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 March 31, 2003
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 LastReport)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X].
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 May 14, 2003.
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
NORTH ATLANTIC TRADING COMPANY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands except share data)
(unaudited)
March 31, December 31,
2003 2002
---- ----
Current assets:
Cash $ 1,106 $ 805
Accounts receivable, net 4,064 7,651
Inventories 44,646 40,818
Income taxes receivable 910 887
Other current assets 5,855 3,457
----------------- -----------------
Total current assets 56,581 53,618
Property, plant and equipment, net 5,140 5,158
Deferred income taxes 27,017 24,916
Deferred financing costs 2,296 2,642
Goodwill 123,557 123,557
Other assets 3,751 3,703
----------------- -----------------
Total assets $ 218,342 $ 213,594
================= =================
Current liabilities:
Accounts payable $ 3,485 $ 2,868
Accrued expenses 7,993 2,429
Deferred income taxes 10,552 10,552
Revolving credit facility 7,500 5,500
----------------- -----------------
Total current liabilities 29,530 21,349
Long-term debt 155,000 155,000
Other long-term liabilities 12,793 12,793
----------------- -----------------
Total liabilities 197,323 189,142
----------------- -----------------
Preferred Stock, (mandatory redemption value of $59,538 and
$57,805, respectively) 59,538 57,805
----------------- -----------------
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 9,246 9,246
Loans to stockholders for stock purchase (159) (157)
Accumulated other comprehensive income (loss) (1,125) (1,125)
Accumulated deficit (46,486) (41,322)
----------------- -----------------
Total stockholders' deficit (38,519) (33,353)
----------------- -----------------
Total liabilities and stockholders' deficit $ 218,342 $ 213,594
================= =================
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
March 31, 2003 March 31, 2002
----------------------- ----------------------
Net sales $ 14,249 $ 21,952
Cost of sales 7,700 8,669
----------------------- ----------------------
Gross profit 6,549 13,283
Selling, general and administrative expenses 7,101 5,799
----------------------- ----------------------
Operating income (loss) (552) 7,484
Interest expense and financing costs, net 4,642 4,721
Other expense 337 362
----------------------- ----------------------
Income (loss) before income tax expense (benefit) (5,531) 2,401
Income tax expense (benefit) (2,101) 912
----------------------- ----------------------
Net income (loss) (3,430) 1,489
Preferred stock dividends (1,734) (1,794)
----------------------- ----------------------
Net loss applicable to common shares $ (5,164) $ (305)
======================= ======================
Basic and Diluted earnings per common share:
Net income (loss) $ (6.49) $ 2.82
Preferred stock dividends (3.29) (3.40)
----------------------- ----------------------
Net loss applicable to common shares $ (9.78) $ (0.58)
======================= ======================
Weighted average common shares outstanding:
Basic 528.2 528.2
Diluted 528.2 528.2
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 CASH FLOWS
(in thousands)
(unaudited)
Three months Three months
Ended Ended
March 31, 2003 March 31, 2002
---------------------- ---------------------
Cash flows from operating activities:
Net income (loss) $ (3,430) $ 1,489
Adjustments to reconcile net income (loss)
to net cash provided by (used in) operating activities:
Depreciation 125 175
Amortization of deferred financing costs 346 347
Deferred income taxes (2,101) 912
Changes in operating assets and liabilities:
Accounts receivable, net 3,587 (3,516)
Inventories (3,828) 444
Other current assets (2,421) 595
Other assets (48) (27)
Accounts payable 617 (1,190)
Accrued liabilities and other 5,564 3,932
---------------------- ----------------------
Net cash provided by (used in) operating activities (1,589) 3,161
---------------------- ----------------------
Cash flows from investing activities:
Capital expenditures (107) (100)
---------------------- ----------------------
Net cash provided by (used in) investing activities (107) (100)
---------------------- ----------------------
Cash flows from financing activities:
Proceeds from revolving credit facility 2,000 -
Payments on term loans - (3,125)
Other (3) (3)
---------------------- ----------------------
Net cash provided by (used in) financing activities 1,997 (3,128)
---------------------- ----------------------
Net increase (decrease) in cash 301 (67)
Cash, beginning of period 805 1,130
---------------------- ----------------------
Cash, end of period $ 1,106 $ 1,063
====================== ======================
The accompanying notes are an integral part of the unaudited condensed
consolidated financial statements.
