FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20459
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 333-31931
NORTH ATLANTIC TRADING COMPANY, INC.
------------------------------------
(Exact name of Registrant as Specified in its Charter)
DELAWARE 13-3961898
-------- ----------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
257 Park Avenue South, New York, New York 10010-7304
----------------------------------------- ----------
(Address of Principal Executive Offices) (Zip Code)
(212) 253-8185
--------------
(Registrant's Telephone Number, Including Area Code)
Unchanged
---------
(Former name, Former Address and Former Fiscal Year, if Changed Since Last
Report)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 528,241 shares of common stock,
$.01 par value, as of August 12, 2002.
NY2:\1185812\02\P#Z802!.DOC\64980.0003
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
North Atlantic Trading Company, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(in thousands except share data)
June 30, December 31,
2002 2001
---- ----
(Unaudited)
Current assets:
Cash $ - $ 1,130
Accounts receivable 6,281 5,672
Inventory 43,739 43,967
Income taxes receivable 910 910
Other current assets 1,903 1,702
---------------- ----------------
Total current assets 52,833 53,381
Property, plant and equipment, net 5,092 5,233
Deferred income taxes 26,178 26,644
Deferred financing costs 3,335 4,028
Goodwill, net 123,557 123,557
Other assets 2,836 2,718
---------------- ----------------
Total assets $ 213,831 $ 215,561
================ ================
Current liabilities:
Revolving credit facility $ 5,000 $ -
Accounts payable 2,392 2,614
Accrued liabilities 3,068 4,080
Deferred income taxes 9,542 9,542
Current portion of long-term debt 6,250 12,500
---------------- ----------------
Total current liabilities 26,252 28,736
Long-term debt 155,000 155,000
Other long-term liabilities 10,994 10,994
---------------- ----------------
Total liabilities 192,246 194,730
---------------- ----------------
Preferred Stock, net of discount of $833 and $918,
respectively (mandatory redemption value of $61,587)
61,082 57,443
---------------- ----------------
Stockholders' Deficit:
Common stock, voting, $.01 par value; authorized shares,
750,000; issued and outstanding shares, 528,241 5 5
Common stock, nonvoting, $.01 par value; authorized shares,
750,000; issued and outstanding shares, -0- - -
Additional paid-in capital 9,144 9,144
Loans to stockholders for stock purchase (193) (187)
Accumulated other comprehensive income (348) (348)
Accumulated deficit (48,105) (45,226)
---------------- ----------------
Total stockholders' deficit (39,497) (36,612)
---------------- ----------------
Total liabilities and stockholders' deficit $ 213,831 $ 215,561
================ ================
The accompanying notes are an integral part of the unaudited condensed
consolidated financial statements.
2
NORTH ATLANTIC TRADING COMPANY, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(in thousands except per share amounts)
(unaudited)
Three Months Three Months
Ended Ended
June 30, 2002 June 30, 2001
------------- -------------
Net sales $ 18,218 $ 16,570
Cost of sales 8,530 7,995
---------------- ----------------
Gross profit 9,688 8,575
Selling, general and administrative expenses 5,854 5,753
Amortization of goodwill - 1,372
---------------- ----------------
Operating income 3,834 1,450
Interest expense and financing costs, net 4,677 4,968
Other expense (income) 333 (5)
---------------- -----------------
Loss before income tax benefit (1,176) (3,513)
Income tax benefit (447) (1,932)
----------------- -----------------
Net loss (729) (1,581)
Preferred stock dividends (1,846) (1,660)
----------------- -----------------
Net loss applicable to common shares (2,575) (3,241)
Add back: goodwill amortization expense, net of tax - 1,022
---------------- ----------------
Adjusted net loss applicable to common shares $ (2,575) $ (2,219)
================= =================
Basic and diluted loss per common share:
Net loss $ (1.38) $ (3.00)
Preferred stock dividends (3.50) (3.14)
------------------- -----------------
Net loss (4.88) (6.14)
Add back: goodwill amortization expense, net of tax - 1.94
------------------- -----------------
Adjusted net loss $ (4.88) $ (4.20)
=================== =================
Weighted average common shares outstanding:
Basic and Diluted 528.2 528.2
Condensed Consolidated Statement of Comprehensive Income
(in thousands)
Net loss $ (729) $ (1,581)
Other comprehensive income, net of tax:
Gain on foreign currency hedges - 49
---------------- ----------------
Comprehensive loss $ (729) $ (1,532)
================= =================
The accompanying notes are an integral part of the unaudited condensed
consolidated financial statements.
3
NORTH ATLANTIC TRADING COMPANY, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(in thousands except per share amounts)
(unaudited)
Six Months Six Months
Ended Ended
June 30, 2002 June 30, 2001
------------- -------------
Net sales $ 40,170 $ 39,012
Cost of sales 17,199 17,502
---------------- ----------------
Gross profit 22,971 21,510
Selling, general and administrative expenses 11,653 11,228
Amortization of goodwill - 2,745
---------------- ----------------
Operating income 11,318 7,537
Interest expense and financing costs, net 9,398 10,048
Other expense (income) 694 (1)
---------------- -----------------
Income (loss) before income tax benefit 1,226 (2,510)
Income tax expense (benefit) 466 (1,380)
---------------- -----------------
Net income (loss) 760 (1,130)
Preferred stock dividends (3,639) (3,256)
----------------- -----------------
Net loss applicable to common shares (2,879) (4,386)
Add back: goodwill amortization expense, net of tax - 2,044
---------------- ----------------
Adjusted net loss applicable to common shares $ (2,879) $ (2,342)
================= =================
Basic and diluted loss per common share:
Net income (loss) $ 1.44 $ (2.14)
Preferred stock dividends (6.89) (6.16)
Net loss (5.45) (8.30)
Add back: goodwill amortization expense, net of tax - 3.87
---------------- ----------------
Adjusted net loss $ (5.45) $ (4.43)
Weighted average common shares outstanding:
Basic and Diluted 528.2 528.2
Condensed Consolidated Statement of Comprehensive Income
(in thousands)
Net income (loss) $ 760 $ (1,130)
Other comprehensive income (loss), net of tax:
Loss on foreign currency hedges - (46)
---------------- -----------------
Comprehensive income (loss) $ 760 $ (1,176)
================= =================
The accompanying notes are an integral part of the unaudited condensed
consolidated financial statements.
