other parties to obtain warrants and stock options for an additional
8,784,293 shares. Because the aggregate number of shares (including shares
issuable upon exercise of options or warrants) to be issued in the transaction
would exceed the remaining available authorized shares, the Company is required
to obtain shareholder approval to increase its authorized number of shares to an
amount sufficient to provide for the additional shares contingently issuable as
a result of the transaction. If shareholder approval is not obtained and the
warrants due STEP and the bank syndication group are not issued by December 31,
2001, STEP has the right to retroactively increase the interest rate on its
subordinated note to 15%, and the bank group has the right to add 75 basis
points to the interest rate on the credit facility.
As a result of these transactions, the Company's board of directors was
expanded to nine members, and six individuals designated by SCH became members
of the board of directors. Subsequent to the consummation of these transactions,
Eric Bescoby (formerly the president and a director of an affiliate of SCH) was
named Chief Executive Officer of the Company. In addition, the board of
directors was expanded to ten members and Mr. Bescoby became a member of the
board of directors. On August 8, 2001 Robert Hersh, the Company's President and
a member of the board of directors, resigned from the board of directors and as
an officer of the Company and terminated his employment with the Company.
23
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
RESULTS OF OPERATIONS
Comparison of Three Months Ended June 30, 2001 and 2000
-------------------------------------------------------
Consolidated Results
The Company's results for 2001 continue to reflect the adverse effects on
sales and gross margins of economic and retail conditions. The Company had a net
loss of $2.4 million, or $.33 per diluted share, in 2001. Net income for 2000
was $1.1 million, or $0.14 per diluted share.
The Company's July 5, 2000 acquisition of Ring PLC ("Ring"), a supplier of
lighting, automotive and consumable products located in the United Kingdom,
significantly affected 2001 operating results and the comparability of current
year results to those for 2000. The Company's 2001 results include net sales of
$24.4 million and a pretax loss of $773,000 attributable to Ring. Ring's pretax
loss of $773,000 includes interest and financing costs and goodwill amortization
related to the acquisition aggregating $1.2 million. Ring's results for the
period were negatively affected by a highly competitive retail sector,
consolidation and direct importation trends in Ring's markets and product lines,
and a continued weakness of the British pound relative to the U.S. dollar. See
"Results By Segment - Ring Limited" for a comparative analysis of Ring's
results.
Net sales for 2001 were $60.5 million, a $13.8 million increase from the
prior year as a result of the Ring acquisition. Excluding Ring, net sales for
2001 were $36.1 million, as compared to $46.7 million in 2000. In 2001, sales to
U.S. and international customers (excluding Ring) were $25.0 million and $11.1
million, respectively, and in 2000 such sales (excluding Ring) amounted to $31.7
million and $15.0 million, respectively. Management believes the U.S. sales
decline is attributable to the general slowdown in the U.S. retail economy that
has affected the purchasing patterns of the Company's major U.S. customers.
Lamps, lighting fixtures, automotive after-market products and industrial
consumables accounted for 40%, 44%, 12% and 4% of net sales in 2001. Lamps and
lighting fixtures accounted for 57% and 43% of net sales in 2000. In 2001,
Ring's largest customer, B & Q, a subsidiary of Kingfisher PLC, accounted for
$10.2 million (16.9%) of the Company's net sales. In 2001 and 2000, Home Depot
accounted for $8.4 million (13.9%) and $14.4 million (30.8%), respectively, of
the Company's net sales. In 2001 and 2000, Wal-Mart and an affiliate accounted
for $7.4 million (12.2%) and $4.4 million (9.4%), respectively, of the Company's
net sales. Sales made from warehouses constituted 52% of the Company's net sales
in 2001, up from 19% in 2000 as a result of the Ring acquisition, as
substantially all Ring sales are made from warehouses.
Gross profit in total dollars decreased from $8.9 million in 2000 to $8.1
million in 2001 and decreased as a percentage of sales from 19.1% in 2000 to
13.3% in 2001. The decrease in the gross profit percent is due to the inclusion
of $24.4 million in sales from Ring at a gross profit percentage of 12.7%, gross
margin pressure attributable to economic conditions and a weak retail
environment, and lost contributions from the decrease in U.S. and international
sales.
Selling, general and administrative expenses ("SG&A") for 2001 were $9.8
million, an increase of $3.0 million from the prior year. The increase reflects
$2.9 million in Ring-related SG&A.
Greater interest expense for 2001 reflects the interest on the loans to
fund the Ring acquisition.
Other expenses of $19,000 for 2001 consisted of a net foreign currency loss
($82,000), dividends on Ring convertible preference stock ($39,000), partially
reduced by interest income ($48,000) and other miscellaneous income ($54,000).
Other income of $54,000 in 2000 consisted primarily of interest income
($123,000), income from joint ventures ($72,000), a net foreign currency loss
($182,000) and miscellaneous income ($41,000).
24
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
The effective income tax rates for 2001 and 2000 were 20.7% and 37.8%,
respectively. The lower effective tax rate for the Company's income tax benefit
in 2001 is attributable to $1.0 million in losses for which no tax benefit has
been provided. The Company's effective income tax rate is dependent both on the
total amount of pretax income generated and the source of such income (i.e.
domestic or foreign). Consequently, the Company's effective tax rate may vary in
future periods. The Company's effective income tax rate reflects the anticipated
tax benefits associated with the Company's 1999 restructuring of its
international operations. Should these tax benefits not materialize, the Company
may experience an increase in its effective consolidated income tax rate.
Outlook
Management believes the economic and business factors that have adversely
impacted the Company's results will continue. The Company expects to report a
net loss for the fourth quarter of fiscal 2001 as a result of these conditions,
the settlement of the Company's employment agreements with former members of
executive management and other factors. On July 23, 2001 the Company obtained
additional financing and restructured its $75 million credit facility. See
"Recent Developments", "Liquidity and Capital Resources" and Notes 4 and 7 of
Notes to Condensed Consolidated Financial Statements.
Results By Segment
See Note 5 of Notes to Consolidated Condensed Financial Statements for the
financial tables for each business segment.
Catalina Industries (United States)
-----------------------------------
Catalina Industries had a segment loss in 2001 of $437,000 as compared to a
contribution of $792,000 in 2000. The decrease in segment contribution in 2001
primarily reflects lower sales.
Sales by Catalina Industries to external customers were $24.9 million in
2001, a decrease of $6.9 million from 2000. Sales to Home Depot were $7.6
million or $4.5 million less than in 2000 and sales to the office superstores
group of customers decreased by $2.1 million. Management believes the sales
decline is attributable to a general slow down in the U.S. retail economy that
has affected the purchasing patterns of the Company's major customers. In 2001,
Home Depot, Wal-Mart and K-Mart accounted for 30.6%, 23.4% and 15.4% of Catalina
Industries' net sales and 38.1%, 10.1% and 14.5% in 2000, respectively.
Gross profit decreased by $1.2 million in 2001 due to the lower sales
volume.
Presently, most major U.S. customers (including Home Depot and Wal-Mart)
purchase from Catalina Industries primarily on a direct basis, whereby the
merchandise is shipped directly from the factory to the customer, rather than
from the warehouse. Approximately 82% of Catalina Industries' sales in the third
quarter of 2001 were made on a direct basis as compared to 80% in 2000,
representing a $1.9 million decrease in warehouse sales from 2000 to 2001.