4
NORTH ATLANTIC TRADING COMPANY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
These condensed consolidated financial statements should be read in conjunction
with the financial statements and related notes thereto included in North
Atlantic Trading Company, Inc.'s (the "Company's") Annual Report on Form 10-K
for the year ended December 31, 2002.
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 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
recorded and were of a normal and 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
$595,000 and $650,000 for the three months ended March 31, 2003 and 2002,
respectively.
MASTER SETTLEMENT AGREEMENT ESCROW ACCOUNT: Pursuant to the Master Settlement
Agreement (the "MSA") entered into in November 1998 by most states (represented
by their attorneys general acting through the National Association of Attorneys
General) and subsequent states' statutes, a "cigarette manufacturer" (which is
defined to include a manufacturer of 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 for prior years, as well as cash-on-hand to fund its projected
deposit based on its monthly sales for the current year, as an other non-current
asset. Each year's obligation is required to be deposited in the escrow account
by April 15 of the following year. As of March 31, 2003, the Company has
recorded as a non-current asset approximately $2.1 million, of which $1.0
million is related to the projected deposit for 2002.
3. INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined on the
last-in, first-out (LIFO) method. Leaf tobacco is presented in current assets in
5
accordance with standard industry practice, notwithstanding the fact that such
tobaccos are carried longer than one year for the purpose of curing.
The impact of LIFO resulted in decreased net income of the Company by
approximately $0.1 million and $0.2 million for the three months ended March 31,
2003 and 2002, respectively.
The components of inventories are as follows (in thousands):
3/31/03 12/31/02
--------------- ---------------
Raw materials and work in process $ 3,773 $ 3,111
Leaf tobacco 9,671 10,328
Finished goods - loose leaf tobacco 4,476 4,174
Finished goods - MYO products 8,231 4,722
Other 865 728
--------------- ---------------
27,016 23,063
LIFO reserve 17,630 17,755
--------------- ---------------
$ 44,646 $ 40,818
=============== ===============
4. PROVISION FOR INCOME TAXES
The provision for income taxes for the three months ended March 31, 2003 and
March 31, 2002 was computed based on the estimated annual effective income tax
rate of 38%.
5. PARENT-ONLY FINANCIAL INFORMATION
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 herein. The
following represents unaudited parent-only summarized financial information of
North Atlantic Trading Company, Inc. (in thousands):
3/31/03 12/31/02
-------------- --------------
Current assets $ - $ -
Noncurrent assets 194,998 189,129
Current liabilities 19,692 10,732
Noncurrent liabilities 155,000 155,000
Redeemable preferred stock 59,538 57,805
6
For the three months ended March 31: 2003 2002
-------------- ---------------
Equity in earnings of subsidiaries $ (11) $ 5,328
Interest expense (4,668) (4,756)
Income tax benefit 1,263 1,060
-------------- ---------------
Net income (loss) before preferred
stock dividends $(3,416) $ 1,632
============== ===============
6. FINANCIAL INSTRUMENTS
The Company occasionally uses short-term forward currency contracts to hedge the
risk in foreign currency exchange rates. In accordance with the provisions of
SFAS No. 133, "Accounting for Derivative Financial Instruments and Hedging
Activities," the Company's policy is to designate its forward currency contracts
as cash flow hedges of its anticipated purchases in Euros. As of March 31, 2003,
the Company had no outstanding forward currency contracts.
