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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For The Fiscal Year Ended July 3, 2004
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 0-19557
SALTON, INC.
(Exact Name Of Registrant As Specified In Its Charter)
DELAWARE 36-3777824
-------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or organization)
1955 FIELD COURT
LAKE FOREST, ILLINOIS 60045
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(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, including area code: (847) 803-4600
Securities registered pursuant to Section 12(b) of the Act:
Title of Class Name of Each Exchange on Which Registered
- -------------- -----------------------------------------
Common Stock, $0.01 par value New York Stock Exchange
Rights to Purchase Series A New York Stock Exchange
Junior Participating Preferred Stock
Securities registered pursuant to section 12(g) of the act: None
Indicate by check mark whether this registrant (1) has filed all reports
required to be filed by section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the Common Stock held by non-affiliates of the
Registrant as of December 27, 2003 was approximately $123,500,000 computed on
the basis of the last reported sale price per share $12.95 of such stock on the
NYSE. This determination of affiliate status is not necessarily a conclusive
determination for other purposes.
The number of shares of the Registrant's Common Stock outstanding as of
September 10, 2004 was 11,371,197.
Documents Incorporated By Reference
-----------------------------------
Part III of this Form 10-K incorporates by reference certain information from
the Registrant's proxy statement relating to its 2004 Annual Meeting of
Stockholders (the "2004 Proxy Statement").
SALTON, INC.
INDEX TO FORM 10-K
FOR THE FISCAL YEAR ENDED JULY 3, 2004
PAGE
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PART I
Item 1. Business 4
Item 2. Properties 18
Item 3. Legal Proceedings 19
Item 4. Submission of Matters to a Vote of Security Holders 20
Item 4A. Executive Officers of the Registrant 21
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters 21
Item 6. Selected Financial Data 23
Item 7. Management's Discussion and Analysis of Financial Conditions and Results of Operation 25
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 37
Item 8. Consolidated Financial Statements and Supplementary Data 38
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures 38
Item 9A. Controls and Procedures 39
Item 9B. Other Information 39
PART III
Item 10. Directors and Executive Officers of the Registrant 39
Item 11. Executive Compensation 39
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters 40
Item 13. Certain Relationships and Related Transactions 40
Item 14. Principal Accounting Fees and Services 40
PART IV
Item 15. Exhibits and Financial Statement Schedules 40
2
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This annual report on Form 10-K includes forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934, including without limitation the statements
under "Risk Factors," and "Management's Discussion and Analysis of Financial
Condition and Results of Operations." The words "believes," "anticipates,"
"plans," "expects," "intends," "estimates" and similar expressions are intended
to identify forward-looking statements. These forward-looking statements involve
known and unknown risks, uncertainties and other factors, which may cause our
actual results, performance or achievements, or industry results, to be
materially different from any future results, performance, or achievements
expressed or implied by such forward-looking statements. Such factors include,
among others, the following:
- our ability to realize the benefits we expect from our U.S.
restructuring plan;
- our substantial indebtedness and restrictive covenants in our debt
instruments;
- our ability to access the capital markets on attractive terms or at
all;
- our relationship and contractual arrangements with key customers,
suppliers, strategic partners and licensors;
- pending legal proceedings;
- cancellation or reduction of orders;
- the timely development, introduction and customer acceptance of our
products;
- dependence on foreign suppliers and supply and marketing
constraints;
- competitive products and pricing;
- economic conditions and the retail environment;
- the availability and success of future acquisitions;
- international business activities;
- the risks related to intellectual property rights;
- the risks relating to regulatory matters and other risks and
uncertainties detailed from time to time in our Securities and
Exchange Commission Filings.
All forward looking statements included in this annual report on Form 10-K are
based on information available to us on the date of this annual report. We
undertake no obligation to publicly update or revise any forward-looking
statement, whether as a result of new information, future events or otherwise.
All subsequent written and oral forward-looking statements attributable to us or
persons acting on our behalf are expressly qualified in their entirety by the
cautionary statements contained throughout this annual report on Form 10-K.
3
PART I
As used in this annual report on Form 10-K, "we," "us," "our," "Salton" and "the
Company" refer to Salton, Inc and our subsidiaries, unless the context otherwise
requires.
ITEM 1. BUSINESS
Salton, Inc. is a leading designer, marketer and distributor of branded, high
quality small appliances, home decor and personal care products. Our product mix
includes a broad range of small kitchen and home appliances, electronics for the
home, tabletop products, time products, lighting products, picture frames and
personal care and wellness products. We sell our products under our portfolio of
well recognized brand names such as Salton(R), George Foreman(R),
Westinghouse(TM), Toastmaster(R), Melitta(R), Russell Hobbs(R), Farberware(R),
Ingraham(R) and Stiffel(R). We believe our strong market position results from
our well-known brand names, our high quality and innovative products, our strong
relationships with our customer base and our focused outsourcing strategy.
We currently market and sell our products in North America, South Africa,
Europe, Asia, Australia, New Zealand, South America and the Middle East through
an internal sales force and a network of independent commissioned sales
representatives. We predominantly sell our products to mass merchandisers,
department stores, specialty stores and mail order catalogs. Our customers
include many premier retailers, such as JD Group, Target Corporation, Wal-Mart,
Argos Limited, Sears, Masstores, J.C. Penney Company, Bed, Bath & Beyond, May
Company Department Stores, Dixon Stores Group Limited and Kohl's Department
Stores. We also sell certain of our products directly to consumers through paid
half-hour television programs referred to as infomercials, our Internet websites
and our retail outlets.
We outsource most of our production to independent manufacturers, located
primarily in the Far East. The Company has substantial experience with and
expertise in managing production relationships with third-party suppliers. We
work with our suppliers to provide the lowest possible cost for our customers
while maintaining reasonable gross margins for us.
Salton was incorporated in Delaware in October 1991. Our common stock traded on
the NASDAQ National market under the symbol "SALT" until February 1999. The
Company moved to the New York Stock Exchange at that time and our common stock
has traded under the symbol "SFP" since. Our principal corporate offices are
located at 1955 Field Court, Lake Forest, Illinois 60045.
On May 16, 2003 we increased our 30.8% interest in Amalgamated Appliance
Holdings Limited (AMAP), a South African Company, to a 52.6% interest for $7.5
million. Due to the increase in ownership, AMAP's results from May 16, 2003
onward have been consolidated with Salton in accordance with accounting
principles generally accepted in the United States of America (GAAP) for
financial statement presentation. Prior to May 16, 2003, our investment in AMAP
was accounted for under the equity method and was included in consolidated
assets.
Our fiscal year ends on the Saturday closest to June 30. Unless otherwise
stated, references to years in this report relate to fiscal years rather than
calendar years. The effect of the extra week in 2004 had an insignificant impact
on results.
FISCAL YEAR YEAR ENDED WEEKS
----------- ------------- -----
2004 July 3, 2004 53
2003 June 28, 2003 52
2002 June 29, 2002 52
4
BUSINESS SEGMENT AND PRODUCT INFORMATION
Salton consists of a single operating segment which designs, sources, markets
and distributes a diversified product mix for use in the home. Our product mix
consists of small kitchen and home appliances, electronics for the home,
tabletop products, time products, lighting products, picture frames and personal
care and wellness products. We believe this segmentation is appropriate based
upon Management's operating decisions and performance assessment. Nearly all of
our products are consumer goods within the housewares market, procured through
independent manufacturers, primarily in the Far East. Our products are
distributed through similar distribution channels and customer base using the
marketing efforts of our Global Marketing Team.
BRAND PORTFOLIO
Our brand portfolio contains many time-honored traditions as well as recently
established names within the international housewares industry. We believe this
brand portfolio contains many brands with strong consumer recognition throughout
the world. While many of our brands are owned, we continue to enhance our
portfolio through licensing agreements and strategic alliances. Our brands
include:
Salton(R) Westinghouse(TM) Toastmaster(R) Sansui(TM)
George Foreman(R) One:One(TM) Westclox(R) Atlantis(TM)
Russell Hobbs(R) Breadman(R) Stiffel(R) Big Ben(R)
Melitta(R) Calvin Klein(R) Carmen(R) Pifco(R)
Farberware(R) Ingraham(R) Relaxor(R) Pioneer(TM)
Beyond(TM) Carmengirls.com(TM) Juiceman(R) Pineware(TM)
Andrew Collinge(TM) Block(R) iCEBOX(R) Haden(TM)
We develop and introduce a wide selection of new products and enhance existing
products to satisfy the various tastes, preferences and budgets of consumers and
to service the needs of a broad range of customers. Our product divisions
include Small Appliances and Electronics for the home, Home Decor, and Personal
Care and Wellness.
The following table sets forth the approximate amounts of our net sales by
product division during the periods shown.
(IN THOUSANDS)
JULY 3, 2004 (1) JUNE 28, 2003(1) JUNE 29, 2002
---------------- ---------------- -------------
Small Appliances and Electronics for the Home $ 948,309 $ 778,636 $ 807,799
Home Decor 85,164 87,605 85,957
Personal Care and Wellness Products 43,262 28,667 28,723
---------- ---------- ----------
Total $1,076,735 $ 894,908 $ 922,479
========== ========== ==========
(1) Includes the results of AMAP since May 16, 2003.
5
SMALL APPLIANCES AND ELECTRONICS FOR THE HOME
We design, market and distribute an extensive line of small appliances and
electronics for the home. These products consist of heating appliances, motor
driven appliances, beverage makers, cookware and floor care. In addition, this
division includes products offered by AMAP. These products consist primarily of
electronic devices such as televisions, music and video equipment.
Within our small appliance and electronics division, Salton is known for the
George Foreman branded product line which started as a single grill in 1995.
Since 1995, Salton has sold over 50 million units of the George Foreman line
worldwide. We have established the George Foreman name as a significant product
brand, representing approximately 32.0%, 44.0% and 47.0%, of our sales, in the
fiscal year ended July 3, 2004, June 28, 2003 and June 29, 2002, respectively.
Salton plans to launch the Next Grilleration in the first half of fiscal 2005.
This new line of George Foreman grills will feature removable grilling plates
for easier cleaning.
We also have a joint product relationship with the Columbian Coffee Federation,
the non-profit organization behind the Juan Valdez brand, and Italian
manufacturer Rossi Corporation SRL. Under this relationship, we have agreed to
market and distribute a new coffee brewing system utilizing single-serve pods of
Columbian specialty coffee as well as the pods in the United States and major
global markets. We expect that the coffee brewing system and pods will be
available in the fall of 2004.
HOME DECOR
This broad range of products consist of tabletop products, picture frames, time
and lighting products marketed by our Salton At Home Division.
Salton has an exclusive licensing agreement with Calvin Klein and Thomas O'Brien
for tabletop and picture frame products. Our time products include a variety of
clocks and timers under well recognized brand names such as Ingraham, Westclox
and Timex. Salton also markets lighting products under the Stiffel name acquired
in August 2001.
PERSONAL CARE AND WELLNESS
Salton offers a broad range of personal care and wellness products. These
products include health and fitness equipment, massagers, hair care, beauty,
oral health care and relaxation items.