Warehouse sales to U.S. customers declined each fiscal year in the six-year
period commencing fiscal 1995, when the present warehouse was constructed in
Tupelo, Mississippi, and warehouse sales were 61% of annual U.S. sales compared
to 18% for the current quarter. This percentage decline represents a significant
decrease in sales dollars. Catalina Industries lowered its warehousing costs by
terminating its other U.S. warehouse operation located in Los Angeles effective
March 31, 1998 and is considering other strategic alternatives to reduce overall
warehousing costs. Catalina Industries may experience further declines in sales
made from its U.S. warehouse and, at least in the short term, may be unable to
further reduce its overall warehousing costs. The need to generate cash to meet
liquidity needs and the requirements of the Company's $75 million credit
facility (see "Liquidity and Capital Resources") have necessitated a lowering of
U.S. warehouse inventories. This need and market conditions resulted in a lower
relative gross profit percentage for Catalina Industries' warehouse sales for
the June 2001 quarter. Further declines in warehouse sales, the need to lower
inventories to generate cash and the continuing weak U.S. retail environment
could adversely impact Catalina Industries' gross profit in the future.
Catalina Industries experienced an increase in SG&A of approximately
$232,000 in 2001 which was partially offset by a $190,000 decrease in interest
expense.
25
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
In September 2000, this business segment finalized plans to consolidate the
functions of its Boston office into the Miami headquarters. Management believes
this consolidation will allow Catalina Industries to serve its customers more
effectively and to generate future cost savings. A $500,000 charge comprised of
employee severance costs ($422,000), property write-downs ($56,000) and lease
termination costs ($22,000) was recorded in September 2000 for the Boston office
closure.
The closing of the Boston office resulted in the termination of two
vice-presidents and eight customer support and administrative personnel. The
non-cash property write-down consisted of the net book value of leasehold
improvements and the office furniture and other equipment not suitable for use
by the Miami headquarters or the Company's Canadian operations. The charge for
lease termination costs represented the remaining aggregate contractual lease
obligation for the Boston office subsequent to the date of its closure, net of
projected sublease income. Catalina Industries continued to incur and expense
normal payroll, depreciation, lease and other operating costs for its Boston
office during the 2001 fiscal year, until the office was closed in December 2000
and certain remaining employees ceased working for the Company in March 2001.
Due to the continuing inability to find a lessee for the Boston office space,
Catalina Industries increased its provision for lease termination costs by
$100,000 during the 2001 quarter. Costs incurred for the Boston office for the
three months ended June 30, 2000 were approximately $247,000.
Go-Gro (China)
--------------
Go-Gro's segment contribution decreased in 2001 to $1.7 million, down $1.3
million from $3.0 million in 2000.
Go-Gro's sales for 2001 were $32.1 million, a decrease of $6.4 million from
the $38.5 million generated in 2000. Sales of products manufactured by Go-Gro in
2001 (as opposed to sales of products purchased for resale by Go-Gro from other
manufacturers) decreased by $3.9 million, to $16.4 million. Third party and
intercompany sales by Go-Gro in 2001 were $5.8 million and $26.3 million,
respectively, while the comparable sales amounts for 2000 were $7.9 million and
$30.6 million, respectively. Third party sales in 2000 included $1.4 million in
sales to Ring Limited. The decline in the intercompany sales in 2001 primarily
reflects the lower overall sales to Catalina Industries attributable to a
decline in Catalina Industries' U.S. business. Sales to one third-party customer
were $1.8 million in 2001 and $3.6 million in 2000.
A $492,000 decrease in SG&A served to partially offset a $1.6 million
decrease in gross profit due to the $6.4 million decrease in sales.
Ring Limited (United Kingdom)
-----------------------------
Ring was acquired by the Company on July 5, 2000, and the 2000 Ring results
provided below for comparative purposes were not part of the Company's
consolidated 2000 results.
The Ring segment recorded a pretax loss of $773,000 for 2001, which
includes $252,000 in goodwill amortization arising from the acquisition and
$905,000 in interest and financing costs for the acquisition-related debt.
Excluding these acquisition costs, Ring's pretax income for the quarter ended
June 30, 2001 was approximately $384,000. Ring benefited from the receipt of
approximately $714,000 in proceeds from the settlement of litigation during the
2001 quarter. Ring generated a pretax loss (excluding non-recurring charges) of
approximately $213,000 for the quarter ended June 30, 2000. Net sales and gross
profit for the three months ended June 30, 2001 were $24.4 million and $3.1
million, respectively, as compared to $27.1 million and $3.2 million,
respectively for the same period of 2000. Net sales to B&Q, a subsidiary of
Kingfisher PLC, accounted for $10.2 million or 41.9% of Ring's sales for 2001.
Ring's sales volume and gross profit reflect a highly competitive retail
business sector stemming from consolidation in both the lighting and automotive
markets, a general decline in the automotive aftermarket (including bankruptcies
of certain customers and the entry of new competitors), and greater direct
importation of products by Ring's customers. In addition, a weakening of the
Great British pound relative to the U.S. dollar has increased Ring's cost of
goods and lowered its margins. The average exchange rate of the dollar to the
pound for the quarter ended June 30, 2001 was approximately 1.42 to 1, a
significant decline from the average exchange rate for the quarter ended June
30, 2000 of 1.53 to 1.
26
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Comparison of Nine Months Ended June 30, 2001 and 2000
------------------------------------------------------
Consolidated Results
The Company had a net loss of $7.7 million, or $1.04 per diluted share, in
2001. Net income for 2000, was $2.4 million, or $0.30 per diluted share.
The Company's July 5, 2000 acquisition of Ring significantly affected 2001
operating results and the comparability of current year results to those for
2000. The Company's 2001 results include net sales of $80.5 million and a pretax
loss of $3.3 million attributable to Ring. Ring's pretax loss of $3.3 million
includes interest and financing costs and goodwill amortization related to the
acquisition aggregating $3.5 million. Ring's results for the period were
negatively affected by a highly competitive retail sector, consolidation and
direct importation trends in Ring's markets and product lines and a continued
weakness of the British pound relative to the U.S. dollar. See "Results By
Segment - Ring Limited" for a comparative analysis of Ring's results.
Net sales for 2001 were $180.9 million, a $49.0 million increase from the
prior year. Excluding Ring, net sales for 2001 were $100.5 million, as compared
to $131.9 million in 2000. In 2001 sales to U.S. and international customers
(excluding Ring) were $60.2 million and $40.3 million, respectively, and in 2000
such sales (excluding Ring) amounted to $88.5 million and $43.4 million,
respectively. Management believes this U.S. sales decline is attributable to the
general slow down in the U.S. retail economy that has affected the purchasing
patterns of the Company's major U.S. customers.
Lamps, lighting fixtures, automotive after-market products and industrial
consumables accounted for 39%, 45%, 12% and 4% respectively of net sales in
2001. Lamps and lighting fixtures accounted for 61% and 39% of net sales in
2000. In 2001, Ring's largest customer, B & Q, a subsidiary of Kingfisher PLC,
accounted for $30.9 million (17.1%) of the Company's net sales. In 2001 and
2000, Home Depot accounted for $23.1 million (12.8%) and $39.0 million (29.5%),
respectively, of the Company's net sales. Sales made from warehouses constituted
57% of the Company's net sales in 2001, up from 23% in 2000 as a result of the
Ring acquisition, as substantially all Ring sales are made from warehouses.