4
NORTH ATLANTIC TRADING COMPANY, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Six Months Six Months
Ended Ended
June 30, 2002 June 30, 2001
------------- -------------
Cash flows from operating activities:
Net income (loss) $ 760 $ (1,130)
Adjustments to reconcile net income (loss)
to net cash provided by (used in) operating activities:
Depreciation 350 350
Amortization of goodwill - 2,745
Amortization of deferred financing costs 693 646
Deferred income taxes 466 (1,408)
Compensation expense 50 46
Changes in operating assets and liabilities:
Accounts receivable (609) (1,027)
Inventory 228 1,976
Other current assets (201) (96)
Other assets (118) (310)
Accounts payable (222) (1,774)
Accrued expenses and other (1,060) (280)
---------------- ----------------
Net cash provided by (used in) operating activities 337 (262)
---------------- ----------------
Cash flows from investing activities:
Capital expenditures (209) (242)
---------------- ----------------
Net cash used in investing activities (209) (242)
---------------- ----------------
Cash flows from financing activities:
Proceeds from revolving credit facility 5,000 5,500
Payments on term loans (6,250) (6,250)
Other (8) 3
---------------- ----------------
Net cash used in financing activities (1,258) (747)
---------------- ----------------
Net decrease in cash (1,130) (1,251)
Cash, beginning of period 1,130 1,453
---------------- ----------------
Cash, end of period $ - $ 202
================ ================
The accompanying notes are an integral part of the unaudited condensed
consolidated financial statements.
5
NORTH ATLANTIC TRADING COMPANY, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(in thousands except per share amounts)
1. Basis of Presentation
The accompanying condensed consolidated financial statements are presented in
accordance with the requirements of Form 10-Q and accordingly do not include all
the disclosures normally required by generally accepted accounting principles.
The condensed consolidated financial statements have been prepared in accordance
with North Atlantic Trading Company, Inc.'s (the "Company's") customary
accounting practices and have not been audited. In the opinion of management,
all adjustments necessary to fairly present the results of operations for the
reported interim periods have been made and were of a normal recurring nature.
The year-end balance sheet data was derived from audited financial statements,
but does not include all disclosures required by generally accepted accounting
principles. Certain prior period amounts have been reclassified to conform to
current period presentation.
2. Summary of Significant Accounting Policies:
Revenue Recognition: The Company recognizes revenues and the related costs upon
transfer of title and risk of loss to the customer.
Shipping Costs: The Company records shipping costs incurred as a component of
selling, general and administrative expenses. Shipping costs incurred were
$1,264,000 and $1,185,000 for the six months ended June 30, 2002 and 2001,
respectively.
Cash: Pursuant to the Master Settlement Agreement entered into in November 1998
by most states (represented by their attorneys general acting through the
National Association of Attorneys General) (the "MSA") and subsequent states'
statutes, a "cigarette manufacturer" (which is defined to also include
make-your-own cigarette tobacco) has the option of either becoming a signatory
to the MSA or opening, funding and maintaining an escrow account to have funds
available for certain potential tobacco-related liabilities, with sub-accounts
on behalf of each settling state. The Company has chosen to open and fund an
escrow account as its method of compliance. It is the Company's policy to record
amounts on deposit in the escrow account, as well as cash on hand to fund its
projected deposit based on its monthly sales activity for the current year
period, as an other non-current asset. Each current year deposit will be funded
to the escrow account by April 15 of the following year.
3. Inventories
The Company uses the last-in, first-out (LIFO) method for valuing its
inventories.
The reduction of LIFO inventory quantities decreased net income of the Company
by approximately $0.5 million and $0.7 million for the six months ended June 30,
6
2002 and 2001, respectively, and approximately $0.3 and $0.3 for the three
months ended June 30, 2002 and 2001, respectively.
The components of inventories are as follows (in thousands):
6/30/02 12/31/01
---------- -----------
Raw materials and work in process $ 2,924 $ 2,125
Leaf tobacco 10,748 12,404
Finished goods - loose leaf tobacco 2,867 2,431
Finished goods - MYO products 5,758 4,694
Other 660 681
---------- -----------
22,957 22,335
LIFO reserve 20,782 21,632
$ 43,967 $ 43,967
========== ===========
4. Goodwill and Other Intangible Assets
In June 2001, the Financial Accounting Standards Board, or FASB, issued
Statement No. 141, Business Combinations ("Statement 141") and Statement No.
142, Goodwill and Other Intangible Assets ("Statement 142"). Statement 141
requires that all business combinations initiated after June 30, 2001 be
accounted for using the purchase method as use of the pooling-of-interest method
is no longer permitted. Statement 142 requires that goodwill no longer be
amortized to earnings, but instead be reviewed at least annually for impairment
using a two-step process. The first step is a test for potential impairment, and
the second measures the amount of impairment, if any. Impairment losses that
arise from completing a transitional impairment test during 2002 are to be
reported as the cumulative effect of a change in accounting principle as of the
beginning of the year. Subsequent impairments, if any, will be classified as an
operating expense. In addition, Statement 142 specifies the types of acquired
intangible assets that are required to be recognized and reported separately
from goodwill.
Upon adopting Statement 142 on January 1, 2002, the Company ceased amortizing
goodwill. Statement 142 required completion of the first step of the
transitional impairment test by June 30, 2002. The Company has completed the
transitional impairment test and reports that no impairment has been incurred.
