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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Fiscal Year Ended September 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission File Number 2-30905
HMI INDUSTRIES INC.
(Exact name of registrant as specified in its charter)
DELAWARE 36-1202810
- -------------------------------- -----------------------------------
State or other jurisdiction of (IRS Employer Identification No.)
Incorporation or organization)
13325 Darice Parkway, Unit A, Strongsville, Ohio 44149
- ---------------------------------------------------- -----------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (440) 846-7800
Securities registered pursuant to Section 12(b) of the Act: None
- ----------------------------------------------------------------
Securities registered pursuant to Section 12(g) of the Act:
Title of class
--------------
Common Stock, $1 par value per share
Indicate by check mark whether 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, and (2) has been subject to such filing requirements
for the past ninety (90) days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12B-2 of the Exchange Act). Yes [ ] No [X]
The aggregate market value of voting and non-voting common equity held by
non-affiliates of the registrant, computed by reference to the average bid and
asked price in the Pink Sheets, as of March 31, 2004 was $1,485,386.
The number of shares outstanding of the registrant's common stock was 6,745,609
as of November 30, 2004.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Definitive Proxy Statement to be filed with the
Commission pursuant to Regulation 14A in connection with the registrant's 2005
Annual Meeting of Stockholders, to be filed subsequent to the date hereof, are
incorporated by reference into Part III of this Report. Such Definitive Proxy
Statement will be filed with the Securities and Exchange Commission not later
than 120 days after the conclusion of the registrant's fiscal year ended
September 30, 2004.
Index to Exhibits is found on page 28. This report consists of 57 pages.
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1
TABLE OF CONTENTS
PART I.............................................................................................. 2
ITEM 1. BUSINESS................................................................................. 2
ITEM 2. PROPERTIES............................................................................... 9
ITEM 3. LEGAL PROCEEDINGS........................................................................ 9
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...................................... 10
PART II............................................................................................. 10
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES................................................................... 10
ITEM 6. SELECTED FINANCIAL DATA.................................................................. 13
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (DOLLARS IN THOUSANDS)....... 25
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.............................................. 25
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE..... 25
ITEM 9A. CONTROLS AND PROCEDURES................................................................. 25
ITEM 9B. OTHER................................................................................... 26
PART III............................................................................................ 26
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT.......................................... 26
ITEM 11. EXECUTIVE COMPENSATION.................................................................. 26
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.......................... 26
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.......................................... 26
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.................................................. 26
PART IV............................................................................................. 27
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K......................... 27
SIGNATURES.......................................................................................... 30
1
PART I
(DOLLARS IN THOUSANDS)
ITEM 1. BUSINESS
In this document, the words "HMI," "the Company," "we," "our," "ours," and "us"
or any derivation thereof, refer only to HMI Industries Inc., and its direct or
indirect subsidiaries and not any other person or entity.
GENERAL DEVELOPMENT OF THE BUSINESS
We are a manufacturer of high quality indoor air filtration systems whose
products are sold exclusively through a worldwide direct sales channel. We
provide our direct sellers an opportunity, through our quality products and
educational programs, to achieve their individual objectives. Our products, a
high filtration portable surface cleaner and portable room air cleaner are sold
under the trade names Filter Queen(R), Princess(R), Majestic(R), Empress(R), and
Defender(R) (portable room air cleaner only).
Although we were known as Health-Mor Inc. until 1995, when our name was changed
to HMI Industries Inc., we continue to distribute our products under the
Health-Mor brand name. HMI was reorganized in 1968 in Delaware, succeeding an
Illinois corporation formed originally in 1928.
Over the last five years we continued to streamline processes and lower costs
while creating new sales programs to position ourselves for future growth
opportunities. Examples include but are not limited to:
- Creation of a U.S. program to aid in the retention of Distributors
and help with the development of their professional careers and
independent businesses (see U.S. MARKET below for additional
information).
- Creation and continued development of Health-Mor at Home(TM), a
direct to consumer outbound sales force designed to assist consumers
in locations where Distributors are no longer located.
- Fully automated our assembly and distribution by moving all
production areas to a new and more efficient facility in
Strongsville, Ohio.
- Obtaining approval for our manufacturing facility as both a Medical
Class II facility by the Food and Drug Administration ("FDA") and as
a Foreign Trade Zone. The Foreign Trade Zone status provides dollar
saving benefits on such things as duty exemption on re-exports, duty
elimination on waste and scrap, no duty on rejected or defective
parts, duty deferral, no duty on domestic content or value added and
relief from local taxes.
- Implementation, in fiscal 2003, of our proven U.S. Edge Success
Sales Program into the international markets.
- Continued development of our After-Market-Sales (AMS) program and
improved lead generations for our network as in accordance with the
Federal "Do Not Call" legislation. See the U.S. MARKETS, MARKETS
OUTSIDE THE U.S., and MARKETING AND ADVERTISING sections below for
additional information.
2
- Formation, in the third quarter of fiscal 2004 of a wholly-owned
subsidiary called AdvantEdge Credit Management Services Inc.
("ACMS"), which is a brokerage service provider for sourcing
consumer credit to assist its clients, our Americas distribution
network, in securing third party financing for end consumers who
purchase products manufactured by HMI.
- Reduction of overhead costs by relocating our sales and
administrative personnel from the Seven Hills, Ohio location to the
Strongsville, Ohio manufacturing facility.
GOING CONCERN
The accompanying financial statements have been prepared in conformity with
generally accepted accounting principles which contemplate continuation of the
Company as a going concern. During the year ended September 30, 2004, we
incurred a net loss of $3,492, had deficit equity of $12,247 at September 30,
2004, and as of the date of the audit opinion did not have an executed long-term
financing agreement. As a result of these factors, our accounting firm has
issued an audit report with a modification expressing substantial doubt about
our ability to continue as a going concern. The financial statements and
financial information presented do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or amounts and
classification of liabilities that might be necessary should we be unable to
continue in existence.
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
Our operations consist of a single operating segment. See Note 1 of the Notes to
the Consolidated Financial Statements for further information.
NARRATIVE DESCRIPTION OF BUSINESS
Products and Distribution
We regard ourselves as a leader in the management of indoor air quality by
offering a complete solution that keeps indoor air cleaner and safer to breathe.
Our principal products include a high filtration portable surface cleaner that
is marketed as a healthier alternative to the typical vacuum cleaner and a
portable room air cleaner that helps to remove particles, gases and odors from
the air. The two products are sold together as a complete Filter Queen Indoor
Air Quality System(TM) throughout the world.
To improve indoor air quality in a consumers' home our Filter Queen(R) products
use a patented multi-filtration system consisting of our Cellupure(R),
MEDIPure(R), and Enviropure(R) filter cones and cartridges. The Filter Queen
Indoor Air Quality System(TM) is designed and proven to reduce airborne
particles and allergens such as dust, smoke, pollen, mold spores, animal dander,
dust mites, and harmful fibers that may lead to allergic reactions. Independent
tests confirm that the Filter Queen Indoor Air Quality System(TM), when used
with our named filters and cartridges, removes 99.98% of particles at .01
micron, which is better than HEPA (high efficiency particulate arrestance
technologies), the industry standard.
WARRANTY. We believe that we offer a superior warranty in the U.S. for our high
filtration portable surface cleaner than all other U.S. manufacturers and
sellers of vacuum cleaners. We warrant our surface cleaner for a two-year period
from the date of purchase and offer a lifetime service benefit for the
replacement of the surface cleaner's motor at a price not to exceed $99 USD (not
in thousands).
3
We also support a five-year optional extended warranty on the portable surface
cleaner offered by our U.S. Distributors to the end consumer as a sales
promotion during an in-home product demonstration. As an enticement to the end
consumer to buy our product during that demonstration, the five year optional
extended warranty is offered to them at no cost; accordingly no revenue for this
optional warranty is recognized by HMI. Our warranty reserve is recorded to
provide for the above extended warranties. We do not allocate a portion of the
product revenue to the extended warranty as there is no objective and reliable
evidence associated with the fair value of the warranty, as we are not in the
business of separately selling extended warranties on our products. In addition,
a general right of return relative to the delivered product does not exist.
Outside the U.S. we offer a two-year warranty for our high filtration portable
surface cleaner. The portable room air cleaner is warranted for renewable
one-year periods if the main air filter is replaced annually. A five-year
warranty is offered for our built-in vacuum system.
DISTRIBUTION NETWORK. Our distribution system consists of approximately 300
independent authorized Distributors and Importers who sell our products. These
Distributors and Importers sell our products in 25 countries worldwide.
Each Distributor and Importer has a defined territory in which it maintains the
exclusive right to sell our products. Each Distributor and Importer sells the
products to consumers through an in-home presentation given by a sales associate
who, in some parts of the world, has been trained and certified by independent
HMI trainers as an "Indoor Air Quality Specialist." Distributors are granted the
right to market our products using the demonstration method and utilizing our
trademarks. These same Distributors and Importers are responsible for providing
service and replacement parts and supplies to the end consumers in their
territories, which provides them with another source of revenue and potential
referral network.
U.S. MARKET. In the United States, we primarily sell our high filtration
portable surface cleaner and portable room air cleaner through Distributors who
sell our products to end consumers through sales associates.
