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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended June 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For the transition period from _______________ to _______________
Commission File Number 2-30905
HMI INDUSTRIES INC.
======================================================
(Exact name of Registrant as Specified in Its Charter)
DELAWARE 36-1202810
- --------------------------------------------------------------------------------
(State or Other Jurisdiction of Incorporation (IRS Employer
or Organization) Identification No.)
Genesis Building, 6000 Lombardo Center, Suite 500, Seven Hills, Ohio 44131
- --------------------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (216) 986-8008
- --------------------------------------------------------------------------------
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 ninety (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]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding at August 1, 2003
- ------------------------------------ -----------------------------
Common stock, $1 par value per share 6,745,609
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INDEX
PART I. FINANCIAL INFORMATION.................................................................................. 3
ITEM 1. FINANCIAL STATEMENTS.................................................................................. 3
Consolidated Condensed Balance Sheets...................................................................... 3
Consolidated Condensed Statements of Operations............................................................ 4
Consolidated Condensed Statements of Cash Flow............................................................. 5
Notes to Consolidated Condensed Financial Statements (unaudited)........................................... 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS................. 11
Critical Accounting Policies............................................................................... 11
Results of Operations...................................................................................... 12
Liquidity and Capital Resources............................................................................ 15
Cautionary Statement for "Safe Harbor" Purposes Under the Private Securities Litigation Reform Act of
1995....................................................................................................... 17
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK............................................ 17
ITEM 4. CONTROLS AND PROCEDURES............................................................................... 17
(A) Evaluation of Disclosure Controls and Procedures....................................................... 17
(B) Changes in Internal Controls........................................................................... 18
PART II. OTHER INFORMATION..................................................................................... 18
ITEM 1. LEGAL PROCEEDINGS..................................................................................... 18
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS............................................................. 18
ITEM 3. DEFAULTS UPON SENIOR SECURITIES....................................................................... 18
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................................................... 18
ITEM 5. OTHER INFORMATION..................................................................................... 19
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K...................................................................... 19
(a) Index to Exhibits...................................................................................... 19
(b) Reports on Form 8-K.................................................................................... 20
SIGNATURES.................................................................................................... 20
Certifications............................................................................................. 21
Certifications............................................................................................. 22
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED CONDENSED BALANCE SHEETS
(UNAUDITED)
JUNE 30, September 30,
2003 2002
----------- -------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 776,451 $ 481,395
Trade accounts receivable (net of allowance of $224,743 and $482,118) 2,682,024 2,006,667
Inventories:
Finished goods 2,200,370 2,076,052
Work-in-progress, raw material and supplies 2,682,397 2,112,656
Deferred income taxes 1,460,812 1,476,182
Prepaid expenses 465,108 291,690
Other current assets 90,826 53,657
----------- -------------
Total current assets 10,357,988 8,498,299
----------- -------------
PROPERTY, PLANT AND EQUIPMENT, NET 3,912,985 4,310,070
----------- -------------
OTHER ASSETS:
Cost in excess of net assets of acquired businesses
(net of amortization of $-0- and $3,738,649) - 5,450,860
Deferred income taxes 2,535,124 2,550,427
Trademarks (net of amortization of $193,128 and $161,556) 387,252 375,272
Other 155,267 270,833
----------- -------------
Total other assets 3,077,643 8,647,392
----------- -------------
Total assets $17,348,616 $ 21,455,761
=========== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Line of credit $ 1,391,000 $ 1,392,000
Trade accounts payable 2,653,594 1,956,677
Income taxes payable 492,343 505,532
Accrued expenses and other liabilities 3,131,826 2,394,881
Long-term debt due within one year 67,028 301,894
----------- -------------
Total current liabilities 7,735,791 6,550,984
----------- -------------
LONG-TERM LIABILITIES:
Long-term debt (less amounts due within one year) 16,386 32,726
----------- -------------
Total long-term liabilities 16,386 32,726
----------- -------------
CONTINGENCIES: - -
STOCKHOLDERS' EQUITY:
Preferred stock, $5 par value; authorized, 300,000 shares; issued, none - -
Common stock, $1 par value; authorized, 10,000,000 shares;
issued and outstanding, 6,745,609 and 6,745,609 shares 6,745,609 6,745,609
Capital in excess of par value 8,231,311 8,231,311
Unearned compensation, net - (2,728)
Retained earnings (5,380,481) 801,459
Accumulated other comprehensive loss - (903,600)
----------- -------------
Total stockholders' equity 9,596,439 14,872,051
----------- -------------
Total liabilities and stockholders' equity $17,348,616 $ 21,455,761
=========== =============
See notes to consolidated condensed financial statements.