5. Provision for Income Taxes
The provision for income taxes for the six months ended June 30, 2002 and June
30, 2001 was computed based on the estimated annual effective income tax rates
of 38% and 55%, respectively. The primary difference between the effective
income tax rate and the statutory income tax rate is certain goodwill
amortization, which is not deductible for income tax purposes. Pursuant to the
adoption of FASB 142, as discussed in Note 4 above, the Company ceased its
amortization of goodwill.
7
6. Notes Payable and Long-Term Debt
North Atlantic Trading Company, Inc. is a holding company with no operations and
assets consisting primarily of its investment in subsidiaries, deferred income
tax assets related to the differences between the book and tax basis of its
investment in National Tobacco Company, L.P., a subsidiary of the Company, and
deferred financing costs related to its debt. All of the Company's subsidiaries
are wholly owned and guarantee the Company's debt on a full, unconditional and
joint and several basis. In management's opinion, separate financial statements
of the subsidiaries are not meaningful and are not included in these financial
statements. The following is unaudited parent-only summarized financial
information of the Company:
6/30/02 12/31/01
--------- ---------
Current assets $ - $ -
Noncurrent assets 194,786 195,462
Current liabilities 18,795 20,164
Noncurrent liabilities 155,000 155,000
Redeemable preferred stock 61,082 57,443
For the three months ended June 30: 2002 2001
--------- ---------
Equity in earnings of subsidiaries $ 3,100 $ 1,690
Interest expense (4,720) (5,032)
Income tax benefit Net 914 1,779
loss before payment of preferred
stock dividends $ (706) $ (1,563)
========= =========
For the six months ended June 30: 2002 2001
--------- ---------
Equity in earnings of subsidiaries $ 8,304 $ 5,268
Interest expense (9,475) (10,151)
Income tax benefit 1,974 3,786
--------- ---------
Net income (loss) before payment of preferred
stock dividends $ 803 $ (1,097)
========= =========
7. Financial Instruments
Effective January 1, 2001 the Company adopted Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Financial Instruments and Hedging
Activities" ("SFAS 133") which establishes accounting and reporting standards
requiring that every derivative financial instrument be recorded on the balance
sheet at its fair value. The statement further requires that the gains and
losses related to changes in the fair value of the derivative financial
instruments be recorded in the income statement unless certain hedge criteria
are met. Gains and losses for qualifying hedges can be deferred in accumulated
"other comprehensive income" and recognized in the income statement along with
the related results of the hedged item. The statement requires that the Company
formally document, designate and assess the effectiveness of such transactions
in order to qualify for such hedge accounting treatment.
8
The Company purchases certain inventory on terms of net 45 days in Euros which
creates exposure to potentially adverse movement in foreign currency rates. The
Company often uses short-term forward currency contracts to hedge the risk in
foreign currency exchange rates. In addition, the supplier of such inventory
provides a contractual hedge against a substantial, downward currency movement
pursuant to its agreement with the Company. The Company does not use derivative
financial instruments for speculative trading purposes, nor does the Company
hedge its foreign currency exposure in a manner that entirely offsets the
effects of changes in foreign exchange rates.
The Company's policy is to designate its forward currency contracts as cash flow
hedges of its anticipated purchases in Euros. Gains and losses on contracts that
are recorded in "other comprehensive income" will be reclassified to cost of
goods sold for the periods in which the related inventory is sold.
The Company recorded a cumulative-effect deferred net gain adjustment of $28,000
(net of tax expense of $17,000) in accumulated other comprehensive income to
recognize the fair value of these contracts upon adoption of SFAS 133 on January
1, 2001. The Company reclassified this net gain from "other comprehensive
income" to cost of goods sold in the first quarter of 2001. In addition, the
Company reclassified the March 31, 2001 net loss of $95,000 (net of tax benefit
of $58,000) recorded in accumulated "other comprehensive income" in a similar
manner during the second quarter of 2001. At June 30, 2002, there were no
forward currency contracts outstanding.
8. Reconciliation of Loss per Common Share
(dollars in thousands, except per share amounts):
Three Months Ended June 30, 2002
- --------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Net Loss $ (729)
Less: preferred stock dividends (1,846)
Basic and Diluted:
Net loss applicable to common stockholders $ (2,575) 528,241 $ (4.88)
============ ============= ===========
Three Months Ended June 30, 2001
- --------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Net Loss $ (1,581)
Less: preferred stock dividends (1,660)
Basic and Diluted:
Net loss applicable to common stockholders $ (3,241) 528,241 $ (6.14)
Add back: goodwill amortization expense, net of tax 1,022 $ 1.94
Adjusted net loss applicable to common stockholders (2,219) 528,241 $ (4.20)
============ ============= ===========
9
Six Months Ended June 30, 2002
- ------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Net Loss $ 760
Less: preferred stock dividends (3,639)
Basic and Diluted:
Net loss applicable to common stockholders $ (2,879) 528,241 $ (5.45)
============ ============= ===========
Six Months Ended June 30, 2001
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Net Loss $ (1,130)
Less: preferred stock dividends (3,256)
Basic and Diluted:
Net loss applicable to common stockholders $ (4,386) 528,241 $ (8.30)
============ ============= ===========
Add back: goodwill amortization expense, net of tax 2,044 3.87
Adjusted net loss applicable to common stockholders $ (2,342) 528,241 $ (4.43)
============ ============= ===========
The calculations are based on the weighted average number of shares of common
stock outstanding during the period. Common stock equivalent shares from
warrants representing 63,500 shares and from stock options representing 61,800
shares were excluded from the computation for the three months and six months
ended June 30, 2002, and 2001, as their effect is antidilutive.
