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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[*]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE
ACT OF 1934 for the fiscal year ended May 31, 2003
OR
[ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE
ACT OF 1934 for the transition period from to
Commission file number: 333-93711
ICON Health & Fitness, Inc.
(Exact name of registrant as specified in its charter)
Delaware 87-0531206
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) No.)
1500 South 1000 West, Logan, Utah 84321
(Address and zip code of principal executive offices)
435 750-5000
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since
last report)
Indicate by checkmark 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 [*] No [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS:
Indicate by checkmark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [ ] 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:
ICON Health & Fitness, Inc. 1,000 shares.
ICON Health & Fitness, Inc.
INDEX
Page No.
--------
PART I
Item 1. Business 3
Item 2. Properties 9
Item 3. Legal Proceedings 9
Item 4. Submission of Matters to a Vote of Security Holders 10
PART II
Item 5. Market for the Registrant's Common Equity and
Related Stockholder Matters 10
Item 6. Selected Financial Data 10
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 7A. Quantitative and Qualitative Disclosures about
Market Risk 24
Item 8. Financial Statements and Supplementary Data 26
Item 9. Changes in and Disagreements with Auditors on
Accounting and Financial Disclosure 26
PART III
Item 10. Directors and Executive Officers of the Registrant 27
Item 11. Executive Compensation 31
Item 12. Security Ownership of Certain Beneficial Owners
and Management 34
Item 13. Certain Relationships and Related Transactions 37
Item 14. Controls and Procedures 39
PART IV
Item 15. Exhibits, Financial Statement Schedules and
Reports on Form 8-K 40
We have proprietary rights to a number of trademarks important to our
business, such as: ProForm(R), NordicTrack(TM), HealthRider(R), IMAGE(TM),
Weslo(R), JumpKing(R), Free Motion(TM), Workout Warehouse(TM), iFIT.com(TM),
iFIT(TM), SpaceSaver(TM), Cross Trainer(TM), Cross Walk(TM), Cardioglide(R),
Incline Trainer(TM), Trekker(TM), QuickSpeed(TM), QuickIncline(TM), EKG Grip
Pulse(TM), SoftDeck(TM), PowerIncline(TM), PowerRamp(TM), PRO SHOX(TM) and
CustomCushioning(TM), all of which are owned by us, and Reebok, Weider and
Gold's Gym, which are used by us under license agreements with the owners of
such trademarks.
PART I
Item 1. Business
Industry
The fitness equipment industry in the United States includes cardiovascular
and other fitness equipment, and strength training equipment. Cardiovascular and
other fitness equipment includes treadmills, ellipticals, exercise bikes, other
equipment, such as trampolines and relaxation products such as spas. Strength
training equipment includes multi-purpose home gyms, free weights and weight
benches and cages. According to the NSGA 2003 annual report, total retail sales
of exercise equipment on an industry-wide basis are estimated to total $4.6
billion in calendar year 2003.
Our Company
We market and distribute a broad line of products in the fitness equipment
market. These fall into two segments, namely cardiovascular and other fitness
equipment, and strength training equipment. We are one of the largest
manufacturers and marketers of home fitness equipment in the United States. In
addition, we manufacture and distribute an innovative line of cardiovascular and
strength training products for the institutional fitness equipment market. Our
brand names include ProForm, NordicTrack, Weslo, Image, JumpKing, Free Motion
Fitness and, under license, Reebok, Weider and Gold's Gym.
Our Brands and Distribution Channels
We market a complete line of products using multiple brands through
multiple distribution channels to reach a wide range of consumers at various
price points. This approach is enabled by our strong portfolio of brands which
are placed strategically to align consumer demographics with respective brand
attributes. We market our products through each distribution channel in which
home fitness equipment products are sold, including: department stores, mass
retailers and warehouse clubs, sporting goods and specialty fitness retailers,
home improvement stores, electronic retailers and direct-to-consumer sales
through catalogs, infomercials, the Internet and our company-owned
NordicTrack(TM) stores.
Products
Cardiovascular and Other Fitness Equipment
Our cardiovascular and other fitness equipment covers a broad range of
technological sophistication and a variety of price points which include the
following:
Treadmills. We design, innovate, manufacture, market and distribute
motorized and manual treadmills, designed to promote cardiovascular fitness.
We are the leading producer of motorized treadmills. Our treadmills include
proprietary technologies in the electronics console and drive train systems and
overall frame design. In the June 2003 issue of Consumer Reports, six of our
treadmills ranked among the top fifteen treadmills worldwide, based on criteria
such as quality, durability, features and ease of use. Certain features offered
by our motorized treadmills that enhance the home user's experience include
bio-feedback electronics such as heart rate control, pulse, certain
programmable speeds and inclines, electronic feedback on speed, elapsed time,
distance traveled, calories/fat calories burned, and cross-training upper body
exercise functions. The SpaceSaver(TM) feature for treadmills (introduced in
1996), for which we hold six United States patents, enables treadmills with this
feature to fold vertically for easy storage. As of the fall of 2001, we have
equipped all our brands of treadmills with a price point of $599 and above with
iFIT(TM) technology, for which we hold two United States patents and have seven
patents pending. iFIT(TM) technology allows us to control and program speed and
incline of a treadmill from remote locations for virtual personal training or
control the treadmill through CDs, VHS tapes, DVD, MP3 and the iFit.com website.
Consumers can benefit from iFIT(TM) technology using streaming workouts from the
iFIT(TM) website, music workouts on compact discs or MP3, or multi-media
iFIT(TM) videos and DVDs. In addition, we also offer live personal training
services via the Internet for consumers who choose to subscribe to our service.
Other popular features on our treadmill line of products include:
cushioning technologies such as PRO SHOX(TM) adjustable leaf springs and soft
belts for a quiet, shock-absorbent workout and the CrossWalk(TM) line of
treadmills, which provides users with upper body exercise for a total body
workout.
Ellipticals. Ellipticals are one of the fastest growing products in the
home fitness industry, growing at a Compound Annual Growth Rate (CAGR) of 24.4%
from 1997 to 2002. Ellipticals offer a low-impact, high-intensity aerobic
workout which harnesses the momentum of a natural striding motion, and reduces
the impact of typical running or walking. Our ellipticals typically provide an
electronic display that provides heart rate control, programmed workouts and
feedback on speed, time, distance and calories burned. Our iFIT(TM) technology,
which automatically adjusts resistance and pace on elliptical trainers, is
included on many elliptical trainers priced at $399 and above. Our ellipticals
were rated the number one, two and three ellipticals, respectively, in the March
2002 Consumer Reports ranking of home exercise equipment.
Exercise Bikes. We offer exercise bikes featuring a variety of resistance
mechanisms including electromagnetic, self-generating, flywheel and air;
electronic monitors which display elapsed time, speed, distance and calories
burned; and dual function design, which allows the user to exercise the upper
body, lower body or both simultaneously. Certain units include heart rate
control, motivational electronics and programmable resistance which allow users
to design their own workouts. Our iFIT(TM) technology, which automatically
adjusts pace and resistance, is included on several recumbent and upright bikes.
Recreational Sports Products. Through our JumpKing subsidiary, we
manufacture and market trampolines that include both mini-trampolines for indoor
home exercise use and full-sized trampolines for outdoor home recreational use.
Relaxation Products. In the spring of 1996, we introduced a full line of
hydrotherapy spas. These hydrotherapy spas are currently distributed through
various channels including department stores, mass retailers and warehouse
clubs, home improvement stores, specialty dealers and direct-to-consumers
through our own direct response marketing efforts.
Strength Training Equipment
We offer a complete line of anaerobic strength training equipment designed
to develop muscle tone and strength. Strength training equipment includes the
following:
Home Gyms. Our multi-purpose home gyms offer a range of resistance
mechanisms, from selectorized weight stacks to plate-loaded gyms to our
powerstroke leverage system and our CRS(TM) ("Compound Resistance System"(TM)).
New products include our Crossbow by Weider(TM) home gym and our patented Free
Motion(TM) equipment, which enables users to enjoy a full range of motion with
"functional movement" versus the rigid "fixed path movement" of traditional
equipment. Other products include our multi-purpose home gyms, which integrate
aerobic functions for cross training. Selected units are designed to allow
multiple users to use the equipment simultaneously, thereby allowing circuit
training.
Weight Benches, Cages and Free Weights. We offer a range of weight benches
and squat cages. We also offer a broad assortment of cast-iron weight plates,
vinyl and neoprene dipped weights and dumbbells, in standard and Olympic size
formats.
Exercise Accessories. We offer a line of back support belts, workout gloves
and exercise accessories, including ankle and hand weights and grip devices.
Product and Design Innovation
Product and design innovation has contributed significantly to our growth.
On an ongoing basis, we evaluate new product concepts and seek to respond to the
desires and needs of consumers by frequently introducing new products and
repositioning existing products. As of May 31, 2003, we had approximately 462
employees in our research and development group. We hold 178 United States
patents, we have 79 United States and 494 foreign trademarks, we have 34 United
States and 58 foreign patents pending and 21 United States and 78 foreign
trademarks pending.
We conduct most of our research and development in 40,000 square feet of
space in our Logan, Utah headquarters. This facility includes industrial design,
mechanical and electrical engineering capabilities that are used in creating
proprietary designs and features.
Customers
Our largest customer since 1985 has been Sears. In fiscal 2003, Sears
accounted for approximately 39% of net sales, a 5% decrease from fiscal 2002.
Other important customers include Sam's Club, Wal-Mart, The Sports Authority,
Dick's Sporting Goods, Costco, Target, Gold's Gym and 24 Hour Fitness. Although
Sears still accounts for a substantial portion of our sales, the percentage of
net sales to Sears has decreased over the past decade from a high of
approximately 68% in 1989. Nevertheless, the dollar amount of our net sales to
Sears has increased during this time period. Several customers have
distinguished us with vendor awards for our commitment in providing quality and
value to the consumer, including, among others, Sears' Vendor of the Year in
2000, Category Source of the Year in 2002 and their Partner in Progress award
twelve times since 1985. Wal-Mart has named us Vendor of the Quarter once in
each of fiscal 1999, 2000, 2001 and 2002. The Sports Authority named us Vendor
of the Year in 2002, and iFIT.com(TM) received The Sports Authority Victor Award
for the most innovative product. We have received the annual SPARC Award seven
times including the last six years consecutively. This annual award is the only
industry-wide vendor recognition program in mass-market retailing, and is
awarded by Discount Store News, a magazine which employs a panel made up of key
merchandising executives from the mass market retailing industry. This award
honors those who excel in new product innovation, on-time delivery, advertising
support and quality control.
We sell our products to customers representing over 7,600 consumer
locations, excluding those consumers we sell to directly through our retail,
direct response, television and Internet distribution channels. Consistent with
industry practice, we generally do not have long-term purchase agreements or
other commitments from our customers as to levels of future sales. The level of
our sales to large customers depends in large part on our continuing commitment
to home fitness products and the success of our efforts to market and promote
our products, as well as our competitiveness in terms of price, quality, product
innovation and customer service. We are not the exclusive supplier of home
fitness equipment to any of our major customers. The loss of, or a substantial
decrease in the amount of purchases by, or the uncollectibility of any
significant receivable due from any of our major customers could have a material
adverse effect on our business.
Competition
The fitness equipment market is highly competitive. It is characterized by
frequent introduction of new products, often accompanied by major advertising
and promotional programs. We believe that the principal competitive factors
affecting our business include price, quality, brand name recognition, product
innovation and customer service.