Gross profit increased in total dollars by $427,000, but decreased as a
percentage of sales from 19.6% in 2000 to 14.5% in 2001. The $427,000 increase
reflects contributions from higher sales resulting from the addition of Ring.
The decrease in the gross profit percent is due to the inclusion of $80.5
million in sales from Ring at a gross profit percentage of 12.3%, gross margin
pressure attributable to economic conditions and a weak retail environment, and
lost contributions from the decrease in sales.
Selling, general and administrative expenses ("SG&A") for 2001 were $31.0
million, an increase of $10.0 million from the prior year. The increase reflects
$10.0 million related to Ring. SG&A for 2000 included a $788,000 charge to
settle the employment contract of an Executive Vice President pursuant to a
reorganization of the Company's executive management structure.
Greater interest expense for 2001 reflects the interest on the loans to
fund the Ring acquisition, interest on Ring's revolving loans of $542,000 and a
greater weighted average interest rate.
Other expenses of $334,000 for 2001 consisted of a net foreign currency
loss ($380,000), dividends on Ring convertible preferred stock ($125,000), and
other miscellaneous expenses partially reduced by interest income ($173,000).
Other income of $426,000 in 2000 consisted of interest income ($346,000), income
from joint ventures ($178,000) and other miscellaneous income partially offset
by a net foreign currency loss ($118,000).
27
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
The effective income tax rates for 2001 and 2000 were 17.9% and 34.8%,
respectively. The lower effective tax rate for the Company's income tax benefit
in 2001 is attributable to $3.7 million in losses for which no tax benefit has
been provided. The Company's effective income tax rate is dependent both on the
total amount of pretax income generated and the source of such income (i.e.
domestic or foreign). Consequently, the Company's effective tax rate may vary in
future periods. The Company's effective income tax rate reflects the anticipated
tax benefits associated with the Company's 1999 restructuring of its
international operations. Should these tax benefits not materialize, the Company
may experience an increase in its effective consolidated income tax rate.
Results By Segment
See Note 5 of Notes to Consolidated Condensed Financial Statements for the
financial tables for each business segment.
Catalina Industries (United States)
-----------------------------------
Catalina Industries had a segment loss in 2001 of $1.8 million as compared
to a contribution of $3.0 million in 2000. The decrease in segment contribution
in 2001 reflects lower sales.
Sales by Catalina Industries to external customers were $60 million in
2001, a decrease of $28.3 million from 2000. Sales to Home Depot were $17.9
million or $14.7 million less than in 2000 and sales to the office superstores
group of customers decreased by $10.4 million. Management believes the sales
decline is attributable to a general slow down in the U.S. retail economy that
has affected the purchasing patterns of the Company's major customers. In 2001,
Home Depot, Wal-Mart and K-Mart accounted for 29.9%, 20.8% and 14.0% of Catalina
Industries' net sales and such customers accounted for 36.9%, 8.9% and 10.1% of
net sales in 2000, respectively.
Gross profit decreased by $5.3 million in 2001 due to the lower sales
volume.
Presently, most major U.S. customers (including Home Depot and Wal-Mart)
purchase from Catalina Industries primarily on a direct basis, whereby the
merchandise is shipped directly from the factory to the customer, rather than
from the warehouse. Approximately 78% of Catalina Industries' sales in 2001 were
made on a direct basis during the nine months ended June 30, 2001 compared to
77% for the same period in 2000, representing a $7.3 million decrease in
warehouse sales from 2000 to 2001. Warehouse sales to U.S. customers declined
each fiscal year in the six-year period commencing fiscal 1995, when the present
warehouse was constructed in Tupelo, Mississippi, and annual warehouse sales
were 61% of U.S. sales compared to the 22% for the most current nine months.
This percentage decline represents a significant decrease in sales dollars.
Catalina Industries lowered its warehousing costs by terminating its other U.S.
warehouse operation located in Los Angeles effective March 31, 1998 and is
considering other strategic alternatives to reduce overall warehousing costs.
Catalina Industries may experience further declines in sales made from its U.S.
warehouse and, at least in the short term, may be unable to further reduce its
overall warehousing costs. The need to generate cash to meet liquidity needs and
the requirements of the Company's $75 million credit facility (see "Liquidity
and Capital Resources") have necessitated a lowering of U.S. warehouse
inventories. This need and market conditions resulted in a lower relative gross
profit percentage for Catalina Industries' warehouse sales for the nine months
ended June 30, 2001. Further declines in warehouse sales, the need to lower
inventories to generate cash and the continuing weak U.S. retail environment
could adversely impact the Catalina Industries' gross profit in the future.
Catalina Industries increased its SG&A by approximately $211,000 in 2001.
Decreases in sales-related expenses and certain other expenses were not
sufficient to offset a $653,000 provision for uncollectible accounts receivable
for customers which filed for bankruptcy.
In September 2000, this business segment finalized plans to consolidate the
functions of its Boston office into the Miami headquarters. Management believes
this consolidation will allow Catalina Industries to serve its customers more
effectively and to generate future cost savings. A $500,000 charge comprised of
employee severance costs ($422,000), property write-downs ($56,000) and lease
termination costs ($22,000) was recorded in September 2000 for the Boston office
closure.
28
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
The closing of the Boston office resulted in the termination of two
vice-presidents and eight customer support and administrative personnel. The
non-cash property write-down consisted of the net book value of leasehold
improvements and the office furniture and other equipment not suitable for use
by the Miami headquarters or the Company's Canadian operations. The charge for
lease termination costs represented the remaining aggregate contractual lease
obligation for the Boston office subsequent to the date of its closure, net of
projected sublease income. Catalina Industries continued to incur and expense
normal payroll, depreciation, lease and other operating costs for its Boston
office during the 2001 fiscal year, until the office was closed in December 2000
and certain remaining employees ceased working for the Company in March 2001.
Costs incurred for the Boston office during the nine months ended June 30, 2001
and 2000 were approximately $400,000 and $786,000, respectively. In addition,
due to the continuing inability to sublease the Boston office space, Catalina
Industries increased its provision for lease termination costs by $150,000
during the 2001 nine-month period.
Go-Gro (China)
--------------
Go-Gro's segment contribution decreased in 2001 to $4.7 million, down $2.5
million from $7.2 million in 2000, reflecting the impact of a $17.3 million
decrease in sales.
Go-Gro's sales for 2001 were $85.6 million, a decrease of $17.3 million
from the $102.9 million generated in 2000. Sales of products manufactured by
Go-Gro in 2001 (as opposed to sales of products purchased for resale by Go-Gro
from other manufacturers) decreased by $5.1 million, to $47.2 million. Third
party and intercompany sales by Go-Gro in 2001 were $19.0 million and $66.6
million, respectively, while the comparable sales amounts for 2000 were $20.3
million and $82.6 million, respectively. The decline in intercompany sales for
2001 is primarily attributable to the overall sales decline to Catalina
Industries reflecting a decrease in Catalina Industries' U.S. business. Third
party sales in 2000 included $5.0 million in sales to Ring Limited. Sales to one
third-party customer were $7.6 million in 2001 and $6.9 million in 2000,
respectively.