To aid in the retention of Distributors and help with the development of their
professional careers and independent businesses, we developed an award winning
unique training and development program called "The Edge Success Program" or
"Distributor Development Program" (the "Edge" or "Program"). The Edge is an
innovative, highly structured multi-step program that provides business training
for all people in our distribution network, from the earliest level of a new
recruit to the most senior level, a Premier Master Distributor. The program
provides incentives at each level to promote the development and retention of
quality Distributors and sales associates. Personal and professional training
includes: sales and recruiting seminars, a business management correspondence
course, and a week-long educational and training course called the Business
Management Institute ("BMI") redesigned in conjunction with Cleveland State
University in Cleveland, Ohio. BMI addresses sales techniques; lead generation;
personal finances; moral, legal and ethical standards; human resource compliance
issues; business ownership; and more. Every Distributor that opens a Filter
Queen(R) office must attend BMI. Our information shows that offices operated by
BMI graduates are more successful in terms of unit sales and associate retention
than those operated before the
4
inception of the program. The reward for working your way through The Edge and
selling 30,000 Filter Queen(R) units within fifteen years is payments from us
totaling $1 million. To date two distributors have earned the million dollar
Edge status. In May of 2001 we received the distinguished Education for Life
Award from the Direct Selling Association for our unique and outstanding
education program, The Edge Success Program. The Direct Selling Association
recognizes companies in the direct selling industry that go beyond just sales
training. Other companies who received this honor in the past include
Tupperware, Avon and Mary Kay.
In an effort to improve our customer service to end consumers, in fiscal 2001 we
created Health-Mor at Home(TM) ("HMAH"). HMAH is a revenue generating inside
sales organization selling replacement parts to Filter Queen(R) owners
throughout the United States who no longer have an authorized Distributor in
their area.
The implementation of several FQ@Home Service Centers in late fiscal 2003 and
into fiscal 2004 will serve to complement our HMAH program. FQ@Home Service
Centers, focused aftermarket businesses aimed at generating repeat business, are
being set-up in territories with a high concentration of customers and no
Distributor. These Service Centers will provide convenient, proactive in-home
replacement of parts and accessories for existing Filter Queen(R) customers.
MARKETS OUTSIDE THE U.S. Success in exporting has occurred for us mostly in the
last twenty years. To sell our products in a foreign market, we usually engage
the services of a single Importer to represent our products in each country. We
have less contact with the direct sales networks employed by Importers because
we have fewer field staff outside the U.S. to support such sales networks. Since
each country poses its own unique set of challenges (among others, currency
fluctuations, differing political and economic systems, unique business and
legal environments, inconsistent duty and tax requirements and even civil unrest
and war), it can be very difficult to penetrate a new market without the help of
an individual from that market. As a consequence, we are dependent on our
Importers to address those challenges.
In fiscal 2002 a reorganization of the management for our international market
resulted in the planned introduction of the most successful U.S. programs. For
example in fiscal 2003, the Edge, BMI, the "System" selling strategy, and the
new power nozzle (formally sold only as an option) were introduced to some of
our largest foreign markets in parts of Asia, Europe and the Middle East.
Marketing and Advertising
Traditionally, we have relied on our Distributors to market and sell our
products to consumers. A portion of the sales of our products by our
Distributors and their sales associates is dependent on telemarketing as a tool
for developing sales leads and arranging in-home demonstrations of our products
with end consumers who purchase these products. Regulatory efforts in Europe and
the U.S. have focused on imposing more restrictions on telemarketing. In October
2003 the federal National "Do Not Call" registry became active, limiting the
number of potential consumers reachable by telephone. There can be no assurance
that such regulations will not further restrict telemarketing, and thereby make
it increasingly difficult to sell our products with the aid of telemarketing.
Because of these increased regulations and the high relative cost of
telemarketing, many of the Distributors have been developing alternative methods
to generate leads for in-home demonstrations. We have assisted our Distributors
by creating a National Exhibit Booth Program that encourages Distributors to
participate in local exhibits, tradeshows,
5
home shows, shopping malls and fairs. As part of this program we developed a
National Sweepstakes Program titled "Live Better Sweepstakes." We have also
created an International outline for this program which will be introduced into
this market in fiscal 2005.
Additionally, we will continue to promote a national mail lead generation
program in order to generate leads and provide opportunities for our
distribution network to demonstrate and sell our products. This program offers
consumers the chance to win prizes and an opportunity to view a Filter Queen(R)
presentation.
Raw Material
We assemble finished units from parts purchased from various suppliers. The raw
materials used by our manufacturing operations are purchased from a number of
suppliers and substantially all such materials are readily available.
Patents and Trademarks
We have numerous United States and foreign patents, patent and trademark
applications, registered trademarks, and trade names that are used in our
business. We generally own the trademarks under which our products are marketed
and have registered our trademarks and will continue to register and protect
them as they are developed or acquired. Trademarks are registered for varying
finite periods but are usually renewable for an unlimited number of periods so
long as they are still in use. Patents are registered for finite periods and are
not renewable. In the case of trademarks used which are owned by others, we have
entered into long-term license agreements to use the trademarks. We also believe
that certain of the trademarks and trade names are of material importance to the
businesses/products to which they relate and may be of material importance to us
as a whole. Although protection of our patents and related technologies are
important components of our business strategy, none of the individual patents is
believed to be material to us. The remaining duration of the patents and
trademarks varies.
Seasonality
Historically, we experience lower product sales in our fiscal fourth quarter, as
compared to the first three fiscal quarters, resulting from fluctuations in our
European product sales as the European importers adjust their inventory volumes
in July/August for the standard European holiday month of August. European net
product sales approximated 15.7%, 11.8%, and 14.6% for the fiscal fourth
quarters in 2004, 2003, and 2002, respectively, as compared to the average of
the first three fiscal quarters in 2004, 2003, and 2002 of 17.6%, 20.5%, and
19.0%, respectively.
Major Customers and Dependence on Independent Distributors
We are subject to risks specific to the individual customers with whom we do
business. In fiscal 2004 and 2003, no individual customer accounted for more
than 10% of our product sales. In fiscal 2002, one international customer in
Japan accounted for more than 10% of our product sales. This international
customer's product sales were 11.9% of our total product sales.
Our revenues, and the stability of such revenues, are dependent on our
relationships with third-party distributors and their sales persons and their
level of satisfaction with our products and us. The Distributors and Importers
are independent third parties who are not our employees and are not directly
under our control. There can be no assurance that the current relationships with
Distributors and Importers will continue on acceptable terms and conditions to
us, nor can there be any assurance that additional distributorship arrangements
with third parties will be obtained
6
on acceptable terms. Moreover, there can be no assurance that the Distributors
and Importers will devote sufficient time and resources to our products to
enable the products to be successfully marketed. Failure of some or all of our
products to be successfully and efficiently distributed could have a material
adverse effect on our financial condition and results of operations.
Backlog
We operate monthly with a minimal backlog (backlog at September 30, 2004, 2003,
and 2002 was $3, $-0-, and $6, respectively).
Competition
We experience strong competition in the sale of our high filtration portable
surface cleaners, and portable room air cleaners. Not only do we compete for
consumer sales but also for Distributors and Importers to sell our products.
Participants in the vacuum and indoor air cleaner industries compete primarily
on price, quality, brand name recognition, product availability, and product
performance, including the perceived amount of particles removed by a vacuum
cleaner or air filter. Economy or disposable vacuums and indoor air filters are
sold through a variety of channels including department stores, discount houses,
appliance stores, and catalogs, generally at substantially lower prices than our
products. We believe that our high filtration portable surface cleaner is
superior to other vacuum cleaners because of its outstanding performance and
warranty.
Our high filtration portable surface cleaner (The Majestic(R)) competes with
many significant vacuum cleaner manufacturers and with regional and private
label manufacturers, including other direct selling companies, such as Rainbow,
Tristar, Kirby, Miracle Mate, Electrolux, and Water-Matic, and companies that
sell through retail outlets such as Miele, Eureka, Hoover, Kenmore, and Royal.
We also manufacture and distribute a portable room air cleaner (The Defender(R))
recognized as a Class II Medical Device by the FDA. (There are basically two
types of air cleaners. The Defender(R) is a mechanical filter that forces dirty
air through a series of filters releasing only cleaner, fresher air. The second
type is an electrostatic precipitator that emits an electronic charge into the
air.)
The portable room air cleaner market is primarily a retail and catalog business.
HMI's Defender(R) competes directly with air cleaners like Alpine, Honeywell,
Bionaire, Hunter, Holmes, Hoover, and Sharper Image. Many of our competitors
have greater financial, marketing, and manufacturing resources and better brand
name recognition than us, and sell their products through broader and more
extensive distribution channels.
Research and Development
Our ongoing research and development program involves redesigning existing
products to reduce manufacturing costs and to increase product quality and
efficiencies. In fiscal year 2004, 2003, and 2002, we invested $53, $75, and
$273, respectively, in new product development. We do not anticipate expending
significant monies on the redesigning of products in fiscal year 2005.
Environmental
To our knowledge, we are in compliance with all applicable Federal, State, and
local laws relating to the protection of the environment. While we anticipate no
current expenses for environmental issues, there can be no assurance that we
will not receive claims for
7
environmental conditions in the future, nor any assurance that any such claims,
if received, would not have a material adverse impact on our financial condition
and results of operations.
Employees
We employed 101 full-time and 11 part-time employees at September 30, 2004. None
of our employees are parties to a collective bargaining agreement, and we
believe our relationships with all our employees to be good.
FINANCIAL INFORMATION ABOUT GEOGRAPHIC AREAS
Sales to international customers represented 41.1%, 35.8%, and 43.1% of net
product sales for the years ending September 30, 2004, 2003, and 2002,
respectively.
AVAILABLE INFORMATION
Our principal executive offices are located at 13325 Darice Parkway, Unit A,
Strongsville, Ohio 44149, and the telephone number is (440) 846-7800.