We compete with several domestic manufacturers and distributors such as
Cybex International, Inc., Fitness Quest, Life Fitness (a division of
Brunswick), Nautilus Group, Inc. and Precor (owned by Amer Group, PLC). We also
compete with a number of United States and foreign importers in both the United
States and global markets including Horizon, Impex and Stamina. In Europe, we
principally compete with BH (Spain), CARE (France), Helmut Kettler, Tunturi,
York (Great Britain) and other domestic competitors. The following table shows
who may be the five largest competitors in the United States:
United States Fitness Competitors
Company Name Primary Distribution Channel Principal Products
- ------------ ---------------------------- ------------------
Cybex International, Inc. Specialty fitness dealers, Cardiovascular,
institutional clubs and spas Strength Training
Fitness Quest TV infomercials, mass Cardiovascular,
distribution channels Strength Training
Life Fitness Institutional clubs and spas, Cardiovascular,
specialty fitness dealers Strength Training
Nautilus Group, Inc. TV infomercials, institutional Cardiovascular,
clubs and spas, sporting goods Strength Training
and specialty retailers
Precor Institutional clubs and spas, Cardiovascular,
specialty fitness dealers and Strength Training
sporting goods retailers
Distribution
We believe our distribution capabilities and post-sales support place us in
a good position to service major retailers. This has been accomplished through
the successful implementation of our integrated distribution and inventory
management system that is used to ensure that the necessary components are
available for manufacturing. This system is also capable of tracking finished
goods through all levels of the distribution chain. Through the effective use of
electronic data interchange, we are able to run manufacturing jobs to fill
specific customer orders, arrange for shipping from many of our manufacturing
facilities and make timely deliveries to our customer locations.
Manufacturing and Purchasing
In fiscal 2003, we manufactured or assembled our products at our company
facilities in Utah, Texas and Canada; or through third parties, principally in
Asia. We have long-standing supply relationships with several offshore vendors,
many of which have exclusive relationships in the fitness industry with us. The
combination of internal manufacturing and assembly capacity and our access to
third-party vendors has helped us meet customer demand on a competitive basis.
In addition, the third party vendors provide greater flexibility in
manufacturing capacity to satisfy seasonal demands.
We utilize more than 1.1 million square feet for manufacturing, including a
300,000 square foot facility in Logan, Utah. We constructed our Logan, Utah,
plant in 1990 and equipped the facility with modern manufacturing and assembly
features, including fully integrated metal fabrication, powdercoat painting,
robotic welding and injection molding equipment. In 1990, we purchased a
trampoline manufacturing operation in Dallas, Texas. In 1991, we began operating
our plant in Smithfield, Utah. In 1994, we began operating our Clearfield, Utah,
manufacturing facility. In 1995, we opened our Smithfield North Plant. In 1996,
we expanded our manufacturing capacity by 233,671 square feet through the
acquisition of our Canadian manufacturing facility in St. Jerome, Canada. In
2003, we announced our plan to set up a manufacturing facility in Xiamen, China.
This facility is expected to be operationally ready in 2004.
We apply a management system to control and monitor freight, labor,
overhead and material cost components of our finished goods. In fiscal 1994, we
received ISO 9001 certification for all of our non-retail facilities in Utah.
ISO is a nonprofit association that monitors industrial companies' manufacturing
processes, quality assurance controls, personnel management and customer service
in order to improve plant efficiency, product quality, customer satisfaction and
company profitability. ISO 9001 is a certification process used for companies
whose business includes a range of activities from design and development to
production, installation and servicing. ICON has been recertified by the ISO
9001 standards every year since 1994.
From fiscal 1996 to fiscal 2003, we have invested over $96.4 million in
tooling, molding, production and computer equipment to develop state-of-the-art
production, research and development, distribution and reporting systems. We
have a fully implemented Enterprise Resource Planning ("ERP") system that
integrates all manufacturing, planning, inventory, purchasing, order entry and
financial functions. Our inventory management and manufacturing productivity are
enhanced by our just-in-time system for purchasing materials and components. We
have also invested in Electronic Data Interchange ("EDI") capabilities,
including Wal-Mart's Retail Link system, which provides us and a substantial
number of our primary customers a seamless flow from initial retailer orders to
parts purchasing to product manufacturing to shipping.
Employees
As of May 31, 2003, we employed approximately 4,569 people, 105 of whom
were and are represented by a Canadian labor union. We are party to a collective
bargaining agreement with this union which expires on August 7, 2004. Factory
employees are compensated through a targeted incentive system. Managerial
employees receive bonuses tied to the achievement of performance targets. As of
May 31, 2003, approximately 462 employees were engaged in research and
development, 625 in sales and marketing, 2,956 in manufacturing and 526 in other
areas, primarily administrative. We are also subject to three employment
agreements with our senior executives.
Environmental Matters
Our operations are subject to federal, state and local health and safety
and environmental laws and regulations that impose workplace standards and
limitations on the discharge of pollutants into the environment and establish
standards for the handling, generation, emission, release, discharge, treatment,
storage and disposal of materials, substances and wastes. The nature of our
manufacturing and assembly operations exposes us to the risk of claims with
respect to environmental matters, and although compliance with local, state and
federal requirements relating to the protection of the environment has not had a
material adverse effect on our financial condition or results of operations,
there can be no assurance that material costs or liabilities will not be
incurred in connection with such environmental matters. Future events, such as
changes in existing laws and regulations or enforcement policies or the
discovery of contamination on sites owned or operated by us may give rise to
additional compliance costs or operational interruptions which could have a
material adverse effect on our financial condition. In addition, many but not
all of our properties have been the subject of either Phase I or Phase II
Environmental Site Assessments. While we are not aware of any existing
conditions that are likely to result in material costs or liabilities to us,
there can be no assurance that all potential instances of soil or ground water
contamination have been identified even where Environment Site Assessments have
been conducted. Accordingly, there can be no assurance that previously unknown
environmental conditions, or known conditions which have not been fully
evaluated, will not be discovered at any of our properties, whether presently or
formerly owned or leased, or that the cost of remediating such condition will
not be material.
Seasonality
The market for exercise equipment is highly seasonal, with peak periods
occurring from late fall through February. As a result, the first and fourth
quarters of every year are generally the Company's weakest periods in terms of
sales. During these periods, ICON builds product inventory to prepare for the
heavy demand anticipated during the upcoming peak season. This operating
strategy helps ICON to realize the efficiencies of a steady pace of year-round
production.
Item 2. Properties
Our headquarters are located in Logan, Utah, and we own the related land
and buildings. Additionally, we own land and buildings in Canada. The total
square footage of our owned buildings is approximately 485,000 square feet.
We lease additional facilities for manufacturing, warehouses and offices in
the United States and various foreign countries including the United Kingdom,
Italy, France and Germany. We sublease certain of these facilities where space
is not fully utilized.
We believe that these facilities are well maintained, in good operating
condition and are adequate for our current needs and that suitable additional or
substitute space will be available as needed to accommodate any expansion of our
operations.
In addition, as of May 31, 2003 we operated under lease 69 NordicTrack(TM)
retail stores in various cities in the United States.
Item 3. Legal Proceedings
We are party to a variety of non-product liability commercial lawsuits
involving contract claims, arising in the ordinary course of our business. We
believe that adverse resolution of these lawsuits would not have a material
adverse effect on our results of operations or financial position.
We are party to a variety of product liability lawsuits, arising in the
ordinary course of our business, as a result of injuries sustained by customers
while using a variety of our products. These claims include injuries sustained
by individuals using trampolines and treadmills. We vigorously defend any and
all product liability claims brought against us and do not believe that any
currently pending claim or series of claims will have a material adverse effect
on our results of operations or financial position.
We are also involved in several intellectual property and patent
infringement claims, arising in the ordinary course of our business. We believe
that the ultimate outcome of these matters will not have a material adverse
effect on our results of operations or financial position.
We are involved in litigation with Service Merchandise in connection with
its filing for bankruptcy protection. Service Merchandise filed three separate
adversarial proceedings against us in the United States Bankruptcy Court, Middle
District of Tennessee, Nashville Division, alleging preferential transfer in
Adversarial Proceedings Nos. 301-0738A and 301-0770A, and Breach of Contract in
Adversarial Proceeding No. 301-0586A. The bankruptcy trustee has filed suit in
connection with the foregoing seeking to recapture an aggregate amount of $1.7
million in payments made to us as a voidable preference. The summons was issued
on April 16, 2001. The proposed claim is currently being vigorously defended by
our counsel. At this time, we are unable to determine the likelihood of an
unfavorable outcome or the amount or range of potential recovery or loss.
Item 4. Submission of Matters to a Vote of Security Holders
We did not submit any matters during the fourth quarter of the fiscal year
covered by this report to a vote of security holders through the solicitation of
proxies or otherwise.
PART II
Item 5. Market for the Registrants' Common Equity and Related
Stockholder Matters
As of May 31, 2003, we had 1,000 shares of common stock outstanding all of
which were held by HF Holdings, Inc. ("HF Holdings"). There is not an
established trading market for the common stock of HF Holdings or us. Our
ability to pay dividends is limited under an indenture dated as of April 9, 2002
between us and Bank of New York, as trustee, and by our Credit Agreement.
Item 6. Selected Financial Data
The selected financial data set forth below with respect to our statements
of operations for the three years ended May 31, 2003 and the balance sheet data
for May 31, 2003 and May 31, 2002 have been derived from our financial
statements included elsewhere in this Form 10-K that have been audited by
PricewaterhouseCoopers LLP, independent auditors, as indicated in their report
included elsewhere in this Form 10-K. Our statement of operations data for the
years ended May 31, 2000 and 1999, and our balance sheet data as of May 31,
2001, 2000 and 1999, have been derived from the financial statements audited by
PricewaterhouseCoopers LLP but not included in this Form 10-K.
The data set forth should be read together with, and is qualified in its
entirety by, "Management's Discussion and Analysis of Financial Condition and
Results of Operations," our consolidated financial statements, and the related
notes thereto appearing elsewhere in this Form 10-K.
For the Year Ended May 31,
(in millions)
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Operating Data:
Net sales(1) $1,011.5 $871.4 $797.0 $712.8 $687.9
Cost of sales 713.4 635.0 580.5 531.6 514.0
-----------------------------------------------
Gross profit 298.1 236.4 216.5 181.2 173.9
Operating expenses:
Selling 134.1 101.4 86.3 75.8 85.3
Research and development 11.6 10.4 10.9 8.3 7.7
General and
administrative 81.8 68.1 64.5 61.3 53.4
-----------------------------------------------
Total operating expenses 227.5 179.9 161.7 145.4 146.4
-----------------------------------------------
Income from operations 70.6 56.5 54.8 35.8 27.5
Interest expense 25.1 26.2 34.8 33.9 33.1
Amortization of deferred
financing fees 1.2 3.1 3.2 2.7 7.0
Net income (loss) 26.7 19.4 13.3 (6.6) (24.7)
Other Financial Data:
Depreciation and
amortization $ 19.2 $ 19.2 $ 17.4 $ 16.7 $ 17.4
Purchases of property
and equipment(2) 17.0 11.6 16.1 12.9 11.6
Net cash provided by
operating activities 31.6 37.5 12.4 0.5 38.0
Net cash used in
investing activities (21.8) (17.1) (22.8) (19.9) (20.1)
Net cash provided by
(used in) financing
activities (12.3) (19.3) 8.7 21.4 (17.1)
Supplemental Data:
EBITDA(3) $ 89.8 $ 68.3 $ 72.1 $ 49.4 $ 44.9
Balance Sheet Data (at the end of the period):
Cash $ 4.7 $ 4.8 $ 3.3 $ 5.9 $ 4.3
Working capital 186.8 164.0 157.6 132.3 108.0
Total assets 465.1 423.2 405.5 368.1 331.9
Long-term obligations 248.9 255.8 253.3 242.2 253.4
- ----------
(1) In November of 2001, the Emerging Issues Task Force issued EITF 01-09,
"Accounting for Consideration Given by a Vendor to a Customer" ("EITF
01-09") effective for annual or interim financial statements for periods
beginning after December 15, 2001. For comparative purposes, net sales are
shown as if EITF 01-09 had been adopted for all periods.