During fiscal 2004, we launched Walk-Run-Fly-Faster ("WRFF"), a trick bike
geared toward kids and young adults and Walkmill, a lightweight, portable
treadmill.
NEW PRODUCT DEVELOPMENT
We believe that the enhancement and extension of our existing products and the
development of new products are necessary for our continued success and growth.
We design style, features and functionality of our products to meet customer
requirements for quality, performance, product mix and pricing. We work closely
with both retail customers and suppliers to identify consumer needs and
preferences and to generate new product ideas. We evaluate new ideas and seek to
develop and acquire new products and improve existing products to satisfy
industry requirements and changing consumer preferences.
6
STRATEGIC ALLIANCES
We continue to pursue strategic alliances which enable us to (a) further expand
the scope of our product offerings and (b) benefit from the manufacturing
expertise and strong brand names of our strategic partners. During fiscal 2004,
we entered into joint product development relationships with several third
parties to develop, market and distribute new products.
One of our joint product relationships is with Melitta North America, Inc.
Together with Melitta, we have developed the Melitta One:One Coffeemaker which
uses Melitta coffee pods to make an individual mug of fresh coffee in less than
60 seconds. We began marketing and distributing the coffee maker and the pods,
which are manufactured by Melitta, in fiscal 2004.
We also have a joint product relationship with the Columbian Coffee Federation,
the non-profit organization behind the Juan Valdez brand, and Italian
manufacturer Rossi Corporation SRL. Under this relationship, we have agreed to
market and distribute a new coffee brewing system utilizing single-serve pods of
Columbian specialty coffee in the United States and major global markets. We
expect that the coffee brewing system and pods will be available in the first
half of fiscal 2005.
The foregoing strategic alliances provide the opportunity for recurring revenues
through the sale of pods. There are arrangements for sharing the profits derived
from each of these strategic alliances once all expenses incurred by Salton
and/or the other members of the alliance, are reimbursed from cash flow
generated by such alliances. Each of these strategic alliances generally
provides for certain license fees and royalties to our strategic partners and
contain minimum sales requirements and other obligations that, if not satisfied,
may result in termination of the strategic alliance.
CUSTOMERS AND DISTRIBUTION CHANNELS
We currently market and sell our products in North America, South Africa,
Europe, Asia, Australia, New Zealand, South America and the Middle East through
an internal sales force and a network of commissioned sales representatives to
mass merchandisers, department stores, specialty stores and mail order catalogs.
We also sell products directly to consumers through infomercials, Internet
websites and our own retail outlets.
We provide promotional support for our products with the aid of television,
radio and print advertising, cooperative advertising with retailers and in-store
displays and product demonstrations. We believe that these promotional
activities are important to strengthening our brand name recognition.
Our total net sales to our five largest customers during fiscal 2004 were 36.1%
of net sales, with JD Group representing 10.4% of our net sales, Target
Corporation representing 9.1 % of our net sales and Wal-Mart representing 8.1%
of our net sales. Our total net sales to our five largest customers during
fiscal 2003 were 39.3% of net sales, with Wal-Mart representing 12.5% of our net
sales and Target Corporation representing 11.9% of our net sales. In fiscal
2002, our five largest customers were 43.0% of net sales, with Wal-Mart
representing 13.9% of our net sales and Target Corporation representing 12.0% of
our net sales.
During fiscal 2004, 2003 and 2002, sales recorded outside of North America
accounted for 50.6%, 30.7%, 16.6% of total net sales, respectively. These
figures include shipments directly imported to customers in North America. See
Note 13 of the Notes to Consolidated Financial Statements for information
regarding revenues of the Company's geographic areas for each of the three
fiscal years ended July 3, 2004, June 28, 2003 and June 29, 2002.
7
SOURCES OF SUPPLY
Most of our products are manufactured to our specifications by manufactures
located primarily in the Far East. We believe that we maintain good business
relationships with our overseas manufacturers.
We do not maintain long-term purchase contracts with manufacturers and operate
principally on a purchase order basis. We believe we are not currently dependent
on any single manufacturer. However, one supplier located in China, accounted
for 23.7% of our product purchases during 2004, 33.2% of our product purchases
in 2003 and 32.5% of purchases in 2002. We believe that the loss of any one
supplier would not have a long term material adverse effect on our business
because other suppliers with which we do business would be able to increase
production to fulfill our requirements. However, the loss of a supplier could,
in the short term, adversely effect our business until alternative supply
arrangements are secured.
BACKLOG
Our backlog consists of orders for our products, which may be subject to change
and cancellation until shipment. The dollar amount of backlog as of September
10, 2004 was approximately $40.0 million. At September 10, 2003, we had backlog
of approximately $48.0 million. Customer order patterns vary from year to year,
largely because of annual differences in consumer acceptance of product lines,
product availability, marketing strategies, inventory levels of retailers and
differences in overall economic conditions. As a result, comparisons of backlog
as of any date in a given year with backlog at the same date in a prior year are
not necessarily indicative of future results of operations or prospects.
COMPETITION
We compete in the global housewares market. While the Domestic and Western
European markets are strongly developed, the remainder of the global market is
less developed and offers, we believe, significant opportunities for business
expansion. We compete with established companies, some of which have
substantially greater facilities, personnel, financial and other resources than
we have. Competition is based upon price, access to retail shelf space, product
features and enhancements, brand names, new product introductions and marketing.
The retail industry continues to consolidate leaving fewer retail outlets and
increased competition for shelf space. We expect retailers will continue to
consolidate their vendor base by dealing primarily with a smaller number of
suppliers that can offer a diversified product mix, meet logistical and volume
requirements and offer comprehensive levels of customer service and marketing
support. We believe our competitive pricing, high level of customer service,
strategic acquisitions and alliances, as well as our portfolio of well
recognized brand names, new technology and innovative products, position us to
compete and benefit from this environment.
SEASONALITY
Due to holiday buying patterns, sales are traditionally higher in the second
fiscal quarter than in the other quarterly periods and the Company typically
earns a disproportionate share of operating income in this quarter.
8
TRADEMARKS, PATENTS AND LICENSING ARRANGEMENTS
We hold numerous patents and trademarks registered in the United States and
foreign countries for various products and processes. We have registered certain
of our trademarks with the United States Patent and Trademark Office and we
consider these trademarks to be of considerable value and of material importance
to our business. The Company's right to use these trademarks continues as long
as it uses these names.
Salton maintains many licensing and contractual relationships to market and
distribute products under specific names and designs. These licensing
arrangements generally require certain license fees and royalties. Some of our
agreements contain minimum sales requirements that, if not satisfied, may result
in the termination of the agreements.
On April 22, 2002, we entered into an exclusive licensing agreement with
Westinghouse Electric Corporation to use its marquis Westinghouse brand name,
Circle W trademark, and the brand awareness statement "You can be sure . . . if
it's a Westinghouse" on the following product categories: kitchen electrics,
microwaves, fans and heaters, personal care, table top air cleaners and
humidifiers, clocks and vacuums. The agreement, which covers North America,
South America, Africa, Europe, Asia and Australia-New Zealand, has a term ending
in June 2008. Upon completion of the six-year term, the agreement is renewable
at the option of both parties for five additional five year terms. We are
subject to pay minimum royalty payments to Westinghouse beginning in the third
year of the agreement.
REGULATION
We are subject to federal, state and local regulations concerning consumer
products safety. Foreign jurisdictions also have regulatory authorities
overseeing the safety of consumer products. In general, we have not experienced
difficulty complying with such regulations and compliance, with them, has not
had an adverse effect on our business. Our small electric appliance products
sold in the United States are listed by Underwriters Laboratory, Inc. (UL) or
ETL; and similar products sold in other countries are listed with local
organizations similar to UL if required.
PRODUCT WARRANTIES
Our products are generally sold with a limited one-to-three year warranty from
the date of purchase. In the case of defects in material workmanship, we agree
to replace or repair the defective product without charge while under the
warranty time frame.
EMPLOYEES
As of September 10, 2004, we employed approximately 2,600 persons, including
approximately 1,500 persons employed in South Africa by Amalgamated Appliance
Holdings Limited.
ADDITIONAL INFORMATION
We file annual, quarterly and periodic reports, proxy statements and other
information with the SEC. You may obtain and copy any document we file with the
SEC at the SEC's public reference room at 450 Fifth Street, NW., Washington,
D.C. 20549. You may obtain information on the operation of the SEC's public
reference facilities by calling the SEC at 1-800-SEC-0330. You can request
copies of these documents, upon payment of a duplicating fee, by writing to the
SEC at its principal office at 450 Fifth Street, N.W., Washington, D.C.
20549-1004. The SEC maintains an Internet website at http://www.sec.gov that
contains reports, proxy and information statements, and other information
regarding issuers that file electronically with the SEC. Our SEC filings are
accessible through the Internet at that website.
9
Our reports on Forms 10-K, 10-Q and 8-K, and amendments to those reports, are
available for download, free of charge, as soon as reasonably practicable after
these reports are filed with the SEC, at our website at
http://www.saltoninc.com. The content of our website is not a part of this
report. You may request a copy of our SEC filings, at no cost to you, by writing
or telephoning us at: Salton, Inc., 1955 Field Court, Lake Forest, Illinois
60045, attention: Marc Levenstein, Assistant Secretary, telephone: (847)
803-4600. We will not send exhibits to the documents, unless the exhibits are
specifically requested and you pay our fee for duplication and delivery.
RISK FACTORS
Prospective investors should carefully consider the following risk factors,
together with the other information contained in this annual report on Form
10-K, in evaluating us and our business before purchasing our securities. In
particular, prospective investors should note that this annual report on Form
10-K contains forward-looking statements within the meaning of Section 27A of
the Securities Act and Section 21E of the Exchange Act and that actual results
could differ materially from those contemplated by such statements. See
"Cautionary Statement Regarding Forward-Looking Information." The factors listed
below represent certain important factors which we believe could cause such
results to differ. These factors are not intended to represent a complete list
of the general or specific risks that may affect us. It should be recognized
that other risks may be significant, presently or in the future, and the risks
set forth below may affect us to a greater extent than indicated.
OUR SUBSTANTIAL INDEBTEDNESS COULD ADVERSELY AFFECT OUR FINANCIAL HEALTH AND
PREVENT US FROM FULFILLING OUR PAYMENT OBLIGATIONS.
We have a significant amount of indebtedness relative to our equity size. As of
July 3, 2004 we had total consolidated indebtedness of $419.0 million, including
$149.1 million of 12 1/4% senior subordinated notes due 2008 and $125.0 million
of 10 3/4% senior subordinated notes due 2005, excluding $9.6 million related
to the fair value of a monetized fixed to floating interest rate swap on the
notes due 2008 and $4.5 million for the loan notes to Pifco shareholders that
are fully cash collateralized, and total stockholders' equity of $173.6 million.
We also had additional availability under our senior secured revolving credit
facility of $26.5 million. We may incur additional indebtedness in the future,
including through additional borrowings under our credit agreement, subject to
availability.