Gross profit decreased by $2.6 million due to the $17.3 million decrease in
sales.
Ring Limited (United Kingdom)
-----------------------------
Ring was acquired by the Company on July 5, 2000, and the 2000 Ring results
provided below for comparative purposes were not part of the Company's
consolidated 2000 results.
The Ring segment recorded a pretax loss of $3.3 million for 2001, which
includes $767,000 in goodwill amortization arising from the acquisition and $2.8
million in interest and financing costs for the acquisition-related debt.
Excluding these acquisition costs, Ring's pretax income for the nine months
ended June 30, 2001 was approximately $260,000. Ring benefited from the receipt
of approximately $714,000 in proceeds from the settlement of litigation during
2001. Ring generated pretax income (excluding non-recurring charges) of
approximately $3.2 million for the nine months ended June 30, 2000. Net sales
and gross profit for the nine months ended June 30, 2001 were $80.4 million and
$9.9 million, respectively, as compared to $91.3 million and $14.2 million,
respectively for the same period of 2000. Net sales to B&Q, a subsidiary of
Kingfisher PLC, accounted for $30.9 million or 38.4% of Ring's sales for 2001.
Ring's sales volume and gross profit reflect a highly competitive retail
business sector stemming from consolidation in both the lighting and automotive
markets, a general decline in the automotive aftermarket (including bankruptcies
of certain customers and the entry of new competitors), and greater direct
importation of products by Ring's customers. In addition, a weakening of the
Great British pound relative to the U.S. dollar has increased Ring's cost of
goods and lowered its margins. The average exchange rate of the dollar to the
pound for the nine months ended June 30, 2001 was approximately 1.44 to 1, a
significant decline from the average exchange rate for the nine months ended
June 30, 2000 of 1.59 to 1. Ring's profitability erosion is directly related to
the economic factors mentioned above.
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
The Company meets its short-term liquidity needs through cash provided by
operations, borrowings under various credit facilities with banks, accounts
payable and the use of letters of credit from customers to fund certain of its
direct import sales activities. Term loans, lease obligations, mortgage notes,
bonds, subordinated debt and capital stock are sources for the longer-term
liquidity and financing needs of the Company.
29
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Cash Flows and Financial Condition
----------------------------------
The Company's operating, investing and financing activities resulted in a
net increase in cash and cash equivalents of $323,000 from September 30, 2000 to
June 30, 2001.
The Company used funds generated from operations and proceeds from its
credit lines to pay for capital expenditures and make payments of $2.5 million
on its term loans. Capital expenditures for the period totaled $4.2 million, of
which $2.6 million related to the planned expansion of the Go-Gro manufacturing
facility and Go-Gro equipment purchases and the remainder primarily related to
the purchase of computer software.
Accounts receivable balances decreased to $28.1 million at June 30, 2001
from $36.6 million at September 30, 2000 resulting from the significant decline
in sales to U.S. customers. Inventory levels at June 30, 2001 were approximately
$43.2 million, as compared to $52.8 million at September 30, 2000, due to
seasonal factors and the Company's focus on lowering its inventories in each of
its principal business segments in response to current business and economic
conditions and liquidity needs.
The Company's agreements with its major customers provide for various sales
allowances (i.e., deductions given the customer from purchases made from the
Company), the most common of which are for volume discounts, consumer product
returns, and cooperative advertising. These allowances are usually defined as a
percentage of the gross sales price, and are recognized as a reduction of gross
sales revenue at the time the related sales are recorded. If the customer
agreement does not provide for the deduction of the allowance amount directly
from the amount invoiced the customer at time of billing, the Company records an
accrual for the amounts due. These accrued sales allowances are settled
periodically either by subsequent deduction from the accounts receivable from
the customer or by cash payment. For financial statement presentation purposes,
these sales allowances are netted against accounts receivable, and amounted to
$10,159,000 and $11,703,000 at June 30, 2001 and September 30, 2000,
respectively. The amounts of the Company's accrued sales allowances, by customer
and in the aggregate, are dependent upon various factors, including sales
volumes, the specific terms negotiated with each customer (including whether the
allowance amounts are deducted immediately from the invoice or accrued) and the
manner and timing of settlement.
Acquisition and Credit Facilities
---------------------------------
On July 5, 2000 the Company acquired Ring Plc ("Ring"), a leading supplier
of lighting, automotive after-market products and industrial consumables in the
United Kingdom. The total consideration for the acquisition was approximately
22.4 million Great British Pounds ("GBP") or approximately U.S. $33.8 million.
The Company entered into a credit facility for approximately $75 million
with a bank syndication group to finance the acquisition of Ring and repay and
terminate its existing U.S. credit facility and Ring's U.K. facility. The
facility consists of two term loans amounting to $15 million and the GBP
equivalent of U.S. $15 million (GBP 10.5 million), respectively, and two
revolving facilities for loans, acceptances, and trade and stand-by letters of
credit for the Company's ongoing operations in the U.S. and the U.K. of $20
million and the GBP equivalent of U.S. $25 million (approximately GBP 17.7
million), respectively. Amounts outstanding under the revolving facilities are
limited under a borrowing base defined as percentages of the combined accounts
receivable and inventory balances for the U.S. and U.K. Obligations under the
facility are secured by substantially all of the Company's U.S. and U.K. assets,
including 100% of the common stock of the Company's U.S. subsidiaries and 65% of
the stock of the Company's Canadian and first tier United Kingdom and Hong Kong
subsidiaries. The agreement prohibits the payment of cash dividends or other
distribution on any shares of the Company's common stock, other than dividends
payable solely in shares of common stock, unless approval is obtained from the
lenders. The Company pays a quarterly commitment fee of .50% per annum based on
the unused portion of the revolving facilities. The $75 million credit facility
contains financial covenants requiring the Company to meet certain debt to
adjusted earnings (i.e. leverage) and fixed charge coverage ratios on a
quarterly basis. The Company obtained an amendment of this credit facility on
December 22, 2000, and without this amendment the Company would not have been in
compliance with one of the financial covenants for the quarter ended September
30, 2000.
30
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
The Company obtained amendments to the credit facility on December 22, 2000
and February 9, 2001, without which the Company would not have been in
compliance with the credit facility's financial covenants for the quarters ended
September 30, 2000 and December 31, 2000. Due to the net loss for the quarter
ended March 31, 2001, the Company was not in compliance with one of the
financial covenants under the $75 million credit facility for that quarter. On
May 15, 2001, the Company obtained a forbearance agreement, which in the absence
of any further breach or default waived and deferred through June 15, 2001 the
lenders' ability to exercise their rights and remedies for the event of default
under the credit facility resulting from the failure to meet the financial
covenant for the quarter ended March 31, 2001.
In addition to requiring compliance with financial covenants, the credit
facility required the Company to complete a "whitewash procedure" by obtaining
certain statutory declarations and an associated auditors' report prescribed
under English law as explained in the following paragraph.