We regularly file reports with the Securities Exchange Commission (SEC). These
reports include, but are not limited to, Annual Reports on Form 10-K, Quarterly
Reports on Form 10-Q, current reports on Form 8-K, and security transaction
reports on Forms 3, 4, or 5. The public may read and copy any materials that we
file with the SEC at the SEC's Public Reference Room located at 450 Fifth Street
NW, Washington, DC 20549. The public may obtain information on the operation of
the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also
maintains electronic versions of our reports on its website at
http://www.sec.gov.
We make our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, current
reports on Form 8-K, and other reports filed or furnished with the SEC available
to the public, free of charge, through our website at www.filterqueen.com. These
reports are provided through our website as soon as reasonably practicable after
we file or furnish these reports with the SEC.
Executive Officers of the Registrant
Name Age Position and Terms of Service as Officer
- ------------------ --- ------------------------------------------------------
Kirk W. Foley 62 Chairman and Principal Executive Officer (1)
John A. Pryor 61 President and Chief Operating Officer (2)
Julie A. McGraw 40 Vice President, Chief Financial Officer, Treasurer and
Assistant Secretary (3)
Joseph Najm 46 Vice President-Operations (4)
Daniel J. Duggan 44 Vice President (5)
Darrell Weeter 48 Vice President (6)
(1) Mr. Foley was elected as Chairman and Principal Executive Officer in
February, 2004. Since 1997 he has also been Chairman and Chief Executive
Officer of Tube-Fab Ltd., a company that shapes, bends and machines metal
tubing. He previously served as Chief Executive Officer of the Company
from 1989 to 1997.
(2) Effective November 22, 2004, Mr. Pryor resigned as President and Chief
Operating Officer although he continues to serve on the Board of
Directors. Mr. Pryor was elected President and Chief Operating Officer in
2001. From 1992 to 2001 he was President of Pryor & Associates, which
provided consulting services to the food service industry. From 1996 to
8
2000 he was President and Chief Executive Officer of Valley Innovative
Services, a food services management company.
(3) Ms. McGraw was elected Chief Financial Officer and Treasurer in 2000 and
Vice President in 1999. She also served as Corporate Controller from 1998
to 2001.
(4) Mr. Najm was elected Vice President-Operations in 1999.
(5) Mr. Duggan has served in various capacities with the Company since 1990.
He was elected Vice President in 2001 and has served as President of the
International Sales Division since 2002. From 1997 to 2002 he was
President of the Asia-Pacific Sales Division.
(6) Mr. Weeter was elected Vice President in 2001. He has also served as
President of the Americas Sales Division since 2000, and was Vice
President of the Americas Sales Division from 1998 to 2000. He has also
served as President of FVS Inc., a distributor of products manufactured by
the Company, since 1985.
ITEM 2. PROPERTIES
The following table sets forth the location, character, and size of the real
estate we used in our operations at September 30, 2004:
Square
Location Character Feet
- ------------------------- ------------------------------------------------- ------
United States of America~
Strongsville, Ohio Leased office, manufacturing, and warehouse space 73,000
Seven Hills, Ohio Leased office space 15,700
Upon the expiration of our Seven Hills, Ohio facility, in November, 2004 we
relocated all of our personnel at the Seven Hills, Ohio location to the
Strongsville, Ohio facility. An additional 7,000 square feet will be added to
the Strongsville office space, via the creation of a mezzanine level, to house
the executive, selling and administrative personnel. The completion of the
mezzanine is anticipated by March 2005. We believe our facility in Strongsville
is adequate for both our manufacturing and office space needs.
ITEM 3. LEGAL PROCEEDINGS
Bliss Technologies, Inc. ("Bliss"), the company formed from the 1998 sale of the
subsidiary of HMI, filed for bankruptcy in January 2000 in the United States
Bankruptcy Court, Eastern District of Michigan. In a separate action filed in
2002, the Official Committee of Unsecured Creditors of Bliss alleges a
fraudulent conveyance claim against us asserting that the sale of Bliss in 1998
was a fraudulent transfer insofar as we received more for Bliss than it was
worth and that Bliss was insolvent from its inception. Former directors of
Bliss, Mark Kirk and Carl
9
Young, are also named as defendants in the action. Claims pending against them
allege that in their capacity as Bliss directors they breached fiduciary duties
to Bliss creditors. The complaint seeks damages in an unspecified sum. In
September 2004 the parties conducted a mediation session with an agreed-upon
mediator which did not result in a settlement. Although we may continue to
pursue the settlement discussions that began at the mediation we are also
continuing to move forward in court with the vigorous defense of the claims
against us and the claims against Mr. Kirk and Mr. Young.
Claims arising in the ordinary course of business are also pending against us.
In the third quarter of fiscal 2004 we increased reserves by $500 to provide for
any contingent liabilities associated with various litigation and contingent
claims. There can be no assurance that an unfavorable outcome in these various
litigation and contingent claims would not have a material adverse effect on our
consolidated financial position, results of operations, or cash flow. Included
in the accompanying Consolidated Balance Sheets at September 30, 2004, and 2003,
were accruals of $515 and $15, respectively, relating to litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
Our Common Stock was quoted in the over-the-counter market on the OTC Bulletin
Board under the symbol "HMII.OB" until February 19, 2004, the date it was
removed. The removal occurred because we were no longer current with regards to
our SEC filings, primarily our Form 10-K for the year ended September 30, 2003,
and therefore the members of the OTC Bulletin Board could no longer quote our
shares. It is now quoted in the Pink Sheets. As of September 30, 2004, there
were 221 stockholders of record.
A summary of the quarterly high and low bid price of our common stock in the
Pink Sheets for the year ended September 30, 2004 and on the OTC Bulletin Board
for the year ended September 30, 2003 are as follows:
2004
High [1] Low [1]
-------- -------
1st Quarter $ 1.05 $ 0.64
2nd Quarter $ 0.70 $ 0.51
3rd Quarter $ 0.51 $ 0.35
4th Quarter $ 0.40 $ 0.35
10
2003
High [1] Low [1]
-------- -------
1st Quarter $ 0.70 $ 0.18
2nd Quarter $ 0.65 $ 0.41
3rd Quarter $ 0.65 $ 0.51
4th Quarter $ 1.05 $ 0.55
[1] The bid price for our common stock was received from Pink Sheets and/or
Nasdaq Trading & Market Services. Such over-the-counter market quotations
reflect inter-dealer prices, without retail mark-up, mark-down or commission,
and may not necessarily represent actual transactions.
The declaration and payment of quarterly dividends is at the discretion of the
Board of Directors, which may raise, lower, or omit the dividend in any quarter.
No dividends were declared in 2004 or 2003 as the credit agreement with our
lender presently prohibits us from declaring or paying any dividends. The
Company has no intention of paying dividends in the foreseeable future.
Securities Authorized for Issuance Under Equity Compensation Plans. Information
about HMI equity compensation plans at September 30, 2004, was as follows
(shares in thousands):
Number of shares
Number of shares to remaining available
be issued upon Weighted average for future issuance
Plan Category exercise of exercise price of under equity
outstanding options outstanding options compensation plans
- ----------------------------------------- ------------------- ------------------- -------------------
Equity compensation plans approved by
shareholders (a) 532 $ 1.17 - (b)
------- --------- ------
Equity compensation plans not approved by
shareholders (c) 385 $ 2.72 -
------- --------- ------
Total 917 $ 1.82 -
(a) These options were issued under the 1992 Omnibus Long-Term Compensation
Plan. See "Notes to Consolidated Financial Statements, Note 6 - Long-Term
Compensation Plan."
(b) The 1992 Omnibus Long-Term Compensation Plan (the "Plan") does not contain
any restriction on the number of shares that can be issued pursuant to an
award under the Plan except for Incentive Stock Options ("ISO"), which are
limited to 2,500 shares, as adjusted for stock splits. No new ISO grants
may be made under the Plan because the Plan was adopted more than ten
years ago. Regulations of the Internal Revenue Service which determine
whether or not an option is an ISO require that the Plan under which an
ISO is granted must have been adopted within the prior ten years. The
number of shares available for grant each year is equal to 5% of the
Company's outstanding Common Stock on December 31 of the prior year. To
the extent that the number of awards in any year is less than 5%, this
unused amount may be carried over to future years. Awards which have
lapsed or been forfeited may also be reissued in future years. The maximum
number of awards that can be made in any year, including carryovers and
lapsed and forfeited
11
awards, is equal to 10% of the Company's outstanding Common Stock on
December 31 of the prior year.
(c) Awards of non-qualified stock options were made to two outside consultants
in connection with their services to HMI. The option price was the fair
market value on the date of grant. One option for 100 shares expires ten
years from the date of grant (2006), while the other option for 35 shares
expires five years from the date of grant (2005). A third grant to our
current Chairman of the Board for 250 shares expires in 2009, five years
from the date of the grant.