(2) Excludes purchases of intangibles and trademarks and acquisitions of $4.9
million for fiscal year 2003, $5.5 million for fiscal year 2002, $6.7
million for fiscal year 2001, $4.4 million for fiscal year 2000 and $8.5
million for fiscal year 1999.
(3) EBITDA is a presentation of "earnings before interest, taxes, depreciation
and amortization." EBITDA data is included because management understands
that such information is considered by bankers and certain investors as an
additional basis on evaluating a company's ability to pay interest, repay
debt and make capital expenditures. EBITDA may not be comparable to
similarly titled measures reported by other companies. In addition, EBITDA
is a non-GAAP measure and should not be considered an alternative to
operating or net income in measuring company results. Our definition of
EBITDA may differ from definitions of EBITDA used by other companies. A
reconciliation of net income to EBITDA can be found in Management's
Discussion and Analysis of Financial Condition and Results of Operations
under the heading Results of Operations. The following table includes a list
of unusual items that have affected EBITDA.
For the Year Ended May 31,
-------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
(In millions)
Loss on extinguishment of debt - 7.4(a) - - -
Kmart bankruptcy bad debt 9.1(b) 2.4(b) - - -
Excess air freight charges - - - 6.0(c) -
Non-recurring recapitalization cost - - - 1.8(d) -
Equity grant to senior management - - - 3.1(e) -
Non-recurring costs in selling expense - - - - 10.5(f)
---------------
(a) A loss of approximately $7.4 million was recorded on the
extinguishment of the Company's Old 1999 Credit Facilities and the 12%
Notes.
(b) On January 22, 2002, Kmart filed for bankruptcy protection. On that
date, we had $12.1 million of unsecured accounts receivable
outstanding with Kmart. We disposed of the remaining balance of the
pre-bankruptcy receivables in the third quarter of fiscal 2003.
(c) We incurred $6.0 million of in-bound air freight charges (in cost of
sales) in excess of normal freight costs. Due to our significant
indebtedness, certain of our vendors shortened our payment terms prior
to our recapitalization in September 1999. Due to liquidity
constraints we had to delay the purchase of certain component parts
and finished goods, and we therefore incurred additional in-bound air
freight expenses related to these items that we needed to receive
rapidly in order to meet our customers' delivery schedules.
(d) We recorded $1.5 million of non-recurring costs (in general and
administrative expense) related to management retention bonuses, paid
to certain executive officers, and $0.3 million of one-time
non-recurring costs associated with the redemption of our 13% senior
subordinated notes due 2002, both in connection with our
recapitalization in September 1999.
(e) We recorded $3.1 million of non-recurring non-cash costs (in general
and administrative expense) related to an equity grant made to certain
members of senior management due to our recapitalization in September
1999.
(f) We recorded $10.5 million of non-recurring costs (in selling expenses)
related to the write-off of accounts receivable due to the bankruptcy
of Service Merchandise.
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.
The following should be read in conjunction with the financial statements
and the related notes thereto appearing elsewhere in this Form 10-K. Our fiscal
year ends on May 31 of the corresponding calendar year. For example, fiscal 2003
ended on May 31, 2003.
Recent Developments
In fiscal 2003, we formed a foreign subsidiary to build a manufacturing
facility in Xiamen, China. The total project cost is anticipated to be
approximately $12.0 million, with $7.0 million to be funded in the form of
capital contributions, and approximately $5.0 million in the form of debt. Our
share of the equity investment is expected to be approximately $5.0 million. We
are in the process of arranging for the debt portion of the financing, which is
expected to be provided by the Bank of China.
Overview
We manufacture and market a broad line of cardiovascular and other
equipment and strength training equipment. We are one of the largest
manufacturers and marketers of home fitness equipment in the United States. In
addition, we manufacture and distribute an innovative line of cardiovascular and
other equipment and strength training equipment for the institutional fitness
equipment market.
We sell our products under a wide variety of brand names and we use our
portfolio of brands to tailor our product offerings to specific distribution
channels. We sell our products to department stores, mass retailers and
warehouse clubs, sporting goods and specialty fitness retailers, directly to
consumers, and health clubs.
The following paragraphs provide a brief description of certain items that
appear in our Consolidated Statements of Operations.
Net sales. Net sales primarily represent our gross sales adjusted for
returns and allowances. We limit our customers' ability to return merchandise to
us to products sold to their customers in which defects were discovered within
the warranty coverage period (usually 90 days from the time of retail sale). We
do not permit our customers to return unsold merchandise.
Cost of sales. Cost of sales primarily includes the cost of components that
we purchase, direct manufacturing labor and overhead, inbound shipping and
freight and depreciation expense related to our property, plant, equipment and
tooling.
Selling expense. Selling expense primarily includes our direct advertising
expense, advertising allowances provided to certain customers and the costs
related to our sales and marketing staff for our home fitness and institutional
fitness business.
Research and development expense. Research and development expense relates
primarily to the activities of our product development group and external
sources related to the development of new products and product enhancements.
General and administrative expense. General and administrative expense
primarily includes expenses related to our senior management team, all
accounting and finance functions, management information systems, legal and
human resources expenses and unallocated overhead expenses.
Critical Accounting Policies
Critical accounting policies are those that require application of
management's most difficult, subjective or complex judgments, often as a result
of the need to make estimates about the effect of matters that are inherently
uncertain and may change in subsequent periods.
Our significant accounting policies are described in Note 2 to the
Consolidated Financial Statements. Not all of these significant accounting
policies require management to make difficult, subjective or complex judgments
or estimates. However, the following accounting policies could be deemed to be
critical.
Inventories - Inventories consist primarily of raw materials (principally
parts and supplies) and finished goods, and are valued at the lower of cost or
market. Cost is determined using standard costs which approximate the first-in,
first-out (FIFO) method.
Intangible Assets - We adopted the provisions of SFAS No. 142, "Goodwill
and Other Intangible Assets" effective June 1, 2002. SFAS No. 142 no longer
requires the amortization of goodwill and other indefinite lived intangibles. As
a result, results for the year ended May 31, 2003 were positively impacted by a
$0.4 million elimination of such amortization. As of May 31, 2003, we had
approximately $5.6 million of unamortized goodwill. Under the provisions of SFAS
No. 142, we are required to test these assets for impairment at least annually.
The annual impairment tests have been completed and did not result in an
impairment charge. To the extent an impairment is identified in the future, we
will record the amount of the impairment as an operating expense in the period
in which it is identified.
Long-Lived Assets - Long-lived assets are reviewed for impairment whenever
events or circumstances indicate that the carrying amount of long-lived assets
may not be recoverable. The carrying value of a long-lived asset is considered
impaired when the anticipated cumulative undiscounted cash flows from that asset
is less than its carrying value. In that event, a loss is recognized based on
the amount by which the carrying value exceeds the fair market value of the
long-lived asset, which is generally based on discounted cash flows. As a result
of our review, we do not believe that any impairment currently exists related to
our long-lived assets.
Revenue Recognition - We recognize revenue upon the shipment of product to
the customer. Allowances are recognized for estimated returns, discounts,
advertising programs and warranty costs associated with these sales.
Income Taxes - We account for income taxes utilizing the asset and
liability method as prescribed by SFAS No. 109, "Accounting for Income Taxes".
Deferred tax assets and liabilities are recorded based on the differences
between the financial statement and tax bases of assets and liabilities at
currently enacted tax rates. If appropriate, deferred tax assets are reduced by
a valuation allowance which reflects expectations of the extent to which such
assets will be realized.
Contingencies - We account for contingencies in accordance with SFAS No. 5,
"Accounting for Contingencies". SFAS No. 5 requires that we record an estimated
loss from a loss contingency when information available prior to issuance of the
consolidated financial statements indicates that it is probable that an asset
has been impaired or a liability can be reasonably estimated. Accounting for
contingencies such as environmental, legal and income tax matters requires us to
use our judgment. While we believe that our accruals for these matters are
adequate, if the actual loss from a loss contingency is significantly different
from the estimated loss, our results of operations will be affected in the
period the contingency is resolved.
Results of Operations
The following table sets forth certain of our financial data, expressed as
a percentage of net sales, for fiscal years ended May 31, 2003, 2002 and 2001:
For the Year Ended May 31,
--------------------------
2003 2002 2001
---- ---- ----
Net sales 100.0% 100.0% 100.0%
Cost of sales 70.5% 72.9% 72.8%
----- ----- -----
Gross profit 29.5% 27.1% 27.2%
Operating expenses:
Selling 13.3% 11.6% 10.8%
Research and development 1.1% 1.2% 1.4%
General and administrative 8.1% 7.8% 8.1%
----- ----- -----
Total operating expenses 22.5% 20.6% 20.3%
----- ----- -----
Income from operations 7.0% 6.5% 6.9%
Interest expense 2.5% 3.0% 4.4%
Amortization of deferred
financing fees 0.1% 0.4% 0.4%
Loss on debt extinguishment - 0.9% -
----- ----- -----
Income before income taxes 4.4% 2.2% 2.1%
Provision for income taxes 1.7% 0.0% 0.4%
----- ----- -----
Net income 2.7% 2.2% 1.7%
===== ===== =====
EBITDA 8.9% 7.8% 9.0%
===== ===== =====
Year Ended May 31, 2003 Compared to Year Ended May 31, 2002
- -----------------------------------------------------------
Net sales for fiscal 2003 increased $140.1 million, or 16.1%, to $1,011.5
million from $871.4 million in the comparable period in 2002. Sales increased
primarily due to increased direct consumer sales and customer demand. Sales of
our cardiovascular and other equipment in fiscal 2003 increased $80.5 million,
to $825.6 million. Sales of our strength training equipment in fiscal 2003
increased $59.6 million, to $185.9 million.
Gross profit for fiscal 2003 was $298.1 million, or 29.5% of net sales,
compared to $236.4 million, or 27.1% of net sales, in fiscal 2002. This 26.1%
increase was largely due to increased direct consumer sales which have higher
margins, changes in product mix and manufacturing efficiencies.
Selling expenses increased $32.7 million, or 32.2%, to $134.1 million in
fiscal 2003. This increase reflected increased bad debt expense related to
pre-bankruptcy receivables of Kmart of $9.1 million. Increased direct consumer
advertising, commissions and freight also contributed to the increase. Expressed
as a percentage of net sales, selling expenses were 13.3% in fiscal 2003 and
11.6% in fiscal 2002. Absent the Kmart bad debt expense, selling expenses were
12.4% in fiscal 2003.
Research and development expenses increased $1.2 million, or 11.5%, to
$11.6 million in 2003. Expressed as a percentage of net sales, research and
development expenses were 1.1% in fiscal 2003 and 1.2% in fiscal 2002.
General and administrative expenses increased $13.7 million, or 20.1%, to
$81.8 million in fiscal 2003. This increase is a factor of normal salary
increases, planned additions to staff, increased insurance costs and increases
attributable to performance based bonus and incentive programs. Increased rent
and lease expense also contributed to the increase. Expressed as a percentage of
net sales, general and administrative expenses were 8.1% in fiscal 2003 compared
with 7.8% in fiscal 2002.