Proceeds from the $75 million credit facility were used in part to fund the
Company's acquisition of Ring, a British company, on July 5, 2000. Under English
law a British company cannot lawfully provide financial assistance for the
purpose of the acquisition of its own shares (which would include using its cash
flows and other sources of funds to make payments due on debt used to fund its
acquisition) unless certain conditions are met. In addition, lenders providing
the financing for the acquisition cannot perfect their collateral interest in
the assets of the acquired British company unless such conditions are met. In
order to lawfully provide financial assistance, the acquired British company
must complete a "whitewash procedure" under English law. In essence, the
whitewash procedure requires the following: (1) every director of the acquired
British company must make a statutory declaration as to the solvency of the
acquired company and its ability to pay its debts for the next twelve months;
and (2) the statutory declarations must be accompanied by an independent
auditors' report stating that the auditors' are not aware of anything to
indicate that the statutory declarations of the directors are not reasonable. In
addition, English law requires that the net assets of the acquired British
company are not reduced by the financial assistance or, to the extent that the
net assets are reduced, the reduction is funded out of distributable profits.
"Net assets" and "distributable profits" have prescribed meanings under the
statute governing the whitewash procedure. Failure to comply with the whitewash
procedure will mean the financial assistance is unlawful, which could result in
the acquired British company facing a fine and its directors and managers facing
a fine or imprisonment or both. In addition, the transaction constituting the
financial assistance together with any security given in contravention of the
financial assistance rules, may be held by English courts to be void and
unenforceable. The financial assistance rules apply to any subsidiaries of the
acquired company which are also involved in providing financial assistance. The
February 9, 2001 amendment to the $75 million credit facility included a
requirement that the Company procure the directors' statutory declarations
regarding Ring's solvency and independent auditors' report thereon by March 31,
2001. On March 30, 2001, the Company obtained an amendment to the credit
facility extending this deadline to May 31, 2001 and on May 15, 2001 the Company
obtained a forbearance agreement which extended this deadline to June 15, 2001.
The forbearance agreement obtained by the Company on May 15, 2001 was
amended and extended on June 15, 2001 and again on July 16, 2001, with the
second amendment extending the terms of the forbearance agreement through July
31, 2001.
31
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
On July 23, 2001 the Company obtained $11.8 million in additional funding
and amended and restructured its $75 million credit facility as a result of
closing a transaction (the "Sun transaction") with Sun Catalina Holdings LLC
(SCH), an affiliate of Sun Capital Partners, Inc. (a merchant banking firm based
in Boca Raton, Florida) and other parties.
In exchange for the $11.8 million, the Company issued SCH 8,489,932 shares
of common stock and $4.5 million in secured subordinated notes, and issued $4.3
million in secured subordinated notes to another lender, SunTrust Equity
Partners (STEP). SCH and STEP also received the right to obtain warrants
exercisable immediately upon receipt at $.01 per warrant to purchase an
additional 3,904,838 and 1,652,636 shares, respectively, of the Company's common
stock. Immediately after the Sun transaction, SCH owned approximately 53% of the
Company's outstanding common shares. In connection with the Sun transaction the
Company redeemed its shareholders rights plan. SCH entered into a ten-year
management services agreement with the Company at an annual fee of $500,000 at
the time of closing.
The secured subordinated notes are due in full on July 23, 2006. These
notes bear interest at 12%, compounded quarterly. Interest on the notes is
payable quarterly in arrears commencing March 31, 2003. Interest and principal
on the notes are prepayable subject to a premium equal to 5% of the note
principal. SCH and STEP are also entitled to additional warrants to purchase
common shares at $.01 per share for the quarters during which interest on the
notes is not paid. Such additional warrants would total 1,078,441, assuming
interest payments do not commence until March 31, 2003.
The Company amended and restructured its $75 million credit facility with
its bank syndicate group in connection with the Sun transaction. The net
proceeds from the transaction amounting to $8.4 million were applied against the
revolving loans and term loans under this credit facility. Borrowings under the
facility bear interest, payable monthly at the Company's option of either the
prime rate plus and applicable margin or the LIBOR rate plus an applicable
margin. Under the amended facility, the Company is required to meet minimum
levels of adjusted quarterly earnings beginning with the quarter ending
September 30, 2001 and revised quarterly debt to adjusted earnings and fixed
charge ratios beginning with the quarter ending December 31, 2002. Annual
capital expenditures are limited under the amendment to $3.75 million. The term
loans are now repayable in installments aggregating (i) $200,000 on each of
September 30, 2001, December 31, 2001, March 31, 2002, June 30, 2002 and
September 30, 2002; (ii) $750,000 on each of December 31, 2002, March 31, 2003,
June 30, 2003, and September 30, 2003, and; (iii) $20,842,000 on December 31,
2003. The revolving loans under the facility mature December 31, 2003. The
amendment eliminated (as an event of default under the facility) the requirement
that the Company obtain certain statutory declarations and associated
independent auditors' report relating to the Company's acquisition of Ring PLC.
However, if such statutory declarations and auditors' report are not obtained by
December 31, 2001, 50 basis points will be added to the facility's effective
interest rate. The bank syndication group's fee for the amendment consisted of
the right to obtain warrants to purchase 329,149 shares of common stock at a
price of $.01 per share.
The Company's employment agreements with its Chief Executive Officer, two
Executive Vice Presidents and Chief Financial Officer provided for certain
payments to these employees in the event the Company experienced a "change in
control". The Company resolved these obligations as part of the Sun transaction
by terminating the previous employment agreements and entering into settlement
agreements with these employees which provide in the aggregate for (i) the
granting of rights to fully vested options to purchase 1,569,229 shares of
common stock at a price of $1.18 per share and (ii) payments of approximately
$198,000 each quarter over a three-year period beginning September 1, 2001. The
quarterly payments under these settlement agreements are suspended at any time
in which a default under the Company's credit facility has occurred and is
continuing. Effective with the closing of the Sun transaction, the Company's
former Chief Executive Officer entered into a new one-year employment agreement
to serve as the Company's President, the Chief Financial Officer signed a new
one-year employment agreement, and the employment of the Company's Executive
Vice Presidents was terminated. In August 2001 the Company's former Chief
Executive Officer (and acting President) resigned from the Company. As part of
the settlement agreements, the Company obtained covenants not to compete through
July 23, 2004.
32
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Prior to the Sun transaction, 7,388,315 shares of the Company's common
stock were outstanding, and another 1,523,434 shares were issuable upon exercise
of outstanding stock options. In connection with the Sun transaction and the
amendment of the credit facility, the Company issued SCH 8,489,932 shares and,
subject to an increase in the Company's authorized shares, granted the rights to
SCH and the other parties to obtain warrants and stock options for an additional
8,784,293 shares. Because the aggregate number of shares (including shares
issuable upon exercise of options or warrants) to be issued in the transaction
would exceed the remaining available authorized shares, the Company is required
to obtain shareholder approval to increase its authorized number of shares to an
amount sufficient to provide for the additional shares contingently issuable as
a result of the transaction. If shareholder approval is not obtained and the
warrants due STEP and the bank syndication group are not issued by December 31,
2001, STEP has the right to retroactively increase the interest rate on its
subordinated note to 15%, and the bank group has the right to add 75 basis
points to the interest rate on the credit facility.