12
ITEM 6. SELECTED FINANCIAL DATA
In thousands except per share amounts, stock prices, percentages, and ratios
2004 2003 2002 2001 2000
------------- ----------- ---------- ---------- ---------
Net product sales $ 31,990 $ 30,170 $ 34,524 $ 31,527 $ 34,621
Cost of product sold and SG&A expenses $ 35,464 $ 35,334(0) $ 35,889 $ 32,676 $ 33,515
Loss on impairment of asset $ - $ 1,711(1) $ - $ - $ -
Other expense (income), net $ 11 $ (105) $ 430 $ 272 $ (6)
(Loss) income from continuing operations
before taxes and cumulative effect of
accounting change $ (3,485) $ (6,770) $ (1,795) $ (1,421) $ 1,112
(Loss) income margin from continuing
operations before taxes and cumulative
effect of accounting change (10.9%) (22.4%) (5.2%) (4.5%) 3.2%
Provision (benefit) for income taxes $ 7 $ 18 $ 38 $ 3,672(2) $ (353)
Income tax rate (0.2%) (0.3%) (2.1%) (258.4%) (31.7%)
(Loss) income from continuing operations
before cumulative effect of accounting
change $ (3,492) $ (6,788) $ (1,833) $ (5,093) $ 1,465
(Loss) income margin from continuing
operations before cumulative effect
of accounting change (10.9%) (22.5%) (5.3%) (16.2%) 4.2%
Cumulative effect of accounting change $ - $ (5,451)(3) $ - $ (4,943)(4) $ -
Gain on disposals $ - $ - $ - $ - $ 425
Net (loss) income $ (3,492) $ (12,239) $ (1,833) $ (10,036) $ 1,890
Net (loss) income margin (10.9%) (40.6%) (5.3%) (31.8%) 5.5%
Per Share Data - Basic and Diluted:
(Loss) income from continuing operations
before cumulative effect of accounting
change $ (0.52) $ (1.01) $ (0.27) $ (0.76) $ 0.24
Cumulative effect of accounting change $ - $ (0.81) $ - $ (0.74) $ -
Gain on disposals $ - $ - $ - $ - $ 0.07
Net (loss) income $ (0.52) $ (1.82) $ (0.27) $ (1.50) $ 0.31
Weighted Average Number of Common
Shares Outstanding:
Basic 6,746 6,744 6,719 6,691 6,113
Diluted 6,746 6,744 6,719 6,691 6,140
Total Assets $ 10,491 $ 10,668 $ 17,430 $ 16,979 $ 20,843
Long-Term Debt $ - $ 11 $ 33 $ 75 $ 71
Stockholders' (Deficit) Equity $ (12,247) $ (8,754) $ 2,577 $ 4,419 $ 14,394
Working Capital $ 1,999 $ 1,444 $ 992 $ 580 $ 4,137
Ratio of Current Assets to Current
Liabilities 1.29 1.22 1.16 1.09 1.67
Stock High(a) 1 1/20 1 1/20 1 1/5 1 11/16 1 3/4
Stock Low(a) 7/20 13/50 25/49 11/16 1/2
(0) This amount includes a $905 write-off, recorded during the second quarter of
fiscal 2003, relating to cumulative translation adjustments associated with the
liquidation of our Canadian subsidiary. In addition it includes a $300 reserve
for obsolete inventory associated with impaired tooling. See Note 1 for further
information.
(1) During the fourth quarter of fiscal 2003, we performed an analysis on the
potential impairment of certain tooling assets, and related patents and
trademarks, approximating $1,711. We concluded from our analysis, which was
based upon the held and used model that the tooling assets were fully impaired
and accordingly recorded an impairment charge of $1,711 as of September 30,
2003.
(2) In the second quarter of fiscal 2001, we concluded that a full valuation
allowance for our deferred tax assets was required. Accordingly, we recorded a
non-cash charge in the second quarter of fiscal 2001 of $6,118 to increase our
valuation allowance for our deferred tax assets.
13
(3) As of October 1, 2002, a full impairment of the goodwill recorded on HMI's
books was recorded through a non-cash charge of $5,451. Such charge is
non-operational in nature. See Note 1 for further information.
(4) In the second quarter of fiscal 2001 a non-cash charge of $4,943 was
recorded on HMI's books to reflect the adoption of the Emerging Issues Task
Force EITF 01-9, Accounting for consideration Given by a Vendor to a Customer
relative to our distributor development program.
(a) Represents closing price of stock
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (DOLLARS IN THOUSANDS)
GOING CONCERN
During the year ended September 30, 2004, we incurred a net loss of $3,492, had
deficit equity of $12,247 at September 30, 2004, and as of the date of the audit
opinion did not have an executed long-term financing agreement. As a result of
these factors, our accounting firm has issued an audit report with a
modification expressing substantial doubt about our ability to continue as a
going concern. The accompanying financial statements have been prepared in
conformity with generally accepted accounting principles which contemplate
continuation of the Company as a going concern. The financial statements and
financial information presented do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or amounts and
classification of liabilities that might be necessary should we be unable to
continue in existence.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of operations
are based upon the consolidated financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United States
of America. The preparation of these consolidated 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 financial statements. Actual
results may differ from these 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. We believe that
the critical accounting policies are limited to those that are described below.
Allowance for Doubtful Accounts
At September 30, 2004, our bad debt reserve was $132. We maintain an allowance
for doubtful accounts for estimated losses resulting from the inability of our
customers to make required payments. Quarterly, we evaluate the collectability
of our accounts receivable based on a combination of factors. In cases where we
are aware of circumstances that may impair a specific customer's ability to meet
its financial obligations to us, we record a specific allowance against amounts
due to us, and thereby reduce the net recognized receivable to the amount we
reasonably believe will be collected. For all other customers, we recognize
allowances for doubtful accounts based on the length of time the receivables are
past due, industry and geographic concentrations, the current business
environment, and our historical experience, including payment patterns. If the
financial condition of our customers deteriorates or if economic conditions
worsen, additional allowances may be required in the future, which could have an
adverse impact on our future operating results.
14
Sales Return and Allowance
We record a provision for estimated sales returns and allowances on product
sales in the same period as the related revenues are recorded. These estimates
are based on historical sales returns and other known factors. If future returns
do not reflect the historical data we use to calculate these estimates,
additional allowances may be required.
Accrued Distributor Development Liabilities
We account for the potential one million dollar award for the Edge Program
pursuant to Emerging Issues Task Force Consensus ("EITF") 01-9, "Accounting for
Consideration Given by a Vendor to a Customer (Including a Reseller of a
Vendor's Products)"; accordingly we reflect the accrual for this award as a
reduction of revenues. We have determined that for purposes of EITF 01-9 it is
not possible to reasonably estimate such a liability and therefore accrue such
awards assuming a maximum accrual rate whereby we assume each eligible
distributor will earn the award. In other words, for each qualifying sale, we
have recorded a liability by reducing revenue. Such a liability will only be
derecognized (i.e. the accrual eliminated) when (i) the award is paid out or
(ii) when a distributor is no longer eligible for the award. For the years ended
September 30, 2004, 2003 and 2002, the accounting for this Program decreased
sales by $3,687, $4,369 and $2,589, respectively. On our Consolidated Balance
Sheets as of September 30, 2004, and 2003 we had accrued $16,321, and $12,958,
respectively, relative to this Program.
Excess and Obsolescence Reserves
Quarterly we evaluate our inventory to determine excess or slow moving items
based on current order activity and projections of future demand. For those
items identified, we estimate their market value or net sales value based on
current trends. An allowance is created for those items having a net sales value
less than cost. If actual market conditions are less favorable than those
projected by management, additional inventory write-downs may be necessary.
Goodwill and Other Intangible Assets
Pursuant to Statement of Financial Accounting Standards ("SFAS") No. 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.
SFAS No. 142 primarily addresses the accounting for goodwill and intangible
assets subsequent to their initial recognition. The provisions of SFAS No. 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). Management does not believe that the market value of our
common stock fairly reflects the value of HMI, because of, among other things,
the absence of liquidity, and the absence of analyst coverage. Accordingly, 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
15
used in any of the three valuations referred to above and depending on the
weighting used for each valuation, results of the valuation could be
significantly changed. However, for accounting purposes we believed that the
weighting methodology used was reasonable and resulted in an accurate and fair
value of HMI.
During the second quarter of fiscal 2003 we completed our initial impairment
test for October 1, 2002, resulting in a full impairment of the goodwill
recorded on HMI's books through a non-cash charge of $5,451. Such charge is
non-operational in nature and is reflected as a Cumulative Effect of Accounting
Change in the accompanying Consolidated Statements of Operations for the year
ended September 30, 2003.
Valuation of Long-Lived Assets
In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" we assess potential impairments to our long-lived 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 asset is not recoverable
and exceeds its fair value. The carrying amount of a long-lived 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 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.
During the fourth quarter of fiscal 2003 we performed an analysis on the
potential impairment on certain tooling assets, and related patents and
trademarks, approximating $1,711 which related to a potential new product. Based
upon our analysis, we concluded that the tooling assets were fully impaired as
of September 30, 2003; this conclusion was based upon the held and used model
which includes significant assumptions regarding future cash flows and utilizes
a model of weighted probability cash flow projections over the estimated life of
the product. Scrap value for these assets was determined to be nominal;
accordingly a $1,711 impairment of this asset was recorded as of September 30,
2003, to write the assets down to their net realizable value. This product will
not have any additional resources devoted to its refinement and completion, nor
will the product be marketed or sold as an ongoing part of our product
portfolio. As a result the impairment is not expected to have an impact on
future revenue or net income. Different assumptions or different weightings of
the projected cash flows could significantly impact our conclusion concerning
the impairment of such assets.
Income Taxes
In determining income (loss) for financial statement purposes, we must make
certain estimates and judgments. These estimates and judgments occur in the
calculation of certain tax liabilities and in the determination of the
recoverability of certain of the deferred tax assets, which arise from temporary
differences between the tax and financial statement recognition of revenue and
expense. SFAS No. 109 "Accounting for Income Taxes" requires that the deferred
tax assets be reduced by a valuation allowance, if based on the weight of
available evidence, it is more likely than not that some portion or all of the
recorded deferred tax assets will not be realized in future periods.
In evaluating our ability to recover our deferred tax assets we consider all
available positive and negative evidence including our past operating results,
the existence of cumulative losses in the most recent three fiscal years, and
our forecast of future taxable income. In determining future taxable income, we
are responsible for assumptions utilized including the amount of state and
federal pre-tax operating income, the reversal of temporary differences, and the
implementation
16
of feasible and prudent tax planning strategies. These assumptions require
significant judgment about the forecasts of future taxable income and are
consistent with the plans and estimates we are using to manage our business.