7. RECONCILIATION OF INCOME (LOSS) PER COMMON SHARE
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS):
THREE MONTHS ENDED MARCH 31, 2003
Income Shares Per Share
(Numerator) (Denominator) Amount
---------------- ------------------ ---------------
Basic and Diluted:
Net loss $ (3,430)
Less: preferred stock dividends (1,734)
----------------
Net loss applicable to common shares $ (5,164) 528,241 $ (9.78)
================ ================== ===============
THREE MONTHS ENDED MARCH 31, 2002
Income Shares Per Share
(Numerator) (Denominator) Amount
---------------- ------------------ ---------------
Basic and Diluted:
Net income $ 1,489
Less: preferred stock dividends (1,794)
----------------
Net loss applicable to common shares $ (305) 528,241 $ (0.58)
================ ================== ===============
The calculations are based on the weighted average number of shares of common
stock outstanding during the respective periods. Common stock equivalent shares
from warrants representing 63,500 shares were excluded from the computations for
the three months ended March 31, 2003 and 2002, and common stock equivalent
shares from stock options representing 95,300 and 61,800 shares were excluded
from the computations for the three months ended March 31, 2003 and 2002,
respectively, as their effects are antidilutive.
8. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB"), issued
Statement No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 142
7
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. Upon adopting SFAS 142 on January 1, 2002, the Company
ceased amortizing goodwill. In completing the required first step of the
transitional impairment test for 2002, the Company reported that it had incurred
no impairment. Subsequent impairments, if any, will be classified as an
operating expense. In addition, SFAS 142 specifies the types of acquired
intangible assets that are required to be recognized and reported separately
from goodwill.
In August 2001, the FASB issued Statement No. 143, "Accounting for Asset
Retirement Obligations" ("SFAS 143"). SFAS 143 requires that obligations
associated with the retirement of a tangible long-lived asset be recorded as a
liability when those obligations are incurred, with the amount of the liability
initially measured at fair value. Upon initially recognizing a liability for an
asset-retirement obligation ("ARO"), an entity must capitalize the cost by
recognizing an increase in the carrying amount of the related long-lived asset.
Over time, the liability is accreted to its present value each period, and the
capitalized cost is depreciated over the useful life of the related asset. Upon
settlement of the liability, an entity either settles the obligation for its
recorded amount or incurs a gain or loss upon settlement. The Company has
adopted the provisions of SFAS 143 effective January 1, 2003. SFAS 143 did not
have an impact on the Company's financial statements.
In April 2002, the FASB issued Statement No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" ("SFAS 145"). SFAS 145 eliminates the automatic classification of
gain or loss on extinguishment of debt as an extraordinary item of income and
requires that such gain or loss be evaluated for extraordinary classification
under the criteria of Accounting Principles Board Opinion No. 30, "Reporting
Results of Operations." This Statement also requires sales-leaseback accounting
for certain lease modifications that have economic effects that are similar to
sales-leaseback transactions, and makes various other technical corrections to
existing pronouncements. This Statement became effective for the Company on
January 1, 2003. The adoption of SFAS 145 did not have an impact on the
Company's financial statements.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" ("SFAS 146"). SFAS 146 sets forth various
modifications to existing accounting guidance which prescribes the conditions
which must be met in order for costs associated with contract terminations,
facility consolidations, employee relocations and terminations to be accrued and
recorded as liabilities in financial statements. The provisions of SFAS 146, as
related to exit or disposal activities, are effective for transactions occurring
after December 31, 2002. The adoption of SFAS 146 does not have an impact on the
Company's financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure" ("SFAS 148"). SFAS 148 amends SFAS 123
providing alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. SFAS 148
also amends the disclosure requirements of SFAS 123 and requires additional
disclosures in annual and interim financial statements regarding the method of
accounting for stock-based employee compensation and the effect of the method
used in determining financial results. The Company accounts for stock-based
compensation in accordance with SFAS No. 123. Therefore, SFAS 148 does not have
an impact on the Company's financial statements.
8
In November 2002, the FASB issued Financial Accounting Standards Board
Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others, and
interpretation of FASB Statements No. 5, 57, and 107 and Rescission of FASB
Interpretations No. 34 ("FIN 45"). FIN 45 requires that, upon issuance of a
guarantee, the entity must recognize a liability for the fair value of the
obligation it assumes under that guarantee. FIN 45 requires disclosure about
each guarantee even if the likelihood of the guarantor's having to make any
payments under the guarantee is remote. The provisions for initial recognition
and measurement are effective on a prospective basis for guarantees that are
issued or modified after December 31, 2002. The adoption of the recognition
provision of FIN 45 did not have an impact on the Company's financial
statements. The disclosure provisions of FIN 45 were effective for the Company's
December 31, 2002 audited financial statements.