3
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
For the three months ended June 30, For the nine months ended June 30,
2003 2002 2003 2002
------------------------------------------------------------------------
REVENUES:
Net product sales $ 8,872,525 $ 9,306,956 $ 26,994,286 $ 29,275,300
----------- ------------ ------------ ------------
OPERATING COSTS AND EXPENSES:
Cost of products sold 5,256,145 5,444,621 16,090,735 16,415,191
Selling, general and administrative expenses 3,538,010 3,512,708 10,742,458 11,996,221
Loss on liquidation of foreign subsidiary - - 904,169 -
Interest expense 12,099 22,023 32,805 64,474
Other (income) expense, net (26,443) 61,542 (86,724) 189,737
----------- ------------ ------------ ------------
Total operating costs and expenses 8,779,811 9,040,894 27,683,443 28,665,623
----------- ------------ ------------ ------------
Income (loss) before income taxes and
cumulative effect of accounting change 92,714 266,062 (689,157) 609,677
Provision (benefit) for income taxes 18,806 108,796 41,923 278,163
----------- ------------ ------------ ------------
Income (loss) before cumulative effect of
accounting change 73,908 157,266 (731,080) 331,514
Cumulative effect of accounting change - - 5,450,860 -
----------- ------------ ------------ ------------
NET INCOME (LOSS) $ 73,908 $ 157,266 $ (6,181,940) $ 331,514
=========== ============ ============ ============
WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING:
Basic and diluted 6,745,647 6,729,860 6,743,425 6,710,756
=========== ============ ============ ============
BASIC AND DILUTED PER SHARE OF COMMON
STOCK:
Income (loss) before cumulative effect of
accounting change $ 0.01 $ 0.02 $ (0.11) $ 0.05
Cumulative effect of accounting change $ - $ - $ (0.81) $ -
----------- ------------ ------------ ------------
NET INCOME (LOSS) $ 0.01 $ 0.02 $ (0.92) $ 0.05
=========== ============ ============ ============
See notes to consolidated condensed financial statements.
4
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOW
(Unaudited)
For the nine months ended June 30,
2003 2002
----------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $(6,181,940) $ 331,514
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH
PROVIDED BY OPERATING ACTIVITIES:
Cumulative effect of accounting change 5,450,860 -
Loss on liquidation of foreign subsidiary 904,169 -
Depreciation and amortization 563,863 663,209
Provision for loss on disposal of assets - 17,000
Common/treasury shares issued, net of unearned
compensation - 41,841
Provision for losses on receivables - 27,526
Unearned compensation 2,728 -
Deferred income taxes 30,673 239,904
CHANGES IN OPERATING ASSETS AND LIABILITIES:
Increase in receivables (675,357) (564,436)
Increase in inventories (694,059) (867,215)
Increase in prepaid expenses (173,418) (151,796)
(Increase) decrease in other current assets (37,169) 307,856
Increase in accounts payable 696,917 1,419,832
Increase in accrued expenses and other liabilities 736,945 270,051
Decrease in income taxes payable (13,189) (14,003)
Other, net 71,446 (83,033)
----------- -----------
Net cash provided by operating activities 682,469 1,638,250
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (135,207) (732,204)
----------- -----------
Net cash used in investing activities (135,207) (732,204)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net repayments under credit facility (1,000) (390,000)
Payment of long term debt (251,206) (522,310)
----------- -----------
Net cash used in financing activities (252,206) (912,310)
----------- -----------
Net increase (decrease) in cash and cash equivalents 295,056 (6,264)
Cash and cash equivalents, beginning of period 481,395 6,865
----------- -----------
Cash and cash equivalents, end of period $ 776,451 $ 601
=========== ===========
See notes to consolidated condensed financial statements.
5
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
1. Summary of Significant Accounting Policies
The interim consolidated condensed financial statements included in this report
have been prepared, without audit, by HMI Industries Inc. from our consolidated
statements and those of our subsidiaries, pursuant to the rules and regulations
of the Securities and Exchange Commission. Although we believe that the
disclosures are adequate to make the information presented not misleading,
certain information and footnote disclosures, including significant accounting
policies, normally included in the annual financial statements have been
condensed or omitted pursuant to such rules and regulations.
In the opinion of our management, the unaudited financial information for the
interim periods presented reflects all adjustments (which include only normal,
recurring adjustments) necessary for a fair presentation. These consolidated
condensed financial statements and related notes should be read in conjunction
with the consolidated condensed financial statements and related notes included
in our Annual Report on Form 10-K for the fiscal year ended September 30, 2002.
Operating results for interim periods are not necessarily indicative of
operating results for an entire fiscal year.
2. Goodwill and Other Intangible Assets
Pursuant to SFAS 142 "Goodwill and Other Intangible Assets" we ceased amortizing
goodwill in the period beginning October 1, 2002. Prior to the adoption of SFAS
No. 142, we amortized goodwill on a straight-line basis over 40 years. Other
intangible assets are amortized on a straight-line basis over their useful
lives, ranging from ten to seventeen years. Goodwill amortization for the three
and nine month periods ended June 30, 2002 was $61,400 and $184,100,
respectively.
FAS 142 primarily addresses the accounting for goodwill and intangible assets
subsequent to their initial recognition. The provisions of FAS 142 prohibit the
amortization of goodwill and indefinite-lived intangible assets, require that
goodwill and indefinite-lived intangible assets be tested annually for
impairment (and in interim periods if certain events occur indicating that the
carrying value of goodwill and/or indefinite-lived intangible assets may be
impaired), require that reporting units be identified for the purpose of
assessing potential impairments of goodwill, and remove the forty-year
limitation on the amortization period of intangible assets that have finite
lives.
During the first quarter of fiscal 2003, we completed the first step of the
two-step implementation process by obtaining a valuation of HMI for comparison
to the carrying value and began the process of measuring the amount of the
impairment (step two). Although management does not believe that the market
value of common stock fairly reflects the value of HMI, because of liquidity,
control premium and small float issues, etc., the valuation experts employed by
us utilized the market value of the common stock as of October 1, 2002 but also
weighted the valuation for comparable values of peer companies, recent sales of
similar types of companies and a discounted cash flow methodology. Based on the
assumptions used in any of the last three
6
valuations and depending on the weighting used for each valuation, results of
the valuation could be significantly changed. However, we believe that the
weighting methodology used is reasonable and results in an accurate and fair
value of HMI.