Periodically, and when indicators suggest, we assess the realizability of our
domestic deferred tax assets, giving consideration to our actual historical
results supplemented by future expected results. SFAS No. 109 considers a
historic pattern of losses as significant negative evidence that tax assets will
not be realized and this consideration is not outweighed by any prospective view
of management that sufficient taxable income will ultimately be available to
realize the tax benefits. Given the history of losses and the results in 2004,
we concluded that under the "more likely than not" criteria of SFAS No. 109 a
full valuation allowance is still required against the net U.S. deferred tax
assets at September 30, 2004.
The valuation allowance has been subject to periodic review and can be partially
or totally reversed either when income is generated that utilizes the loss or
when sufficient positive evidence emerges (i.e. A sustained positive trend of
U.S. income for financial accounting purposes.) Our income tax expense recorded
in the future will be reduced to the extent of offsetting decreases in our
valuation allowance.
Warranty Reserves
Our policy is to record a provision for the expected cost of warranty-related
claims at the time of the sale and adjust the provision to reflect actual
experience quarterly. The amount of warranty liability accrued reflects
management's best estimate of the expected future cost of honoring our
obligations under the warranty plans. Historically, the cost of fulfilling our
warranty obligations has principally involved replacements parts, labor and
sometimes travel. Our estimates are based on historical experience, the number
of units involved, and the extent of features/components included in product
models. If future returns and warranty settlements do not reflect the historical
data we use to calculate these estimates, additional allowances may be required.
RESULTS OF OPERATIONS - 2004 COMPARED WITH 2003
PRODUCT SALES- Product sales, net of returns and allowances and before
distributor development program revenue reduction ("Product Sales"), were
$35,591 for the year ended September 30, 2004, $1,052 or 3.0% higher than prior
year Product Sales of $34,539. The increase was largely attributable to
increased sales in Asia of $2,766, offset by decreased revenues in the Americas
and Europe/Middle East of $1,266 and $468, respectively.
Asian sales increased primarily as a result of shipments to a new customer in
Malaysia whose first shipment was in December 2003, and improved sales to Hong
Kong and Korea. The largest increase was associated with Malaysia.
The sales decline in the Americas was largely related to office closings in a
particular sales territory. A new divisional director was assigned to this
territory during the year in order to provide the additional support that had
been requested.
The sales decline in Europe/Middle East was driven by reduced sales to Portugal
and was attributable to the ongoing challenges of lead generation, the
recruiting of new sales associates and the retention of existing associates
within this importer's territories.
Product sales after returns and allowances were not materially impacted by
changing prices.
DISTRIBUTOR DEVELOPMENT PROGRAM- The reduction to Product Sales associated with
the Edge Program for the year ended September 30, 2004 was $3,687 compared to
$4,369 in fiscal 2003, a
17
$682 decrease. This decrease was driven by termination gains which were largely
attributable to one established U.S. distributor who left the business during
the second quarter and consequently lost his eligibility to participate in the
Program and therefore the accrued liability related to him was derecognized. The
termination gain was offset by increased international sales volume as well as
the number of international countries participating in the Program. See Note 1
to our Consolidated Financial Statements for a further discussion of the
accounting pertaining to this Program.
OTHER REVENUE- We formed a wholly owned subsidiary, AdvantEdge Credit Management
Services ("ACMS") during the third quarter of fiscal 2004. ACMS is a brokerage
service provider for sourcing consumer credit and assists its clients, our
Americas distribution network, in securing third party financing for end
consumers who purchase products manufactured by HMI. We earned $86 in brokerage
service revenue during the third and fourth quarters of fiscal 2004 for these
services.
GROSS MARGIN, EXCLUSIVE OF DISTRIBUTOR DEVELOPMENT PROGRAM- The gross margin,
exclusive of Distributor Development Program costs, for the year ended September
30, 2004, was $14,112 or 39.7% of sales as compared to $13,514 or 39.1% of sales
in 2003, an increase of $598. The $598 increase was a result of favorable sales
and materials variances approximating $584 and $197, respectively, offset by
increased overhead expenses of $197. The favorable materials variance was a
direct result of lower current year inventory obsolescence expense. As a result
of the discontinuance of our Central Vac product and the abandonment of a
potential new product we recorded loss on disposal charges of $170 during the
third quarter of fiscal 2004 to fully impair the associated tools and molds as
their estimated net realizable value which was considered to be nominal.
SELLING, GENERAL, AND ADMINISTRATIVE ("SG&A")- SG&A expenses of $13,985 for the
year ended September 30, 2004, were greater than fiscal 2003 expenses of $13,404
by $581. This increase was largely due to a $500 and $317 increase in litigation
reserve and audit expenses, respectively, related to pending legal proceedings
and the restatement of our prior years' financial statements in connection with
the adoption of EITF 01-9. It was also impacted by $240 of expenses associated
with certain independent professionals who were engaged by a Special Committee
of the Board of Directors to review relationships we had with certain
affiliates, as well as by the February 2, 2004 resignation and retirement of
James R. Malone, the former Chairman and Chief Executive Officer. We recorded
$200 of compensation expense in association with Mr. Malone's resignation. The
remaining difference was largely the result of reductions of $632 related to
commissions and compensation expenses which followed the lower sales in the
Americas and Europe/Middle East.
LOSS ON IMPAIRMENT OF ASSET- During the fourth quarter of fiscal 2003, we
performed an analysis on the potential impairment of certain tooling assets, and
related patents and trademarks. We concluded from our analysis, which was based
upon the held and used model that the tooling assets were fully impaired and
accordingly recorded an impairment charge of $1,711 as of September 30, 2003, as
the scrap value for these assets was determined to be nominal.
LOSS ON LIQUIDATION OF 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 $905 for
cumulative translation adjustments associated with this subsidiary.
18
INTEREST EXPENSE- Interest expense for fiscal year 2004 was $77 or $24 higher
than the fiscal 2003 amount of $53. The increased expense primarily reflects the
increased level of borrowings on our line of credit when compared to the prior
year.
OTHER EXPENSE (INCOME), NET- The decrease of $92 in other (income) expense, net,
from ($158) in fiscal 2003 to ($66) for the year ended September 30, 2004, was
attributable to a variety of individually insignificant items.
INCOME TAXES- The effective income tax rate for the year ended September 30,
2004, was (0.2%) compared to (0.3%) in fiscal 2003. Driven by pre-tax earnings,
the recorded tax expense, which is associated with state franchise taxes, was
not material in either year because of the full valuation allowance against our
deferred tax assets.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE- On October 1, 2002, we adopted SFAS No.
142. Under SFAS No. 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 $5,451 to fully eliminate the
carrying value of our goodwill (See Note 1 to the Consolidated 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- While inflation or changing prices have not had, and we
do not expect them to have, a material impact upon operating results, there can
be no assurances that our business will not be affected by inflation or changing
prices in the future.
RESULTS OF OPERATIONS - 2003 COMPARED WITH 2002
PRODUCT SALES- Product Sales of $34,539 for the year ended September 30, 2003,
were $2,574 or 6.9% lower when compared to the prior year sales of $37,113. The
decrease in Product Sales was primarily attributable to reduced international
sales, largely Asia, and the cessation of the National Advertising Campaign
("NAC"), offset by increased revenues in the Americas of $2,466.
The largest decline in Asia was attributable to lower sales to Japan. Our
Japanese importer struggled all year to realign his inventory levels in
anticipation of the launch of our 75th Anniversary Majestic(R) (our portable
surface cleaner), which occurred in Japan in fiscal 2004. The reduced sales to
Japan also reflected 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, resulting in lower Defender(R)
sales while the importer sold this inventory. To assist our importer in Japan
with their continued inventory realignment as well as the development and
execution of training and sales programs, we created a new sales position within
HMI to provide experienced, dedicated sales support to this region.
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. NAC sales accounted for $1,495 of total revenue in fiscal 2002.
The increase in the Americas was due to the growth of several of our key
distributors who grew their businesses through effective recruiting, retention,
and the opening of new offices.
Product sales after returns and allowances were not materially impacted by
changing prices.
19
DISTRIBUTOR DEVELOPMENT PROGRAM- The reduction to product sales associated with
the Distributor Development Program for the year ended September 30, 2003 was
$4,369 compared to $2,589 in fiscal 2002, a $1,780 increase. This increase was
primarily a result of making the international market part of the Program during
the first quarter of fiscal 2003 which accounted for approximately $1,350 of the
$1,780 increase in sales reduction. See Note 1 to our Consolidated Financial
Statements for a further discussion of the accounting pertaining to this
program.
GROSS MARGIN, EXCLUSIVE OF DISTRIBUTOR DEVELOPMENT PROGRAM- The gross margin,
exclusive of Distributor Development Program costs, for the year ended September
30, 2003, was $13,514 or 39.1% of sales as compared to $15,815 or 42.6% of sales
in 2002, a decrease of $2,301. Approximately $1,256 of the decrease in gross
margin was associated with the cessation of the NAC. The balance of the decrease
was primarily the result of an unfavorable volume variance due to lower
international sales, increased Defender(R) warranty costs of $167 largely
associated with certain international markets that utilize peak demand
electricity transmission and control systems, and an additional charge of $299
related to obsolete inventory associated with impaired tooling, of which the
unfavorable international sales volume variance was the largest.