In January 2003, the FASB issued Financial Accounting Standards Board
Interpretation No. 46, Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51 ("FIN 46"). FIN 46 requires certain variable
interest entities to be consolidated by the primary beneficiary of the entity if
the equity investors in the entity do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FIN 46 is effective immediately for all new variable
interest entities created or acquired after January 31, 2003. For variable
interest entities created or acquired prior to February 1, 2003, the provisions
of FIN 46 must be applied for the first interim or annual period beginning after
June 15, 2003. As the Company does not currently hold any variable interest
entities, FIN 46 does not have an impact on the Company's financial statements.
9. ASSET PURCHASE AGREEMENT
On February 18, 2003, the Company entered into an asset purchase agreement (the
"Star Cigarette Asset Purchase Agreement") with Star Scientific, Inc. ("Star
Scientific"), and Star Tobacco, Inc., a wholly-owned subsidiary of Star
Scientific ("Star Tobacco" and, together with Star Scientific, "Star"). Pursuant
to the Star Cigarette Asset Purchase Agreement, the Company has agreed to
purchase substantially all of the assets of Star relating to the manufacturing,
marketing and distribution of four discount cigarette brands in the United
States (the "Star Cigarette Assets"). The purchase price for the Star Cigarette
Assets is $80 million in cash, subject to certain closing adjustments and the
assumption of certain liabilities related to the Star Cigarette Assets.
All requisite corporate approvals for this transaction have been obtained,
including the approvals of the Star Cigarette Asset Purchase Agreement by the
respective Boards of Directors of the Company and Star, by the holders of a
majority of the outstanding shares of common stock of Star Scientific and by
Star Scientific as the sole stockholder of Star Tobacco.
The transaction is expected to close in the third quarter of 2003. The closing
is subject to the Company's receipt of financing and to customary closing
conditions. Contemporaneously with the signing of the Star Cigarette Asset
Purchase Agreement, the Company placed a $2 million earnest money deposit into
escrow. In the event that, on or after July 15, 2003, the Star Cigarette Asset
Purchase Agreement is terminated by either the Company or Star and, at that
time, the Company has been unable to obtain the requisite financing for the
9
transaction and all other conditions to closing have been satisfied or are
capable of being satisfied, then such deposit will be paid to Star. In all other
events, the deposit will either be used to satisfy a portion of the purchase
price or repaid to the Company, as applicable. Although the Company is currently
in the process of seeking financing for the acquisition and a related
recapitalization of the Company, there can be no assurance that such financing
will be obtained.
Through March 31, 2003, the Company has incurred approximately $4.6 million of
direct costs relating to this acquisition. Such costs have been deferred and
will be included in the purchase price of the acquisition for financial
reporting purposes upon completion of the transaction. In the event the
transaction is not successfully completed, these costs will be expensed at that
time. These costs are included in Other current assets in the accompanying
Condensed Consolidated Balance Sheets.
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 Form 10-K for the
year ended December 31, 2002.
Kentucky & Illinois Complaints.
A trial date of June 30, 2003 has been set for Republic Tobacco's claims against
the Company on Republic's claims of defamation per se and under the Lanham Act.
Minnesota Complaint.
All of the plaintiff's claims for personal injury against the Company have been
dismissed, and the Court denied the plaintiff's motion for reconsideration.
Plaintiff has filed notice to appeal these dismissals. To date, the Court has
not set a briefing schedule.
California Infringing Products Litigation.
In addition to the judgment previously entered in Bollore, S.A. and the
Company's (the "plaintiffs' ") favor in the amount of approximately $1.7
million, the Court has ordered Downey Wholesale Inc. and Fadel El-Shahawi (the
"defendants' ") to pay plaintiffs $751,000 in attorneys' fees and expenses. Bond
on the damages judgment (but not the attorneys' fees and expenses) has been
posted and the defendants have filed their notice of appeal. Defendants' initial
brief is due on August 4, 2003.
11. PREFERRED STOCK
On July 1, 2002 the Company commenced a consent solicitation (the "Consent
Solicitation") 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. Consent by the holders of a
majority of the Company's outstanding common stock was executed on June 28,
10
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, (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
approximately $1.0 million in consent fees was paid during 2002. The Company
paid an additional $0.2 million in legal and other fees related to the Consent
Solicitation during 2002.