Our ability to service our debt obligations, including the notes, and to fund
planned working capital needs and planned capital expenditures will depend upon
our future operating performance, which will be affected by prevailing economic
conditions in the markets we serve and financial, business and other factors,
certain of which are beyond our control. We cannot assure you that our business
will generate sufficient cash flow from operations or that future borrowings
will be available under our senior secured revolving credit facility in an
amount sufficient to enable us to service our indebtedness, including the notes,
or to fund our other liquidity needs. If we are unable to satisfy such liquidity
needs, we could be required to adopt one or more alternatives, such as reducing
or delaying capital expenditures, borrowing additional funds, restructuring
indebtedness, selling other assets or operations and/or reducing expenditures
for new product development, cutting other costs, and some or such actions would
require the consent of our senior lenders and/or the holders of our senior
subordinated notes. We cannot assure you that any of such actions could be
effected, or if so, on terms favorable to us, that such actions would enable us
to continue to satisfy our liquidity needs, that such actions would not dilute
the ownership interest of stockholders and/or that such actions would be
permitted under the terms of our senior secured revolving credit facility or the
indentures governing our senior subordinated notes.
10
Our high level of debt could have important consequences for you, such as:
- our debt level makes us more vulnerable to general adverse economic
and industry conditions;
- our ability to obtain additional financing for acquisitions, or to
fund future working capital, capital expenditures or other general
corporate requirements may be limited;
- we will need to use a substantial portion of our cash flow from
operations for the payment of principal of, and interest on, our
indebtedness, which will reduce the amount of money available to
fund working capital, capital expenditures or other general
corporate purposes;
- our flexibility in planning for, or reacting to, changes in our
business and the industry in which we compete may be limited;
- our debt level could limit our ability or increase the costs to
refinance indebtedness; and
- our debt level may place us at a competitive disadvantage to our
less leveraged competitors.
OUR DEBT INSTRUMENTS CONTAIN RESTRICTIVE COVENANTS THAT COULD ADVERSELY AFFECT
OUR BUSINESS BY LIMITING OUR FLEXIBILITY.
Our senior secured revolving credit agreement and the indentures governing the
12 1/4% senior subordinated notes and the 10 -3/4% senior subordinated notes
impose restrictions that affect, among other things, our ability to incur debt,
pay dividends, sell assets, create liens, make capital expenditures and
investments, merge or consolidate, enter into transactions with affiliates, and
otherwise enter into certain transactions outside the ordinary course of
business. Our senior secured revolving credit agreement also requires us to
maintain specified financial ratios, including a minimum EBITDA, a consolidated
fixed charge coverage ratio and a foreign leverage ratio, and meet certain other
financial tests. Our ability to continue to comply with these covenants and
restrictions may be affected by events beyond our control. If we are unable to
comply with the terms of our senior secured revolving credit agreement and
indentures, or if we fail to generate sufficient cash flow from operations, or
to refinance our debt as described below, we may be required to refinance all or
a portion of our indebtedness or to obtain additional financing. If cash flow is
insufficient and refinancing or additional financing is unavailable because of
our high levels of debt and the debt incurrence restrictions under our senior
secured revolving credit agreement and indentures, we may be forced to default
on our senior secured revolving credit agreement and senior subordinated notes.
In the event of a default under the terms of any of our indebtedness, the debt
holders may accelerate the maturity of our obligations, which could cause
defaults under our other obligations.
For example, during fiscal 2004 we failed to comply with the consolidated and
U.S. fixed charge coverage ratios under our previous senior secured revolving
credit facility. Our previous senior lenders agreed to forbear for a specified
period of time from exercising any of their remedies as a result of our
non-compliance, and we were able to refinance the senior secured revolving
credit agreement with new senior lenders and more flexible financial covenants.
We cannot assure you that we will be able to comply with the financial covenants
and other covenants in our debt instruments or that, if we fail to so comply,
our debt holders would waive our compliance or forbear from exercising their
remedies.
11
WE MUST REFINANCE OUR 10 3/4% SENIOR SUBORDINATED NOTES MATURING IN DECEMBER
2005.
We have $125.0 million of 10 3/4% senior subordinated notes outstanding with a
maturity date of December 15, 2005. We may incur additional debt, or may issue
debt or equity securities, to repay and/or refinance the 10 3/4% senior
subordinated notes on or before maturity. The availability and attractiveness of
any outside sources of funds will depend on a number of factors, some of which
relate to our financial condition and performance, and some of which are beyond
our control, such as prevailing interest rates and general economic conditions.
We cannot assure you that such additional funds will be available, or if
available, that such funds will be on terms we find acceptable.
WE HAVE EXPERIENCED A DECLINE IN DOMESTIC MARKET SALES AND HAVE IMPLEMENTED A
U.S. RESTRUCTURING PLAN.
Although our consolidated sales have increased during fiscal 2004 due to our
international expansion, our domestic sales declined during fiscal 2004. While
our domestic sales improved slightly during the fourth quarter of fiscal 2004,
they are still not sufficient to cover our domestic operating expenses. We are
in the process of implementing a U.S. restructuring plan in the domestic market
in order to align domestic operating expenses with current sales levels.
Although the restructuring of our domestic operations through workforce layoffs,
consolidation of facilities and reduction of certain marketing and advertising
programs will reduce our operating expenses, such actions may also have an
adverse effect on our domestic sales. In addition, our current and prospective
customers and suppliers may decide to delay or not purchase or supply our
products due to the perceived uncertainty caused by our U.S. restructuring plan.
In connection with our U.S. restructuring plan, fiscal 2004 fourth quarter
included a $23.6 million pre-tax charge consisting of $20.2 million related to
the write-down of certain inventory identified for liquidation as part of the
Company's decision to rationalize warehouse and distribution facilities; $1.7
million for the discontinuation of several marketing programs; $1.2 million of
consulting and legal costs directly associated with the development and
implementation of the restructuring plans and $0.5 million in severance.
The fourth quarter also reflected pre-tax charges taken related to the
restructuring efforts and subsequent valuation reviews in light of those
decisions, which include a $6.5 million intangible asset impairment charge and a
$3.8 million fixed asset charge primarily related to tooling.
Other items impacting the 2004 fourth quarter results include a $6.9 million
charge for the establishment of a valuation allowance against certain foreign
income tax credits and a $5.0 million pre-tax loss on the early extinguishment
of debt.
We may be required to take additional similar charges in the future, which could
have a material and adverse effect on our operating results. We cannot assure
you that the U.S. restructuring plan will allow us to better align our domestic
cost structure with our current sales levels.
IF WE WERE TO LOSE ONE OR MORE OF OUR MAJOR CUSTOMERS, OUR FINANCIAL RESULTS
WOULD SUFFER.
Our success depends on our sales to our significant customers. Our total net
sales to our five largest customers during fiscal 2004 were 36.1% of net sales,
with JD Group representing 10.4% of our net sales, Target Corporation
representing 9.1 % of our net sales and Wal-Mart representing 8.1% of our net
sales. Our total net sales to our five largest customers during fiscal 2003 were
39.3% of net sales, with Wal-Mart representing 12.5% of our net sales and Target
Corporation representing 11.9% of our net sales. In fiscal 2002, our five
largest customers were 43.0% of net sales, with Wal-Mart representing 13.9% of
our net sales and Target Corporation representing 12.0% of our net sales. We do
not have long-term agreements with our major customers, and purchases are
generally made through the use of individual purchase orders. A significant
reduction in purchases by any of these
12
major customers or a general economic downturn in retail sales could have a
material adverse effect on our business, financial condition and results of
operations.
OUR DEPENDENCE ON FOREIGN SUPPLIERS SUBJECTS US TO THE RISKS OF DOING BUSINESS
ABROAD.
We depend upon unaffiliated foreign companies for the manufacture of most of our
products. Our arrangements with our suppliers are subject to the risks of doing
business abroad, including:
- import duties;
- trade restrictions;
- production delays due to unavailability of parts or components;
- increase in transportation costs and transportation delays;
- work stoppages;
- foreign currency fluctuations; and
- political and economic instability which could lead to the business
failure of major suppliers.
THE SMALL HOUSEHOLD APPLIANCE INDUSTRY IS HIGHLY COMPETITIVE AND WE MAY NOT BE
ABLE TO COMPETE EFFECTIVELY.
We believe that competition is based upon several factors, including:
- price;
- access to retail shelf space;
- product features and enhancements;
- brand names;
- new product introductions; and
- marketing support and distribution approaches.
We compete with established companies, some of which have substantially greater
facilities, personnel, financial and other resources than we have. Significant
new competitors or increased competition from existing competitors may adversely
affect our business, financial condition and results of operations.
13
IF THE RETAIL INDUSTRY CONTINUES TO EXPERIENCE AN ECONOMIC SLOWDOWN, OUR
FINANCIAL RESULTS WILL BE ADVERSELY AFFECTED.
We sell our products to consumers through major retail channels, primarily mass
merchandisers, department stores, specialty stores and mail order catalogs. As a
result, our business and financial results can fluctuate with the financial
condition of our retail customers and the retail industry. The current general
slowdown in the retail sector has adversely impacted our net sales of products,
our operating margins and our net income. If such conditions continue or worsen,
it could have a material adverse effect on our business, financial condition and
results of operations.
The current general slowdown in the retail sector has resulted in, and we expect
it to continue to result in, additional pricing and marketing support pressures
on us. Certain of our retail customers have filed for bankruptcy protection in
recent years. We continually monitor and evaluate the credit status of our
customers and attempt to adjust sales terms as appropriate. Despite these
efforts, a bankruptcy filing by, or other adverse change in the financial
condition of, a significant customer could adversely affect our financial
results.
OUR CREDIT RATINGS HAVE BEEN DOWNGRADED AND COULD BE DOWNGRADED FURTHER.
On February 11, 2004, Standard & Poor's downgraded our senior subordinated notes
rating to CCC+.
On May 11, 2004, Standard & Poor's downgraded our senior subordinated notes
rating to CCC-.
On April 13, 2004, Moody's downgraded our senior subordinated notes rating to
Caa2.
On May 14, 2004, Moody's downgraded our senior subordinated notes rating to Ca.
Such downgrades can have a negative impact on our liquidity by reducing
attractive financing opportunities. We cannot assure you that Standard & Poor's
and Moody's will not further downgrade our credit ratings in the future. If our
credit rating is downgraded, it could make our efforts to raise capital more
difficult and have an adverse impact on our financial condition and results of
operation.
ACQUISITIONS MAY BE DIFFICULT TO INTEGRATE AND MAY DISRUPT OUR BUSINESS.
We continue to seek opportunities to acquire businesses and product lines that
fit within our acquisition strategy, including the expansion of our
international sales through the acquisition of complementary businesses. We may
not successfully identify acceptable acquisition candidates or integrate any
acquired operations. For instance, we cannot assure you that the anticipated
benefits of our recent acquisition of a majority interest in Amalgamated
Appliance Holdings Limited will be realized. Opportunities for growth through
acquisitions, future operating results and the success of acquisitions may be
subject to the effects of, and changes in, U.S. and foreign trade and monetary
policies, laws and regulations, political and economic developments, inflation
rate and tax laws.