The Sun transaction may constitute a change of ownership of the Company as
defined under Internal Revenue Code Section 382 ("IRC 382"). In general, IRC 382
can limit an entity's utilization of its net operating loss carryforwards and
other anticipated tax return deductions existing at the time the change in
ownership occurs. Management is presently evaluating and has not yet determined
the impact of IRC 382 on the Company arising from the Sun transaction. The
Company had $4.7 million in deferred tax assets at June 30, 2001. A portion or
all of these deferred tax assets may be required to be expensed should it
ultimately be determined that the utilization of the components of these
deferred tax assets is limited under IRC 382.
The Company utilizes the revolving portions of its $75 million credit
facility to support its operations in the U.S. and U.K. The Company's U.S.
operations are also supported to a limited extent by cash flows from the
Company's China operations. Due to an inability to transfer funds from the U.K.
to the U.S. until the whitewash procedure is completed, all payments on the
Company's term loans must presently be made by the Company's U.S. operations. As
of August 10, 2001, the Company had $13.9 million available under its revolving
facilities to support U.S. and U.K. operations. Should its operating losses
continue, or should its cash needs in the future exceed its available borrowings
under the revolving facilities, the Company may be required to obtain either a
modification of the $75 million credit facility or funding from other sources to
continue to support its operations.
The Company's ability to satisfy the terms of its $75 million credit
facility in future quarters depends on business and economic conditions,
including demand for the Company's products. The Company's continuation as a
going concern is dependent upon its ability to successfully maintain the
necessary financing arrangements and to comply with the terms of its $75 million
credit facility. Although no assurances can be given, the Company believes that
it will be able to continue operating as a going concern.
The Company's credit facilities, English law, and U.S. and foreign income
tax considerations, impact the flow of the Company's funds between its major
subsidiaries. The Hong Kong credit facility prohibits the payment of dividends
without the consent of the bank and limits the amount of loans or advances from
Go-Gro to other Company subsidiaries. Any loan made or dividends paid either
directly or indirectly by Go-Gro to the Company or its U.S. subsidiaries could
be considered by U.S. taxing authorities as a repatriation of foreign source
income subject to taxation in the U.S. at a higher rate than that assessed in
Hong Kong. The net impact of such a funds transfer from Go-Gro could be an
increase in the Company's U.S. income taxes payable and its effective tax rate.
The $75 million credit facility prohibits loans to Go-Gro from either Ring or
the Company other than normal intercompany payables arising from trade. This
facility permits loans from the Company to Ring, but prohibits loans from Ring
to the Company to payments constituting dividends or a return of capital.
English laws and the Company's current inability to complete the whitewash
procedure also restrict the amount of funds that may be transferred from Ring to
the parent Company and other subsidiaries.
Ring has an arrangement with a U.K. bank which is secured by standby
letters of credit issued under the GBP revolving credit facility with the bank
syndication group. The arrangement provides for borrowings, trade letters of
credit, bonds, and foreign currency forward contracts and transactions.
Borrowings, trade letters of credit, bonds and foreign currency forward
contracts outstanding under this arrangement amounted to approximately $6.4
million, $24,000, $190,000 and $7.5 million, respectively, at June 30, 2001.
33
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
The Company's Canadian subsidiary has a credit facility with a Canadian
bank which provides 5.5 million Canadian dollars or U.S. equivalent
(approximately U.S. $3.6 million) in revolving demand credit. Canadian dollar
advances bear interest at the Canadian prime rate plus .5% (6.75% at June 30,
2001) and U.S. dollar advances bear interest at the U.S. base rate of the bank
(7.25% at June 30, 2001). The credit facility is secured by substantially all of
the assets of the Company's Canadian subsidiary. The agreement contains certain
minimum covenants to be met by the Canadian subsidiary, prohibits the payment of
dividends, and limits advances by the bank to a borrowing base calculated based
upon receivables and inventory. At September 30, 2000, $2.5 million in net
assets of the Company's Canadian subsidiary were restricted under the credit
facility and could not be transferred to the parent Company. This facility is
payable upon demand and is subject to an annual review by the bank. The Company
pays a monthly commitment fee of .25% based on the unused portion of the
facility. At June 30, 2001, U.S. $274,000 was available under the borrowing base
calculation. On August 13, 2001, the Company received verbal notification from
the bank of their intention to demand repayment by December 31, 2001.
Go-Gro, the Company's Hong Kong subsidiary, has a 60 million Hong Kong
dollars (approximately U.S. $7.7 million) credit facility with a Hong Kong bank.
The facility provides credit in the form of acceptances, trade and stand-by
letters of credit, overdraft protection, and negotiation of discrepant documents
presented under export letters of credit issued by banks. Advances bear interest
at the Hong Kong prime rate plus .25% (7.25% at June 30, 2001). The facility is
secured by a guarantee issued by the Company and requires Go-Gro to maintain a
minimum level of equity. This agreement prohibits the payment of dividends
without the consent of the bank and limits the total amount of trade
receivables, loans or advances from Go-Gro to its parent and affiliates. At
September 30, 2000, $17.2 million in net assets of Go-Gro were restricted under
the agreement and could not be transferred to the parent Company. This facility
is repayable upon demand and is subject to an annual review by the bank. At June
30, 2001, the Company had used $1.6 million of this line for letters of credit
(there were no borrowings) and U.S. $6.1 million was available. As a result of
the Company's present financial situation, the Hong Kong bank is currently
requiring Go-Gro to maintain additional collateral in the form of cash deposits
as security on this facility. Such deposits amounted to $1.4 million at June 30,
2001.
The Company arranged for the issuance in 1995 of $10.5 million in State of
Mississippi Variable Rate Industrial Revenue Development Bonds to finance (along
with internally generated cash flow and the Company's $1 million leasing
facility) its warehouse located near Tupelo, Mississippi. The bonds have a
stated maturity of May 1, 2010 and require mandatory sinking fund redemption
payments, payable monthly, of $900,000 per year through 2002, $600,000 per year
in 2003 and 2004, and $500,000 per year from 2005 to 2010. The bonds bear
interest at a variable rate (4.0% at June 30, 2001) that is adjustable weekly to
the rate the remarketing agent for the bonds deems to be the market rate for
such bonds. The bonds are secured by a lien on the land, building, and all other
property financed by the bonds. Additional security is provided by a $5.2
million direct pay letter of credit which is not part of the Company's credit
lines. This direct pay letter of credit provides that any default under any
other agreement involving a material borrowing or guarantee constitutes a
default under the direct pay letter of credit. The unpaid balance of these bonds
was $5.1 million at June 30, 2001. In January 1999, the Company entered into an
interest rate swap agreement maturing May 1, 2004, to manage its exposure to
interest rate movements by effectively converting its debt from a variable
interest rate to a fixed interest rate of 5.52%. Interest rate differentials
paid or received under the agreement are recognized as adjustments to interest
expense.
The Company has a $1 million facility with a U.S. financial institution to
finance the purchase of equipment in the United States, of which $870,000 was
available at June 30, 2001.
The Company financed its corporate headquarters in Miami, Florida with a
loan payable monthly through 2004, based on a 15-year amortization schedule,
with a balloon payment in 2004. The loan bears interest at 8% and is secured by
a mortgage on the land and building. The unpaid balance of this loan was
$845,000 at June 30, 2001.