During the second quarter of fiscal 2003, we completed our initial impairment
test, based upon the above valuation, for October 1, 2002 resulting in a full
impairment of the goodwill recorded on HMI's books through a non-cash charge of
$5,450,900. Such charge is non-operational in nature and is reflected as a
Cumulative Effect of Accounting Change in the accompanying Consolidated
Condensed Statements of Operations for the nine months ended June 30, 2003.
A reconciliation of the reported net (loss) income and net (loss) income per
share to the amounts adjusted for the exclusion of amortization of goodwill and
the cumulative effect of a change in accounting principle for the three and nine
months ended June 30, 2003 and 2002, respectively, had the provisions of SFAS
142 been applied on October 1, 2001, is as follows:
For the three months ended June 30, For the nine months ended June 30,
2003 2002 2003 2002
----------- ----------- -------------- -----------
Income (loss) before cumulative effect of
accounting change $ 73,908 $ 157,266 $ (731,080) $ 331,514
Cumulative effect of accounting change - - 5,450,860 -
----------- ----------- -------------- -----------
NET INCOME (LOSS) 73,908 157,266 (6,181,940) 331,514
Goodwill amortization add back, net of tax - 61,375 - 184,126
----------- ----------- -------------- -----------
ADJUSTED NET INCOME (LOSS) $ 73,908 $ 218,641 $(6,181,940) $ 515,640
=========== =========== ============== ===========
WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING:
Basic and diluted 6,745,647 6,729,860 6,743,425 6,710,756
=========== =========== ============== ===========
BASIC AND DILUTED PER SHARE OF COMMON
STOCK:
Income (loss) before cumulative effect of
accounting change $ 0.01 $ 0.02 $ (0.11) $ 0.05
Cumulative effect of accounting change $ - $ - $ (0.81) $ -
Goodwill amortization add back, net of tax $ - $ 0.01 $ - $ 0.03
=========== =========== ============== ===========
ADJUSTED NET INCOME (LOSS) $ 0.01 $ 0.03 $ (0.92) $ 0.08
=========== =========== ============== ===========
The following proforma financial information compares our (loss) income before
cumulative effect of accounting change, net (loss) income and net (loss) income
per share for the three and nine month periods ended December 31, 2002 and June
30, 2003, respectively, had the transitional goodwill impairment charge of
$5,450,900 been recorded on October 1, 2002:
Three Months Ended Nine Months Ended
December 31, 2002 June 30, 2003
--------------- -----------------
Income (loss) before cumulative effect of accounting change $ 88,920 $ (731,080)
Cumulative effect of accounting change 5,450,860 5,450,860
--------------- ---------------
ADJUSTED NET LOSS $ (5,361,940) $ (6,181,940)
=============== ===============
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING:
Basic and diluted 6,742,314 6,743,425
=============== ===============
BASIC AND DILUTED PER SHARE OF COMMON STOCK:
Income (loss) before cumulative effect of accounting change $ 0.01 $ (0.11)
Cumulative effect of accounting change $ (0.81) $ (0.81)
--------------- ---------------
ADJUSTED NET LOSS $ (0.80) $ (0.92)
=============== ===============
7
Total amortization expense for trademarks and patents was $31,600 and $30,400
for the nine months ended June 30, 2003 and 2002, respectively. Amortization
expense for trademarks and patents is estimated for the remainder of fiscal 2003
and for the next four fiscal years ending September 30, 2004 through 2007 as
$10,400, $34,400, $12,300, $11,800 and $10,000.
3. Valuation of Long-Lived Assets
As of the beginning of fiscal 2003, we adopted Statement of Financial Accounting
Standards ("FAS") No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets". The adoption of this accounting standard did not have a
material impact on our operating results and financial position. We assess
potential impairments to our long-lived and intangible assets when there is
evidence that events or changes in circumstances indicate that the carrying
amount of an asset may not be recovered. An impairment loss is recognized when
the carrying amount of the long-lived and intangible asset is not recoverable
and exceeds its fair value. The carrying amount of a long-lived and intangible
asset is not recoverable if it exceeds the sum of the undiscounted cash flows
expected to result from the use and eventual disposition of the asset. Any
required impairment loss is measured as the amount by which the carrying amount
of a long-lived and intangible asset exceeds its fair value and is recorded as a
reduction in the carrying value of the related asset and a charge to operating
results.
4. Foreign Currency Translation
During the second quarter of fiscal 2003, we recorded a write-off of $904,200
for cumulative translation adjustments associated with the liquidation of our
Canadian subsidiary.
5. Comprehensive Income/Loss
Comprehensive income/loss combines net income/loss and "other comprehensive
items," which represented foreign currency translation adjustments, reported as
a component of stockholders' equity in the accompanying Consolidated Condensed
Balance Sheets. We present such information in our Statement of Stockholders'
Equity on an annual basis and in a footnote in our quarterly reports. We had
comprehensive income of $73,900 for the quarter ended June 30, 2003 and
comprehensive losses of $6,182,500, for the nine months ended June 30, 2003. For
the three and nine months ended June 30, 2002, we had comprehensive income of
$178,500 and $348,000, respectively.
6. Guarantees
During the second quarter of fiscal 2003 we adopted Financial Accounting
Standards Board Interpretation No. 45 ("FIN 45") "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others". FIN 45 requires that a liability be recorded in the
guarantor's balance sheet upon issuance of a guarantee. In addition, FIN 45
requires disclosures about the guarantees that an entity has issued, including a
reconciliation of changes in the entity's product warranty liabilities. The
disclosure requirements are effective for financial statements for interim or
annual periods ended after December 15, 2002, while the recognition and
measurement provisions of FIN 45 are applicable on a prospective basis to
guarantees issued or modified after December 31, 2002.