As a result of the foregoing factors, operating income increased $14.1
million, or 25.0%, to $70.6 million in fiscal 2003. Expressed as a percentage of
net sales, operating income was 7.0% in 2003 compared with 6.5% in fiscal 2002.
As a result of the foregoing factors, EBITDA increased $21.5 million, or
31.5%, to $89.8 million in fiscal 2003. Expressed as a percentage of net sales,
EBITDA was 8.9% in fiscal 2003 compared with 7.8% in fiscal 2002.
Interest expense, including amortization of deferred financing fees,
decreased $3.0 million, or 10.2%, to $26.3 million in fiscal 2003. This decrease
reflects lower interest rates during fiscal 2003. In addition, deferred
financing fees decreased as a result of the April 2002 debt refinancing.
Expressed as a percentage of net sales, interest expense including amortization
of deferred financing fees was 2.6% in fiscal 2003 compared with 3.4% in fiscal
2002.
The provision for income taxes increased $17.2 million, or 4300.0%, to
$17.6 million in fiscal 2003. Our effective tax rate was 39.7% in 2003 compared
to 1.9% in fiscal 2002. The lower effective tax rate in fiscal 2002 is the
result of adjustments pursuant to an Internal Revenue Service audit. These
adjustments created a deferred tax benefit of approximately $11.5 million. No
valuation allowance was recorded against this asset because we believe that we
will generate sufficient future taxable income through operations to realize the
net deferred asset. However, there can be no assurance that we will generate any
specific level of taxable earnings or that we will be able to realize any of the
deferred tax asset in future periods. If we are unable to generate sufficient
taxable income in the future, an additional valuation allowance against this
deferred tax asset would result in a charge to earnings.
As a result of the foregoing factors, net income was $26.7 million in
fiscal 2003 compared to net income in fiscal 2002 of $19.4 million.
Year Ended May 31, 2002 Compared to Year Ended May 31, 2001
- -----------------------------------------------------------
Net sales for fiscal 2002 increased $74.4 million, or 9.3%, to $871.4
million from $797.0 million in the comparable period in 2001. Sales increased
primarily due to increased customer demand and the introduction of our new line
of institutional fitness equipment which represented $11.0 million, or 14.8%, of
the sales increase. Sales of our cardiovascular and other equipment in fiscal
2002 increased $57.9 million, to $745.1 million. Sales of our strength training
equipment in fiscal 2002 increased $16.5 million, to $126.3 million.
Gross profit for fiscal 2002 was $236.4 million, or 27.1% of net sales,
compared to $216.5 million, or 27.2% of net sales in fiscal 2001.
Selling expenses increased $15.1 million, or 17.5%, to $101.4 million in
fiscal 2002. This increase was the result of higher selling costs associated
with the increase in sales combined with the impact of the introduction of our
new line of institutional fitness equipment as well as increased advertising
expenses. Expressed as a percentage of net sales, selling expenses were 11.6% in
fiscal 2002 compared to 10.8% in fiscal 2001.
Research and development expenses decreased $0.5 million, or 4.6%, to $10.4
million in fiscal 2002. Expressed as a percentage of net sales, research and
development expenses were 1.2% in fiscal 2002 and 1.4% in fiscal 2001.
General and administrative expenses increased $3.6 million, or 5.6%, to
$68.1 million in fiscal 2002. This increase was the result of higher costs
associated with our increase in sales combined with the impact of the
introduction of our new line of institutional fitness equipment. Expressed as a
percentage of net sales, general and administrative expenses were 7.8% in fiscal
2002 and 8.1% in fiscal 2001.
As a result of the foregoing factors, operating income increased $1.7
million, or 3.1%, to $56.5 million in fiscal 2002. Expressed as a percentage of
net sales, operating income was 6.5% in fiscal 2002 compared with 6.9% in fiscal
2001.
As a result of the foregoing factors, EBITDA decreased $3.8 million, or
5.3%, to $68.3 million in fiscal 2002. Expressed as a percentage of net sales,
EBITDA was 7.8% in fiscal 2002 compared with 9.0% in fiscal 2001.
Interest expense, including amortization of deferred financing fees,
decreased $8.7 million, or 22.9%, to $29.3 million in fiscal 2002. This
decrease reflects our lower borrowing levels during the period combined with
lower interest rates on our borrowings.
A loss of $7.4 million was recorded on the extinguishment of the existing
credit facility and the 12% Notes.
The provision for income taxes decreased $3.0 million, or 88.2%, to $0.4
million in fiscal 2002. Our effective tax rate was 1.9% in fiscal 2002 compared
to 20.7% in fiscal 2001. The lower effective tax rate in fiscal 2002 was the
result of adjustments pursuant to an Internal Revenue Service audit. These
adjustments created a deferred tax benefit of approximately $11.5 million.
As a result of the foregoing factors, our net income was $19.4 million in
fiscal 2002 compared to net income in fiscal 2001 of $13.3 million.
Seasonality
The market for exercise equipment is highly seasonal, with peak periods
occurring from late fall through February. As a result, the first and fourth
quarters of every year are generally the Company's weakest periods in terms of
sales. During these periods, ICON builds product inventory to prepare for the
heavy demand anticipated during the upcoming peak season. This operating
strategy helps ICON to realize the efficiencies of a steady pace of year-round
production.
The following are the net sales, operating income (loss) and net income
(loss) of our Company by quarter for fiscal years 2003, 2002 and 2001:
First Second Third Fourth
Quarter(1) Quarter(2) Quarter(3) Quarter(4)
---------- ---------- ---------- ----------
(in millions)
Net Sales(5)
2003 $170.2 $292.7 $344.0 $204.6
2002 134.2 264.6 296.0 176.6
2001 125.9 267.6 247.6 155.9
Operating Income (Loss)
2003 $ 2.0 $ 28.8 $ 37.5 $ 2.3
2002 (4.5) 26.9 33.8 0.3
2001 (2.3) 31.9 29.4 (4.2)
Net Income (Loss)
2003 $ (3.4) $ 13.7 $ 20.3 $ (3.9)
2002 (7.5) 11.1 25.5 (9.7)
2001 (8.2) 11.7 10.8 (1.0)
The following is a reconciliation of net income (loss) to EBITDA by quarter (6):
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
----------------------------------------------------------------
2003
Net income (loss) $ (3.4) $ 13.7 $ 20.3 $ (3.9) $ 26.7
Add back:
Depreciation and
amortization 4.2 4.0 5.0 6.0 19.2
Provision (benefit)
for income tax (1.2) 8.3 10.7 (0.2) 17.6
Interest expense 6.4 6.5 6.3 5.9 25.1
Amortization of deferred
financing fees 0.3 0.2 0.2 0.5 1.2
------ ------ ------ ------ ------
EBITDA $ 6.3 $ 32.7 $ 42.5 $ 8.3 $ 89.8
====== ====== ====== ====== ======
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
----------------------------------------------------------------
2002
Net income (loss) $ (7.5) $ 11.1 $ 25.5 $ (9.7) $ 19.4
Add back:
Depreciation and
amortization 4.5 4.3 4.9 5.5 19.2
Provision (benefit)
for income tax (4.8) 8.2 1.4 (4.4) 0.4
Interest expense 6.8 6.8 6.0 6.6 26.2
Amortization of deferred
financing fees 0.9 0.9 0.9 0.4 3.1
------ ------ ------ ------ ------
EBITDA $ (0.1) $ 31.3 $ 38.7 $ (1.6) $ 68.3
====== ====== ====== ====== ======
2001
Net income (loss) $ (8.2) $ 11.7 $ 10.8 $ (1.0) $ 13.3
Add back:
Depreciation and
amortization 4.0 4.0 4.3 5.1 17.4
Provision (benefit)
for income tax (3.2) 8.0 7.0 (8.4) 3.4
Interest expense 8.2 9.7 9.3 7.6 34.8
Amortization of deferred
financing fees 0.8 0.8 0.8 0.8 3.2
------ ------ ------ ------ ------
EBITDA $ 1.6 $ 34.2 $ 32.2 $ 4.1 $ 72.1
====== ====== ====== ====== ======
The following is a reconciliation of net loss to EBITDA for the fiscal years
ended May 31, 2000 and 1999.
2000 1999
-----------------------------
Net loss $ (6.6) $(24.7)
Add back:
Depreciation and
amortization 16.7 17.4
Provision for income tax 2.7 12.1
Interest expense 33.9 33.1
Amortization of deferred
financing fees 2.7 7.0
-----------------------------
EBITDA $ 49.4 $ 44.9
=============================
(1) Our first quarter ended August 31, September 1, and September 2 for fiscal
years 2003, 2002 and 2001, respectively.
(2) Our second quarter ended November 30, December 1, and December 2 for fiscal
years 2003, 2002 and 2001, respectively.
(3) Our third quarter ended March 1, March 2, and March 3 for fiscal years 2003,
2002 and 2001, respectively.
(4) Our fourth quarter ended May 31 for the fiscal years 2003, 2002 and 2001,
respectively.
(5) In November of 2001, the Emerging Issues Task Force issued EITF 01-09,
"Accounting for Consideration Given by a Vendor to a Customer" ("EITF 01-09")
effective for annual or interim financial statements for periods beginning after
December 15, 2001. EITF 01-09 provides guidance on the accounting treatment of
various types of consideration given by a vendor to a customer. We adopted EITF
01-09 in fiscal 2003. Net sales are shown as if EITF 01-09 were adopted for all
periods presented. Net sales without the adjustment for EITF 01-09 were as
follows:
First Second Third Fourth
Quarter Quarter Quarter Quarter
----------------------------------------------
(in millions)
Net Sales
2003 $175.8 $301.5 $354.8 $210.9
2002 138.1 272.1 304.9 181.0
2001 129.5 276.0 254.6 160.4
(6) EBITDA is a presentation of "earnings before interest, taxes, depreciation
and amortization." EBITDA data is included because management understands that
such information is considered by bankers and certain investors as an additional
basis on evaluating a company's ability to pay interest, repay debt and make
capital expenditures. EBITDA may not be comparable to similarly titled measures
reported by other companies. In addition, EBITDA is a non-GAAP measure and
should not be considered an alternative to operating or net income in measuring
company results.
Liquidity and Capital Resources
Net cash provided by operating activities was $31.6 million in fiscal 2003,
as compared to $37.5 million of cash provided by operating activities in fiscal
2002. In fiscal 2003, major sources of funds were net income of $26.7 million,
non-cash provisions of $19.2 million for depreciation and amortization and an
increase in accounts payable and accrued expenses of $18.5 million. These
changes were offset by increases in accounts receivable of $22.0 million, due
partially to increased direct response receivables, and inventories of $28.0
million, due primarily to building inventory levels to meet anticipated sales
levels. In fiscal 2002, major sources of funds were net income of $19.4 million,
non-cash provisions of $19.2 million for depreciation and amortization, and a
decrease in inventories of $12.2 million. These changes were offset by an
increase in accounts receivable of $20.0 million.
Net cash used in investing activities was $21.8 million in fiscal 2003,
compared to $17.1 million of cash used in investing activities in fiscal 2002.
Investing activities in fiscal 2003 consisted primarily of capital expenditures
of $17.0 million related to upgrades in plant and tooling and purchases of
additional manufacturing equipment and purchases of intangible assets of $4.9
million. Cash used in investing activities in fiscal 2002 consisted primarily of
capital expenditures of $11.6 million related to upgrades in plant and tooling
and purchases of additional manufacturing equipment and purchases of intangible
assets of $5.2 million.