34
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Capital Expenditures
--------------------
In September 2000 the Company's wholly-owned Hong Kong subsidiary, Go-Gro
Industries ("Go-Gro") made a deposit of approximately $1 million to purchase its
joint venture partner's interest in Go-Gro's Chinese cooperative joint venture
manufacturing subsidiary, Shenzhen Jiadianbao Electrical Products Co., Ltd.
("SJE"). This purchase was finalized in December 2000. During the quarter ended
March 31, 2001, SJE was converted under Chinese law from a cooperative joint
venture to a wholly owned foreign entity and its name changed to Jiadianbao
Electrical Products (Shenzhen) Co., Ltd. ("JES").
JES obtained non-transferable land use rights for the land on which its
primary manufacturing facilities were constructed under a Land Use Agreement
dated April 11, 1995 between SJE and the Bureau of National Land Planning Bao-An
Branch of Shenzhen City. This agreement provides JES with the right to use this
land until January 18, 2042 and required SJE to construct approximately 500,000
square feet of factory buildings and 211,000 square feet of dormitories and
offices. This construction is complete and total costs aggregated $15.8 million
through June 30, 2001.
In connection with the settlement with Go-Gro's former joint venture
partner in SJE, JES acquired the land use rights for a parcel of land adjoining
its primary manufacturing facilities. Under the separate land use agreement for
this parcel, JES has the right to use the land through March 19, 2051 and is
obligated to complete new construction on the land (estimated to cost
approximately $1.3 million) by March 20, 2002. If this construction is not
completed by that date JES is subject to fines, and if the construction is not
completed by March 20, 2004, the local municipal planning and state land bureau
may take back the land use rights for the parcel without compensation and
confiscate the structures and attachments.
Westinghouse License
--------------------
On April 26, 1996, the Company entered into a license agreement with
Westinghouse Electric Corporation to market and distribute a full range of
lighting fixtures, lamps and other lighting products under the Westinghouse
brand name in exchange for royalty payments. Subject to the minimum sales
conditions discussed below, the agreement terminates on September 30, 2002 with
the Company having options to extend the agreement for two additional five-year
terms. The royalty payments are due quarterly and are based on a percent of the
value of the Company's net shipments of Westinghouse branded products, subject
to annual minimum net shipments. Either party has the right to terminate the
agreement if the Company does not meet the minimum net shipments of $30 million
for fiscal 2001 and $60 million for fiscal 2002. Net sales of Westinghouse
branded products amounted to $13.3 million and $20.0 million for the nine months
ended June 30, 2001 and 2000, respectively. The Company does not expect to meet
the $30 million in minimum net shipments for 2001, and is presently discussing
with Westinghouse a possible amendment of the terms of this license agreement.
NYSE Listing
------------
On August 9, 1999 the New York Stock Exchange ("NYSE") notified the Company
that it had changed its rules regarding continued listing for companies which
have shares traded on the NYSE. The new rules changed and increased the
requirements to maintain a NYSE listing. Through March 31, 2001, the Company did
not meet the new rules, which required a total market capitalization of $50
million and the maintenance of minimum total stockholders' equity of $50
million. On April 5, 2001 the NYSE announced that it had determined that the
common stock of the Company should be removed from the list of companies trading
on the NYSE. The Company decided not to appeal the NYSE's decision. On May 21,
2001 the company's common stock began trading on the NASDAQ Over-the-Counter
Bulletin Board under the symbol "CALA.OB".
35
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Litigation
----------
During the past few years the Company received a number of claims relating
to halogen torchieres sold by the Company to various retailers. After January 1,
1999, the Company is self-insuring up to $10,000 per incident. Based upon its
experience, the Company is presently accruing for this self-insurance provision
and has accrued $230,000 for this contingency as of June 30, 2001. Management
does not believe that this self-insurance provision will have a material adverse
impact on the Company's financial position or annual results of operations.
However, no assurance can be given that the number of claims will not exceed
historical experience or that claims will not exceed available insurance
coverage or that the Company will be able to maintain the same level of
insurance.
On September 15, 1999, the Company filed a complaint entitled Catalina
Lighting, Inc. v. Lamps Plus, Civil Action 99-7200, in the U.S. District Court
for the Southern District of Florida. The lawsuit requested declaratory relief
regarding claims of trade dress and patent infringement made by Lamps Plus
against a major customer of the Company. Lamps Plus filed an Answer and
Counterclaim against Catalina and its customer on October 6, 1999 alleging
patent infringement and trade dress. The trade dress claim was dismissed with
prejudice before trial in March 2001. In April 2001, a jury returned a verdict
finding liability against the Company on the patent infringement claim and in
June 2001 the Court entered a judgment of approximately $1.8 million for damages
and interest thereon. The Company plans to appeal the judgment entered by the
Court and to obtain the necessary surety bond for the appeal. Based upon advice
of counsel, the Company believes that it ultimately will not be found liable for
patent infringement in this case. Accordingly, no provision for loss has been
recorded in the accompanying June 30, 2001 Condensed Consolidated Financial
Statements for this matter.
Other Matters
-------------
The People's Republic of China ("China") currently enjoys normal trading
relations ("NTR"). In the context of United States tariff legislation, such
treatment means that products are subject to favorable duty rates upon entry
into the United States. The United States annually reconsiders the renewal of
NTR trading status for China. Members of Congress and the "human rights
community" also monitor the human rights issues in China and adverse
developments in human rights and other trade issues in China could affect U.S. -
China relations. As a result of various political and trade disagreements
between the U.S. Government and China, it is possible restrictions could be
placed on trade with China in the future which could adversely impact the
Company's operations and financial position.
Ring has a defined benefit pension plan which covers 29 current employees
and over 1,000 other members formerly associated with Ring. The plan is
administered externally and the assets are held separately by professional
investment managers. The plan is funded by contributions at rates recommended by
an actuary. The Company is reviewing the future of the plan and believes that in
the future it may begin the process of terminating the Company's liability under
the plan. It is anticipated that a termination will require payment of a lump
sum equal to the "Minimum Funding Requirement ("MFR") shortfall. The most recent
estimate as of January 2001 placed the MFR shortfall at approximately $2.0
million. The U.K. Government announced in its March 2001 budget that it intends
to abolish the MFR and to replace it with funding standards individually
tailored to the circumstances of plans and employers. Based on current
information, it appears that this change is not likely to occur before April
2003, and should the Company not terminate its U.K. pension plan prior to that
date, the cost to terminate the Company's U.K. plan under the new rules is
likely to be much greater than the current $2 million deficit under the MFR
method.
As of June 30, 2001, Ring had outstanding 9.5 million convertible
preference shares of which 2.5 million shares were held by third parties and the
remaining 7 million shares were owned by the Company. The holders of the
convertible preference shares are entitled to receive in priority to the equity
shareholders a fixed cumulative dividend of 19.2 % per annum until January 1,
2004. The shares are convertible at the option of the holder into fully paid
ordinary shares on the basis of two ordinary shares for every five preference
shares. Any outstanding preference shares on January 1, 2004 automatically will
convert into fully paid ordinary shares on the same basis.