8
We have guaranteed repayment to a finance company for certain events of default
by some of our Canadian distributors. The finance company purchased the
installment sales contracts that the distributors entered into with their
customers for the sale of products manufactured by HMI. We require the
participating Canadian distributors to provide us with cash reserves, which are
held as liabilities on our records, in order to provide a fund for the payments
of any defaults by the participating Canadian distributors. Our obligation to
repurchase any contracts is limited to situations in which the borrower has any
valid defense, right of set-off or counterclaim regarding the loan; the loan
does not comply with all applicable laws and regulations; or the loan is not a
binding obligation of the borrower. From the commencement of the contract in
July 2002 through June 30, 2003 we have not had to repurchase any contract under
this guarantee.
WARRANTY
Changes in our warranty liability were as follows:
Three Months Ended Nine Months Ended
----------------------- ------------------------
June 30, June 30, June 30, June 30,
2003 2002 2003 2002
---------- ---------- --------- ---------
Balance at beginning of period $ 181,200 $ 198,500 $ 190,500 $ 299,400
Charges to expense 36,300 27,100 184,800 16,300
Usage (35,500) (34,000) (193,300) (124,100)
---------- ---------- --------- ---------
Balance at end of period $ 182,000 $ 191,600 $ 182,000 $ 191,600
========== ========== ========= =========
7. Earnings Per Share
As of June 30, 2003, all 1,164,700 outstanding options were not included in the
computation of diluted EPS because the options' exercise prices were greater
than the average market price of the common shares the period and, therefore,
the effect would be anti-dilutive. The exercise prices of these options range
from $1.00 to $7.50 per share and expire between the period January 4, 2004 and
August 29, 2010.
As of June 30, 2002, 1,212,700 outstanding options were not included in the
computation of diluted EPS because the options' exercise prices were greater
than the average market price of the common shares. The exercise prices of these
options range from $1.0625 to $7.50 per share and expire between the period July
2, 2002 and August 29, 2010.
8. Long-term Compensation Plan
During the second quarter of fiscal 2003 we adopted the Financial Accounting
Standards Board Statement of Financial Accounting Standard ("SFAS") No. 148
"Accounting for Stock-Based Compensation-Transition and Disclosure," which
provides alternative methods of accounting for stock-based compensation and
amends SFAS No. 123 "Accounting for Stock-Based Compensation." We record
stock-based compensation expense using the intrinsic value method on the date of
grant in accordance with Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees," and its related interpretations. Because we
establish the exercise price based on the fair market value of our stock at the
date of grant, the options have no intrinsic value upon grant, and therefore no
expense is recorded. Each quarter, we report the potential dilutive impact of
stock options in our diluted earnings per share. As
9
allowed by SFAS 148, we have elected to continue to apply the intrinsic
value-based method of accounting and have adopted the disclosure requirements of
SFAS 123. If we had measured compensation cost for stock options granted under
the fair value based method prescribed by SFAS 123, net income would have
changed to the pro forma amounts set forth below:
For the three months ended June 30, For the nine months ended June 30,
2003 2002 2003 2002
-------------- ----------- --------------- ----------------
Net income (loss), as reported $ 73,908 $ 157,266 $ (6,181,940) $ 331,514
Add: Stock-based employee
compensation expense included in
reported net income, net of related tax
effects - - - -
----------- ----------- ------------ ----------------
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards, net
of related tax effects 23,309 23,217 69,834 69,487
----------- ----------- ------------ ----------------
PRO FORMA NET INCOME (LOSS) $ 50,599 $ 134,049 $ (6,251,774) $ 262,027
=========== =========== ============ ================
BASIC AND DILUTED PER SHARE OF COMMON
STOCK:
As reported $ 0.01 $ 0.02 $ (0.92) $ 0.05
Proforma $ 0.01 $ 0.02 $ (0.93) $ 0.04
9. Debt
In January 2003 we entered into an amendment to our credit facility agreement
with our current lender. This amendment, which expires January 31, 2004,
increased our revolving line of credit from $2 million to $3 million, and
carries the same interest rate and similar covenants as the original loan
agreement.
There were no covenant violations under the credit facility agreement as of or
for the three and nine month periods ended June 30, 2003.
10. Commitments and Contingencies
CONET Industries, Inc., Royal Queen Club International Limited, Chang-whan Chang
and Young-so Song ("Plaintiffs") filed a complaint against HMI on or about
February 18, 2001 in the Seoul, Korea District Court. It was served by
Registered Mail upon HMI at our corporate offices in Seven Hills, Ohio on or
around April 10, 2002. The complaint was filed as a result of lawsuits by us
against Mr. Song, a former HMI Distributor in Korea, and Royal Queen Club
concerning Mr. Song's CYVAC product. In our lawsuits, we sought and were granted
preliminary injunctions against Plaintiffs that prohibited Plaintiffs from
manufacturing and selling the old model CYVAC for 311 days and the new model
CYVAC for 209 days, until the Seoul High Court issued a declaration of
suspension of the injunctions. Despite the fact that Plaintiffs had been
enjoined by the Courts, Plaintiffs allege that we should compensate them for
actual damages for sale discontinuance, supplemental managerial costs and new
mold fabrication costs due to the interruption in the manufacturing and
marketing of each product during that period. Plaintiffs also claim that we
tortuously interfered with Plaintiffs' business advantages, caused irreparable
harm to Plaintiffs' normal business activities and damaged Plaintiffs'
reputation and standing. Chang-whan Chang and Young-so Song allege that they
have been critically damaged personally due to the accusations, improper
provisional seizure and criminal allegations alleged by us, which they assert
resulted in disturbance to business, reputation and credit. All matters are
10
pending. The Plaintiffs allege damages in excess of U.S. $21,894,000. After
several hearings the court ruled in our favor and against the Plaintiffs on all
counts. The Plaintiffs may seek to appeal the decision in accordance with Korean
law.