Net cash used in financing activities was $12.3 million in fiscal 2003,
compared to $19.3 million of cash used in financing activities in fiscal 2002.
Cash used in financing activities in fiscal 2003 resulted from payments on the
revolving credit facility, payments on the April 2002 term notes, payment of
debt issuance fees and payments on other long-term debt. Cash used in financing
activities in fiscal 2002 resulted from the issuance in April 2002 of the 11.25%
Senior Subordinated Notes, borrowings on our new credit facility, repayment of
our old credit facility and the redemption of our 12% subordinated notes.
Net cash provided by operating activities was $37.5 million in fiscal 2002,
as compared to $12.4 million of cash provided by operations in fiscal 2001. In
fiscal 2002, major sources of funds were net income of $19.4 million, non-cash
provisions of $19.2 million for depreciation and amortization, and a decrease in
inventories of $12.2 million. These changes were offset by increases in accounts
receivable of $20.0 million. In fiscal 2001, major sources of funds were net
income of $13.3 million, non-cash provisions of $17.4 million for depreciation
and amortization, and increases in accounts payable and accrued expenses of
$10.0 million. These increases were offset by increases in accounts receivable
of $14.1 million and inventories of $14.8 million. Such increases were due to
the aforementioned factors relating to sales increases.
Net cash used in investing activities was $17.1 million in fiscal 2002,
compared to $22.8 million in fiscal 2001. Investing activities in fiscal 2002
consisted primarily of capital expenditures of $11.6 million related to upgrades
in plant and tooling and purchases of additional manufacturing equipment and
purchases of intangible assets of $5.2 million. Cash used in investing
activities in fiscal 2001 was primarily for capital expenditures of $16.1
million, acquisitions of $4.0 million and purchases of intangible assets of $2.7
million.
Net cash used in financing activities was $19.3 million in fiscal 2002,
compared to $8.7 million of cash provided by financing activities in fiscal
2001. Cash used in financing activities in fiscal 2002 resulted from the
issuance in April 2002 of the 11.25% Senior Subordinated Notes, borrowings on
our new credit facility, repayment of our old credit facility and the redemption
of our 12% subordinated notes. Cash provided by financing activities in fiscal
2001 resulted from borrowings on the revolving credit facility, payments on the
September 1999 term notes, payments of debt issuance fees and payments on other
long-term debt.
We made capital expenditures of approximately $17.0 million during fiscal
2003 and expect to make capital expenditures of approximately $15.0 million in
fiscal 2004. Capital expenditures are primarily for expansion of physical plant,
purchases of additional or replacement manufacturing equipment and revisions and
upgrades in plant tooling.
On January 22, 2002, Kmart, a customer for over a decade, filed for
bankruptcy protection. At the time of the bankruptcy filing, we had $12.1
million of unsecured accounts receivable outstanding with Kmart. We disposed of
the remaining balance of the pre-bankruptcy receivable in the third quarter of
fiscal 2003. We had net sales to Kmart of $26.7 million in fiscal 2003,
representing approximately 2.6% of total net sales for that period. In fiscal
2002, we had net sales to Kmart of approximately $28.9 million, representing
approximately 3.3% of total net sales for that period. We resumed shipments to
Kmart on February 5, 2002 and continue with payment terms of 30 days. Kmart
emerged from Chapter 11 protection on May 6, 2003.
Our primary short-term liquidity needs consist of financing seasonal
merchandise inventory buildups and paying cash interest expense under our
existing credit facilities and on the 11.25% subordinated notes due in April
2012. Our principal source of financing for our seasonal merchandise inventory
buildup and increased accounts receivable is revolving credit borrowings under
the existing credit facilities. At May 31, 2003, we had $110.7 million of
availability under these facilities. Our working capital borrowing needs are
typically at their lowest level from April through June, increase somewhat
through the summer and sharply increase from September through November to
finance accounts receivable and purchases of inventory in advance of the
Christmas and post-holiday selling season. Generally, in the period from
November through February, our working capital borrowings remain at their
highest level and then are paid down to their lowest annual levels from April
through August.
In connection with our debt refinancing in April 2002, we entered into our
existing credit facility totaling $235.0 million of revolving and term loans
with a syndicate of banks and financial services companies. The revolving and
term loans are due in 2007.
Proceeds of our existing credit facility were used to refinance our then
existing credit facility and 12% senior subordinated notes due 2005, to fund
transaction fees and expenses and to provide general working capital.
As of May 31, 2003 the balance outstanding under the existing credit
facility consisted of (in millions):
Revolver $ 72.6
Term Loan 18.7
------
$ 91.3
======
As of May 31, 2003, our consolidated indebtedness was approximately $244.2
million, of which approximately $91.3 million was senior indebtedness.
Based on our current level of operations, management believes that cash
flow from operations and available cash, together with available borrowings
under our existing credit facility, will be adequate to meet future liquidity
needs for at least the next few years. We may, however, need to refinance all or
a portion of the principal amount of the notes on or prior to maturity.
As of May 31, 2003, our contractual cash obligations and commercial
commitments were as follows:
Payments Due by Period (in millions)
-----------------------------------------------------
Less Than 1 After 5
Total Year 2-3 Years 4-5 Years Years
-----------------------------------------------------
Credit facilities $ 91.3 $ 5.0 $ 86.3 $ - $ -
Senior subordinated notes 152.9 - - - 152.9
Operating leases 36.4 9.1 18.7 6.2 2.4
-----------------------------------------------------
Total contractual cash
obligations $280.6 $ 14.1 $105.0 $ 6.2 $155.3
=====================================================
As part of our cash management activities, we seek to manage accounts
receivable credit risk, collections and accounts payable and payments thereof to
maximize our free cash at any given time.
Careful management of credit risk has allowed us to avoid (except for
Kmart, as discussed above) significant accounts receivable losses in light of
the poor financial condition of many of our potential and existing customers. In
light of current and prospective global regional economic conditions, we cannot
assure you that we will not be materially adversely affected by accounts
receivable losses in the future.
Recent Accounting Pronouncements
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations," which establishes accounting standards for the
recognition and measurement of an asset retirement obligation and its associated
asset retirement cost. SFAS No. 143 is effective for fiscal years beginning
after June 15, 2002. The adoption of SFAS No. 143 effective June 1, 2003 did not
have a material effect on our financial position or results of operations.
In August 2001, the FASB issued SFAS No. 144, "Accounting for Impairment of
Disposal of Long-Lived Assets" which supercedes SFAS No. 121 and requires that
one accounting model be used for long-lived assets to be disposed of by sale,
whether previously held and used or newly acquired. SFAS No. 144 also broadens
the presentation of discontinued operations to include more disposal
transactions. SFAS No. 144 is effective for fiscal years beginning after
December 15, 2001. The adoption of SFAS No. 144 did not have a material effect
on our financial position or results of operations.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FAS Nos. 4, 44
and 64, Amendment of FAS 13 and Technical Corrections as of April 2002", which
rescinds FAS Nos. 4, 44 and 64 and amends other existing authoritative
pronouncements to make various technical corrections, clarify meaning or
describe their applicability under changed conditions. SFAS No. 145 is effective
for fiscal years beginning after May 15, 2002 and resulted in the 2002 loss on
debt extinguishment being reclassified from an extraordinary item to income from
continuing operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities", which addresses significant issues
relating to the recognition, measurement and reporting of costs associated with
exit and disposal activities. SFAS No. 146 is effective for exit or disposal
activities initiated after December 31, 2002 and is not expected to have a
material effect on our financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of FASB 123". This
statement provides alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
In addition, this statement amends disclosure requirements of SFAS No. 123 to
ensure that fair value disclosures are prominent in both annual and interim
financial statements. We have adopted the disclosure provisions of SFAS No. 148,
but will continue to account for our stock-based compensation plans in
accordance with APB 25.
In November 2001, the Emerging Issues Task Force issued EITF 01-09,
"Accounting for Consideration Given by a Vendor to a Customer". EITF 01-09
provides guidance on the accounting treatment of various types of consideration
given by a vendor to a customer. The Company has adopted EITF 01-09 effective
June 1, 2002 which reduced net sales for the fiscal year ended May 31, 2003 by
approximately $31.5 million with a corresponding reduction of selling, general
and administrative expenses. This change has no effect on income from operations
or net income. For comparative purposes, net sales for fiscal years ended May
31, 2002 and 2001 have been reduced by approximately $24.7 million and $23.5
million, respectively, with a corresponding reduction of selling, general and
administrative expenses.
In November 2002, the FASB issued FASB Interpretation No. ("FIN") 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others". FIN 45 elaborates on the
existing disclosure requirements for most guarantees, including loan guarantees
such as standby letters of credit. It also clarifies that at the time a company
issues a guarantee, the Company must recognize an initial liability for the fair
value, or market value, of the obligations it assumes under that guarantee and
must disclose that information in its interim and annual financial statements.
FIN 45 is effective on a prospective basis for guarantees issued or modified
after December 31, 2002. The disclosure requirements of FIN 45 are effective for
financial statements of interim or annual periods ending after December 15,
2002. We do not expect FIN 45 to have a material effect on our consolidated
financial statements.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities", which clarifies the application of Accounting Research
Bulletin No. 51, "Consolidated Financial Statements" to certain entities in
which equity investors do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties. FIN 46 is applicable immediately for variable interest entities
created after January 31, 2003. For variable interest entities created prior to
January 31, 2003, the provisions of FIN 46 are applicable no later than July 1,
2003. We do not expect FIN 46 to have a material effect on our consolidated
financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity". SFAS
No. 150 establishes standards on the classification and measurement of certain
financial instruments with characteristics of both liabilities and equity. The
provisions of SFAS No. 150 are effective for financial instruments entered into
or modified after May 31, 2003 and to all other instruments that exist as of the
beginning of the first interim financial reporting period beginning after June
15, 2003. We are currently evaluating the effects SFAS No. 150 may have on our
financial statements.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Market Risk
Fluctuations in the general level of interest rates on our current and
future fixed and variable rate debt obligations expose us to market risk. We are
vulnerable to significant fluctuations in interest rates on our variable rate
debt and on any future repricing or refinancing of our fixed rate debt and on
future debt.
We use long-term and medium-term debt as a source of capital. At May 31,
2003, we had approximately $152.9 million in outstanding fixed rate debt,
consisting of 11.25% subordinated notes maturing in April 2012. When debt
instruments of this type mature, we typically refinance such debt at the
then-existing market interest rates, which may be more or less than the interest
rates on the maturing debt.
Our credit facility has variable interest rates and any fluctuation in
interest rates could increase or decrease our interest expense. At May 31, 2003,
we had approximately $91.3 million in outstanding variable rate debt. The
weighted average rate of interest on the variable interest rate debt was
approximately 4.8% for the fiscal year ended May 31, 2003. If the interest rate
for our variable rate debt increased or decreased by 1% during fiscal year 2003,
our interest expense on outstanding variable rate debt would increase or
decrease by approximately $1.5 million.
Due to the uncertainty of fluctuations in interest rates and the specific
actions that might be taken by us to mitigate the impact of such fluctuations
and their possible effects, the foregoing sensitivity analysis assumes no
changes in our financial structure.