9. Recently Adopted Accounting Pronouncements
On January 1, 2002, the Company adopted FASB Statement No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets ("Statement 144"). Statement 144
develops a single accounting model for long-lived assets to be disposed of by
sale, and addresses significant implementation issues related to previous
guidance. Statement 144 requires that long-lived assets to be disposed of by
sale be measured at the lower of their carrying amount or fair value less cost
to sell, whether reported in continuing operations or in discontinued
operations. Statement 144 also broadens the reporting of discontinued operations
by potentially qualifying more disposal transactions for discontinued operations
reporting. The adoption of Statement 144 does not have an impact on the
Company's consolidated financial statements.
During 2001, the Emerging Issues Task Force issued: 1) EITF No. 00-14,
"Accounting for Certain Sales Incentives" addressing the recognition,
measurement and statement of earnings classification of certain sales incentives
and 2) EITF No. 00-25, "Vendor Income Statement Characterization of
Consideration Paid to a Reseller of the Vendor's Products" addressing the
statement of earnings classification of consideration from a vendor to an entity
10
that purchases the vendor's products for resale. The Company adopted EITF 00-14
and EITF 00-25 in the first quarter of 2002. As a result of this adoption,
certain expenses have been reclassified from selling, general and administrative
expenses to allowances in determining net sales and to cost of goods sold for
the three months and six months period ended June 30, 2001. Due to adopting EITF
00-14 and EITF 00-25, for the three months period ended June 30, 2001, net sales
decreased by $0.62 million, cost of goods sold increased by $0.99 million and
selling, general and administrative expenses were reduced by $1.61 million from
the previously reported figures. For the six months period ended June 30, 2001,
net sales decreased by $1.47 million, cost of goods sold increased by $1.94
million and selling, general and administrative expenses were reduced by $3.41
million from the previously reported figures. The adoption of EITF 00-14 and
EITF 00-25 had no impact on the Company's net income for either of these
periods.
10. Contingencies
Except as described below, there have not been any significant developments with
respect to legal proceedings and pending litigation or any change to the
Company's position as previously disclosed in the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 2001 and the Company's
Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2002.
Kentucky & Illinois Complaints.
- -------------------------------
On April 5, 2002 the District Court for the Northern District of Illinois
decided the summary judgment motions by dismissing all claims of both the
Company and Republic Tobacco, Inc. and its affiliates ("Republic"), except for
Republic's claim of defamation per se against the Company, Republic's unfair
competition claim for injunctive relief against the Company and the Company's
claim against Republic for tortious interference with prospective business
advantage. The Court also granted Republic leave to move for summary judgment on
the Company's tortious interference claim. On April 29, 2002, Republic made a
motion for summary judgment with respect to the Company's tortious interference
claim. The briefings were completed on August 9, 2002 and the parties are
awaiting the Court's decision.
Texas Infringing Products Litigation.
- -------------------------------------
In Bollore S.A. v. Import Warehouse, Inc. Civ. No. 3-99CV-1196-R (N.D. Texas),
the Company entered into a settlement with the remaining defendants, the
principal terms of which included an agreed permanent injunction, the withdrawal
of the defendants' appeal of the civil contempt order, an agreed judgment of $11
million from the civil contempt order and an agreement to forbear from enforcing
that $11 million money judgment until such time in the future that the
defendants violate the terms of the permanent injunction. Two of the defendants
also agreed to provide complete information concerning the counterfeiting
conspiracy that operated as well as information on other parties engaged in the
purchase and distribution of infringing Zig-Zag premium cigarette papers.
11
Subsequent to such settlement, the Company instituted a contempt proceeding
against Ravi Bhatia and Import Warehouse Inc. for violation of the civil
contempt order and a hearing was held on April 10, 2002. After evidence related
to this matter was discovered by plaintiffs and upon plaintiffs application,
another hearing was held on August 1, 2002. The Court has allowed the defendants
three weeks to supplement the record with additional evidence after which, the
Court indicated, it would make its ruling.
California Infringing Products Litigation.
- -----------------------------------------
On April 15, 2002, Downey Wholesale and L.A. International, defendants in the
A&A Smart Shopping litigation, moved for summary judgment. On May 3, 2002, the
Court made a tentative ruling, denying Downey's motion in all respects, holding
that the plaintiffs had shown genuine issues of material fact on all claims,
including the paper quality contained in the counterfeit booklets, cartons and
cases. However, the Court tentatively granted L.A. International's motion for
summary judgment, holding that the plaintiffs had not provided sufficient proof
that the involved paper was a different quality.
After a subsequent hearing on the summary judgment motion on May 15, 2002, the
Court affirmed its ruling against Downey Wholesale. The Court also reversed its
tentative ruling granting LA International's summary judgment and, in its final
ruling, denied LA International's motions in all respects.
On June 5, 2002, the Court granted the plaintiffs' application to consolidate
the A&A Smart Shopping and the Buy Rite Wholesale cases for trial purposes. In
an effort to better manage this case for trial, the plaintiffs have settled
against certain defendants, obtaining judgments for damages and permanent
injunctions against all of the settling defendants. A trial of the plaintiffs'
claims against the remaining defendants, Downey Wholesale, LA Top, LA
International, New Rainbow, LA Price Leader Inc. and JT Saniya Inc., has been
tentatively set for October 1, 2002.
On June 6, 2002, the plaintiffs moved for contempt sanctions against JT Saniya
Inc., asserting that JT Saniya had violated the terms of the preliminary
injunction issued against it by selling 38 cases of counterfeit product. JT
Saniya failed to dispute the allegations and a default judgment of $420,369.09
was entered against JT Saniya on July 23, 2002. The plaintiffs have commenced
collection proceedings.