The Company has recorded the Preferred Stock at its current value in the
accompanying Balance Sheet. The Company's future ability to make dividend
payments in cash will depend 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 un-issued shares of Preferred Stock to make its dividend payments
through the issuance of additional shares. For the March 15, 2003 dividend
payments, the Company chose to make these payments in-kind.
Persons affiliated with the initial purchases of the Preferred Stock were also
issued warrants, with an original fair value of $0.7 million, to purchase 19,050
shares of common stock of the Company for $0.01 per share, exercisable
immediately. The original fair value of these warrants has been recorded in
equity, with a corresponding amount capitalized and included in deferred
financing costs.
12. SEGMENT INFORMATION
In accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information", the Company has two reportable segments. The smokeless
tobacco segment manufactures smokeless tobacco products that are distributed
primarily through wholesale and food distributors in the United States. The
make-your-own segment imports and distributes premium cigarette papers and
contract manufactures and distributes cigarette tobaccos and related products
primarily through wholesale distributors in the United States.
The accounting policies of the segments are the same as those of the Company.
Segment data includes a charge allocating all corporate costs to each operating
segment. Elimination and Other includes the assets of the Company not assigned
to segments and the elimination of intercompany accounts between segments. The
11
Company evaluates the performance of its segments and allocates resources to
them based on earnings before interest, taxes, depreciation, amortization,
certain non-cash charges and other income and expenses (Adjusted EBITDA).
The table below presents financial information about reported segments for the
three months ended March 31, 2003 and 2002, respectively (in thousands):
FOR THE THREE MONTHS ENDED: SMOKELESS ELIMINATIONS
MARCH 31, 2003 TOBACCO MAKE-YOUR-OWN AND OTHER TOTAL
- ------------------------------------ ----------------- ------------------------ ----------------- --------------
Net Sales $ 8,222 $ 6,027 $ - $ 14,249
Operating Income (Loss) 1,578 (2,130) - (552)
Adjusted EBITDA 2,178 (1,980) - 198
Assets 68,359 256,143 (106,160) 218,342
MARCH 31, 2002
- ------------------------------------
Net Sales $ 8,829 $ 13,123 $ - $ 21,952
Operating Income 1,939 5,545 - 7,484
Adjusted EBITDA 2,614 5,694 - 8,308
Assets 66,193 240,435 (90,736) 215,892
The table set forth below is a reconciliation of the Company's Net income (loss)
to Adjusted EBITDA for the three months ended March 31, 2003 and 2002,
respectively (in thousands):
FOR THE THREE MONTHS ENDED:
MARCH 31
-------------------------------------------
2003 2002
-------------------- -------------------
Net income (loss) $ (3,430) $ 1,489
Interest expense, net and amortization
of deferred financing fees 4,642 4,721
Income tax expense (benefit) (2,101) 912
Depreciation 125 175
Other expense 337 362
LIFO adjustment 125 374
Stock option compensation expense 50 25
Postretirement/Pension expense 450 250
-------------------- -------------------
Adjusted EBITDA $ 198 $ 8,308
==================== ===================
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 sector, and the MYO cigarette market is
comprised of the MYO premium cigarette papers sector and the MYO cigarette
tobaccos and related products sector. The Company manufactures and markets loose
12
leaf chewing tobacco and imports and distributes MYO premium cigarette papers,
and contract manufactures and markets MYO cigarette tobaccos and related
products.
RESULTS OF OPERATIONS
COMPARISON OF THREE MONTHS ENDED MARCH 31, 2003 AND 2002
Net Sales. Net sales for the three months ended March 31, 2003 were $14.2
million, a decrease of $7.7 million or 35.2% from the corresponding period of
the prior year.
Net sales of the smokeless tobacco segment for the current period decreased $0.6
million or 6.9% from the corresponding period of the prior year. This segment's
aggregate case volumes for the current period decreased by 8.5% as compared to
the prior period, due to increased discounting from other loose leaf
competitors, growth of the moist snuff value brands and discounting activity by
moist snuff manufacturers, coupled with the declining industry trend in the
loose leaf category of the smokeless tobacco segment. The impact of the
declining volume of the Company's smokeless tobacco segment was partially offset
by a price increase of approximately 5% instituted in the fourth quarter of
2002.