Claims arising in the ordinary course of business are also pending against us.
Although these are in various stages of the litigation process, we believe that
none of these matters will have a material adverse effect on our consolidated
financial position, results of operations or cash flows.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of operations
are based upon the consolidated condensed financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these consolidated condensed
financial statements required us to make estimates and judgments that affect the
reported amount of assets and liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities at the date of the consolidated
condensed financial statements. Actual results may differ from those estimated
under different assumptions or conditions.
Critical accounting policies are defined as those that are reflective of
significant judgment and uncertainties, and potentially may result in materially
different outcomes under different assumptions and conditions. For a more
complete description of our critical accounting policies please refer to our
Annual Report on Form 10-K for the fiscal year ended September 30, 2002. The
following policies reflect changes and/or updates to the detailed descriptions
included in the aforementioned Form 10-K.
Goodwill and Other Intangible Assets
Pursuant to FAS 142 "Goodwill and Other Intangible Assets" we ceased amortizing
goodwill in the period beginning October 1, 2002. Prior to the adoption of SFAS
No. 142, we amortized goodwill on a straight-line basis over 40 years. Other
intangible assets are amortized on a straight-line basis over their useful
lives, ranging from ten to seventeen years.
FAS 142 primarily addresses the accounting for goodwill and intangible assets
subsequent to their initial recognition. The provisions of FAS 142 prohibit the
amortization of goodwill and indefinite-lived intangible assets, require that
goodwill and indefinite-lived intangible assets be tested annually for
impairment (and in interim periods if certain events occur indicating that the
carrying value of goodwill and/or indefinite-lived intangible assets may be
impaired), require that reporting units be identified for the purpose of
assessing potential impairments of goodwill, and remove the forty-year
limitation on the amortization period of intangible assets that have finite
lives.
During the first quarter of fiscal 2003, we completed the first step of the
two-step implementation process by obtaining a valuation of HMI for comparison
to the carrying value and began the
11
process of measuring the amount of the impairment (step two). Although
management does not believe that the market value of common stock fairly
reflects the value of HMI, because of liquidity, control premium and small float
issues, etc., the valuation experts employed by us utilized the market value of
the common stock as of October 1, 2002 but also weighted the valuation for
comparable values of peer companies, recent sales of similar types of companies
and a discounted cash flow methodology. Based on the assumptions used in any of
the last three valuations referred to above and depending on the weighting used
for each valuation, results of the valuation could be significantly changed.
However, we believe that the weighting methodology used is reasonable and
results in an accurate and fair value of HMI.
During the second quarter of fiscal 2003, we completed our initial impairment
test, based upon the above valuation, for October 1, 2002 resulting in a full
impairment of the goodwill recorded on HMI's books through a non-cash charge of
$5,450,900. Such charge is non-operational in nature and is reflected as a
Cumulative Effect of Accounting Change in the accompanying Consolidated
Condensed Statements of Operations.
Valuation of Long-Lived Assets
As of the beginning of fiscal 2003, we adopted Statement of Financial Accounting
Standards ("FAS") No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets". The adoption of this accounting standard did not have a
material impact on our operating results and financial position. We assess
potential impairments to our long-lived and intangible assets when there is
evidence that events or changes in circumstances indicate that the carrying
amount of an asset may not be recovered. An impairment loss is recognized when
the carrying amount of the long-lived or intangible asset is not recoverable and
exceeds its fair value. The carrying amount of a long-lived or intangible asset
is not recoverable if it exceeds the sum of the undiscounted cash flows expected
to result from the use and eventual disposition of the asset. Any required
impairment loss is measured as the amount by which the carrying amount of a
long-lived and intangible asset exceeds its fair value and is recorded as a
reduction in the carrying value of the related asset and a charge to operating
results.
RESULTS OF OPERATIONS
Net Product Sales
THIRD QUARTER OF FISCAL 2003 COMPARED TO THIRD QUARTER OF FISCAL 2002
Net product sales of $8,872,500 for the quarter ended June 30, 2003, were
$434,500 or 4.7% lower when compared to the prior year sales of $9,307,000. The
decrease in sales was largely attributable to reduced sales in Asia and the
cessation of the Americas National Advertising Campaign ("NAC"), offset by
$578,000 in increased revenues in Europe and the Americas distributor network.
The sales decline in Asia was primarily due to lower sales to Japan, Korea and
New Zealand of which Japan was the largest. The reduced sales to Japan reflect
continued realignments this importer has made to his inventory levels in
anticipation of the upcoming launch of our 75th Anniversary Majestic(R) (our
portable surface cleaner), which is planned to occur in Japan in mid-August. The
reduced sales to Japan also reflect Defender(R) (our portable room air cleaner)
sales that were made in the prior year with the intent of selling them with the
Majestic(R) as a system similar to how our products are marketed in the U.S.;
however, this program was not as successful as anticipated and as a result
Defender(R) sales will
12
be less than the prior year while the importer sells through his inventory. We
are currently reviewing different alternatives to promote our products in Japan.
The NAC, a thirty-minute television infomercial which began airing in July 2001,
was designed to increase brand awareness, generate sales leads and open new
territories. In August 2002, we stopped broadcasting the infomercial as
anticipated profits for this program were not being achieved and the infomercial
had exceeded the industry standard expected life cycle of twelve months.