36
CATALINA LIGHTING, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Pursuant to a reorganization of the Company's executive management
structure, William D. Stewart, an Executive Vice-President of the Company left
the employ of the Company in December 1999 to pursue other interests. Under the
terms of the settlement agreement, Mr. Stewart will continue to provide
consulting services under a three-year non-compete and consulting agreement. The
Company has recorded a non-recurring pretax charge of $788,000 during the
quarter ended December 31, 1999 related to the settlement of its contractual
employment obligation to Mr. Stewart and is obligated to pay $250,000 annually
through December 2002 under the non-compete and consulting agreement.
Impact of New Accounting Pronouncements
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101") which summarizes certain of the staff's
view in applying generally accepted accounting principles to revenue recognition
in financial statements. The effective date of SAB 101 for the Company is the
quarter ending September 30, 2001. The Company has evaluated the impact that SAB
101 will have on the timing of revenue recognition in future periods and
believes SAB 101 will not have a material impact on its financial position or
results of operations.
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of financial Accounting Standards No. 141 ("SFAS 141") "Business
Combinations". SFAS 141 addresses financial accounting and reporting for
business combinations and supercedes Accounting Principles Board Opinion No. 16,
"Business Combinations and Statement of Financial Accounting No. 38 "Accounting
for Preacquisition Contingencies of Purchased Enterprises". All business
combinations in the scope of SFAS 141 are to be accounted for under the
purchased method. SFAS 141 is effective June 30, 2001. The Company does not
expect the adoption of SFAS 141 to have an impact on its financial position,
results of operations or cash flows.
In July 2001, the FASB also issued Statement of Financial Accounting
Standards No. 142 "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 142
addresses financial accounting and reporting for intangible assets acquired
individually or with a group of other assets (but not those acquired in a
business combination) at acquisition. SFAS 142 also addresses financial and
accounting and reporting for goodwill and other intangible assets subsequent to
their acquisition. With the adoption of SFAS 142, goodwill is no longer subject
to amortization. Rather, goodwill will be subject to at least an annual
assessment for impairment by applying a fair-value based test. The impairment
loss is the amount, if any, by which the implied fair value of goodwill is less
than carrying or book value. SFAS 142 is effective for fiscal years beginning
after December 15, 2001. Impairment loss for goodwill arising from the initial
application of SFAS 142 is to be reported as resulting from a change in
accounting principle. As of June 30, 2001, the Company has not assessed the
impact of adopting SFAS 142.
Impact of Inflation and Economic Conditions
Go-Gro has periodically experienced price increases in the costs of raw
materials, which reduced Go-Gro's profitability due to an inability to
immediately pass on such price increases to its customers. Significant increases
in raw materials prices could have an adverse impact on the Company's net sales
and income from continuing operations.
37
CATALINA LIGHTING, INC. AND SUBSIDIARIES
ITEM III QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency Risk
---------------------
The Company maintains investments in subsidiaries in Canada, Mexico and
Chile and sells its products into these foreign countries. The Company sells
into Europe and maintains major capital investments in manufacturing facilities
in China and supporting administrative offices in Hong Kong. With the
acquisition of Ring in July 2000, the Company has a major capital investment and
significant operations in the United Kingdom. Due to the significance of its
international sales and operations, the Company's business and operating results
are impacted by fluctuations in foreign currency exchange rates. If any of the
currencies of the foreign countries in which it conducts business depreciated
against the U.S. dollar the Company could experience significant changes in its
translations of assets, liabilities and transactions denominated in foreign
currencies, which could adversely impact the Company's future earnings. Large
fluctuations in currency exchange rates could have a material adverse effect on
the Company's cost of goods purchased (or manufactured) or on the Company's
selling prices thereby harming the Company's competitive position and
profitability. The Company borrows in British pounds, Canadian dollars and Hong
Kong dollars and will increase or decrease these foreign borrowings for various
business reasons (including anticipated movements in foreign exchange rates).
Ring also enters into forward contracts to exchange Great British pounds ("GBP")
for various foreign currencies. These contracts are fair value hedges of
liabilities related to commitments to purchase inventory in currencies other
than the GBP, and are entered into at the time the goods are shipped to Ring.
Presently, the Company has not entered into any other derivative instruments to
hedge its foreign currency exposure. During the nine months ended June 30, 2001
the Company's pretax loss reflected foreign currency losses for its Chinese,
Canadian and Chilean operations of $246,000, $85,000 and $59,000, respectively,
and a foreign currency gain for its Mexican operations of $10,000. In addition,
the Company's stockholders' equity at June 30, 2001 has been reduced by a $1.3
million foreign currency translation loss related to U.K. operations.
38
CATALINA LIGHTING, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On September 15, 1999, the Company filed a complaint entitled Catalina Lighting,
Inc. v. Lamps Plus, Civil Action 99-7200, in the U.S. District Court for the
Southern District of Florida. The lawsuit requested declaratory relief regarding
claims of trade dress and patent infringement made by Lamps Plus against a major
customer of the Company. Lamps Plus filed an Answer and Counterclaim against
Catalina and its customer on October 6, 1999 alleging patent infringement and
trade dress. The trade dress claim was dismissed with prejudice before trial in
March 2001. In April 2001, a jury returned a verdict finding liability against
the Company on the patent infringement claim and in June 2001 the Court entered
a judgment of approximately $1.8 million for damages and interest thereon. The
Company plans to appeal the judgment entered by the Court and to obtain a
necessary surety bond for the appeal. Based upon advice of counsel, the Company
believes that it ultimately will not be found liable for patent infringement in
this case and that the chances are remote that any enhanced damages will result
from the outcome of this case.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the Company's Annual Meeting of Stockholders, held on June 15, 2001, the
stockholders voted on the following matters:
(i) The following six persons were elected to serve as directors of the
Company until the 2002 Annual Meeting of Stockholders:
% Shares Cast
----------------------------------------
For (%) Against (%) Withheld (%)
------- ----------- ------------
Robert Hersh 87.76
Robert Lanzillotti 90.97
Henry Latimer 90.94
Jesse Luxton 90.98
Howard Steinberg 90.97
Brion Wise 90.98
Effective with the closing of the Sun Capital transaction on July 23, 2001
Messrs. Lanzillotti, Latimer and Luxton resigned as directors of the
Company
(ii) The appointment of Deloitte & Touche LLP to serve as the Company's
auditors for the fiscal year ending September 30, 2001 was ratified by a
vote of 6,874,390 (93.4%) shares cast for the proposal in favor and 7,010
(.10%) shares against.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
--------
10.208 First Amendment to Forbearance and Amendatory Agreement between
Catalina Lighting, Inc., Catalina International PLC, Ring
Limited and SunTrust Bank dated June 15, 2001.
11 Schedule of Computation of Diluted Earnings (loss) per Share.
(b) Reports on Form 8-K
-------------------
On August 7, 2001, a Form 8-K was filed concerning the change in control
of the Registrant effective July 23, 2001.
39
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
/s/ David W. Sasnett
----------------------------------------------
David W. Sasnett
Chief Financial Officer, Senior Vice President,
Chief Accounting Officer
Date: August 14, 2001
40
Exhibit Index
Exhibit No. Description
----------
Ex 10.208 First Amendment to Forbearance and Amendatory Agreement
Ex 11 Schedule of Computation of Diluted Earnings