In addition to the United States, we have operations or transact business
in Canada, United Kingdom, France, Italy, Germany, and Asia. The operations in
these foreign countries conduct business in their local currencies as well as
other regional currencies. To mitigate our exposure to transactions denominated
in currencies other than the functional currency of each entity, we enter into
forward exchange contracts from time to time to protect our margin on a portion
of our forecast foreign currency sales. As of May 31, 2003 and 2002, no forecast
sales were hedged by forward exchange contracts. Because of the variety of
currencies in which purchases and sales are transacted, it is not possible to
predict the impact of a movement in foreign currency exchange rates on future
operating results. However, we intend to continue to mitigate our exposure to
foreign exchange gains or losses.
Assessment of the Euro
On January 1, 1999, eleven of the member countries of the European Union
established fixed conversion rates between their existing currencies (called
"LEGACY CURRENCIES") and one common currency called the euro. The euro trades on
currency exchanges and may be used in business transactions. In January 2002,
the legacy currencies began being withdrawn from circulation. Our subsidiaries
affected by the conversion have established plans to address issues raised by
the conversion. We believe that, under current conditions, the conversion of
legacy currencies to the euro will not have a material adverse effect on our
results of operations or financial position.
Item 8. Financial Statements and Supplementary Data
Index to Consolidated Financial Statements
and Schedule
Page
----
Report of Independent Auditors 46
Consolidated Financial Statements:
Consolidated Balance Sheets as of May 31, 2003 and 2002 47
Consolidated Statements of Operations and Comprehensive
Income for the Years Ended May 31, 2003, 2002 and 2001 48
Consolidated Statement of Stockholder's Equity (Deficit)
for the Years Ended May 31, 2003, 2002 and 2001 49
Consolidated Statements of Cash Flows for the Years
Ended May 31, 2003, 2002 and 2001 50
Notes to Consolidated Financial Statements 51
Financial Statement Schedule:
Schedule II - Valuation and Qualifying Accounts for
the Three Years Ended May 31, 2003 79
Item 9. Changes in and Disagreements with Auditors on Accounting
and Financial Disclosure None
PART III
Item 10. Directors and Executive Officers of the Registrant
Management Directors and Officers
The directors and executive officers of the Company, their ages and number
of years with ICON Health & Fitness are as follows:
Years
Name Age with ICON Position
- --------------------- --- --------- -------------------------------------
Scott R. Watterson 48 25 Chairman of the Board and Chief
Executive Officer
Gary E. Stevenson 48 25 President, Chief Operating Officer
and Director
S. Fred Beck 45 14 Chief Financial and Accounting
Officer, Vice President and
Treasurer
David J. Watterson 44 23 President, North American Operations
Jon M. White 55 16 Senior Vice President, Manufacturing
William T. Dalebout 55 15 Vice President, Design
M. Joseph Brough 39 14 Vice President, Operations and
Information Technology
Matthew N. Allen 39 19 Vice President, Product Development
Douglas L. Clausen 56 12 Vice President, Purchasing
Brad H. Bearnson 49 8 General Counsel, Secretary
Wallace J. Smith 60 14 Vice President, Business Development
Jeff Carmignani 55 20 Vice President, Imports,
Transportation and New Business
Development
Giovanni Lato 45 10 President, ICON Europe
Richard Hebert 58 9 President, ICON Canada
Colleen Logan 41 8 Director, Marketing
David Packham 42 7 Director, NordicTrack Retail Stores
Jace Jergensen 40 9 Vice President and General Manager,
JumpKing
Lynn C. Brenchley 57 13 Vice President, Business Development
Robert C. Gay 51 - Vice Chairman of the Board
Ronald P. Mika 42 - Director
Gregory Benson 49 - Director
Stanley C. Tuttleman 84 - Director
Alan H. Freudenstein 38 - Director
W. Steve Albrecht 56 - Director
Scott R. Watterson. Mr. Watterson has served as Chairman of the Board of
Directors and CEO since 1988. Prior to 1988, Mr. Watterson co-founded Weslo,
Inc., a predecessor entity of the Company, in 1977. In addition, Mr. Watterson
is a director of the Utah State University Foundation. He is also on the Board
of Trustees for the Utah Foundation and the Make-A-Wish Foundation of Utah. Mr.
Watterson graduated from Utah State University College of Business, Cum Laude,
in 1979 with a B.S. in Business Marketing and a minor in Chinese.
Gary E. Stevenson. Mr. Stevenson has served as President, COO and as one
of the Company's directors since 1988. Prior to 1988, Mr. Stevenson co-founded
Weslo, Inc., the predecessor entity of the Company, in 1977. Mr. Stevenson's
current and past affiliations include: Utah State University President's
National Advisory Council, Utah State University College of Business and
Engineering Advisory Board, Marriott School, Brigham Young University National
Advisory Council, among others. Mr. Stevenson graduated from Utah State
University College of Business in 1979 with a B.S. in Business Administration
and a minor in Japanese.
S. Fred Beck. Mr. Beck has served as the Company's CFO and Accounting
Officer, VP and Treasurer since 1989. Mr. Beck is a CPA and a member of the
AICPA (national chapter of CPAs) and the UACPA (the Utah chapter of CPAs). Mr.
Beck is also a member of the Board of Directors of Regence BlueCross BlueShield
of Utah and a member of The Regence Group Board of Directors. Mr. Beck graduated
from Utah State University with a B.S. in Accounting.
David J. Watterson. Mr. Watterson was recently named President of North
America. Prior to his role as President of North America, Mr. Watterson served
as SVP of Marketing and Research and Development since November 1992. Prior to
1992, Mr. Watterson served as ICON's Sales Manager and VP of Sales since joining
the Company in 1980. Mr. Watterson is Scott R. Watterson's brother. Mr.
Watterson graduated from Utah State University with a B.S. in Marketing.
Jon M. White. Mr. White has served as SVP and VP of Manufacturing since
1988. Mr. White is responsible for all domestic manufacturing operations in the
Logan, Clearfield and Smithfield plants in Utah and product distribution at the
Clearfield distribution center. Prior to 1988, Mr. White served as Plant Manager
of Weathershield Manufacturing Inc.'s, Nibley, Utah plant and production control
manager for the Wurlitzer Co.'s, Logan, Utah, manufacturing plant.
William T. Dalebout. Mr. Dalebout has served as VP of Design since 1987.
Prior to working for ICON, Mr. Dalebout was President and founder of Ziba Design
Inc., an industrial design consultancy. Prior to founding and managing Ziba
Design Inc., Mr. Dalebout worked for Hewlett-Packard, Tektronix Inc. and Smith
Corona Marchant. Mr. Dalebout graduated with a B.A. in Industrial Design from
Brigham Young University.
M. Joseph Brough. Mr. Brough joined the Company in 1989 and has served as
VP of Operations and Information Technology since 1995. Prior to working for
ICON, Mr. Brough worked for Andersen Consulting. Mr. Brough graduated with a
M.B.A from the University of Utah in 1987 where he was ranked number one in his
graduating class.
Matthew N. Allen. Mr. Allen joined the Company in 1984 and has served as VP
of Product Development since 1999. He served as VP of Sales from 1996-1999.
Between 1984 and 1996, Mr. Allen served in various roles in sales, quality
control and production. Mr. Allen graduated with B.S. in Business Marketing
from Utah State University.
Douglas L. Clausen. Mr. Clausen has served as VP of Purchasing since
joining the Company in 1992. Prior to working for ICON, Mr. Clausen worked for
the Jacobsen Division of Textron as a Purchasing Manager/Materials Manager from
1987 to 1992. Prior to working for Textron, Mr. Clausen worked for Lunar
Radiation, Spring Mills and the U.S. Air Force. Mr. Clausen has a M.B.A. from
Capital University in Columbus, Ohio and has a Bachelor's degree in Business
Administration from the University of Wisconsin-Madison.
Brad A. Bearnson. Mr. Bearnson joined the Company in 1995 and presently
serves as General Counsel and Secretary. Mr. Bearnson is a CPA and was admitted
to the Utah State Bar in 1982. Mr. Bearnson has also served as a Member of the
Legislative Affairs Committee of the Utah State Bar from 1997-2000. Mr.
Bearnson graduated with a B.S. from Utah State University and then earned his
Juris Doctorate degree from the University of Utah.
Wallace J. Smith. Mr. Smith joined the Company in 1989 and has served as
VP in the Business Development Division. Prior to this, Mr. Smith was the Chief
Operating Officer of IMAGE, Inc., which was a wholly owned business of ICON
Health and Fitness, Inc. IMAGE supplied fitness products primarily to specialty
fitness dealers. Prior to managing IMAGE, Inc., Mr. Smith was responsible for
the planning, development and construction of ICON's main office and
manufacturing facility in Logan, Utah. Mr. Smith is Scott R. Watterson's
brother-in-law. Mr. Smith earned a B.S. degree in Psychology and Chemistry at
the University of Utah. He then completed his M.B.A. degree at the same
university.
Jeff Carmignani. Mr. Carmignani joined the Company in 1983 and has served
as VP of Imports, Transportation and New Business Development from 1987 to
present. Prior to joining ICON, Mr. Carmignani served as VP of Operations of
Exectech Inc.
Giovanni Lato. Mr. Lato has served as the President of ICON Europe since
1999. Mr. Lato joined Weider, Inc. in 1993. Previously, Mr. Lato served as VP
of Sales for Gianni Versace SpA since 1989. Mr. Lato graduated in 1981 with a
B.S. in Business Administration from Luiss University in Rome, Italy.
Richard Hebert. Mr. Hebert has served as President of ICON Canada since
1994. Mr. Hebert founded his first manufacturing company in 1967 named
Athletimonde, Inc. In 1980, Mr. Hebert established his second manufacturing
company named Rickbend Industries, Inc. In 1990, Mr. Hebert began a third
company called Fitquip, Inc. These three companies were consolidated into one
entity in an acquisition by ICON Health & Fitness Inc. in 1994.
Colleen Logan. Ms. Logan has served as Director of Marketing since 1996.
Prior to working for ICON, Ms. Logan was VP, Management Supervisor at Oglivy &
Mather in Chicago, working in their Public Relations, Advertising, and Direct
Response divisions. During her nearly 10 years at Ogilvy, she created marketing
plans for such diverse clients as Sears, Roebuck and Co., Equal sweetener, and
various brands of Kraft General Foods. Her prior experience also includes
William Cook Advertising in Jacksonville, Florida as part of the team that
launched the Mayo Clinic Florida. Ms. Logan holds a B.S. in Journalism from the
University of Florida with a minor in Microbiology & Cell Science.
David Packham. Mr. Packham has served as the head of the retail group
since 1996. Prior to working for ICON, Mr. Packham spent three years in
strategic marketing at the Walt Disney Company and three years at General Mills
in national brand management. Mr. Packham has also served on the Fitness
Institute Board since 1999. Mr. Packham earned his Masters of Management from
Kellogg Business School in 1990 with majors in Marketing, Finance and
International Business.
Jace Jergensen. Mr. Jergensen has served as the VP and General Manager of
ICON's JumpKing operation since 1999. From 1994 to 1999, Mr. Jergensen served
as the Director of New Product Development for ICON. Prior to joining ICON, Mr.
Jergensen held various positions with Black & Decker, First Interstate Bank and
Ernst & Whinney. Mr. Jergensen earned an M.B.A. in 1989 and B.S. in Accounting
in 1987 from Brigham Young University.
Lynn C. Brenchley. Mr. Brenchley joined the Company in 1989 and has served
as VP of Business Development since 1992. Mr. Brenchley has been involved with
Mergers and Acquisitions since joining the Company. Prior to working for ICON,
Mr. Brenchley worked for a regional meat processing company where he was Chief
Financial Officer for nine years and President and Chief Executive Officer for 8
years. Mr. Brenchley served as an officer in the Army Reserves for 12 years.