Exclusive of the third quarter 2002 NAC sales of $197,500, revenues would have
decreased $237,500.
European sales were driven by increased Defender(R) sales primarily to Portugal
and Spain and were largely associated with the recent launch of the Edge Success
Program ("the Edge") in both countries. The Edge, first created for the Americas
direct sales distribution network, is a multi-step program that provides
business training from the earliest level of a new recruit to the most senior
level of premier master distributor and provides incentives at each level to
promote the development and retention of quality distributors and sales
associates. The improved Defender(R) sales were reduced by decreased Majestic(R)
sales to Portugal and Spain. A foundational element of the Edge Program is the
marketing of the Majestic(R) and the Defender(R) together as an "indoor air
quality system." It is therefore anticipated that going forward the focus will
be on the "system" rather than just the Majestic(R).
The increased sales in the Americas exclusive of NAC sales was due to the growth
of the direct sales network primarily resulting from several of our key master
distributors who have grown their business through effective recruiting,
retention and the opening of new offices.
FIRST NINE MONTHS OF FISCAL 2003 COMPARED TO FIRST NINE MONTHS OF FISCAL 2002
Net product sales of $26,994,300 for the nine months ended June 30, 2003, were
$2,281,000 or 7.8% lower when compared to the prior year sales of $29,275,300.
The decrease in sales was largely attributable to reduced sales in Asia, the NAC
and Europe offset by increased revenues in the Americas distributor network of
$2,386,100; with the exception of Europe the rationale for these fluctuations is
consistent with the above discussion.
The decreased sales to Europe were driven by lower Majestic(R) sales largely
associated with Spain and Portugal, which were impacted in the second quarter by
these importers selling through their old model units in anticipation of the
introduction of the 75th Anniversary models in these countries. The introduction
of the 75th Anniversary model occurred in these and several other European
countries during the second quarter of fiscal 2003.
Gross Profit
THIRD QUARTER OF FISCAL 2003 COMPARED TO THIRD QUARTER OF FISCAL 2002
The gross margin for the quarter ended June 30, 2003, was $3,616,400 or 40.8% of
sales as compared to $3,862,300 or 41.5% of sales in 2002, a decrease in gross
margin of $245,900. The cessation of the aforementioned NAC resulted in
approximately $172,100 of the decrease. The remaining $73,900 was largely
attributable to the decreased international sales volume.
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FIRST NINE MONTHS OF FISCAL 2003 COMPARED TO FIRST NINE MONTHS OF FISCAL 2002
The gross margin of $10,903,600 for the nine months ended June 30, 2003, was
$1,965,500 or 15.2% lower when compared to the prior year gross margin of
$12,860,100. Approximately $1,192,000 of the decrease in gross margin was
associated with the cessation of the NAC. Unfavorable volume variance due to
lower international sales, overhead absorption, warranty costs and depreciation
comprised the remaining difference of which the unfavorable international sales
volume variance was the largest.
Selling, General, and Administrative ("SG&A")
THIRD QUARTER OF FISCAL 2003 COMPARED TO THIRD QUARTER OF FISCAL 2002
SG&A expenses of $3,538,000 for the quarter ended June 30, 2003, were $25,300
higher when compared to the same period in fiscal 2002 of $3,512,700. While this
variance is not considered significant, it should be noted that increased costs
associated with certain growth initiatives in the Americas division were offset
by expenses incurred in the prior year associated with our aforementioned
National Advertising Campaign and the Americas' launch of our 75th Anniversary
Majestic(R).
FIRST NINE MONTHS OF FISCAL 2003 COMPARED TO FIRST NINE MONTHS OF FISCAL 2002
SG&A expenses of $10,742,500 or 39.8% of sales for the nine months ended June
30, 2003, were $1,253,700 lower when compared to the same period in fiscal 2002
of $11,996,200 or 41.0% of sales. The reduced level of expense was driven by the
absence of advertising and administrative costs associated with our
aforementioned NAC of approximately $2,206,900, costs associated with the Form
13D that was filed with the Securities and Exchange Commission in the prior year
of $425,400 and reduced outside consulting expenses of $235,000. These decreases
were partially offset by increased costs associated with certain growth
initiatives in the Americas division.
Liquidation of Foreign Subsidiary
During the second quarter of fiscal 2003, after reviewing possible future
options for our Canadian subsidiary, we chose to liquidate the entity and
therefore recorded a loss on disposal of $904,200 for cumulative translation
adjustments associated with this subsidiary.
Interest Expense
Interest expense was $12,100 and $32,800 for the quarter and nine months ended
June 30, 2003, respectively, and was $22,000 and $64,500 for the same periods in
2002. The decreased expense was primarily due to interest paid in the prior year
to vendors associated with the short term financing of certain tools and molds
as well as an overall reduced line of credit balance on a year-to-date basis.
Other (income) expense, net
For the quarter and nine months ended June 30, 2003, other (income) expense,
net, decreased $88,000 and $276,500, respectively, primarily resulting from the
absence of goodwill amortization associated with the adoption of SFAS No. 142
(see Note 2 to the Consolidated Condensed Financial Statements).
14
Income Taxes
The effective tax rate for the quarter ended June 30, 2003 was 20.3% compared to
an effective rate of 40.9% for the same period in fiscal 2002. The current
quarter's effective rate is below the federal statutory rate of 34% primarily
due to favorable tax benefits from foreign export sales. The change in the
effective rate from the same period in the prior fiscal year is primarily due to
the absence of non-deductible goodwill in this quarter. The impact of the
favorable tax treatment of export sales in the current year as well as the
goodwill amortization in the prior year has been magnified by the low level of
pre-tax earnings.