Net sales of the Company's MYO segment declined $7.1 million or 54.1% in
comparison to the corresponding period of the prior year. Within the MYO
segment, premium cigarette paper sales decreased $7.5 million or 74.2% from the
corresponding period of the prior year. Though anticipated to a lesser degree,
this decrease was due to reduced premium cigarette paper sales resulting from a
change in the Company's pricing strategy, which became effective January 1,
2003, from three major paper promotions each year to an "Every Day Low Price"
strategy. Thus, on a comparative basis, the sales for the first quarter 2002
incorporated the results of its Spring 2002 Paper Promotion, whereas, there was
no such paper promotion in the first quarter of 2003. As a result of this change
in pricing strategy, several of the Company's more significant customers delayed
their normal level of purchases. The Company is addressing these customers'
concerns and Management expects an increase in sales of its premium cigarette
papers in subsequent quarters during 2003 to result in annual sales of premium
cigarette papers comparable to results of the prior year. The MYO cigarette
tobaccos and related products sales increased by $0.4 million or 13.8% in
comparison to the corresponding period of the prior year, despite incurring an
out-of-stock situation with respect to its cigarette tubes line.
Gross Profit. Gross profit for the three months ended March 31, 2003 totaled
$6.5 million, a decrease of $6.7 million or 50.8% from the corresponding period
of the prior year due primarily to the decrease in premium cigarette paper
sales, as described above.
Gross profit of the smokeless tobacco segment declined 3.5% from the
corresponding period of the prior year as the result of lower aggregate case
volume. Gross margins for this segment increased to 52.7% of net sales for the
current period from 50.9% in the corresponding period of the prior year due
principally to the manufacturer's price increase.
Due to the significant sales declines of premium cigarette papers, gross profit
of the MYO segment for the current period declined $6.6 million or 74.8%, as
compared to the prior period. The gross margin of the MYO segment declined to
36.7% of net sales for the current period in comparison to 67.0% for the prior
period. This reduction in gross margin was due principally to the sales decline
13
in the higher margin MYO premium cigarette paper category, coupled with the
growth in the lower margin MYO cigarette tobacco and related products category.
Selling, General, and Administrative Expenses. Selling, general, and
administrative expenses for the three months ended March 31, 2003 were $7.1
million, an increase of $1.3 million or 22.4% compared to the corresponding
period of the prior year. As previously reported, during the second quarter of
2002, the Company undertook a review of its sales and marketing organization and
their activities. Based on this review, the Company has initiated a concentrated
effort to expand and redirect its sales efforts with increased emphasis on the
large chain convenience stores, which have significant tobacco sales and growth
opportunities. Further, as a component of this initiative, the Company's focus
is to expand its distribution of its higher margin products. This initiative has
resulted in increased personnel, sales and marketing expenses of $0.8 million
during the first quarter of 2003 in comparison to the prior year.
Interest Expense and Financing Costs. Interest expense and financing costs
declined $0.1 million or 2.1% to $4.6 million for the three months ended March
31, 2003 as compared to the corresponding period of the prior year. This
reduction was due principally to a lower average outstanding loan balance.
Other Expense. Other expense was $0.3 million for the three months ended March
31, 2003 as compared to expense of $0.4 million during the corresponding period
of the prior year.
Income Tax Benefit (Expense). Income tax benefit was $2.1 million for the three
months ended March 31, 2003 compared to an expense of $0.9 million for the
corresponding period of the prior year due to the lower operating results in
2003. The effective income tax rate for both periods was 38%.
Net Income (Loss). Due to the factors described above, the net loss for the
three months ended March 31, 2003 was $3.4 million compared to net income of
$1.5 million for the corresponding period of the prior year.