Mr. Brenchley graduated from Utah State University with a B.S. degree in
Accounting and minor in Business Administration.
Robert C. Gay. Mr. Gay became Vice Chairman of our Board of Directors in
November 1994. Mr. Gay has been a Managing Director of Bain Capital, a private
investment firm, since April 1993 and has been a General Partner of Bain Venture
Capital, the venture capital arm of Bain Capital, which focuses on first
and second institutional round investing in software, technology-driven business
services, hardware and information companies, since February 1989. In addition,
Mr. Gay serves as a director of Nutraceutical, GS Technologies Corporation,
Anthony Crane and Alliance Laundry and Buhrmann.
Ronald P. Mika. Mr. Mika became one of our directors in November 1994. Mr.
Mika is a principal at Sorenson Capital Partners. Prior to joining Sorenson
Capital, Mr. Mika was a managing director at Bain Capital. In addition, Mr. Mika
serves as a director of Professional Services Industries.
Gregory Benson. Mr. Benson became one of our directors in September 1999.
Mr. Benson has been an executive vice president of Bain Capital since 1996.
Prior to joining Bain Capital, Mr. Benson was an executive vice president of
American Pad and Paper Company.
Stanley C. Tuttleman. Mr. Tuttleman became one of our directors in
September 1999. Mr. Tuttleman has been the Chief Executive Officer and President
of Tuttson Capital Corp., a financial services corporation, since 1983. Mr.
Tuttleman also serves as the Chief Executive Officer of Telepartners
International, a wireless program company. In addition, Mr. Tuttleman is a
director of Mothers Work, Inc., and a trustee of the Franklin Institute, the
Philadelphia Orchestra, the Philadelphia Museum of Art, Graduate Hospital,
Gratz College and the Harrison Foundation.
Alan H. Freudenstein. Mr. Freudenstein became one of our directors in
November 2002. Mr. Freudenstein is a Managing Director in the Private Equity
Group of Credit Suisse First Boston, LLC. He is also a Vice President of Credit
Suisse First Boston Management Corporation and Special Situations Holdings, Inc.
- - Westbridge. From 1992 through July 2000, Mr. Freudenstein was a Managing
Director at Bankers Trust Company, where he was responsible for incubation and
venture investments within the New World Ventures Group. Mr. Freudenstein is
also on the board of directors of Ascent Assurance, Inc. (OTCBB:AASR).
Dr. W. Steve Albrecht. Dr. Albrecht became one of our directors in November
2002. Dr. Albrecht serves as the Associate Dean of the Marriott School of
Management and Arthur Andersen Professor at Brigham Young University. Prior to
becoming Associate Dean, Dr. Albrecht served as director of the School of
Accountancy and Information Systems at Brigham Young University for eight years.
Dr. Albrecht is a certified public accountant, a certified internal auditor and
a certified fraud examiner. Dr. Albrecht is also on the board of directors of
Cypress Semiconductor Corp. (NYSE:CY), SkyWest, Inc. (NASDAQ:SKYW) and Red Hat,
Inc. (NASDAQ:RHAT).
Board Committees
Compensation Committee
We maintained a compensation committee during fiscal 2003. The Compensation
Committee consists of the following non-employee directors: Messrs. Gay, Benson
and Tuttleman. The Compensation Committee of the Board of Directors, composed
of Messrs. Gay, Benson and Tuttleman, has the authority to administer the
executive compensation for Scott R. Watterson, our Chief Executive Officer.
Messrs. Watterson and Stevenson participated in the deliberations concerning the
compensation of other officers other than their own, and Mr. Beck participated
in the deliberations concerning the compensation of officers other than himself
and Messrs. Watterson and Stevenson.
Audit Committee
The Audit Committee includes Messrs. Albrecht, Tuttleman, and Mika. This
committee reviews the professional services provided by the Company's
independent auditors and the independence of such firm from the management of
the Company. This committee also reviews the scope of the audit by the Company's
independent auditors, the annual and interim financial statements of the
Company, the Company's systems of internal accounting controls, and such other
matters with respect to the accounting, auditing, and financial reporting
practice and procedures of the Company as it may find appropriate.
Item 11. Executive Compensation
The following table sets forth information concerning the compensation for
fiscal 2003, 2002, and 2001 for Mr. Scott Watterson and our other four most
highly compensated executive officers (collectively, the "Named Executive
Officers"):
SUMMARY COMPENSATION TABLE
Annual Compensation Other Long-term All
------------------- Annual Compensation Other
Fiscal Salary Bonus Compensation Options Compensation
Name and Position Year ($) ($) ($) (#)(2) ($)(3)
- -----------------------------------------------------------------------------------------
Scott R. Watterson 2003 677,250 1,879,640 102,473(1)(5) - 71,539(4)
Chairman of the Board 2002 604,813 995,000 103,679(1)(5) - 580,527(4)
and Chief Executive 2001 551,250 448,905 116,808(1)(5) - 42,000(4)
Officer
Gary E. Stevenson 2003 624,000 1,656,320 71,967(1)(5) - 68,534(4)
President and Chief 2002 524,000 875,600 62,213(1)(5) - 368,969(4)
Operating Officer 2001 498,750 398,149 62,900(1)(5) - 42,000(4)
S. Fred Beck 2003 270,000 334,390 10,815(1) - 9,433
Chief Financial and 2002 249,000 165,910 - - 188,500
Accounting Officer 2001 235,000 145,059 - - 9,230
Vice President and
Treasurer
David J. Watterson 2003 323,000 340,390 25,302(1) - 10,972
President, 2002 300,000 520,910 - - 85,165
North America 2001 284,400 155,559 - - 8,500
Operations
Richard Hebert 2003 294,914 157,549 10,165(1) - -
General Manager, 2002 262,000 145,850 8,700(1) - -
ICON Du Canada, Inc. 2001 296,974 155,000 10,496(1) - -
(1) Includes the annual cost of providing the named person with the use of an
automobile during the year.
(2) Options to purchase shares of HF Holdings' common stock.
(3) Includes amounts contributed by the Company for the benefit of the Named
Executive Officers under the Company's 401 (K) Plan and the Company's
deferred compensation plan.
(4) Includes a management fee of $33,500 paid by the company.
(5) Includes amounts for personal use of the Company jet.
The following table sets forth information as of May 31, 2003, concerning
options of HF Holdings, Inc. exercised by each of the named executive officers
in 2003 and year-end option values:
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR END OPTION VALUES
Value of
Unexercised In-the-
Number of Unexercised Money Options at
Name Options at May 31, 2003($)(1)
Shares Acquired Value May 31, 2003(#) Exercisable/
On Exercise(#) Realized($) Exercisable/Unexercisable Unexercisable
- -----------------------------------------------------------------------------------------
Name Common Stock Common Stock Common Stock Common Stock
Scott Watterson - - -/- -/-
Gary Stevenson - - -/- -/-
S. Fred Beck - - 49,995/49,995 -/-
David J. Watterson - - 59,979/59,979 -/-
Richard Hebert - - -/- -/-
- -----------
(1) As of May 31, 2003, there was no market for the common stock of HF Holdings,
Inc.; no value has been attributed to the equity underlying these options.
There have been no arm's length sales of HF Holding's common stock since the
closing of the recapitalization in September of 1999.
1999 Junior Management Stock Option Plan
In September 1999, HF Holdings adopted its 1999 Junior Management Stock
Option Plan (the "1999 Stock Option Plan") which provides for the grant of
nonstatutory options to eligible employees. A total of 333,300 shares of common
stock of HF Holdings were reserved and issued under the 1999 Stock Option Plan,
which is administered by the Board of Directors or a committee thereof.
Committee Interlocks and Insider Participation
We maintained a compensation committee during fiscal 2003. The Compensation
Committee consists of the following non-employee directors: Messrs. Gay, Benson
and Tuttleman.
Report of the Compensation Committee
The Compensation Committee of the Board of Directors, composed of Messrs.
Gay, Benson and Tuttleman, has the authority to administer the executive
compensation for Scott R. Watterson, our Chief Executive Officer. Messrs.
Watterson and Stevenson participated in the deliberations concerning the
compensation of other officers other than their own, and Mr. Beck participated
in the deliberations concerning the compensation of officers other than himself
and Messrs. Watterson and Stevenson.
Compensation of Directors
Our directors do not receive any compensation for serving on the Board of
Directors except for Mr. Tuttleman and Mr. Albrecht. Mr. Tuttleman is paid
$35,000 annually for his services as a director. Mr. Albrecht is paid $40,000
annually plus $1,000 for each meeting attended for his services as a director.
Directors are reimbursed for their out-of-pocket expenses incurred in connection
with their service as directors. We also maintain liability insurance policies
for our directors.
Performance Bonus
In fiscal 2003 and 2002, the Board of Directors approved the establishment
of a bonus pool of $1.0 million and $1.5 million, respectively. The Board gave
discretion to Gary Stevenson and Scott Watterson to determine eligible employees
and the amounts payable to each employee. These bonuses were paid in August of
each year and accrued in our May 31, 2003 and May 31, 2002 financial statements.
Employment Agreements
In May of 2003, we renegotiated the September 27, 1999 employment
agreements ("second amendment") with each of Mr. Watterson and Mr. Stevenson.
The second amendment extends these agreements to September 27, 2005. The
employment agreements provide for the continued employment of Mr. Watterson as
Chairman and Chief Executive Officer with an increase in base salary from
$525,000 to $625,000, and Mr. Stevenson as President and Chief Operating Officer
with an increase in base salary from $475,000 to $575,000. Except as set forth
below, in all other material respects the agreements are substantially identical
to the September 1999 agreement.
The second amendment provides for a one-time retention bonus for each of
Mr. Watterson and Mr. Stevenson of $300,000. Each executive is also entitled to
participate in a bonus program providing for a bonus equal to a percentage of
our consolidated EBITDA (as defined in our credit facility) and our subsidiaries
(our "EBITDA") which percentage shall equal 1.50% for Mr. Watterson and 1.32%
for Mr. Stevenson. The executives will not be entitled to a bonus, however,
unless our Profits exceed 5.5% of net sales.
We may terminate each executive's employment (1) for cause as provided in
each agreement, (2) upon six months' disability, or (3) without cause. Each
executive may similarly terminate his employment immediately for cause as
provided in his employment agreement, upon three months notice to perform
full-time church service or for any reason upon six months' notice. In the event
we terminate either executive's employment for cause, or such employment
terminates as a result of the death of the executive, as the case may be, the
executive will not be entitled to further salary, benefits or bonus. If we
terminate the executive's employment without cause, or the executive terminates
his employment with or without cause, we will be obligated to pay the executive
his salary and bonus for a period of three years from the date of termination.
If we terminate the executive's employment upon the executive's disability, we
are obligated to pay as severance an amount equal to one month's base salary
then in effect for each calendar year or part thereof elapsed since January 1,
1988, provided that such severance pay is reduced by payments under applicable
disability insurance.
The employment agreements prohibit the executives from engaging in outside
business activity during the term, subject to exceptions. The employment
agreements provide for customary confidentiality obligations and, in addition, a
non-competition obligation for a period of four years following termination (two
years if the executive quits with cause or without cause or is terminated
without cause, except that we may, at our option, extend such period for up to
two additional years by paying the executive his salary and bonus during the
extended period).
Under the employment agreements, the executives (and their affiliates)
shall be entitled to indemnification to the fullest extent allowed by Delaware
law with respect to all losses, costs, expenses and other damages in connection
with any lawsuits or other claims brought against them in their capacity as
officers or directors or shareholders (or affiliates thereof) of HF Holdings or
any of its past or present parent or subsidiary or other affiliated companies.