Our acquisitions of additional businesses and product lines may require
additional capital and the consent of our lenders and may have a significant
impact on our business, financial condition and results of operations. We may
finance acquisitions with internally generated funds, bank borrowings, public
offerings or private placements of debt or equity securities, or through a
combination of these sources. This may have the effect of increasing our debt
and reducing our cash available for other purposes. Our senior secured revolving
credit facility contains restrictions on our ability to do acquisitions.
14
Acquisitions may also require substantial attention from, and place substantial
additional demands upon, our senior management. This may divert senior
management's attention away from our existing businesses, making it more
difficult to manage effectively. In addition, unanticipated events or
liabilities relating to these acquisitions or the failure to retain key
personnel could have a material adverse effect on our business, results of
operations and financial condition.
EXPANDING OUR INTERNATIONAL SALES WILL SUBJECT US TO ADDITIONAL BUSINESS RISKS
AND MAY CAUSE OUR PROFITABILITY TO DECLINE DUE TO INCREASED COSTS.
We intend to pursue growth opportunities internationally. During fiscal 2004,
2003 and 2002, sales recorded outside of North America accounted for 50.6%,
30.7%, 16.6% of total net sales, respectively. Our pursuit of international
growth opportunities may require significant investments for an extended period
before returns on these investments, if any, are realized. International
operations are subject to a number of other risks and potential costs,
including:
- the risk that because our brand names may not be locally recognized,
we must spend significant amounts of time and money to build a brand
identity without certainty that we will be successful;
- unexpected changes in regulatory requirements;
- inadequate protection of intellectual property in foreign countries;
- foreign currency fluctuations;
- transportation costs;
- adverse tax consequences; and
- political and economic instability.
We cannot assure you that we will not incur significant costs in addressing
these potential risks.
LONG LEAD TIMES, POTENTIAL MATERIAL PRICE INCREASES AND CUSTOMER DEMANDS MAY
CAUSE US TO PURCHASE MORE INVENTORY THAN NECESSARY.
Due to manufacturing lead times and a strong concentration of our sales
occurring during the second fiscal quarter, as well as potential material price
increases, may lead us to purchase products and thereby increase inventories
based on anticipated sales and forecasts provided by our customers and our sales
personnel. In an extended general economic slowdown, we cannot assure you that
our customers will order these inventories as anticipated.
IF WE HAVE TO EXPEND SIGNIFICANT AMOUNTS TO REMEDIATE ENVIRONMENTAL LIABILITIES,
OUR FINANCIAL RESULTS WILL SUFFER.
Prior to 2003, we manufactured certain of our products at our owned plants in
the United States and Europe. Our previous manufacturing of products at these
sites exposes us to potential liabilities for environmental damage that these
facilities may have caused or may cause nearby landowners. During the ordinary
course of our operations, we have received, and we expect that we may in the
future receive, citations or notices from governmental authorities asserting
that our facilities are not in compliance with, or require investigation or
remediation under, applicable environmental statutes and regulations. Any
citations or notices could have a material adverse effect on our business,
results of operations and financial condition.
15
THE SEASONAL NATURE OF OUR BUSINESS COULD ADVERSELY IMPACT OUR OPERATIONS.
Our business is highly seasonal, with operating results varying from quarter to
quarter. We have historically experienced higher sales during the second fiscal
quarter primarily due to increased demand by customers for our products
attributable to holiday sales. This seasonality has also resulted in additional
interest expense for us during this period due to an increased need to borrow
funds to maintain sufficient working capital to finance product purchases and
customer receivables for the seasonal period. Lower sales than expected by us
during this period, a lack of availability of product, a general economic
downturn in retail sales or the inability to service additional interest expense
due to increased borrowings could have a material adverse effect on our
business, financial condition and results of operations.
PRODUCT RECALLS OR LAWSUITS RELATING TO DEFECTIVE PRODUCTS COULD ADVERSELY
IMPACT OUR FINANCIAL RESULTS.
We face exposure to product recalls and product liability claims in the event
that our products are alleged to have manufacturing or safety defects or to have
resulted in injury or other adverse effects. We cannot assure you that we will
be able to maintain our product liability insurance on acceptable terms, if at
all, or that product liability claims will not exceed the amount of our
insurance coverage. As a result, we cannot assure you that product recalls and
product liability claims will not adversely affect our business.
THE INFRINGEMENT OR LOSS OF OUR PROPRIETARY RIGHTS COULD HAVE AN ADVERSE EFFECT
ON OUR BUSINESS.
We regard our copyrights, trademarks, service marks and similar intellectual
property as important to our success. We rely on copyright and trademark laws in
the United States and other jurisdictions to protect our proprietary rights. We
seek to register our trademarks in the United States and elsewhere. These
registrations could be challenged by others or invalidated through
administrative process or litigation. If any of these rights were infringed or
invalidated, our business could be materially adversely affected.
We license various trademarks and trade names from third parties for use on our
products. These licenses generally place marketing obligations on us and require
us to pay fees and royalties based on net sales or profits. Typically, each
license may be terminated if we fail to satisfy minimum sales obligations or if
we breach the license. The termination of these licensing arrangements could
adversely affect our business, financial condition and results of operations.
WE MAY BE SUBJECT TO LITIGATION AND INFRINGEMENT CLAIMS, WHICH COULD CAUSE US TO
INCUR SIGNIFICANT EXPENSES OR PREVENT US FROM SELLING OUR PRODUCTS.
We cannot assure you that others will not claim that our proprietary or licensed
products are infringing their intellectual property rights or that we do not in
fact infringe those intellectual property rights. If someone claimed that our
proprietary or licensed products infringed their intellectual property rights,
any resulting litigation could be costly and time consuming and would divert the
attention of management and key personnel from other business issues. We also
may be subject to significant damages or an injunction against use of our
proprietary or licensed products. A successful claim of patent or other
intellectual property infringement against us could harm our financial
condition.
16
COMPLIANCE WITH GOVERNMENTAL REGULATIONS COULD SIGNIFICANTLY INCREASE OUR
OPERATING COSTS OR PREVENT US FROM SELLING OUR PRODUCTS.
Most federal, state and local authorities require certification by Underwriters
Laboratory, Inc., an independent, not-for-profit corporation engaged in the
testing of products for compliance with certain public safety standards, or
other safety regulation certification prior to marketing electrical appliances.
Foreign jurisdictions also have regulatory authorities overseeing the safety of
consumer products. Our products, or additional electrical appliances which may
be developed by us, may not meet the specifications required by these
authorities. A determination that we are not in compliance with these rules and
regulations could result in the imposition of fines or an award of damages to
private litigants.
IF WE DO NOT ATTRACT AND RETAIN SKILLED PERSONNEL, OUR ABILITY TO GROW AND
DEVELOP OUR BUSINESS WILL SUFFER.
Our continued success will depend significantly on the efforts and abilities of
David C. Sabin, Chairman; Leonhard Dreimann, Chief Executive Officer; William B.
Rue, President and Chief Operating Officer and David Mulder, Executive Vice
President, Chief Administrative Officer and Senior Financial Officer. The loss
of the services of one or more of these individuals could have a material
adverse effect on our business. In addition, as our business develops and
expands, we believe that our future success will depend greatly on our ability
to attract and retain highly qualified and skilled personnel. We do not have,
and do not intend to obtain, key-man life insurance on our executive officers.
THE INTERESTS OF OUR SIGNIFICANT STOCKHOLDER MAY CONFLICT WITH YOUR INTERESTS.
As of July 3, 2004 Centre Partners Management LLC and entities directly or
indirectly controlled by Centre Partners beneficially owned in the aggregate
27.0% of our common stock. Centre Partners is able to exercise significant
influence with respect to the election of directors or major corporate
transactions such as a merger or sale of all or substantially all of our assets.
Centre Partners generally has the right to designate two directors as long as it
and its affiliates own at least 12.5% of the total voting power of our
outstanding common stock and one director as long as it and its affiliates own
at least 7.5% of the total voting power of our outstanding common stock. The
interests of Centre Partners may conflict with your interests in certain
circumstances.
TAKEOVER DEFENSE PROVISIONS WHICH WE HAVE IMPLEMENTED MAY ADVERSELY AFFECT THE
MARKET PRICE OF OUR COMMON STOCK.
Various provisions of Delaware corporation law and of our corporate governance
documents may inhibit changes in control not approved by our board of directors
and may have the effect of depriving stockholders of an opportunity to receive a
premium over the prevailing market price of our common stock in the event of an
attempted hostile takeover or may deter takeover attempts by third parties. In
addition, the existence of these provisions may adversely affect the market
price of our common stock. These provisions include:
- a classified board of directors;
- a prohibition on stockholder action through written consents;
- a requirement that special meetings of stockholders be called only
by the board of directors;
- availability of "blank check" preferred stock.
17
WE DO NOT ANTICIPATE PAYING DIVIDENDS.
We have not paid dividends on our common stock and we do not anticipate paying
dividends in the foreseeable future. We intend to retain future earnings, if
any, to finance the expansion of our operations and for general corporate
purposes, including future acquisitions. In addition, our senior secured
revolving credit agreement and senior subordinated notes contain restrictions on
our ability to pay dividends on our capital stock.
OUR STOCK PRICE MAY CONTINUE TO BE VOLATILE
The trading price of our common stock is subject to significant fluctuations in
response to variations in quarterly operating results; changes in earnings
estimates by analysts; announcements of new products by us or our competitors;
changes in the domestic and international economic, political and business
conditions; general conditions in the housewares industry; the recent lack of
confidence in corporate governance and accounting practices; the open short
interest in our common stock; and other events or factors. In addition, the
stock market in general has experienced extreme price and volume fluctuations
that have affected the market prices for many companies that have been unrelated
to the operating performance of these companies. These market fluctuations have
adversely affected and may continue to adversely affect the market price of our
common stock.
ITEM 2. PROPERTIES
Salton leases its principal executive offices based in Lake Forest, Illinois. In
addition, Salton also leases the following:
SALES &
ADMINISTRATIVE WAREHOUSE RETAIL OUTLETS FACTORY
-------------- --------- -------------- -------
North America 12 8 3 0
European Union 4 1 0 0
Africa 2 1 2 1
Asia 1 1 0 0
Australia and New Zealand 3 1 0 0
In addition, Salton also owns the following:
SALES &
ADMINISTRATIVE WAREHOUSE RETAIL OUTLETS FACTORY
-------------- --------- -------------- -------
North America 2 6 0 0
European Union 1 3 0 0
Africa 0 0 0 1
As part of our U.S. Restructuring Plan introduced on May 11, 2004, we continue
to consolidate facilities in an effort to reduce costs and restore profitability
to the domestic operations. We anticipate the following changes to our domestic
properties subsequent to year end:
The Company has identified two leased distribution facilities and three leased
sales/administrative offices to be closed during fiscal 2005.
In addition, the Company also plans to close an owned sales/administrative
office during fiscal 2005.
To accommodate international expansion, we are currently in the process of
renovating a warehouse in Europe. This renovation is scheduled to be complete
during the first half of the 2005 fiscal year.