SELLING, GENERAL, AND ADMINISTRATIVE ("SG&A")- SG&A expenses of $13,404 for the
year ended September 30, 2003, were favorable to fiscal 2002 expenses of $14,591
by $1,187. The reduced level of expense was driven by the absence of advertising
and administrative costs associated with our aforementioned NAC of approximately
$2,334, costs associated with the Form 13D that was filed, in fiscal 2002, by a
group led by our current Chairman, Kirk W. Foley, with the Securities and
Exchange Commission of $435, and reduced outside consulting expenses of $235.
These decreases were partially offset by increased costs of $1,223 associated
with the training, development, and retention of our Americas and International
networks as well as expenses approximating $871 associated with certain growth
initiatives in the Americas division.
LOSS ON IMPAIRMENT OF ASSET- During the fourth quarter of fiscal 2003, we
performed an analysis on the potential impairment of certain tooling assets, and
related patents and trademarks. We concluded from our analysis, which was based
upon the held and used model that the tooling assets were fully impaired and
accordingly recorded an impairment charge of $1,711 as of September 30, 2003, as
the scrap value for these assets was determined to be nominal.
LOSS ON LIQUIDATION OF 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 $905 for
cumulative translation adjustments associated with this subsidiary.
INTEREST EXPENSE- Interest expense for fiscal year 2003 was $53 or $33 lower
than the fiscal 2002 amount of $86 due primarily to lower interest expense
associated with our line of credit whose balance was on average lower than the
prior year. It was also impacted by reduced interest expense on our capital
lease obligations which reflects lower outstanding balances compared to those in
fiscal 2002.
OTHER (INCOME) EXPENSE, NET- The increase of $502 in other (income) expense,
net, from $344 of expense in fiscal 2002 to $158 of income for the year ended
September 30, 2003, largely resulted from the absence of goodwill amortization
associated with the adoption of SFAS No. 142 (see Note 1 to the Consolidated
Financial Statements).
INCOME TAXES- The effective income tax rate for the year ended September 30,
2003, was (0.3%) compared to (2.1%) in fiscal 2002. This difference was driven
by pre-tax earnings as the tax
20
expense recorded was not material in either year as a result of a full valuation
allowance against our deferred tax assets.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE- On October 1, 2002, we adopted SFAS No.
142. Under SFAS No. 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 $5,451 to fully eliminate the
carrying value of our goodwill (See Note 1 to the Consolidated Financial
Statements). There was no tax effect related to this item, as this charge was a
permanent difference for income tax purposes.
LIQUIDITY AND CAPITAL RESOURCES
OPERATING ACTIVITIES- Cash flows from operating activities provided net cash of
$902 for the year ended September 30, 2004, principally due to non-cash expenses
of $3,986, cash inflows resulting from decreases in inventories and prepaid
expenses of $300 and $201, respectively, as well as increases in distributor
development liabilities, and accrued expenses and other liabilities of $200 and
$508, respectively. Offsetting cash inflows were net losses of $3,492 and
increases in receivables of $875.
Non-cash expenses consisted of $3,163 relating to the accounting associated with
our distributor development program, $653 in depreciation and amortization, and
$170 associated with the loss on disposal of our Central Vac product and the
abandonment of a potential new product, both which were impaired in the third
quarter of fiscal 2004. A general trend to improve our working capital balances,
through improved procurement and production policies, is largely responsible for
the decrease in inventories, while amortization of prepaid risk insurance was
the contributing factor to the decrease in prepaid expenses. The $200 increase
in our distributor development liability is associated with the amount to be
paid in fiscal 2005 to our second Edge Program achiever. Accrued expenses and
other liabilities increased largely as a result of a $500 accrual recorded in
the third quarter of fiscal 2004 to provide for reasonably estimated and
probable obligations associated with current litigation issues.
The increase in the receivables balance is largely attributable to sales volume
increases related to several international customers all of whom receive credit
terms to assist with the time delay in shipping products overseas. Additional
increases are associated with our newly formed subsidiary AdvantEdge Credit
Management Services Inc. ("ACMS"). ACMS, formed in the third quarter of fiscal
2004, is a brokerage service provider for sourcing consumer credit and assists
its clients, our Americas distribution network, in securing third party
financing for end consumers who purchase products manufactured by HMI. The ACMS
receivable balance of $298 at September 30, 2004 represents monies owed to them
from third party financing companies.
INVESTING ACTIVITIES- Capital expenditures of $96 represent the entire net cash
used in investing activities for the year ended September 30, 2004, which
relates to engineering testing equipment, computer hardware, and tooling
associated with our current product line.
FINANCING ACTIVITIES- Net cash used in financing activities for the year ended
September 30, 2004 was $443, which included $421 for net repayments under our
credit facility and $22 for payment of other long-term debt.
21
Our $3,000 credit facility agreement includes various covenants that limit our
ability to incur additional indebtedness, restricts paying dividends and limits
capital expenditures, and requires we maintain a minimum net worth. As of
September 30, 2003, we were not in compliance with our interest coverage ratio,
and net worth covenants; however, we obtained a waiver on these covenants which
was effective until February 20, 2004. We were required to maintain an interest
coverage ratio of greater than or equal to 5.0 to 1.0 interest to earnings
before interest, taxes, depreciation and amortization ("EBITDA") and a net worth
of at least $7,400, calculated quarterly and increasing by 50% of net income
annually.
On February 20, 2004, an amendment of our credit facility agreement was executed
with our lender. The expiration date was extended to October 15, 2004. The
amended agreement carried the same interest rate and similar covenants as the
previous amended loan agreement, with the exception of the interest coverage
ratio which was amended to exclude non-cash expenses from the 5.0 to 1.0 ratio,
including but not limited to, the impairment of tooling assets and associated
inventory, and the tangible net worth covenant in which the minimum amount was
reset to $2,400.
On October 15, 2004, an amendment of our $3,000 credit facility agreement was
executed with our lender. The bank agreed to extend the maturity date of the
loan until December 31, 2004. The amended agreement carries an interest rate of
prime plus one percent and covenants similar to the previous amended loan
agreement, with the exception of the tangible net worth covenant which was
eliminated through the maturity date of the loan. On December 16, 2004, we
received a letter from our current lender which outlined their commitment to
amend the maturity date of our credit facility until March 31, 2005.
Additionally, we agreed to reduce the facility availability from $3,000 to the
original $2,000 credit limit. The purpose of the additional $1,000 availability,
to assist with the build-up of inventory associated with new product launches,
has been fulfilled and consequently the borrowing capacity is no longer
necessary.
We are actively seeking; through the use of both internal personnel and an
outside broker, finance sources to replace the credit facility prior to its
expiration. Although no long-term debt arrangement is in place as of the date of
this filing, our current lender has been agreeable to extending our current
facility on a quarter-to-quarter basis until such time, in the near future, as
we have a new lender in place.
As of November 30, 2004, there was $847 borrowed on the $3,000 credit facility.
Management's other plans to alleviate substantial concern about the Company's
ability to continue as a going concern include, but are not limited to, the
following:
- We have generated net cash from operations of $902, $954, and $1,356
for the three years ended September 30, 2004, 2003, and 2002.
Overall, since February 2004, we have reduced expenses, both in the
manufacturing environment and in administrative arenas, by
approximately $2 million on an annualized basis. It is our intention
to continue to concentrate on expense reduction with a significant
concentration on product sourcing and material costs through fiscal
2005. We currently anticipate that our operating activities will
continue to provide net cash from operations through fiscal 2005.
- We have approximately $1,370 invested in 90-day treasury bills. This
investment, although segregated for our Edge Program, can be
utilized for working capital needs. If
22
we cannot replace the credit facility prior to March 31, 2005, we
currently anticipate that we will have sufficient liquidity to repay
the credit facility and cover all our cash needs through September,
2005 without use of the treasury bill investment, and, if we were to
use the treasury bill investment, we believe we will have sufficient
liquidity to cover our cash needs through December 2005.
CONTRACTUAL OBLIGATIONS / OFF-BALANCE SHEET ARRANGEMENTS- We have no significant
contractual obligations not fully recorded on our Consolidated Balance Sheets or
fully disclosed in the Notes to our Consolidated Financial Statements. We have
no material off-balance sheet arrangements. Set forth below, in tabular form, is
information as of September 30, 2004, for the periods indicated concerning our
obligations and commitments to make future payments under long-term obligations:
Fiscal Fiscal Beyond
Fiscal 2006- 2008- Fiscal
Contractual Obligations Total 2005 2007 2009 2009
- ------------------------------ --------- ---------- ---------- -------- ----------
Line of credit $ 962 $ 962 $ - $ - $ -
Long-term debt 11 11 - - -
Operating leases 4,514 524 811 798 2,381
Earned distributor development
program awards 1,400 400 800 200 -
--------- ---------- ---------- -------- ----------
Total $ 6,887 $ 1,897 $ 1,611 $ 998 $ 2,381
========= ========== ========== ======== ==========
Our line of credit is our credit facility as described above. Long-term debt of
$11 consists entirely of capital leases for certain plant equipment which we
expect will be fully paid by March 2005. Rent associated with our manufacturing
and corporate office buildings as well as monthly obligations for various office
equipment, primarily a phone system and copiers, largely comprise our operating
leases. These leases expire on various dates through 2014.
ACCRUED DISTRIBUTOR DEVELOPMENT LIABILITIES
We account for the potential one million dollar award for the Edge Success
Program ("Program") pursuant to EITF 01-9 "Accounting for Consideration Given by
a Vendor to a Customer (Including a Reseller of the Vendor's Products)". The
Program was designed to aid the Master Distributors in their
retirement/succession plan, and promote growth and retention within the new
Distributor network. Prior to the adoption of EITF 01-9 in fiscal 2001, we
utilized the services of an independent actuary who developed a model based on
our historical sales and other factors that identified the probability of
distributors reaching the goal (in aggregate) thereby triggering our cash
payment obligation. We recognized expense and recorded a liability based on that
model. However, as HMI is selling to distributors, any monetary amounts that are
paid to the distributors, pursuant to a program that is geared to volume of
sales falls within EITF 01-9.