Item 12. Security Ownership of Certain Beneficial Owners and
Management
HF Holdings owns all of our outstanding common stock. The following table
and related notes set forth information with respect to the beneficial ownership
of HF Holdings' 7,771,613 outstanding shares of common stock as of May 31, 2003
by (i) each person known to HF Holdings to beneficially own more than 5.0% of
the outstanding shares of common stock of HF Holdings, and (ii) each director
and executive officer of HF Holdings individually and (iii) all directors and
executive officers of HF Holdings as a group.
Common Stock
Beneficially Owned(1)
----------------------------
Percent of
Number of Outstanding
Names Shares Shares
- ----- --------- -----------
Scott R. Watterson*(2) 376,000 4.86%
c/o ICON Health & Fitness, Inc.
1500 South 1000 West
Logan, Utah 84321
Gary E. Stevenson*(3) 292,700 3.78%
c/o ICON Health & Fitness, Inc.
1500 South 1000 West
Logan, Utah 84321
The Bain Funds(4) 5,161,035 66.69%
c/o Bain Capital, Inc.
111 Huntington Avenue
Boston, Massachusetts 02199
Common Stock
Beneficially Owned(1)
----------------------------
Percent of
Number of Outstanding
Names Shares Shares
- ----- --------- -----------
Robert C. Gay*(5) 5,161,035 66.69%
c/o Bain Capital, Inc.
111 Huntington Avenue
Boston, Massachusetts 02199
Ronald P. Mika*(5) 5,161,035 66.69%
c/o Sorenson Capital Partners
10150 South Centennial Parkway
Suite 450
Sandy, UT 84070
Gregory Benson*(5) 5,161,035 66.69%
c/o Bain Capital, Inc.
Devonshire House
Mayfair Place
London WIJ 8AJ
Credit Suisse First Boston Corporation(6) 1,312,934 16.96%
c/o Credit Suisse First Boston
Corporation
Eleven Madison Avenue
New York, New York 10010-3629
Alan H. Freudenstein*(7) 1,312,934 16.96%
c/o Credit Suisse First Boston Corp.
Eleven Madison Avenue
New York, New York 10010-3629
HF Investment Holdings, LLC 5,160,035 66.69%
c/o ICON Health & Fitness, Inc.
1500 South 1000 West
Logan, Utah 84321
Stanley C. Tuttleman* 172,002 1.72%
Tuttson's Inc.
349 Montgomery Avenue
P.O. Box 22405
Bala Cynwyd, Pennsylvania 19004
David Watterson(8) 18,173 -
c/o ICON Health & Fitness, Inc.
1500 South 1000 West
Logan, Utah 84321
S. Fred Beck(8) 15,149 -
c/o ICON Health & Fitness, Inc.
1500 South 1000 West
Logan, Utah 84321
All directors and executive officers
as a group (9 persons) 7,692,264 98.55%
- ----------
* - Director of HF Holdings
(1) Except as otherwise indicated, (a) each owner has sole voting and
investment power with respect to the shares set forth and (b) the figures in
this table are calculated in accordance with Rule 13d-3, under the Exchange Act
of 1934, as amended. The table includes the HF Holdings Warrants (which have an
exercise price, subject to adjustment, of $.01 per share) which are presently
exercisable. The shares reported in this table as owned by a stockholder do not
include the shares over which such stockholder has the right to direct the vote
pursuant to the Stockholders Agreement.
(2) Includes 1,000 shares of common stock owned by HF Investment Holdings, of
which Mr. Watterson is deemed the beneficial owner by virtue of being a
director. Mr. Watterson disclaims beneficial ownership of any such shares in
which he does not have a pecuniary interest.
(3) Includes 1,000 shares of common stock owned by HF Investment Holdings, of
which Mr. Stevenson is deemed the beneficial owner by virtue of being a
director. Mr. Stevenson disclaims beneficial ownership of any such shares in
which he does not have a pecuniary interest.
(4) Includes 5,160,035 shares of common stock beneficially owned by HF
Investment Holdings, of which the Bain Funds may be deemed the beneficial owners
by virtue of their control of HF Investment Holdings pursuant to its operating
agreement. Also includes 1,000 shares of common stock owned by HF Investment
Holdings, of which the Bain Funds may be deemed the beneficial owners by virtue
of the fact that one or more of their general partners or principals, or one or
more general partners or principals of one of their general partners, is a
director of HF Investment Holdings. The Bain Funds disclaim beneficial ownership
of any shares in which they do not have a pecuniary interest.
(5) Includes the shares beneficially owned by each of the Bain Funds, of which
each of Mr. Gay, Mr. Mika and Mr. Benson may be deemed the beneficial owner by
virtue of being a general partner or principal, or a general partner or a
principal of the general partner, of such Bain Fund. Also includes 1,000 shares
owned by HF Investment Holdings, of which each of Mr. Gay, Mr. Mika or Mr.
Benson may be deemed the beneficial owner by virtue of each being a director.
Each of Mr. Gay, Mr. Mika and Mr. Benson disclaims the beneficial ownership of
any such shares in which he does not have a pecuniary interest.
(6) Includes 669,179 shares of common stock subject to purchase upon exercise of
warrants that are presently exercisable.
(7) Includes 1,312,934 shares beneficially owned by Credit Suisse First Boston
Corporation, of which Mr. Freudenstein may be deemed the beneficial owner by
virtue of being an officer of Credit Suisse First Boston Corporation. Mr.
Freudenstein disclaims beneficial ownership of any such shares in which he does
not have a pecuniary interest.
(8) Represents shares of common stock issuable upon exercise of the vested
portion of options awarded pursuant to the 1999 HF Holdings Junior Management
Stock Option Plan.
Item 13. Certain Relationships and Related Party Transactions
Management Equity Grant. On September 27, 1999, HF Holdings issued to Scott
Watterson and Gary Stevenson, without cost, an aggregate of 666,700 shares of
the common stock of HF Holdings (or approximately 6.7% of its common stock
outstanding on a fully diluted basis upon the consummation of the September
recapitalization). Mr. Watterson received 375,000 of these shares, while Mr.
Stevenson received 291,700 shares.
Stockholders Agreement. On September 27, 1999, we entered into a
stockholders agreement (the "Stockholders Agreement") with HF Holdings, HF
Investment Holdings, Bain, Credit Suisse First Boston Corporation ("CFSB") and
Scott Watterson and Gary Stevenson.
Under the Stockholders Agreement, holders of HF Holdings' common stock, who
received such common stock in the exchange offer, are subject to transfer
restrictions with respect to their common stock. In addition, these holders
received customary tag along and drag along rights with respect to sales of
common stock of HF Holdings (including sales by any Bain Holder) and pre-emptive
rights with respect to any issuances of common stock by HF Holdings to HF
Investment Holdings. The tag along, drag along and registration rights of our
management are subject to the condition that our senior management own at least
25% of the common stock held by all management holders and the junior management
own at least 15% of the common stock of HF Holdings held by all management
holders, provided such person is still employed by us or has been employed
within the 12 preceding months and the purchaser of the common stock is a
financial buyer.
Holders of warrants to purchase common stock of HF Holdings issued in the
exchange offer received registration rights with respect to the common stock
issuable upon exercise of such warrants.
Pursuant to the Stockholders Agreement, HF Investment Holdings granted to
CSFB an option to purchase a certain percentage (based on the date of exercise
of such option) of the common stock of HF Holdings held by HF Investment
Holdings. HF Investment Holdings also granted to members of our junior
management an option to purchase 216,700 shares of common stock of HF Holdings
held by HF Investment Holdings. Each of these options is exercisable only upon
the occurrence of a Liquidity Event (as defined in the Stockholders Agreement).
In addition, HF Investment Holdings is entitled to appoint seven directors
and CSFB is entitled to appoint two directors to our Board of Directors. Upon a
liquidation of HF Investment Holdings, Bain will be entitled to appoint five
directors and Scott Watterson and Gary Stevenson shall have the right to be
directors, provided they remain employed by us.
Management Agreements. On September 27, 1999, our Company and HF Holdings
also entered into a new management agreement with Bain which provides an annual
management fee not to exceed $366,500 in exchange for management consulting
services including providing advice on strategic planning, development and
acquisitions. In addition, if we enter into any acquisition transactions
involving a gross purchase price of at least $10.0 million, Bain will receive a
fee in an amount which will approximate 1% of the gross purchase price of the
transaction (including assumed debt). In the event of a Liquidity Event (as
defined in the Stockholders Agreement), Bain will also receive a fee in an
amount which will approximate 1% of the gross purchase price of the transaction.
Additionally, HF Holdings entered into a management arrangement with CSFB
which provides for an annual management fee of $366,500 in exchange for
consulting services. In addition, if we enter into transactions which will
constitute a Liquidity Event (as defined in the Stockholders Agreement), CSFB
will receive a fee in an amount which will approximate 50% of the fee payable
under the management agreement with Bain in connection with such transaction.
On September 27, 1999, our Company and HF Holdings also entered into
management agreements with each of Mr. Watterson and Mr. Stevenson which
provide, so long as Bain is receiving a management fee under its management
agreement, an annual management fee of $67,000 in the aggregate shall be paid to
Mr. Watterson and Mr. Stevenson.
The respective management agreements include full indemnification and
expense reimbursement provisions in favor of Bain, CSFB, Mr. Watterson and Mr.
Stevenson, respectively.
Loans to Senior Management
On September 27, 1999 we made non-recourse loans to Scott Watterson and
Gary Stevenson in the principal amounts of $1,209,340 and $990,660 respectively.
The loans were made in connection with stock grants made to Messrs. Watterson
and Stevenson at the time of our September 1999 recapitalization. The notes bear
interest only to the extent that we have taxable net income less than zero in
any given fiscal year. The notes are secured by shares of ICON and shares of HF
Investment Holdings LCC held by Messrs. Watterson and Stevenson. The notes have
a maturity of 10 years and may be accelerated upon specified events of default
and liquidity events.
Aircraft Lease
In June 1996, we entered into an agreement with FG Aviation, Inc. ("FG"), a
company which is jointly owned by our officers, whereby we committed to lease an
airplane from FG. Minimum rentals under the lease, which expires in May 2005,
are $56,610 per month.
In February 2002, we entered into a new agreement with FG whereby we
terminated the original airplane lease and committed to lease a new airplane
from FG. Minimum lease rentals under the lease, which expires February 2009, are
$120,000 per month. We are responsible for scheduled maintenance and fuel costs;
however, these costs reduce the monthly rental. In addition, we are responsible
for payment of the aircraft crew and any unscheduled maintenance of the
aircraft. In connection with its airplane lease commitments, we recorded
$809,000, $695,000 and $903,000 of rental expense for the fiscal years ended May
31, 2003, 2002 and 2001, respectively. In addition, in February 2002, we
advanced $280,000 to FG as a security deposit on the aircraft lease.
Item 14. Controls and Procedures
Evaluation of Disclosure Controls and Procedures. Our Chief Executive
Officer, Chief Operating Officer and Chief Financial Officer have evaluated the
effectiveness of the Company's disclosure controls and procedures (as such term
is defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of
1934, as amended (the "Exchange Act")) as of May 31, 2003 (the "Evaluation
Date"). Based on such evaluation, such officers have concluded that, as of the
Evaluation Date, our disclosure controls and procedures are effective in
alerting them, on a timely basis, to material information relating to our
Company (including our consolidated subsidiaries) required to be included in our
periodic filings under the Exchange Act.
Changes in Internal Controls. Since the Eval