11. Subsequent Event
On July 1, 2002, the Company commenced a consent solicitation ("Consent
Solitation") from registered holders of its 12% Senior Exchange Payment-in-Kind
Preferred Stock, par value $0.01 per share ("Preferred Stock"), for certain
amendments to the certificate of incorporation of the Company which would amend
the terms of the Preferred Stock. The proposed amendments required the consent
of the holders of a majority of the issued and outstanding shares of common
stock of the Company and the consent of the holders of a majority of the issued
and outstanding shares of Preferred Stock. A consent by the holders of a
majority of the Company's outstanding common stock was executed on June 28,
12
2002. On July 29, 2002 the Consent Solicitation was successfully completed, with
the Company receiving consents from the holders of more than 99% of the
outstanding shares of Preferred Stock.
The amendments to the Preferred Stock, among other things: (i) accelerated the
mandatory redemption date of the Preferred Stock from June 15, 2007 to June 15,
2005, which will require the Company to redeem the Preferred Stock at an earlier
date, (ii) reduced the liquidation preference from $25.00 to $22.00 per share,
which will lower the Company's cost of redeeming the Preferred Stock and will
lower the amount of dividends payable thereon (which dividends are equal to 12%
of the liquidation preference per annum), (iii) eliminated any redemption
premium, which will lower the Company's potential cost of redeeming the
Preferred Stock prior to June 15, 2005, (iv) reduced the repurchase price that
the Company must offer the holders of Preferred Stock upon a change of control
from 101% to 100% of the liquidation preference, which will lower the Company's
potential cost of any such repurchase obligation, (v) permitted future dividends
to be paid through the issuance of additional shares of preferred stock, which
will provide the Company with greater flexibility in financing its operations,
and (vi) included a definition for the term "Permitted Investments", which
definition was inadvertently omitted from the Certificate of Designation
pursuant to which the Preferred Stock was created.
As consideration for these amendments, the Company paid each registered holder
of Preferred Stock that consented thereto $0.40 per share in cash. A total of
$984,642 in consent fees was paid, including $750,000 that was paid prior to
June 30, 2002, and has been included in Other Current Assets in the accompanying
financial statements. The total fees will be deferred and amortized ratably from
July 1, 2002 through June 15, 2005.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The Company competes in two distinct markets: (1) the smokeless tobacco market
and (2) the Make-Your-Own ("MYO") cigarette market. The smokeless tobacco market
includes the loose leaf chewing tobacco segment, and the MYO cigarette market is
comprised of the premium cigarette papers sector and the MYO smoking tobaccos
and related products sector. The Company manufactures and markets loose leaf
chewing tobacco and imports and distributes premium cigarette papers and related
products, and contract manufactures and markets MYO smoking tobaccos and related
products.
Results of Operations
Comparison of Three Months Ended June 30, 2002 and 2001
Net Sales. Net sales for the three months ended June 30, 2002 were $18.2
million, a increase of 9.6%, or $1.6 million, from the prior year's period. Net
sales of the smokeless tobacco segment were flat compared to the prior year.
This segment's volume decreased by 3.2%, continuing the declining industry trend
in the loose leaf category of the smokeless tobacco segment. This decline was
13
offset by a manufacturer's price increase. Net sales of the Make-Your-Own
("MYO") segment increased 25.2%, or $1.6 million from the prior year. This
increase was due to the continued growth of the MYO tobacco products category
and to an increase in the premium cigarette paper category, which was related to
its Spring 2002 Promotion. Overall, the volume of the Spring 2002 Promotion
exceeded that of the Spring 2001 Promotion by 9.0%. Thus, consistent with the
results of the Winter 2001 Promotion, management believes that this category
continues to recover and benefit from the decline or cessation of illicit
counterfeiting activity.
Gross Profit. Gross profit for the three months ended June 30, 2002 was $9.7
million, an increase of $1.1 million, or 13.0%, from the prior year's period.
Gross profit of the smokeless tobacco segment increased $0.3 million, or 5.5%,
and the segment's gross margin increased to 47.9% of net sales from 45.6% in the
prior year. This increase was primarily due to a reduction in the non-cash LIFO
inventory adjustment of $0.5 million for 2002, which positively impacted the
gross profit margin of this segment. If the non-cash LIFO adjustment were to be
disregarded, the smokeless tobacco segment's gross margin percentage would have
been 52.8% of net sales in comparison to 52.0% for the prior year. Gross profit
of the MYO segment increased $0.8 million, or 20.5%. The gross margin of the MYO
segment decreased to 59.9% of net sales from 61.6% of net sales in the prior
year's period. The reduction in gross margin was due primarily to the impact of
growth, as well as the product mix, in the other MYO tobacco products category,
which generally has a lower gross margin than the premium cigarette paper
category.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the three months ended June 30, 2002 were $5.9
million, an increase of 1.7% from the prior year. This was due primarily to
increased costs associated with overall compensation costs, including benefits,
and to an increase in shipping costs due to an overall increase in the number of
shipments within the MYO segment.
Amortization of Goodwill. Amortization of goodwill was eliminated for the three
months ending June 30, 2002 compared to an expense of $1.4 million in the prior
year's period. As discussed in Note 4 to the Financial Statements, effective
January 1, 2002, the Company ceased amortizing goodwill as required under FASB
Statement 142.
Interest Expense and Financing Costs. Interest expense and financing costs
decreased $0.3 million, or 6.0% to $4.7 million for the three months ended June
30, 2002. This reduction was the result of a lower average term loan balance,
coupled with a lower average interest rate on the Company's variable rate debt.
Other Expense. Other expense was $0.3 million for the three months ended June
30, 2002 as compared with no such expense during the same period of the prior
year. Other expense in 2002 represents legal, investigative and related expenses
with respect to the Texas and California Infringing Products Litigations
involving Zig-Zag(R) premium cigarette papers which are detailed in Part II,
Item 1 under "Legal Proceedings."
14
Income Tax Benefit. Income tax benefit was $0.4 million for the three months
ended June 30, 2002 compared to a benefit of $1.9 million for the prior year
due, in part, to the improved operating results in 2002. In addition, the
effective income tax rate was reduced to 38% for the three months ended June 30,
2002 from 55% for the prior year's period due to the elimination of goodwill
amortization, in accordance with the adoption of FASB Statement 142, as
discussed in Note 4 to the Financial Statements.