The effective income tax rate for the nine months ended June 30, 2003 was (6.0%)
compared to 45.6% in fiscal 2002. This difference was primarily attributable to
the aforementioned goodwill and foreign export tax benefits as well as the
non-deductible loss from the second quarter liquidation of our Canadian
subsidiary.
Cumulative Effect of Accounting Change
On October 1, 2002, we adopted SFAS 142. Under SFAS 142, goodwill impairment is
deemed to exist if the net book value of a reporting unit exceeds its estimated
fair value. During the second quarter of fiscal 2003, we completed our initial
impairment test as of October 1, 2002 and recorded a non-cash charge of
$5,450,900 to fully eliminate the carrying value of our goodwill (See Note 2 to
the Consolidated Condensed Financial Statements). There was no tax effect
related to this item as this charge is a permanent difference for income tax
purposes.
Inflation and Pricing
Net product sales and income from continuing operations were not materially
impacted by inflation or changing prices.
LIQUIDITY AND CAPITAL RESOURCES
Operating Activities
Cash flows from operating activities provided net cash of $682,500 for the nine
months ended June 30, 2003, which reflects a net loss of $6,181,900 offset by
non-cash charges of $6,952,300 and a decrease in operating assets and
liabilities of $87,900.
Non-cash charges consist primarily of $5,450,900 related to the cumulative
effect of accounting change from our adoption of SFAS 142, $904,200 associated
with the loss on the liquidation of our Canadian Subsidiary and $563,900 in
depreciation and amortization expense.
The decrease in operating assets and liabilities principally relates to
increases in accounts receivables and inventories of $675,400 and $694,100,
respectively, offset by increases in payable and accrued expenses and other
liabilities of $696,900 and $736,900, respectively.
The increase in the receivables balance is largely attributable to sales volume
increases related to several international customers, primarily in Europe, who
all receive credit terms to assist with the time delay in shipping products
overseas. The introduction of the 75th Anniversary models as well as the launch
of the Edge Success Program, in the second quarter of fiscal 2003, have led to
increased sales volume for these customers.
15
Lower Asian sales as well as the build up of raw materials for the international
release of our 75th Anniversary Majestic(R), and the purchase of printed
materials for the International promotion of our Edge Success Program lead to
increased inventories.
During the last two months of our fiscal year 2002 we re-adjusted our raw
material stock levels which led to a significant reduction, as of our year-end,
in both inventory purchases and accounts payable. As the sales volume rose in
fiscal 2003, primarily in the Americas Division, we returned to more
characteristic purchasing levels thus increasing our overall payable balance for
the nine months ended June 30, 2003. Also impacting the payable balance were
corporate insurance costs and expenses associated with the Americas Division
yearly sales convention.
The increase in accrued expenses and other liabilities primarily related to the
Americas Division Distributor programs and variable selling compensation
expenses which increased as a result of the continued Americas revenue growth in
fiscal 2003.
Investing Activities
Capital expenditures of $135,200 represent the entire net cash used in investing
activities for the nine months ended June 30, 2003. These expenditures mainly
relate to tooling associated with new products, office furniture and new office
computer hardware.
Financing Activities
Net cash used in financing activities was $252,200, which included $251,200 for
payment of long-term debt and $1,000 for net repayments under the credit
facility.
Current working capital, together with anticipated cash flows generated from
future operations and our existing credit facility are believed to be adequate
to cover our anticipated cash requirements, including but not limited to capital
expenditures and expenses associated with our research and development and sales
projects. As of June 30, 2003, there was $1,391,000 outstanding on our
$3,000,000 amended credit facility.
Cash Obligations
There have been no material changes outside the ordinary course of our business
with regards to cash obligations that have not been previously disclosed in our
fiscal 2002 Annual Report on Form 10-K.
FUTURE ACCOUNTING REQUIREMENTS
Financial Accounting Standards Board (FASB) Interpretation No. 46 (FIN 46),
"Consolidation of Variable Interest Entities," was issued in January 2003. 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. The provisions of FIN 46 are
effective immediately for all arrangements entered into after January 31, 2003.
For those arrangements entered into prior to January 31, 2003, we are required
to adopt the provisions of FIN 46 at the beginning of the fourth
16
quarter of fiscal 2003. The adoption of FIN 46 is not expected to have a
significant effect, if any, on our financial position, results of operation, or
cash flows.
In May 2003 the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity". SFAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. SFAS
No. 150 applies specifically to a number of financial instruments that companies
have historically presented within their financial statements either as equity
or between the liabilities section and the equity section, rather than as
liabilities. SFAS No. 150 is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003. The adoption of SFAS No. 150
is not expected to have a significant effect, if any, on our financial position,
results of operations, or cash flows.