18
We believe the reduced number of facilities and renovation projects will be
suitable and adequate for our current level of operations, as well as support
future growth.
ITEM 3. LEGAL PROCEEDINGS
SECURITIES CLASS ACTION LAWSUITS
In May, 2004, two stockholder lawsuits, named Mariss Partners, LLP v. Salton,
Inc., Leonhard Dreimann and David M. Mulder and Warren Beeler v. Salton, Inc.,
Leonhard Dreimann and David Mulder, were filed in the United States District
Court for the Northern District of Illinois against us and certain Salton
executives. The complaints allege that the defendants violated the federal
securities laws, specifically Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934 and Rule 10b-5 of the Securities and Exchange Commission,
by making certain alleged false and misleading statements. The plaintiffs seek
unspecified damages on behalf of a purported class of purchasers of our
securities during the period from November 11, 2002 through May 11, 2004. We
believe that these lawsuits are without merit and that we have compelling
defenses to the allegations contained in the complaints. We intend to vigorously
defend against these cases. The outcome of the class action lawsuits cannot be
predicted with certainty, however, we do not believe that this matter will have
a material adverse affect on our business, financial condition or results of
operations. Therefore, no amounts have been accrued for such claims.
PHILIPS
In June, 2003, we received a letter from Philips Domestic Appliances and
Personal Care B.V. (Philips) accusing us of interfering in a contractual
relationship between Philips and a manufacturing source for Salton, Electrical
and Electronics (E&E), misappropriating trade secrets and infringing other
unspecified intellectual property rights in connection with its development and
marketing of the One:One single serve coffee maker. On August 14, 2003, we filed
a complaint in the United States District Court for the Northern District of
Illinois seeking a declaratory judgment that we had not infringed the alleged
trade secret rights of Philips and had not tortiously interfered with the
contractual relationship between Philips and E&E.
Philips response has been to file a series of lawsuits against us. On October
23, 2003, Philips filed a counterclaim against us in the Northern District of
Illinois, Declaratory Judgment case, reiterating the allegations of Philips'
June letter and adding a claim for copyright infringement. The counterclaim
sought to enjoin the distribution of the One:One in the United States and money
damages. On January 5, 2004, the Court dismissed the action for failure to join
E&E and suggested that the matter should be litigated in the courts of Hong
Kong. Philips has appealed the Court's decision to the United States Court of
Appeals for the Seventh Circuit. A decision on this appeal is not expected for a
number of months. In view of the District Court's ruling, we sought and obtained
the consent of E&E to join in the action previously filed by Philips in Hong
Kong in May 2003, against E&E, alone. That Hong Kong suit alleges that E&E
misappropriated trade secrets, infringed intellectual property and breached its
contract with Philips in the process of developing and manufacturing the One:One
coffee maker for Salton.
On January 6, 2004, Philips filed a new action in the United States District
Court for the Northern District of Illinois, against us alleging violations of
U.S. Copyright Law seeking to enjoin us from selling the One:One coffee maker
and any monetary damages that the Court deems proper. Contemporaneously, Philips
sought a preliminary injunction. On January 30, 2004, the Court dismissed
Philips' new action on the ground that it was barred by the Court's dismissal
decision in the prior action. Philips appealed this dismissal and the appeal was
consolidated with the appeal of the earlier case in the United States Court of
Appeals for the Seventh Circuit.
19
On November 24, 2003, Philips and Sara Lee NV also filed a patent infringement
suit against us asserting that the One:One infringed a U.S. patent. Like the
other actions, this case seeks damages and injunctive relief. The case is
pending as in the United States District Court for the Northern District of
Illinois.
Philips has also filed an action for copyright infringement in the United
Kingdom. This suit seeks unspecified money damages and injunctive relief. This
case currently pends in the United Kingdom. E&E has intervened in that
litigation, and it is anticipated E&E will seek to have the suit dismissed in
favor of the Hong Kong action where the issue is already being litigated.
The outcome of the foregoing legal matters cannot be predicted with certainty,
however we do not believe that these actions will have a material adverse affect
on our business, financial condition or results of operations. Therefore, no
amounts have been accrued for such claims.
HOMEPLACE OF AMERICA
Homeplace of America, a company in liquidation under the United States
Bankruptcy Code, brought a lawsuit for recovery of preferential payments made to
Salton and its subsidiary, Toastmaster, during the 90 day "preference" period
prior to filing for bankruptcy. Homeplace's total claimed preferences are
approximately $3.5 million. Salton believes that it has meritorious defenses to
all of the preference claims. The lawsuit is scheduled for trial in the U.S.
Bankruptcy Court for the District of Delaware, during the first week of November
2004. Salton does not believe that this matter will have a material adverse
affect on its business, financial condition or results of operations. Therefore,
no material amounts have been accrued for such claims.
ENVIRONMENTAL
The Company has accrued approximately $0.2 million for the anticipated costs of
environmental remediation at four of our sites. Although such costs could exceed
that amount, we believe any such excess will not have a material adverse effect
on the financial condition or annual results of operations of the Company.
OTHER
We are a party to various other actions and proceedings incident to our normal
business operations. We believe that the outcome of any litigation will not have
a material adverse effect on our business, financial condition or results of
operations. We also have product liability and general liability insurance
policies in amounts we believe to be reasonable given our current level of
business. Although historically we have not had to pay any material product
liability claims, it is conceivable that we could incur claims for which we are
not insured.
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
20
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
Our executive officers and their respective ages as of September 10, 2004, are
as follows:
NAME AGE POSITION
---- --- --------
David C. Sabin 54 Chairman
Leonhard Dreimann 56 Chief Executive Officer
William B. Rue 57 President and Chief Operating Officer
David M. Mulder 43 Executive Vice President, Chief Administrative
Officer and Senior Financial Officer
DAVID C. SABIN has served as Chairman of the Company since September 1991 and
has served as Secretary and a director of the Company since its inception in
August 1988 and is a founder of the Company.
LEONHARD DREIMANN has served as Chief Executive Officer and a director of the
Company since its inception in August 1988 and is a founder of the Company. From
1988 to July 1998, Mr. Dreimann served as President of the Company. From 1987 to
1988, Mr. Dreimann served as president of the Company's predecessor Salton,
Inc., a wholly-owned subsidiary of SEVKO, Inc. Prior to 1987, Mr. Dreimann
served as managing director of Salton Australia Pty. Ltd., a distributor of
Salton brand kitchen appliances.
WILLIAM B. RUE has been a director of the Company since August 1998. Mr. Rue has
served as President of the Company since August 1998, as Chief Operating Officer
of the Company since December 1994 and as Chief Financial Officer and Treasurer
of the Company from September 1988 to January 1999. He is also a founder of the
Company. From 1985 to 1988, he was Treasurer of SEVKO, Inc. and from 1982 to
1984 he was Vice President-Finance of Detroit Tool Industries Corporation. Prior
to that time, Mr. Rue had been employed since 1974 by the accounting firm of
Touche Ross & Co.
DAVID M. MULDER serves as the Executive Vice President, Chief Administrative
Officer and Senior Financial Officer. Mr. Mulder is responsible for overseeing
corporate finance, U.S. operations, U.S. information technology and U.S. human
resources. Prior to joining the Company, Mr. Mulder recently served as Chief
Financial and Administrative Officer of KoSa, an international manufacturing
company in Houston, Texas. From 1995 to 2000, he held a number of senior level
positions at Fruit of the Loom, a consumer products company. Mr. Mulder's most
recent position at Fruit of the Loom was a corporate Executive Vice President
and the Chief Executive Officer of their European division.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The registrant's common stock has traded on the New York Stock Exchange under
the symbol "SFP" since February 26, 1999. From October 1991 until February 25,
1999, our common stock traded on the NASDAQ National Market under the symbol
"SALT." The following table sets forth, for the periods indicated, the high and
low sales prices for the common stock as reported on the New York Stock
Exchange.
21
HIGH LOW
----- ----
FISCAL 2004
First Quarter 11.75 8.92
Second Quarter 14.13 9.25
Third Quarter 15.20 8.46
Fourth Quarter 10.00 2.50
FISCAL 2003
First Quarter 14.43 7.61
Second Quarter 14.40 8.01
Third Quarter 11.60 8.60
Fourth Quarter 13.50 8.13
DIVIDENDS
We have not paid dividends on our common stock and we do not anticipate paying
dividends in the foreseeable future. We intend to retain future earnings, if
any, to finance the expansion of our operations and for general corporate
purposes, including future acquisitions. In addition, our senior secured
revolving credit agreement and senior subordinated notes contain restrictions on
our ability to pay dividends on our capital stock.
STOCKHOLDER RIGHTS PLAN
On June 28, 2004, the Board of Directors of Salton adopted a stockholder rights
plan (the "Rights Plan") pursuant to which a dividend consisting of one
preferred stock purchase right (a "Right") was distributed for each share of
Common Stock held as of the close of business on July 9, 2004, and is to be
distributed to each share of Common Stock issued thereafter until the earlier of
(i) the Distribution Date (as defined in the Rights Plan), (ii) the Redemption
Date (as defined in the Rights Plan) or (iii) June 28, 2014. The Rights Plan is
designed to deter coercive takeover tactics and to prevent an acquirer from
gaining control of us without offering fair value to our stockholders. The
Rights will expire on June 28, 2014, subject to earlier redemption or exchange
as provided in the Rights Plan. Each Right entitles the holder thereof to
purchase from us one one-thousandth of a share of a new series of Series B
Junior Participating Preferred Stock at a price of $45.00 per one one-thousandth
of a share, subject to adjustment. The Rights are generally exercisable only if
a Person (as defined) acquires beneficial ownership of 20 percent or more of our
outstanding Common Stock.
A complete description of the Rights, the Rights Agreement between us and UMB
Bank, N.A., as Rights Agent, and the Series B Junior Participating Preferred
Stock is hereby incorporated by reference from the information appearing under
the caption "Item 1. Description of the Registrant's Securities to be
Registered" contained in the Registration Statement on Form 8-A filed on June
28, 2004.
COMMON STOCK
The Certificate of Incorporation authorizes the issuance of 40,000,000 common
shares, par value $0.01 per share. As of September 10, 2004, there were
approximately 317 holders of record of our common stock.
PREFERRED STOCK
The Certificate of Incorporation authorizes the issuance of 2,000,000 preferred
shares, par value $0.01 per share.
22
We have 40,000 outstanding shares of convertible preferred stock. The
convertible preferred stock is generally non-dividend bearing; however, if we
breach in any material respect any of our material obligations in the preferred
stock agreement or the Certificate of Incorporation relating to the convertible
preferred stock, the holders of convertible preferred stock are entitled to
receive quarterly cash dividends on each share of convertible preferred stock
from the date of such breach until it is cured at a rate per annum equal to 12
- -1/2% of the Liquidation Preference as defined below. The payment of dividends
is limited by the terms of our credit agreement.