EITF 01-9 states that any such amounts accrued must be reflected in the income
statement as a reduction of sales rather than selling expense. It also sets out
the standard that a liability should be recognized based on a systematic and
rational allocation of the cost of honoring rebates or refunds earned and
claimed to each of the underlying revenue transactions that result in progress
by the customer toward earning the rebate or refund. Breakage (the amount of
distributors who
23
will not reach the goal) should be estimated only if it can be reasonably
estimated. EITF 01-9 indicates that the ability to make a reasonable estimate
depends on many factors. Certain factors (such as a relatively long period in
which a particular rebate or refund may be claimed, as is in the case of our
Program) may indicate that breakage cannot be reasonably estimated. Related
guidance states that if recurring variances between the actual and estimated
amount of refunds are immaterial to either revenue or net income in quarterly or
annual financial statements then the item is considered reasonably estimable.
Over fifteen quarters ended September 30, 2004 to which EITF 01-9 applies, our
average actuarial gain (loss) may or may not be deemed material; however, on an
individual quarter-by-quarter basis the significant volatility of the actuarial
gains/loss to pre-tax income was deemed material to our financial results.
Therefore we concluded breakage from that perspective may not be reasonably
estimated and we could not use our actuarial method to estimate the liability.
This results in our recording a liability related to every qualifying sale and
only derecognizing such liability (i.e. the accrual is eliminated) when (i) the
award is paid out or (ii) when a distributor is no longer eligible for the
award. The application of EITF 01-9 requires a $16,321 accrual at September 30,
2004, to reflect the future obligation associated with the Program since the
effective adoption of EITF 01-9. This amount was determined by multiplying the
percentage of attainment of the 30,000 unit goal for every eligible distributor
by the present value of five payments of $200,000, discounted at a risk adjusted
interest rate.
We have been operating with a distributor network for over seventy years and we
implemented the Program in 1997. During those periods we have closely monitored
the distributor network and the turnover rate in the network. Based on that
accumulated knowledge, we believe that application of EITF 01-9, which requires
accruing on each sale as if every distributor involved with the sale was going
to earn the $1 million award, results in the recognition of an obligation we
believe will be significantly in excess of the payouts from the Program for the
foreseeable future. This is due to the assumption inherent in the maximum
accrual calculation that every distributor involved with a sale will qualify to
earn the award. Our history shows this not to be the case. During the twelve
quarters ended September 30, 2004, our turnover rate was, on average, more than
50%. For example, the participants in the Program from the Americas network who
left the Program during the twelve months ended September 30, 2004 represented
an accrual of over $2,800 and that period was not a period of extraordinary
turnover. Because we measure the accrual quarterly, departures may cause
quarterly results to vary greatly. In addition, the criteria for derecognizing
the accrual for any distributor requires that the distributor has lost
eligibility to participate in the Program.
We have been funding the actuarially determined present value of total award
payouts calculated on an aggregate basis under this program since September 2000
and such fund had a balance of $1,293 as of September 30, 2004. It is our
current intention to continue to fund the projected stream of cash payouts
subject to our cash flow model based on our aggregate actuarial model, which
will continue to be updated annually by our independent actuaries based on our
experience. These funds are maintained in a short term investment account and
recorded as cash and cash equivalents in our Consolidated Balance Sheets.
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
24
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 "Product Sales" regarding
the hope to rebuild a certain sales territory in the Americas, 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 difficulty in protecting our intellectual property rights
in a particular foreign jurisdiction; dependency on key personnel and the
ability to retain them; recessions in economies where we sell our products;
longer payment cycles for and greater difficulties collecting accounts
receivable; export controls, tariffs and other trade protection measures;
social, economic and political instability; changes in United States and foreign
countries laws and policies affecting trade; anticipated sales trends; the
ability to attract and retain Distributors and Importers; improved lead
generation and recruiting; and the ability to obtain financing for the end
consumer through consumer financing companies, including ACMS. 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 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (DOLLARS IN
THOUSANDS)
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 September 30, 2004, we had $962
outstanding under our credit facility bearing interest at prime rate (4.75%). If
interest rates were to increase 50 basis points (0.5%) from the September 30,
2004, rates and assuming no changes in outstanding debt levels from the
September 30, 2004, levels, we would realize an increase in our annual interest
expense of approximately $5.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the Index to Financial Statements included in this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Under the supervision and with the participation of management, including our
principal executive officer and principal financial officer we conducted an
evaluation of our disclosure controls and procedures, as such term is defined
under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as
amended (the Exchange Act). The principal executive officer and principal
financial officer have concluded, based on their review, that our disclosure
controls and procedures, were effective as of the end of the period covered by
this annual report 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.
25
CHANGES IN INTERNAL CONTROLS
We have undertaken and are in the process of hiring an employee in the Finance
department with a prime responsibility being the ongoing research and analysis
of all new accounting pronouncements and their implications to our Company. The
analysis of the new pronouncements will be reviewed with the Chief Financial
Officer, Corporate Controller and outside accountants to access their
applicability to the financial statements and disclosure requirements necessary
to meet the requirements of the SEC and generally accepted accounting
principles.
Other then noted above, no significant changes were made to our internal
controls or other factors during the last fiscal quarter that could
significantly affect the evaluation of these controls as referenced in the above
section "Evaluation of Disclosure Controls and Procedures."
ITEM 9B. OTHER
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
The information required by this item regarding directors is incorporated by
reference to our Definitive Proxy Statement to be filed with the Securities and
Exchange Commission in connection with the Annual Meeting of Stockholders to be
held in 2005 (the "2005 Proxy Statement") under the headings "Election of
Directors." Information regarding executive officers is set forth in Item 1 of
Part I of this Report under the caption "Executive Officers." The information
regarding our code of ethics is available on our website at www.filterqueen.com.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to the 2005
Proxy Statement under the heading "Executive Compensation."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to the 2005
Proxy Statement under the heading "Security Ownership of Certain Beneficial
Owners and Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to the 2005
Proxy Statement under the heading "Certain Transactions."
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this item is incorporated by reference to the 2005
Proxy Statement under the heading "Fees Paid to Grant Thornton LLP and
PricewaterhouseCoopers LLP."
26
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) DOCUMENTS FILED AS PART OF THIS REPORT.
1. FINANCIAL STATEMENTS AND RELATED SCHEDULES:
Page
Number
------
Report of Independent Registered Public Accounting Firm on the
September 30, 2004 financial statements 31
Report of Independent Registered Public Accounting Firm on the
September 30, 2003 and 2002 financial statements 32
Consolidated Balance Sheets as of September 30, 2004, and 2003 33
Consolidated Statements of Operations for the years ended
September 30, 2004, 2003, and 2002 34
Consolidated Statements of Stockholders' Equity for the years ended
September 30, 2004, 2003, and 2002 35
Consolidated Statements of Cash Flows for the years ended
September 30, 2004, 2003, and 2002 36
Notes to Consolidated Financial Statements 37
Schedule II - Valuation and Qualifying Accounts and Reserves 57
Schedules other than those listed above are omitted because they are not
required or are not applicable, or the required information is shown in
the consolidated financial statements, the notes thereto, or in
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
27
2. EXHIBIT LIST:
Exhibit
Number Description
- ------- --------------------------------------------------------------------------------------
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~
Incorporated by reference from Form 10-Q for the quarter ended June 30, 2003
Voting Trust Agreement~
9.0 Stockholders Voting Agreement, incorporated by reference from Form 13-D filed on
October 19, 2001, and Form 13-D/A3 filed on October 11, 2004.
10.00 Material Contracts~
U.S. Bank N.A. $2,000,000 Revolving Credit Note, incorporated by reference from
Form 10-Q for the quarter ended June 30, 2001
10.01 Material Contracts~
U.S. Bank N.A.$1,000,000 Revolving Credit Note, incorporated by reference from
Form 10-Q for the period ended March 31, 2002
10.02 Material Contracts~
Amendment to U.S. Bank N.A. $1,000,000 Revolving Credit Note, incorporated by
reference from Form 10-K for the year ended September 30, 2002
10.03 Material Contracts~
Amendment to U.S. Bank N.A. $2,000,000 Revolving Credit Note, incorporated by
reference from Form 10-Q for the quarter ended December 31, 2002
10.04 Material Contracts~
Amendment to U.S. Bank N.A. $2,000,000 Revolving Credit Note, incorporated by
reference from Form 10-K for the year ended September 30, 2003
10.05 Material Contracts~
U.S. Bank N.A. Waiver Letter and Amendment to Revolving Credit Note, dated
February 20, 2004, incorporated by reference from Form 10-K for the year ended
September 30, 2003.
10.06 Material Contracts~
U.S. Bank N.A. Waiver Letter and Amendment to Revolving Credit Note, dated
October 15, 2004, incorporated by reference from Form 8-K filed on October 21, 2004.
10.07 Material Contracts~
13-D Settlement Agreement incorporated by reference from Form 8-K filed on
February 19, 2002
10.08 Material Contracts~
Change of Control Agreement - Weeter, incorporated by reference from Form 10-K for
the year ended September 30, 2003.