LIQUIDITY AND CAPITAL REQUIREMENTS
At March 31, 2003, working capital was $27.1 million compared to $32.3 million
at December 31, 2002. The lower working capital position was the result of a
decrease in accounts receivable coupled with increased inventories due to lower
sales, an increase in other current assets due to transaction costs relating to
the Star acquisition (see Note 9, "Asset Purchase Agreement") and an increase in
accrued expenses relating to the interest accrual on the Company's long-term
debt. The Company expects to continue to fund its seasonal working capital
requirements through its operating cash flows and, if needed, bank borrowings
under the revolving credit facility. As of March 31, 2003, the Company had
additional availability of $11.2 million under its committed $20.0 million
revolving credit facility.
On February 18, 2003, the Company entered into an asset purchase agreement to
purchase substantially all of the assets of Star relating to the manufacturing,
marketing and distribution of four discount cigarette brands in the United
States for approximately $80 million in cash. The Company intends to finance
14
this acquisition by offering debt and/or equity securities. The ability to do so
will depend, among other things, on the financial performance of the Company and
the availability of funds from debt and equity financing sources. Although the
Company believes it will be able to effect such a financing, there can be no
assurance that such a financing will be obtained. See Note 9, "Asset Purchase
Agreement" above for a discussion of the acquisition of the Star Cigarette
Assets.
The Company is currently operating under a Loan Agreement (the "Loan
Agreement"), dated December 31, 2000, with Bank One, Kentucky, N.A. as Agent and
the banks named therein. Borrowings under the Loan Agreement bear interest at
variable rates based, at the Company's option, on prime or LIBOR rates. On
December 31, 2002 the Company entered into an Amended Loan Agreement (the
"Amended Loan Agreement") with Bank One in which the previous revolving credit
facility was increased to $20 million and extended to December 31, 2003. All
terms of the original loan agreement remain in place except for the replacement
of a Fixed Charge Covenant with an Interest Coverage Covenant. The Company's
obligations under the Loan Agreement are guaranteed by its subsidiaries. As of
March 31, 2003, the interest rate on borrowings under the Amended Loan Agreement
was 3.66%.
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 the fixed rate of 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 Amended 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. At March 31, 2003, the
Company was in compliance with all provisions of the Amended Loan Agreement and
Senior Notes.
On July 29, 2002, the Company successfully completed a consent solicitation (the
"Consent Solicitation") 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
relating to the terms of the Preferred Stock. See Note 11 to the Financial
Statements for information concerning changes to the terms of the Preferred
Stock.
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 future ability to make
dividend payments in cash will depend 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 un-issued shares of Preferred Stock to make its
15
dividend payments through the issuance of additional shares. For the March 15,
2003 dividend payments, the Company chose to make these payments in-kind.
The Company is considering its options for redeeming its Preferred Stock and
refinancing its Senior Notes either in connection with the acquisition of the
Star Cigarette Assets or otherwise prior to the maturity of the Senior Notes.
The Company believes that, in general, it maintains adequate inventories based
on its historical and projected future sales activity and that it will be able
to source its inventory requirements for the foreseeable future. In the event
that growth in any area outstrips the Company's projections, the Company will
incur a temporary out-of-stock situation, which may result in a loss of sales.
This occurred during the first quarter of 2003 as the demand for cigarette tubes
exceeded available supply, resulting in lost or deferred sales of approximately
$0.3 million.
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 operations, the Company believes that its capital expenditure
requirements for 2003 will be approximately $1.3 million. For the three months
ended March 31, 2003, the Company had funded capital expenditures of $0.1
million. Currently, the Company believes that its operating cash flows, together
with its revolving credit facility and any renewal or replacement of such
facility, should be adequate to satisfy its reasonably foreseeable capital
requirements (other than the financing of the Star Cigarette Assets or the
refinancing of its Senior Notes and redemption of its Preferred Stock). The
financing of any other significant future products, business or property
acquisitions will 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, including
but not limited to those statements regarding: (i) our expectations regarding
2003 sales of premium cigarette papers; (ii) our ability to finance the
acquisition of the Star Cigarette Assets; (iii) our ability to refinance our
Senior Notes; (iv) our ability to redeem the Preferred Stock; (v) our ability to
source inventory requirements; (vi) our belief that we will be able to continue
to increase prices at a rate equal to or greater than inflation; and (vii) our
ability to satisfy our reasonably foreseeable capital requirements.