Each holder of the convertible preferred stock is generally entitled to one vote
for each share of Salton common stock which such holder could receive upon the
conversion of the convertible preferred stock. Each share of convertible
preferred stock is convertible at any time into that number of shares of Salton
common stock obtained by dividing $1,000 by the Conversion Price in effect at
the time of conversion. The "Conversion Price" is equal to $11.33, subject to
certain anti-dilution adjustments.
In the event of a Change of Control (as defined), each holder of shares of
convertible preferred stock has the right to require us to redeem such shares at
a redemption price equal to the Liquidation Preference plus an amount equivalent
to interest accrued thereon at a rate of 7% per annum compounded annually on
each anniversary date of July 28, 1998 for the period from July 28, 1998 through
the earlier of the date of such redemption or July 28, 2003.
In the event of a liquidation, dissolution or winding up of the Company, whether
voluntary or involuntary, holders of the Convertible Preferred Stock are
entitled to be paid out of the assets of the Company available for distribution
to its stockholders an amount in cash equal to $1,000 per share, plus the amount
of any accrued and unpaid dividends thereon (the "Liquidation Preference"),
before any distribution is made to the holders of any Salton common stock or any
other of our capital stock ranking junior as to liquidation rights to the
convertible preferred stock.
We may optionally convert in whole or in part, the convertible preferred stock
at any time on and after July 15, 2003 at a cash price per share of 100% of the
then effective Liquidation Preference per share, if the daily closing price per
share of our common stock for a specified 20 consecutive trading day period is
greater than or equal to 200% of the then current Conversion Price. On September
15, 2008, we will be required to exchange all outstanding shares of convertible
preferred stock at a price equal to the Liquidation Preference per share,
payable at the Company's option in cash or shares of Salton common stock.
As of September 10, 2004 there were 40,000 shares of the convertible preferred
stock outstanding, held by 7 shareholders of record. There is no established
market for the convertible preferred stock.
ITEM 6. SELECTED FINANCIAL DATA
The following financial data as of and for the fiscal years ended July 3, 2004,
June 28, 2003, June 29, 2002, June 30, 2001 and July 1, 2000 have been derived
from and should be read in conjunction with, our audited consolidated financial
statements, including the notes thereto.
23
FIVE-YEAR SUMMARY OF FINANCIAL DATA
---------------------------------------------------------------------------------
(IN THOUSANDS) JULY 3, 2004(1) JUNE 28, 2003 JUNE 29, 2002 JUNE 30, 2001 JULY 1, 2000
--------------- ------------- ------------- ------------- ------------
STATEMENT OF INCOME:
Net sales(2) $ 1,076,735 $ 894,908 $ 922,479 $ 792,114 $ 837,302
Cost of goods sold 751,012 578,826 544,147 474,256 467,250
Distribution expenses 72,088 58,475 60,831 49,395 37,639
--------------- ------------- ------------- ------------- ------------
Gross profit 253,635 257,607 317,501 268,463 332,413
Selling, general, and administrative expenses 273,257 208,203 223,577 156,885 156,749
Lawsuit settlements, net - - 2,580 - -
Impairment loss on goodwill and intangible assets 40,855 800 - - -
Restructuring costs 1,798 - - - -
--------------- ------------- ------------- ------------- ------------
Operating (loss) income (62,275) 48,604 91,344 111,578 175,664
Interest expense, net 40,192 40,204 44,431 37,732 28,761
Loss on early extinguishment of debt 5,049 - - - -
Fair market value adjustment on derivatives - (2,516) 2,372 - -
--------------- ------------- ------------- ------------- ------------
(Loss) Income before income taxes (107,516) 10,916 44,541 73,846 146,903
Income tax (benefit) expense (20,089) 2,685 14,394 27,692 55,087
Minority interest, net of tax 7,745 260 - - -
--------------- ------------- ------------- ------------- ------------
Net (loss) income $ (95,172) $ 7,971 $ 30,147 $ 46,154 $ 91,816
=============== ============= ============= ============= ============
Weighted average common shares outstanding 11,258 11,152 11,005 11,750 11,221
Net (loss) income per share:
Basic $ (8.45) $ 0.71 $ 2.74 $ 3.93 $ 8.18
Weighted average common shares and common
Equivalent shares outstanding 11,258 15,114 15,042 16,065 15,526
Net (loss) income per share:
Diluted $ (8.45) $ 0.53 $ 2.00 $ 2.87 $ 5.91
BALANCE SHEET DATA (AT PERIOD END):
Working capital $ 306,104 $ 353,492 $ 279,519 $ 310,648 $ 197,671
Total assets 854,552 812,372 823,927 722,884 564,276
Total debt(3) 418,991 374,152 460,066 402,713 327,220
Stockholders' equity 173,576 253,904 245,036 211,497 173,808
Dividends Paid - - - - -
(1) Includes the effect of costs related to our U.S. restructuring plan and
other items excluded from senior management's assessment of the operating
performance of Salton's business (See "Year in Review" in Management's
Discussion and Analysis of Financial Condition and Results of Operations) which
on a combined basis, decreased income before income taxes $73.2 million, $57.0
million after tax ($5.06 per basic share).
(2) AMAP's results from May 16, 2004 onward have been consolidated with Salton's
financial statements.
(3) Excludes $4.5 million in fiscal 2004, $4.6 million in fiscal 2003, and $18.2
million in fiscal 2002 related to the loan notes to Pifco shareholders which
were fully cash collateralized and excludes $9.6 million in fiscal 2004, $12.1
million in fiscal 2003, and $8.4 million in fiscal 2002 related to the fair
value of a monetized fixed to floating interest rate swap on the notes due 2008.
Certain prior year information has been reclassified to conform with current
year presentation.
24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
Salton designs, markets and distributes small home appliances and electronics
for the home, home decor and personal care products under recognized brand names
in the International Housewares Industry. Our product mix consists of kitchen
and home appliances, electronics, tabletop products, time products, lighting
products, picture frames and personal care and wellness products. In recent
years, we have expanded our international presence and strengthened our product
offerings through strategic acquisitions and alliances as well as internal
international growth.
ACQUISITIONS
On May 16, 2003 we increased our 30.8% interest in Amalgamated Appliance
Holdings Limited (AMAP), a South African Company, to a 52.6% interest for $7.5
million. Due to the increase in ownership, AMAP's results from May 16, 2003
onward have been consolidated with Salton in accordance with accounting
principles generally accepted in the United States of America (GAAP) for
financial statement presentation. Prior to May 16, 2003, our investment in AMAP
was accounted for under the equity method and was included in consolidated
assets.
NEW ACCOUNTING PRONOUNCEMENTS
In April 2003, the Financial Accounting Standards Board (FASB) issued SFAS No.
149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities," which amends and clarifies financial accounting and reporting for
derivative instruments. SFAS No. 149 is effective for contracts entered into or
modified after June 30, 2003, and for hedging relationships designated after
June 30, 2003. The provisions of SFAS 149 did not have any impact on the
Company's Consolidated Financial Statements.
In December 2003, the FASB issued a revision to SFAS No. 132, "Employer's
Disclosures About Pensions and Other Postretirement Benefits" (SFAS No. 132R).
SFAS No. 132R changes employers' disclosures about pension plans and other
postretirement benefits and requires additional disclosures about assets,
obligations, cash flows and net periodic benefit cost. The Statement is
effective for annual periods ending after December 15, 2003, and interim periods
beginning after December 15, 2003. The Company adopted SFAS No. 132R as of March
27, 2004, resulting in additional disclosures in the Company's Consolidated
Financial Statements (See Note 9 "Employee Benefit Plans").
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" (FIN No. 46), which addresses consolidation by
business enterprises of variable interest entities (VIEs). FIN No.46 is
applicable immediately for VIEs created after January 31, 2003 and are effective
for reporting periods ending after December 15, 2003, for VIEs created prior to
February 1, 2003. In December 2003, the FASB published a revision to FIN 46 (FIN
46R) to clarify some of the provisions of the interpretation and to defer the
effective date of implementation for certain entities. Under the guidance of FIN
46R, public companies that have interests in VIE's that are commonly referred to
as special purpose entities are required to apply the provisions of FIN 46R for
periods ending after December 15, 2003. A public company that does not have any
interests in special purpose entities but does have a variable interest in a VIE
created before February 1, 2003, must apply the provisions of FIN 46R by the end
of the first interim or annual reporting period ending after March 14, 2004. The
Company adopted FIN 46 and FIN 46R during the year ended July 3, 2004. The
adoption of FIN 46 had no impact on the financial condition or results of
operations since the Company does not have investments in VIE's.
25
DISCUSSION OF CRITICAL ACCOUNTING POLICIES
Our financial statements have been prepared in accordance with accounting
principles generally accepted in the United States of America, which require us
to make estimates and judgments that significantly affect the reported amounts
of assets, liabilities, revenues and expenses and related disclosure of
contingent assets and liabilities. We regularly evaluate these estimates,
including those related to our allowance for doubtful accounts, reserve for
inventory valuation, reserve for returns and allowances, valuation of reporting
units with goodwill, valuation of intangible assets having indefinite lives,
cooperative advertising accruals, pension benefits and depreciation and
amortization. We base these estimates on historical experience and on
assumptions that are believed by management to be reasonable under the
circumstances. Actual results may differ from these estimates, which may impact
the carrying value of assets and liabilities.
The following critical accounting policies required the most significant
estimates used in the preparation of our consolidated financial statements
ALLOWANCE FOR DOUBTFUL ACCOUNTS - We calculate allowances for estimated losses
resulting from the inability of our customers to make required payments. We
utilize a number of tools to evaluate and mitigate our customer credit risk.
Management evaluates each new customer account using a combination of some or
all of the following sources of information: credit bureau reports, industry
credit group reports, customer financial statement analysis, customer supplied
credit references and bank references. Appropriate credit limits are set in
accordance with our credit risk policy and monitored on an on-going basis.
Existing customers are monitored and credit limits are adjusted according to
changes in their financial condition. Based on the procedures outlined herein,
and the fact that no customer accounted for 10.0% or more of the gross accounts
receivable at July 3, 2004 and June 28, 2003, we believe there is no
concentration of credit risk.
Our exposure to credit loss on our foreign currency forward contracts in the
event of non-performance by the counterparties is believed to be remote due to
the requirements that the counterparties consist only of major financial
institutions that have a long-term credit rating of single-A or better from both
Moody's and Standard& Poor's. Additionally, our foreign currency forward
contracts generally have a term of one year or less.
INVENTORY VALUATION - The Company values inventory at the lower of cost or
market, and regularly reviews the book value of discontinued product lines and
stock keeping units (SKUs) to determine if these items are properly valued. If
market value is less than cost, the Company writes down the related inventory to
the estimated net realizable value. The Company regularly evaluates the
composition of inventory to identify slow-moving and obsolete inventories to
determine if additional write-downs are required. The Company's domestic
inventories are generally determined by the last-in, first-out (LIFO) method.
These inventories account for approximately 53.7% and 67.6% of the Company's
inventories as of 2004 and 2003, respectively. All remaining inventory cost is
determined on the first-in, first-out basis. See Note 4 "Inventories."