Net Loss. Due to the factors described above, the net loss for the three months
ended June 30, 2002, was $0.7 million compared to a net loss of $1.6 million for
the prior year's period.
Comparison of Six Months Ended June 30, 2002 and 2001
Net Sales. Net sales for the six months ended June 30, 2002 were $40.2 million,
an increase of 3.1%, or $1.2 million, from the prior year's period. Net sales of
the smokeless tobacco segment decreased $0.7 million, or 3.7%, from the prior
year. This reduction was primarily the result of a volume decline of 6.3%,
continuing an overall volume decline in the loose leaf category of the smokeless
tobacco segment. This decline was partially offset by a manufacturer's price
increase. Net sales of the Make-Your-Own ("MYO") segment increased $1.9 million,
or 9.8%, from the prior year. This increase was due to the continued growth of
the MYO tobacco products category and to an increase in the premium cigarette
paper category related to the Spring 2002 Promotion. Overall, the volume of the
Spring 2002 Promotion exceeded that of the Spring 2001 Promotion by 9.0%. Thus,
consistent with the Winter 2001 Promotion, management believes that this
category continues to recover and benefit from the decline or cessation of
illicit counterfeiting activity.
Gross Profit. Gross profit for the six months ended June 30, 2002 was $23.0
million, an increase of $1.5 million, or 6.8%, from the prior year's period.
Gross profit of the smokeless tobacco segment increased $0.6 million, or 6.4%
and the segment's gross margin increased to 49.3% of net sales from 44.6% in the
prior year. This increase was primarily due to a reduction in the non-cash LIFO
inventory adjustment of $0.8 million for 2002, which positively impacted the
gross profit and gross margin of this segment. If the non-cash LIFO adjustments
were to be disregarded, the smokeless tobacco segment's gross margin would have
been 53.8% of net sales in comparison to 52.2% for the prior year. Gross profit
of the MYO segment increased $0.9 million, or 7.1%. The gross margin of the MYO
segment decreased to 64.3% of net sales from 66.0% of net sales in the prior
year's period. The reduction in the gross margin was due primarily to the impact
of growth, as well as the product mix, in the other MYO tobacco products
category, which generally has a lower gross margin than the premium cigarette
paper category.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the six months ended June 30, 2002 were $11.6
million, an increase of 3.6% from the prior year. This was due primarily to
increased costs associated with overall compensation costs, including benefits,
15
and to an increase in marketing and shipping costs due to the growth of the MYO
segment.
Amortization of Goodwill. Amortization of goodwill was eliminated for the six
months ending June 30, 2002 compared to an expense of $2.7 million in the prior
year's period. As discussed in Note 4 to the Financial Statements, effective
January 1, 2002, the Company ceased amortizing goodwill as required under FASB
Statement 142.
Interest Expense and Financing Costs. Interest expense and financing costs
decreased $0.6 million, or 6.0%, to $9.4 million for the six months ended June
30, 2002. This reduction was the result of a lower average term loan balance
coupled with a lower average interest rate environment.
Other Expense. Other expense was $0.7 million for the six months ended June 30,
2002 as compared with no such expense during the same period of the prior year.
Other expense in 2002 represents legal, investigative and related expenses with
respect to the Texas and California Infringing Products Litigations involving
Zig-Zag(R) premium cigarette papers which are detailed in Part II, Item 1 under
"Legal Proceedings."
Income Tax Expense (Benefit). Income tax expense was $0.5 million for the six
months ended June 30, 2002 compared to a benefit of $1.4 million for the prior
year due in part, to an increase in taxable income as a result of improved
operating performance. In addition, the effective income tax rate was reduced to
38% for the six months ended June 30, 2002 from 55% for the prior year's period
due to the elimination of goodwill amortization, in accordance with the adoption
of FASB Statement 142, as discussed in Note 4 to the Financial Statements.
Net Income (Loss). Due to the factors described above, the net income for the
six months ended June 30, 2002, was $0.8 million compared to a net loss of $1.1
million for the prior year's period.
Liquidity and Capital Requirements
At June 30, 2002, working capital was $26.6 million compared to $24.6 million at
December 31, 2001. This increase was primarily the result of a reduction in
current liabilities as the reduction in the term loan balance of $6.3 million
was partially offset by an increase in the revolving line of credit of $5.0
million and to a reduction of $1.0 million in accrued liabilities. The Company
expects to continue to fund its seasonal working capital requirements through
its operating cash flows and, if needed, bank borrowings. The Company currently
has an undrawn availability of $6.0 million under its committed $10.0 million
revolving credit facility.
The Company has a Loan Agreement (the "Loan Agreement"), dated December 31,
2000, with Bank One, Kentucky, N.A. as Agent (the "Agent"), and the banks named
therein, which provided for a $25 million term loan and a $10 million revolving
line of credit. Borrowings under the Loan Agreement bear interest at variable
16
rates based, at the Company's option, on prime or LIBOR rates. The term loan is
payable in eight (8) quarterly installments of $3,125,000 each plus accrued
interest, which commenced on March 31, 2001. Both the term loan and the
revolving line mature on December 31, 2002. As part of the revolving line, the
lenders agreed to issue up to $10 million of standby letters of credit. The
Company's obligations under the Loan Agreement are guaranteed by the Company's
subsidiaries. In addition, the Company's obligations are secured by all of the
Company's assets and the Company's equity in its subsidiaries. The average
interest rate on borrowings under the Loan Agreement was 4.40% at June 30, 2002.
In addition, the Company must pay a quarterly commitment fee of 0.5% per annum
of the average unused portion of the revolving line of credit. It is the
Company's intention to renew or replace its revolving line of credit by December
31, 2002.