CAUTIONARY STATEMENT FOR "SAFE HARBOR" PURPOSES UNDER THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995
This report, including Management's Discussion and Analysis of Financial
Condition and Results of Operations contains forward-looking statements within
the meaning of the Federal securities laws. As a general matter, forward-looking
statements are those focused upon future plans, objectives or performance as
opposed to historical items and include statements of anticipated events or
trends and expectations and beliefs relating to matters not historical in
nature, including by way of example, but not limited to, the statements made in
"Net Product Sales" regarding the optimism of the 75th Anniversary model and the
Edge Success Program's impact on International sales, and "Liquidity" regarding
anticipated cash requirements and the adequacy of our current ability to meet
those requirements. Such forward-looking statements are subject to uncertainties
such as anticipated sales trends, improved lead generation and recruiting and
the ability to obtain financing for the end consumer through consumer financing
companies. Such uncertainties are difficult to predict and could cause our
actual results of operation to differ materially from those matters expressed or
implied by such forward-looking statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to interest rate risk is related to our borrowings. Fixed rate
borrowings may have their fair market value adversely impacted from changes in
interest rates. Variable rate borrowings will lead to additional interest
expense if interest rates increase. As of June 30, 2003, we had $1,391,000
outstanding under our credit facility bearing interest at the prime rate. If
interest rates were to increase 50 basis points (0.5%) from the June 30, 2003
rates and assuming no changes in outstanding debt levels from June 30, 2003
levels, we would realize an increase in our annual interest expense of
approximately $7,000.
ITEM 4. CONTROLS AND PROCEDURES
(A) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
We evaluated the design and operation of our disclosure controls and procedures
to determine whether they are effective in ensuring that the disclosure of
required information is timely and made in accordance with the Exchange Act and
the rules and forms of the Securities and Exchange Commission. This evaluation
was made under the supervision and with the
17
participation of management, including our chief executive officer and chief
financial officer within the 90-day period prior to the filing of this Form
10-Q. The chief executive officer and chief financial officer have concluded,
based on their review, that our disclosure controls and procedures, as defined
at Exchange Act Rules 13a-14(c) and 15d-14(c), are effective to ensure that
information required to be disclosed by us in reports that we file under the
Exchange Act is recorded, processed, summarized and reported accurately and
within the time periods specified in Securities and Exchange Commission rules
and forms.
(B) CHANGES IN INTERNAL CONTROLS
No significant changes were made to our internal controls or other factors that
could significantly affect these controls subsequent to the date of their
evaluation referenced in paragraph (A) above.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
CONET Industries, Inc., Royal Queen Club International Limited, Chang-whan Chang
and Young-so Song ("Plaintiffs") filed a complaint against HMI on or about
February 18, 2001 in the Seoul, Korea District Court. It was served by
Registered Mail upon HMI at our corporate offices in Seven Hills, Ohio on or
around April 10, 2002. The complaint was filed as a result of lawsuits by us
against Mr. Song, a former HMI Distributor in Korea, and Royal Queen Club
concerning Mr. Song's CYVAC product. In our lawsuits, we sought and were granted
preliminary injunctions against Plaintiffs that prohibited Plaintiffs from
manufacturing and selling the old model CYVAC for 311 days and the new model
CYVAC for 209 days, until the Seoul High Court issued a declaration of
suspension of the injunctions. Despite the fact that Plaintiffs had been
enjoined by the Courts, Plaintiffs allege that we should compensate them for
actual damages for sale discontinuance, supplemental managerial costs and new
mold fabrication costs due to the interruption in the manufacturing and
marketing of each product during that period. Plaintiffs also claim that we
tortuously interfered with Plaintiffs' business advantages, caused irreparable
harm to Plaintiffs' normal business activities and damaged Plaintiffs'
reputation and standing. Chang-whan Chang and Young-so Song allege that they
have been critically damaged personally due to the accusations, improper
provisional seizure and criminal allegations alleged by us, which they assert
resulted in disturbance to business, reputation and credit. All matters are
pending. The Plaintiffs allege damages in excess of U.S. $21,894,000. After
several hearings the court ruled in our favor and against the Plaintiffs on all
counts. The Plaintiffs may seek to appeal the decision in accordance with Korean
law.
Claims arising in the ordinary course of business are also pending against us.
Although these are in various stages of the litigation process, we believe that
none of these matters will have a material adverse effect on our consolidated
financial position, results of operations or cash flows.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our Annual Meeting of Shareholders was held on May 22, 2003. The only proposal
considered was the election of directors. Each nominee received the following
votes:
18
FOR WITHHELD
--------- --------
Robert Breadner 4,290,728 -
Thomas Davidson 4,290,728 -
Kirk Foley 4,287,726 3,002
Eric Foley 4,287,676 3,052
James Malone 4,290,728 -
John Pryor 4,290,728 -
Murray Walker 4,290,728 -
Ivan Winfield 4,290,728 -
All of the foregoing nominees were elected. There were no broker non-votes.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) INDEX TO EXHIBITS
3.1 Certificate of Incorporation Incorporated by reference from Annual Report on
form 10-K for the year ended September 30, 1995
3.2 Bylaws Article III, Section 2(a) amended as of April 7,
2003, attached.
10.00 Material Contract Amendment to U.S. Bank N.A. Loan Agreement
and Note, incorporated by reference from Form 10-
Q for the quarter ended December 31, 2002.
31.1 Rule 13a-14(a)/15d-14(a) Certification Pursuant to 15 U.S.C. Section 7241
Certification for James R. Malone, attached
31.2 Rule 13a-14(a)/15d-14(a) Certification Pursuant to 15 U.S.C. Section 7241
Certification for Julie A. McGraw, attached
32.1 Section 1350 Certification Certification for James R. Malone Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
(18 U.S.C. Section 1350), attached
32.2 Section 1350 Certification Certification for Julie A. McGraw Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
(18 U.S.C. Section 1350), attached
19
(b) REPORTS ON FORM 8-K
No report on Form 8-K was filed during the quarter ended June 30, 2003.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HMI Industries Inc.
------------------
(Registrant)
Date: August 7, 2003 /s/ Julie A. McGraw
------------------------------------
Julie A. McGraw
Vice President - Chief Financial
Officer
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