COMMITMENTS AND CONTINGENCIES - We are subject to lawsuits and other claims
related to product and other matters that are being defended and handled in the
ordinary course of business. We maintain reserves and or accruals for such costs
that may be incurred, which are determined on a case-by-case basis, taking into
consideration the likelihood of adverse judgments or outcomes, as well as the
potential range of probable loss. The reserves and accruals are monitored on an
ongoing basis and are updated for new developments or new information as
appropriate.
26
INTANGIBLE ASSETS - We record intangible assets through transactions and
acquisitions. The cost of acquisitions are allocated to the assets and
liabilities acquired, including identifiable intangible assets, with the
remaining amount being classified as goodwill. Under current accounting
guidelines that became effective on July 1, 2001, goodwill arising from
transactions occurring after July 1, 2001 and any existing goodwill as of June
30, 2002 are not amortized to expense but rather assessed for annually for
impairment. Other intangible assets that have an indefinite life are also
assessed annually for impairment.
The allocation of the acquisition cost to intangible assets and goodwill
therefore has a significant impact on our future operating results. The
allocation process requires the extensive use of estimates and assumptions,
including estimates of future cash flows expected to be generated by the
acquired assets. Further, when impairment indicators are identified with respect
to previously recorded intangible assets, the values of the assets are
determined using a variety of techniques including discounted future cash flows,
which are based on estimated future operating results. Significant management
judgment is required in the forecasting of future operating results, which are
used in the preparation of projected discounted cash flows.
YEAR IN REVIEW
In 2004, Salton continued its focus on increasing international opportunities
and during the fourth quarter, launched an effort to return its domestic
business to profitability. Fiscal year 2004 was our first full year of
consolidating the financial results of AMAP. We also started expansion into
Brazil, Italy, Spain and Germany. However, our international growth was offset
by the continued decline in sales and profitability of the domestic operations.
As part of an effort to improve profitability in our domestic operations, we
announced a U.S. restructuring plan in the domestic market in order to better
align domestic operating costs with current sales levels. We expect to generate
at least $40.0 million in annual cost savings from our U.S. restructuring plan
when fully implemented in fiscal 2005 through a reduction in operating expenses
and a consolidation of U.S. operations.
We completed the initial phase of this U.S. restructuring plan by reducing
headcount in the domestic operations by approximately 25.0% in the fourth
quarter of fiscal 2004. The salaried headcount reduction is expected to reduce
annualized costs by $11.5 million.
In connection with the U.S. restructuring plan and subsequent valuation reviews
in light of those decisions, we recorded certain pretax charges in the fourth
quarter as follows:
- $20.2 million write-down of certain inventory identified for
liquidation as part of the Company's decision to rationalize
warehouse and distribution facilities
- $6.5 million of intangible asset impairment charge associated with
trademarks effected by the restructuring plan
- $3.8 million fixed assets charge related primarily to tooling
- $1.7 million write-down of costs associated with several marketing
programs that were discontinued
- $1.2 million in consulting and legal costs directly associated with
the development and implementation of the U.S. restructuring plan;
and
- $0.5 in termination and severance costs associated with the
headcount reduction in the U.S.
27
Other items impacting the 2004 third quarter results include:
- $34.3 million impairment charge consisting of consolidated goodwill
and certain other indefinite lived intangible assets (See
"Impairment Loss on Goodwill and Intangible Assets").
Other items impacting the 2004 fourth quarter and fiscal year-end results
include:
- $6.9 million valuation allowance against certain foreign income tax
credits
- $5.0 million pre-tax loss on the early extinguishment of debt
The restructuring costs and other items listed above affected comparability of
reported operating income, net income and earnings per share for the fourth
quarter and fiscal year 2004.
RESULTS OF OPERATIONS
The following table sets forth our results of operations as a percentage of net
sales for the years ended:
JULY 3, 2004 JUNE 28, 2003 JUNE 29, 2002
------------ ------------- -------------
Net sales 100.0% 100.0% 100.0%
Cost of goods sold 69.8(1) 64.7 59.0
Distribution expenses 6.7 6.5 6.6
----- ----- -----
Gross profit 23.5 28.8 34.4
Selling, general and administrative expense 25.4 23.3 24.2
Lawsuit settlements, net 0.0 0.0 0.3
Impairment loss on goodwill and intangible assets 3.8(2) 0.1 0.0
Restructuring costs 0.2 0.0 0
----- ----- -----
Operating (loss) income (5.9)% 5.4% 9.9%
===== ===== =====
(1) Includes $ 24.0 million (2.2% of net sales ) of fourth quarter
restructuring costs (See "Year in Review").
(2) Consists of an aggregate of $40.9 million of impairment charges (See
"Impairment Loss on Goodwill and Intangible Assets").
2004 COMPARED TO 2003
NET SALES AND GROSS PROFIT
Salton reached $1.1 billion in net sales for 2004 compared to the $894.9 million
reported in 2003. The largest increase was the inclusion of a full year of
AMAP's results which amounted to $206.4 million of additional sales. In
addition, Salton had $29.2 million of exchange rate gain and $12.6 million of
other foreign sales increases. The other foreign sales increases were primarily
driven by the George Foreman and Russell Hobbs product lines. While Foreman
sales continued to increase internationally, domestic volume decline in the
first half of the year was the primary reason for a $66.5 million decrease in
domestic sales for the fiscal year. Management believes Foreman will continue
its success overseas as we expand our foreign operations and introduce the
Foreman Grill in new markets. In addition, the launch of the new George Foreman
Grills with removable plates (The Next Grilleration) is expected to help
accelerate the replacement cycle among existing customers in North America, a
factor in further stabilizing domestic sales volumes.
28
Gross profit for 2004 declined $4.0 million from $257.6 million in 2003 to
$253.6 million in 2004. As a percent of net sales, it was 23.5% in 2004 compared
to 28.8% in 2003, a decrease of 5.3%. These decreases are attributed to a $65.2
million decline in domestic gross profit associated with a volume and mix shift
from higher margin George Foreman products to lower margin new products such as
the Westinghouse electrics, Melitta One:One and various other new products
introduced at the International Housewares Show. As part of the $65.2 million of
domestic decline in operations, we incurred $24.0 million of fourth quarter
charges in connection with the U.S. restructuring plan announced on May 11,
2004. These costs included inventory and tooling write-downs associated with the
Company's decision to rationalize warehouse and distribution facilities and exit
certain marketing programs. The decreases caused by domestic gross profit
declines and U.S. restructuring costs were partially offset by a $44.7 million
increase due to the inclusion of a full year of AMAP's gross profit, $9.6
million in foreign currency gains and $6.9 million in other foreign gross profit
increases associated with growth and expansion of our international
subsidiaries.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses increased to 25.4% of net sales or
$273.3 million in 2004 compared to 23.3% of net sales or $208.2 million for
2003. The $65.1 million increase in selling, general and administrative was due
to increases of $39.7 million driven by international growth from expansion,
including $22.4 million from AMAP and $9.8 million from other foreign increases
as the Company launched new products internationally and expanded operations on
the European Continent and in Brazil. The remaining $7.5 million were of
international increases attributed to foreign currency fluctuations.
Selling, general and administrative expenses for domestic operations increased
$25.4 million. As a result of approximately $30.0 million of additional
expenditures for television, royalty expense, certain other media and
cooperative advertising and trade show expenses. Of the $30.0 million,
approximately $8.0 million related to cooperative advertising and promotional
activities associated with an aggressive retailer position following product
shortages during the holidays. It was management's intention to drive additional
sales through significant new product introductions. We had varied success on
the new product launches and continued to experience declines in overall
domestic sales in the first three quarters, which was the primary driver of the
U.S. restructuring plans, launched in the fourth quarter. As part of those
plans, we incurred a $1.7 million charge associated with the termination of
certain advertising and marketing programs as part of our U.S. restructuring
plan. These increases from domestic operations were offset by $6.3 million of
various other insignificant decreases in other selling, general and
administrative expense categories.
IMPAIRMENT LOSS ON GOODWILL AND INTANGIBLE ASSETS
Effective with the beginning of fiscal year 2003, we adopted SFAS No. 142,
"Goodwill and Other Intangible Assets". Upon adoption of SFAS No. 142, we
discontinued the amortization of goodwill and indefinite lived intangible
assets. Goodwill and intangible assets that are not amortized are subject to a
fair-value based impairment test on an annual basis or more frequently if
circumstances indicate a potential impairment.
The annual test for impairment of goodwill and other intangible assets is
conducted during the fourth quarter of each fiscal year. At the beginning of
2004, management believed that projected operating results would validate the
amount of goodwill and other intangible assets on the financial statements. As
discussed in our 2003 Annual Report on Form 10-K filed with the Securities and
Exchange Commission, shortfalls in future operating results or the application
of more conservative market assumptions could have an adverse affect on the
comparison of fair value to carrying value for goodwill and other intangible
assets. Management determined that the combination of the shortfall beginning in
the third quarter in meeting projected operating results along with the our
inability to meet financial debt covenants required for the senior secured
revolving credit facility for two consecutive quarters and a downgrade in the
debt rating could have such an adverse effect, and as such, an interim
impairment test was necessary. A valuation of goodwill and other intangible
assets
29
was conducted. The valuation incorporated performance through the third quarter.
The valuation did not incorporate the future U.S. restructuring plan that
management started in the fourth quarter of fiscal 2004.
As a result, we determined that the implied fair value of goodwill and the fair
value of certain other indefinite lived intangible assets were less than their
carrying values. We recorded a non-cash impairment charge totaling $34.3 million
pre-tax or $29.9 million net of tax, consisting of consolidated goodwill of
$28.2 million and certain other indefinite lived intangible assets associated
with iCEBOX of $6.1 million.
In conjunction with the U.S. restructuring plan and extensive individual product
line reviews, we completed our annual test for impairment of indefinite lived
intangible assets as of the end of the fourth quarter. As a result, we
determined that an additional charge of $6.5 million was necessary against
trademarks impacted by the U.S. restructuring plan.
RESTRUCTURING COSTS
As a result of our U.S. restructuring plan, we incurred $1.7 million in
restructuring costs consisting of $1.2 million for consulting and legal costs
directly associated with the development and implementation of the restructuring
plan and $0.5 million associated with the termination and severance cost as a
result of a 25.0% U.S. headcount reduction in the fourth quarter.
NET INTEREST EXPENSE
Net interest expense was $40.2 million for both fiscal 2004 and fiscal 2003. Our
rate of interest on amounts outstanding under the revolver, term loan and senior
subordinated debt was a weighted average annual rate of 9.7% in fiscal 2004
compared to 8.9% in fiscal 2003. The average amount of all debt outstanding was
$381.3 million for fiscal 2004 compared to $428.3 million for fiscal 2003. This
was a result of lower average borrowings under the current and former revolver
and term loan agreement and our repayment of certain other obligations.
LOSS ON EARLY EXTINGUISHMENT OF DEBT
During the fourth quarter, the Company incurred a non-cash pretax charge of $5.0
million for the write-off of unamortized financing costs under the previous
credit agreement. (See Liquidity discussion surrounding new financing
arrangements).