On June 25, 1997, the Company issued $155.0 million of 11% Senior Notes due 2004
(the "Senior Notes"). The Senior Notes mature and are payable on June 15, 2004.
The Notes bear interest at 11% per annum, payable semiannually on June 15 and
December 15. At the present time, the Company projects that it will not have
sufficient funds to effect repayment in full at maturity in the absence of a
refinancing. The Company intends to refinance this debt in advance of its
maturity date. The ability to do so will depend, among other things, on the
financial performance of the Company and the availability of funds from the
capital markets. Although the Company believes it will be able to effect such a
refinancing, there can be no assurance that such a refinancing will be obtained.
The Loan Agreement and the Senior Notes include cross default provisions and
limit the incurrence of additional indebtedness, dividends, transactions with
affiliates, asset sales, acquisitions, mergers, prepayments of indebtedness,
liens and encumbrances, and other matters. The Loan Agreement also requires the
Company to meet a fixed charge coverage test. At June 30, 2002, the Company was
in compliance with all provisions of the Loan Agreement and Senior Notes.
As a result of amendments to the Company's certificate of incorporation
resulting from the Consent Solicitation, among other things, dividends on the
Company's Preferred Stock are payable either in cash or through the issuance of
additional shares of Preferred Stock. The Company's ability to make dividend
payments in cash depends upon the availability of funds and whether the Company
has satisfied the "restricted payments" provision under the Indenture pursuant
to which the Senior Notes were issued. The Company has sufficient authorized and
unissued shares of Preferred stock to make its dividend payments through the
issuance of additional shares. See "Item 2. Changes in Securities and Use of
Proceeds" for additional information concerning changes to the terms of the
Preferred Stock.
The Company believes that it maintains adequate inventories based on its past
and projected future sales activity and that it will be able to source its
inventory requirements for the foreseeable future.
17
The Company believes that any effect of inflation at current levels will be
minimal. Historically, the Company has been able to increase prices at a rate
equal to or greater than that of inflation and believes that it will continue to
be able to do so for the foreseeable future. In addition, the Company has been
able to maintain a relatively stable variable cost structure for its products
due, in part, to its successful procurement and reformulation activities with
regard to its tobacco products and, in part, to its existing contractual
agreement for the purchase of its premium cigarette papers.
Given its current operation, the Company believes that its capital expenditure
requirements for 2002 will be in the range of $600,000 to $750,000. Through June
30, 2002, the Company has incurred capital expenditures of $209,000. Currently,
the Company believes that its operating cash flows, together with its revolving
credit facility, should be adequate to satisfy its reasonably foreseeable
capital requirements (other than the refinancing of its Senior Notes, as
discussed above). The financing of any significant future products, business or
property acquisitions would likely require additional debt or equity financing.
Forward-looking Statements
The Company cautions the reader that certain statements in the Management's
Discussion and Analysis of Financial Condition and Results of Operations section
as well as elsewhere in this Form 10-Q are "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements are not guarantees of future performance. They
involve risks, uncertainties and other important factors, including the risks
discussed below. The Company's actual future results, performance or achievement
of results may differ materially from any such results, performance or
achievement implied by these statements. Among the factors that could effect the
Company's actual results and could cause results to differ from those
anticipated in the forward-looking statements contained herein is the Company's
ability to implement its business strategy successfully, which will be dependent
on business, financial, and other factors beyond the Company's control,
including, among others, federal, state and/or local regulations and taxes;
competitive pressures; changes in consumer preferences; consumer acceptance of
new product introductions and other marketing initiatives; access to sufficient
quantities of raw material or inventory to meet demand; wholesale ordering
patterns; product liability litigation and any disruption in access to capital
necessary to achieve the Company's business strategy.
The Company cautions the reader not to put undue reliance on any forward-looking
statements. In addition, the Company does not have any intention or obligation
to update the forward-looking statements in this document. The Company claims
the protection of the safe harbor for forward-looking statements contained in
Section 21E of the Securities Exchange Act of 1934.
Item 3. Not Applicable
18
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
Except as described below, there have not been any significant developments with
respect to legal proceedings and pending litigation or any change to the
Company's position as previously disclosed in the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 2001 and the Company's
Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2002.
Kentucky & Illinois Complaints.
- ------------------------------
On April 5, 2002 the District Court for the Northern District of Illinois
decided the summary judgment motions by dismissing all claims of both the
Company and Republic Tobacco, Inc. and its affiliates ("Republic"), except for
Republic's claim of defamation per se against the Company, Republic's unfair
competition claim for injunctive relief against the Company and the Company's
claim against Republic for tortious interference with prospective business
advantage. The Court also granted Republic leave to move for summary judgment on
the Company's tortious interference claim. On April 29, 2002, Republic made a
motion for summary judgment with respect to the Company's tortious interference
claim. The briefings were completed on August 9, 2002 and the parties are
awaiting the Court's decision.
Texas Infringing Products Litigation.
- -------------------------------------
In Bollore S.A. v. Import Warehouse, Inc. Civ. No. 3-99CV-1196-R (N.D. Texas),
the Company entered into a settlement with the remaining defendants, the
principal terms of which included an agreed permanent injunction, the withdrawal
of the defendants' appeal of the civil contempt order, an agreed judgment of $11
million from the civil contempt order and an agreement to forbear from enforcing
that $11 million money judgment until such time in the future that the
defendants violate the terms of the permanent injunction. Two of the defendants
also agreed to provide complete information concerning the counterfeiting
conspiracy that operated as well as information on other parties engaged in the
purchase and distribution of infringing Zig-Zag premium cigarette papers.
Subsequent to such settlement, the Company instituted a contempt proceeding
against Ravi Bhatia and Import Warehouse Inc. for violation of the civil
contempt order and a hearing was held on April 10, 2002. After evidence related
to this matter was discovered by plaintiffs and upon plaintiffs application,
another hearing was held on August 1, 2002. The Court has allowed the defendants
three weeks to supplement the record with additional evidence after which, the
Court indicated, it would make its ruling.