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
16
on business, financial, and other factors beyond the Company's control,
including, among others, federal, state and/or local regulations and taxes;
competitive pressures; prevailing changes in consumer preferences; consumer
acceptance of new product introductions and other marketing initiatives; market
acceptance of the Company's distribution program for Zig- Zag premium cigarette
papers; access to sufficient quantities of raw material or inventory to meet any
sudden increase in demand; disruption to historical wholesale ordering patterns;
product liability litigation; the ability or inability to raise financing for
the acquisition of the Star Cigarette Assets; 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. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
There have not been any significant changes with respect to quantitative and
qualitative disclosures about market risk as previously disclosed in the
Company's Form 10-K for the year ended December 31, 2002.
ITEM 4. CONTROLS AND PROCEDURES.
(a) We maintain disclosure controls and procedures that are designed to ensure
that information required to be disclosed in our filings under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the
periods specified in the rules and forms of the Securities and Exchange
Commission. Such information is accumulated and communicated to our management,
including our principal executive officer and principal financial officer, as
appropriate, to allow timely decisions regarding required disclosure. Our
management, including the principal executive officer and the principal
financial officer, recognizes that any set of controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives.
Within 90 days prior to the filing date of this quarterly report on Form 10-Q,
we have carried out an evaluation, under the supervision and with the
participation of our management, including our principal executive officer and
our principal financial officer, of the effectiveness of the design and
operation of our disclosure controls and procedures. Based on such evaluation,
our principal executive officer and principal financial officer concluded that
our disclosure controls and procedures are effective.
(b) There have been no significant changes in the Company's internal controls or
in other factors that could significantly affect the internal controls
subsequent to the date of their evaluation in connection with the preparation of
this quarterly report on Form 10-Q. However, the Company is in the process of
enhancing internal controls relating to its cash management activities.
17
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 Form 10-K for the
year ended December 31, 2002.
Kentucky & Illinois Complaints.
A trial date of June 30, 2003 has been set for Republic Tobacco's claims against
the Company on Republic's claims of defamation per se and under the Lanham Act.
Minnesota Complaint.
All of the plaintiff's claims for personal injury against the Company have been
dismissed, and the Court denied the plaintiff's motion for reconsideration.
Plaintiff has filed notice to appeal these dismissals. To date, the Court has
not set a briefing schedule.
California Infringing Products Litigation.
In addition to the judgment previously entered in Bollore, S.A. and the
Company's (the "plaintiffs' ") favor in the amount of approximately $1.7
million, the Court has ordered Downey Wholesale Inc. and Fadel El-Shahawi (the
"defendants' ") to pay plaintiffs $751,000 in attorneys' fees and expenses. Bond
on the damages judgment (but not the attorneys' fees and expenses) has been
posted and the defendants have filed their notice of appeal. Defendants' initial
brief is due on August 4, 2003.
18
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
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.
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 February 19, 2003, reporting under Item
5 "Other Events" and including the Asset Purchase
Agreement between Star and the Company and a copy of the
press release announcing the proposed acquisition of the
Star Cigarette Assets as Exhibits 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: May 15, 2003 /s/ Thomas F. Helms, Jr.
-------------------------------------
Thomas F. Helms, Jr.
Chief Executive Officer
/s/ David I. Brunson
-------------------------------------
David I. Brunson
Chief Financial Officer
19
CERTIFICATIONS
I, Thomas F. Helms, Jr., certify that:
1. I have reviewed this quarterly report on Form 10-Q of North
Atlantic Trading Company, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this quarterly
report;
4. The registrant's other certifying officer and I are responsible
for establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
20
6. The registrant's other certifying officer and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 15, 2003
/s/ Thomas F. Helms, Jr.
- --------------------------------------------
Name: Thomas F. Helms, Jr.
Title: Chief Executive Officer
21
CERTIFICATIONS
I, David I. Brunson, certify that:
1 I have reviewed this quarterly report on Form 10-Q of North
Atlantic Trading Company, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this quarterly
report;
4. The registrant's other certifying officer and I are responsible
for establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
22
6. The registrant's other certifying officer and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 15, 2003
/s/ David I. Brunson
- ------------------------------
Name: David I. Brunson
Title: Chief Financial Officer
23