FAIR MARKET VALUE ADJUSTMENT ON DERIVATIVES
The Company uses foreign exchange contracts to hedge anticipated foreign
currency transactions, primarily U.S. dollar inventory purchases. The contracts
generally mature within one year and are designed to limit exposure to exchange
rate fluctuations. Unrealized pre-tax losses resulting from foreign exchange
contracts that qualified as cash flow hedges were $7.6 million.
INCOME TAXES
Income tax expense was a tax benefit of $20.1 million in fiscal 2004 as compared
to income tax expense of $2.7 million in fiscal 2003. The effective tax rate
(benefit) for federal, state, and foreign income taxes was approximately (18.7)%
in 2004 versus approximately 24.6% in 2003. The effective tax rate (benefit) in
2004 is less than the statutory U.S. Federal tax rate primarily because of $13.3
million of non-deductible goodwill that was written off as a result of an
impairment charge in 2004 and $6.9 million of tax reserves provided as a
valuation allowance against certain foreign income tax credits that have a five
year life for U.S. tax purposes.
30
2003 COMPARED TO 2002
NET SALES AND GROSS PROFIT
Salton's net sales for 2003 were $894.9 million. This represented a decrease of
6.4% compared to 2002. While overall sales in the domestic market decreased, our
strong portfolio of brand names contributed to our success internationally. We
experienced significant volume decreases in the domestic market as a result of a
disappointing holiday season at retail. This left retailers overstocked during
the third quarter of fiscal 2003 further depressing sales. In addition, we
experienced a decrease of approximately $37.0 million in net sales attributable
to domestic price reductions in an effort to gain long term market presence, an
initiative to reduce domestic inventory levels and reduce the number of stock
keeping units (SKUs) the Company carries in inventory. These actions occurred
primarily in the second half of 2003. These decreases were offset by just over
$110.0 million in international sales increases primarily associated with the
George Foreman and Russell Hobbs brands, foreign currency fluctuations of $19.2
million, the inclusion of approximately $22.0 million of sales from AMAP for the
period of May 16, 2003 through June 28, 2003 and the inclusion of approximately
$13.0 million of sales from the Look For acquisition, now renamed Salton France.
Gross profit in 2003 decreased to $257.6 million or 28.8% of net sales as
compared to $317.5 million or 34.4% of net sales in 2002 primarily as a result
of approximately $37.0 million in domestic price reductions, $38.0 million in
domestic volume reductions and approximately $12.0 million in product mix
changes. These reductions were partially offset by approximately $27.3 million
in volume increases internationally and $5.7 million of foreign currency
exchange rate fluctuations.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administration expense decreased $15.4 million in fiscal
year 2003 compared to fiscal year 2002. Amortization expense decreased $15.8
million as amortization of goodwill and certain intangible assets ceased in
fiscal year 2003 due to the adoption of SFAS No. 142, "Goodwill and Other
Intangible Assets". Expenditures for television, royalty expense, certain other
media and cooperative advertising and trade show expenses were 9.8% of net sales
or $88.1 million in fiscal 2003 compared to 10.8% of net sales or $99.7 million
in fiscal 2002. This decrease is primarily associated with a $12.3 million
decline in infomercial advertising partially offset by a $6.6 million increase
in direct advertising. In addition, changes in foreign currency exchange rates
decreased selling, general and administration expense $4.5 million. These
decreases in selling, general and administrative expenses were partially offset
by an $8.4 million increase in salary expense, $5.6 million bad debt provision,
and $2.3 million from the inclusion of AMAP for the period May 16, 2003 through
June 28, 2003.
LAWSUIT SETTLEMENTS NET
The $2.6 million recorded in fiscal year 2002 for lawsuit settlements, net is
comprised of the following items:
- A $8.9 million charge related to the September 5, 2002 settlement
and related legal expenses associated with the Attorney Generals of
New York and Illinois regarding the Company's future conduct with
retailers relating to the Company's indoor electric grills.
- A $2.0 million charge related to the June 28, 2002 settlement and
related legal expenses associated with the patent infringement
alleged by AdVantage Partners LLC regarding the Company's "George
Foreman Jr." rotisserie grills.
- A $8.3 million gain related to the September 5, 2002 settlement
reached with Applica, Inc regarding the Company's lawsuit filed
against Applica in January 2001 for breach of its noncompetition
agreement. The gain primarily related to cancellation of the $15.0
million dollar promissory note issued by the Company to Applica in
1998 as partial consideration for the repurchase of the Company's
common stock from Applica. As part of the settlement, the
31
Company agreed to pay Applica $2.0 million on or before June 30,
2004. The gain associated with the carrying value of the note upon
cancellation of $10.8 million was partially offset by the present
value of the $2.0 million payment due to Applica and legal expenses
related to the litigation.
All legal expenses included in the $8.9 million charge related to the Attorney
Generals of New York and Illinois settlement were either incurred prior to June
29, 2002 or were legally required within the terms of the settlement agreement.
The cost legally required per the statement agreement included reimbursement of
Plaintiff States attorneys' fees and other administrative cost, the amount of
which was stated in the agreement, as well as estimated costs to provide public
notice as ordered by the Court. All legal expenses were recorded as incurred and
were included in the $2.0 million charge related to the AdVantage Partners LLC
settlement in fiscal 2002. Legal expenses associated with the Applica lawsuit
described above were expensed as incurred and netted against the related gain
for purposes of income statement presentation. No legal expenses were deferred.
In accordance with SFAS No. 5, the Company recorded a liability for those
amounts that were probable and could be reasonably estimated.
IMPAIRMENT LOSS ON GOODWILL AND INTANGIBLE ASSETS
During the first quarter of fiscal year 2003, the Company recorded an impairment
charge of $0.8 million related to the Company's decision to abandon the Welbilt
tradename and discontinue the related product line.
NET INTEREST EXPENSE
Net interest expense was $40.2 million for fiscal 2003 compared to $44.4 million
in fiscal 2002. The decrease is primarily attributable to lower average
borrowings under the current and former revolver and term loan agreement and our
repayment of certain other obligations existing in 2002. Our rate of interest on
amounts outstanding under the revolver, term loan and senior subordinated debt
was a weighted average annual rate of 8.9% in fiscal 2003 compared to 8.2% in
fiscal 2002. The average amount of all debt outstanding was $428.3 million for
fiscal 2003 compared to $485.2 million for fiscal 2002.
FAIR MARKET VALUE ADJUSTMENT ON DERIVATIVES
Salton Europe uses foreign exchange contracts to hedge anticipated foreign
currency transactions, primarily U.S. dollar inventory purchases. The contracts
generally mature within one year and are designed to limit exposure to exchange
rate fluctuations. We recognized a pre-tax benefit for an increase in the fair
market value of the derivatives of $2.5 million, or $1.8 million net of tax,
from foreign exchange contracts that did not qualify as cash flow hedges for
accounting purposes in accordance with U.S. GAAP. Certain foreign exchange
contracts entered into by Salton Europe in fiscal 2002 did not qualify as cash
flow hedges because their terms failed to meet the cash flow hedge definition
requirements within SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities, as amended (SFAS No. 133). Such contracts were
marked-to-market through their respective settlement dates. All subsequent
foreign exchange contracts entered into by Salton Europe met the conditions of
SFAS No. 133 to qualify as cash flow hedges and were recorded as such. All
foreign exchange contracts are related to the purchase of inventory in U.S.
dollars from an affiliate, Salton Hong Kong, Ltd. Unrealized pre-tax losses
resulting from foreign exchange contracts that qualified as cash flow hedges
were de minimis.
INCOME TAXES
The effective tax rate for federal, state and foreign income taxes were
approximately 24.6% in 2003 versus approximately 32.3% in 2002. The Company's
income tax rate for 2003 was favorably impacted due to a disproportionately
greater amount of income subject to lower foreign tax rates and a taxable loss
in the domestic entities. The Company anticipates that in future years, its
effective income tax rate will return to that of historical rates.
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NET INCOME
The Company reported net income of $8.0 million or basic earnings per common
share of $0.71 per share for the fiscal year 2003 compared with net income of
$30.1 million or basic earnings per common share of $2.74 per share for the
fiscal year 2002. Net income for 2003 was primarily reduced by a pricing
transition in the domestic market partially offset by expansion and internal
growth in the international markets. Pricing transition refers to the domestic
price reductions granted by the Company to its customers in advance of product
cost reductions that were later realized from the Company's suppliers.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW FROM OPERATIONS
Our primary sources of liquidity are our cash flow from operations and
borrowings under our senior secured revolving credit facility. In 2004, Salton's
operations provided $23.4 million in cash flow, compared with $130.6 million in
2003. This decrease is primarily a result of decreased profits and higher
international inventories, offset by decreases in accounts receivable and
increases in accounts payable. Given the seasonal nature of our business,
borrowings and availability tend to be highest in mid-Fall and early Winter.
Our results of operations for the periods discussed have not been significantly
affected by inflation or foreign currency fluctuation. We generally negotiate
our purchase orders with our foreign manufacturers in United States dollars.
Thus, our cost under any purchase order is not subject to change after the time
the order is placed due to exchange rate fluctuations. However, the weakening of
the United States dollar against local currencies could result in certain
manufacturers increasing the United States dollar prices for future product
purchases. In addition, the Company has recently experienced an upward trend in
raw material prices. As a result, the Company may use working capital to build
inventories to take advantage of current lower prices.
The Company also currently uses foreign exchange contracts to hedge anticipated
foreign currency transactions, primarily U.S. dollar inventory purchases. The
contracts generally mature within one year and are designed to limit exposure to
exchange rate fluctuations, primarily the British Pound Sterling and South
African Rand against United States dollars.
INVESTING ACTIVITIES
We incurred approximately $33.1 million for capital expenditures during fiscal
2004 including approximately $12.0 million in construction-in-progress for a
warehouse renovation in Europe.
During fiscal 2004, we made our final $21.9 million installment payment
associated with the acquisition of the George Foreman tradename.
FINANCING ACTIVITIES
We had net proceeds from worldwide credit facilities of $61.0 million. These
proceeds were offset by $16.1 million of additional compensating balances on
deposit and $4.3 million of financing costs associated with refinancing
activities.
REVOLVING CREDIT FACILITY
On June 15, 2004, we entered into an amended and restated $275.0 million senior
secured revolving credit facility, which initially provides us with the ability
to borrow up to $207.0 million (including $10.0 million for letters of credit).
Advances under the senior secured revolving credit facility are primarily based
upon percentages of eligible accounts receivable and inventories. The facility
has a maturity date of June 15, 2007 and is subject to a prepayment premium of
3.0% of $275.0 million if the facility is repaid by June 15, 2005, 2.0% if the
facility is repaid between June 16, 2005 and June 15, 2006 and 1.0% if the
facility is repaid between June 16, 2006 and June 15, 2007.
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As of July 3, 2004, we had borrowed $132.7 under the senior secured revolving
credit facility and had approximately $26.5 million available under this
facility for future borrowings.
Our senior secured revolving credit facility replaced a $275.0 million senior
credit agreement we had with our previous senior lenders. We had failed to
comply with certain consolidated and U.S. fixed charge coverage ratios contained
in