19
California Infringing Products Litigation.
- -----------------------------------------
On April 15, 2002, Downey Wholesale and L.A. International, defendants in the
A&A Smart Shopping litigation, moved for summary judgment. On May 3, 2002, the
Court made a tentative ruling, denying Downey's motion in all respects, holding
that the plaintiffs had shown genuine issues of material fact on all claims,
including the paper quality contained in the counterfeit booklets, cartons and
cases. However, the Court tentatively granted L.A. International's motion for
summary judgment, holding that the plaintiffs had not provided sufficient proof
that the involved paper was a different quality.
After a subsequent hearing on the summary judgment motion on May 15, 2002, the
Court affirmed its ruling against Downey Wholesale. The Court also reversed its
tentative ruling granting LA International's summary judgment and, in its final
ruling, denied LA International's motions in all respects.
On June 5, 2002, the Court granted the plaintiffs' application to consolidate
the A&A Smart Shopping and the Buy Rite Wholesale cases for trial purposes. In
an effort to better manage this case for trial, the plaintiffs have settled
against certain defendants, obtaining judgments for damages and permanent
injunctions against all of the settling defendants. A trial of the plaintiffs'
claims against the remaining defendants, Downey Wholesale, LA Top, LA
International, New Rainbow, LA Price Leader Inc. and JT Saniya Inc., has been
tentatively set for October 1, 2002.
On June 6, 2002, the plaintiffs moved for contempt sanctions against JT Saniya
Inc., asserting that JT Saniya had violated the terms of the preliminary
injunction issued against it by selling 38 cases of counterfeit product. JT
Saniya failed to dispute the allegations and a default judgment of $420,369.09
was entered against JT Saniya on July 23, 2002. The plaintiffs have commenced
collection proceedings.
Item 2. Changes in Securities and Use of Proceeds
Upon the approval of the requisite number of holders of its common stock and
Preferred Stock as described below, on July 30, 2002, the Company amended its
certificate of incorporation to amend the terms of the Preferred Stock.
The amendments to the Preferred Stock, among other things, (i) accelerated the
mandatory redemption date of the Preferred Stock from June 15, 2007 to June 15,
2005, which will require the Company to redeem the Preferred Stock at an earlier
date, (ii) reduced the liquidation preference from $25.00 to $22.00 per share,
which will lower the Company's cost of redeeming the Preferred Stock and will
lower the amount of dividends payable thereon (which dividends are equal to 12%
of the liquidation preference per annum), (iii) eliminated any redemption
premium, which will lower the Company's potential cost of redeeming the
Preferred Stock prior to June 15, 2005, (iv) reduced the repurchase price that
the Company must offer the holders of Preferred Stock upon a change of control
from 101% to 100% of the liquidation preference, which will lower the Company's
20
potential cost of any such repurchase obligation, (v) permitted future dividends
to be paid through the issuance of additional shares of preferred stock, which
will provide the Company with greater flexibility in financing its operations,
and (vi) included a definition for the term "Permitted Investments", which
definition was inadvertently omitted from the Certificate of Designation
pursuant to which the Preferred Stock was created.
Item 4. Submission of Matters to a Vote of Security Holders
By action of the Board of Directors on April 9, 2002, Geoffrey J.F. Gorman was
elected as a director, increasing the number of directors to five.
On June 28, 2002, persons having the right to vote a majority of the outstanding
shares of the Company's common stock, acting by written consent, approved the
amendments to certificate of incorporation of the Company that amended the terms
of the Preferred Stock as discussed in Item 2 above. The written consent was
signed by persons having the right to vote 447,400 shares of the Company's
common stock or 84.7% of the outstanding common shares.
On July 1, 2002, the Company began soliciting consents from the registered
holders of its Preferred Stock to amendments to the certificate of incorporation
of the Company that amended the terms of the Preferred Stock. Upon completion of
the consent solicitation, on July 29, 2002, the Company received consents from
holders of more than 99% of the issued and outstanding shares of Preferred
Stock.
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits
10.1 Promissory Note dated March 31, 2002 issued by David I. Brunson
in favor of North Atlantic Trading Company, Inc.
10.2 Promissory Note dated March 31, 2002 issued by Chris Kounnas in
favor of North Atlantic Trading Company, Inc.
10.3. Secured Promissory Note dated March 31, 2002 issued by Helms
Management Corp. in favor of North Atlantic Trading Company,
Inc.
10.4 Secured Promissory Note dated March 31, 2002 issued by Thomas F.
Helms, Jr. in favor of North Atlantic Trading Company, Inc.
10.5. Pledge and Security Agreement, dated as of March 31, 2002,
between Thomas F. Helms, Jr., Helms Management Corp. and North
Atlantic Trading Company, Inc.
99.1 Certification by the Chief Executive Officer pursuant to 18
U.S.C.ss. 1350, as adopted by Section 906 of the Sarbanes-Oxley
Act of 2002.
21
99.2 Certification by the Chief Financial Officer pursuant to 18
U.S.C.ss. 1350, as adopted by Section 906 of the Sarbanes-Oxley
Act of 2002.
b. Reports on Form 8-K.
(i) Form 8-K, filed on July 1, 2002, reporting under Item 5 "Other
Events".
(ii) Form 8-K filed on July 31, 2002, reporting under Item 5 "Other
Events" and including an amendment to the certificate of
incorporation of the Company as an Exhibit under Item 7
"Financial Statements, Pro Forma Information and Exhibits."
SIGNATURES
The Company has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
NORTH ATLANTIC TRADING COMPANY, INC.
Date: August 14, 2002 /s/ Thomas F. Helms, Jr.
------------------------------------------------
Thomas F. Helms, Jr.
Chief Executive Officer
/s/ David I. Brunson
------------------------------------------------
David I. Brunson
Chief Financial Officer
22