10.09 Material Contracts~
Change of Control Agreement - Duggan, incorporated by reference from Form 10-K for
the year ended September 30, 2002
28
10.10 Material Contracts~
Change of Control Agreements - McGraw, incorporated by reference from Form 10-K/A3
for the year ended September 30, 1997
10.11 Material Contracts~
Incentive Stock Option Agreement - Pryor, incorporated by reference from Form 10-K
for the year ended September 30, 2001
10.12 Material Contracts~
Incentive Stock Option Agreements, incorporated by reference from Form 10-K for
the year ended September 30, 2001
10.13 Material Contracts~
Incentive Stock Option Agreements, incorporated by reference from Form 10-K for the
year ended September 30, 2000
11 Statement re: Computation of per share earnings~
See Note 1 on Page 45 of the Financial Statements
14 Code of Ethics~
Code of Ethics and related amendment available on the Company's website at
www.filterqueen.com.
21 Subsidiaries of Registrant~
Note 1 on Page 57 of this report
23.1 Consent of Independent Accountants (Grant Thornton LLP)~
Attached
23.2 Consent of Independent Accountants (PricewaterhouseCoopers LLP)~
Attached
31.1 Rule 13a-14(a)/15d-14(a) Certification~
Certification Pursuant to 15 U.S.C. Section 7241 for Kirk. W. Foley, attached
31.2 Rule 13a-14(a)/15d-14(a) Certification~
Certification Pursuant to 15 U.S.C. Section 7241 for Julie A. McGraw, attached
32.1 Section 1350 Certification~
Certification for Kirk W. Foley 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
(B) REPORTS ON FORM 8-K.
We filed a report with the SEC on Form 8-K dated November 19, 2004,
announcing that John Pryor, President of the Company, resigned effective
November 22, 2004. Mr. Pryor will remain a member of the Company's Board
of Directors.
(C) EXHIBITS.
29
Reference is made to the above Exhibit List table.
(D) FINANCIAL STATEMENT SCHEDULES.
Schedules required to be filed in response to this Item are listed above
in the Financial Statements and Related Schedules table.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this Report on Form 10-K to be
signed on its behalf by the undersigned, thereunto duly authorized.
HMI INDUSTRIES INC.
(Registrant)
by /s/ Julie A. McGraw
-----------------------------------
Julie A. McGraw
Vice President, Chief Financial Officer
and Treasurer
December 17, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
on Form 10-K has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
/s/ Kirk W. Foley /s/ John A. Pryor /s/ Robert Breadner
- ------------------------------------------ ---------------------------------------- ---------------------------------------
Kirk W. Foley John A. Pryor Robert Breadner
Chairman of the Board and Director Director Director
December 17, 2004 December 17, 2004 December 17, 2004
/s/ Wesley E. Foley /s/ Murray Walker /s/ Ivan J. Winfield
- ------------------------------------------ ---------------------------------------- ---------------------------------------
Wesley E. Foley Murray Walker Ivan J. Winfield
Director Director Director
December 17, 2004 December 17, 2004 December 17, 2004
/s/ Earl J. Watson
- ------------------------------------------
Earl J. Watson
Corporate Controller
December 17, 2004
30
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and
Shareholders of HMI Industries Inc.
We have audited the accompanying consolidated balance sheet of HMI Industries
Inc. (a Delaware corporation) and its subsidiaries as of September 30, 2004, and
the related consolidated statements of operations, stockholders' equity, and
cash flows for the year then ended. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the 2004 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of HMI
Industries Inc. and its subsidiaries as of September 30, 2004, and the results
of their operations and their cash flows for the year then ended in conformity
with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 2, the
Company incurred aggregate net losses of $17,564,000 during its most recent
three fiscal years and, as of September 30, 2004 the Company's total liabilities
exceeded its total assets by $12,247,000. In addition, the Company's credit
agreement expires on December 31, 2004. These factors, among others, as
discussed in Note 2, raise substantial doubt about the Company's ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note 2. The consolidated financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
/s/ Grant Thornton LLP
Cleveland, Ohio
December 16, 2004
31
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, stockholders' equity, and cash flows
present fairly, in all material respects, the financial position of HMI
Industries, Inc. and its subsidiaries at September 30, 2003, and the results of
their operations and their cash flows for each of the two years in the period
ended September 30, 2003, in conformity with accounting principles generally
accepted in the United States of America. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
As discussed in Note 1 to the consolidated financial statements, the Company
changed its method of accounting for goodwill and other intangible assets to
comply with the provisions of Statement of Financial Accounting Standard No.
142, "Goodwill and Other Intangible Assets," effective October 1, 2002.
As discussed in Note 5, the Company's credit facility agreement expires on
December 31, 2004.
The consolidated financial statements reflect the restatement described in Note
2 to the September 30, 2003 consolidated financial statements (which Note is not
separately presented herein).
/s/ PricewaterhouseCoopers LLP
Cleveland, Ohio
February 13, 2004 (except for the restatement described above and Note 5, as to
which the date is October 20, 2004)
32
HMI INDUSTRIES INC.
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, September 30,
Dollars and shares in thousands, except par values 2004 2003
- --------------------------------------------------------------------------- ------------- -------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,311 $ 948
Trade accounts receivable (net of allowance of $132 and $194) 2,767 1,892
Inventories:
Finished goods 2,458 2,555
Work-in-progress, raw material and supplies 1,950 2,153
Prepaid expenses 196 397
Other current assets 134 152
------------- -------------
Total current assets 8,816 8,097
------------- -------------
PROPERTY, PLANT AND EQUIPMENT, NET 1,526 2,178
------------- -------------
OTHER ASSETS:
Trademarks (net of accumulated amortization of $239 and $202) 149 272
Other - 121
------------- -------------
Total other assets 149 393
------------- -------------
Total assets $ 10,491 $ 10,668
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Line of credit $ 962 $ 1,383
Trade accounts payable 2,036 2,143
Income taxes payable 501 506
Accrued expenses and other liabilities 2,907 2,399
Distributor Development Liability due within one year 400 200
Long-term debt due within one year 11 22
------------- -------------
Total current liabilities 6,817 6,653
------------- -------------
LONG-TERM LIABILITIES:
Long-term debt (less amounts due within one year) - 11
Distributor Development Liability (less amounts due within one year) 15,921 12,758
------------- -------------
Total long-term liabilities 15,921 12,769
------------- -------------
STOCKHOLDERS' DEFICIT:
Preferred stock, $5 par value; authorized, 300 shares; issued, none - -
Common stock, $1 par value; authorized, 10,000 shares;
issued and outstanding, 6,746 shares 6,746 6,746
Capital in excess of par value 8,230 8,231
Accumulated deficit (27,223) (23,731)
------------- -------------
Total stockholders' deficit (12,247) (8,754)
------------- -------------
Total liabilities and stockholders' deficit $ 10,491 $ 10,668
============= =============
See notes to consolidated financial statements.
33
HMI INDUSTRIES INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED SEPTEMBER 30,
Dollars and shares in thousands, except per share data 2004 2003 2002
- --------------------------------------------------------------------------- ------------ ------------ ------------
REVENUES:
Product sales, less returns and allowances 35,591 34,539 37,113
Distributor development program (3,687) (4,369) (2,589)
------------ ------------ ------------
Net product sales 31,904 30,170 34,524
Other revenues 86 - -
------------ ------------ ------------
Total revenues $ 31,990 $ 30,170 $ 34,524
------------ ------------ ------------
OPERATING COSTS AND EXPENSES:
Cost of products sold 21,479 21,025 21,298
Selling, general and administrative expenses 13,985 13,404 14,591
Loss on impairment of asset - 1,711 -
Loss on liquidation of subsidiary - 905 -
Interest expense 77 53 86
Other (income) expense, net (66) (158) 344
------------ ------------ ------------
Total operating costs and expenses 35,475 36,940 36,319
------------ ------------ ------------
Loss before income taxes and cumulative effect of accounting change (3,485) (6,770) (1,795)
Provision for income taxes 7 18 38
------------ ------------ ------------
Loss before cumulative effect of accounting change (3,492) (6,788) (1,833)
Cumulative effect of accounting change - 5,451 -
------------ ------------ ------------
NET LOSS $ (3,492) $ (12,239) $ (1,833)
============ ============ ============
Weighted average number of shares outstanding:
Basic 6,746 6,744 6,719
Diluted 6,746 6,744 6,719
============ ============ ============
BASIC AND DILUTED PER SHARE OF COMMON STOCK (NOTE 1):
Loss before cumulative effect of accounting change $ (0.52) $ (1.01) $ (0.27)
Cumulative effect of accounting change $ - $ (0.81) $ -
------------ ------------ ------------
NET LOSS $ (0.52) $ (1.82) $ (0.27)
============ ============ ============
See notes to consolidated financial statements.
34
HMI INDUSTRIES INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED SEPTEMBER 30, 2004, 2003, AND 2002
Capital
in Accumulated Total
Excess Other Treasury Stockholders'
Common of Par Unearned Accumulated Comprehensive Treasury Stock Equity
Dollars in thousands Stock Value Compensation Deficit Loss Shares Amount (Deficit)
- ----------------------------- ------ ------- ------------ ----------- ------------- -------- -------- -------------
Balance at September 30, 2001 $6,708 $ 8,279 ($ 8) ($ 9,659) ($ 900) - $ - $ 4,420
Comprehensive income:
Net loss, restated (1,833) (1,833)
Translation adjustment (5) (5)
---------
Total comprehensive income (1,838)
Issuance of common stock 38 38
Unearned compensation 5 5
Employee benefit stock (48) (48)
------ ------- ------------ ----------- ---------- -------- -------- ---------
Balance at September 30, 2002 6,746 8,231 (3) (11,492) (905) - - 2,577
Comprehensive income:
Net loss, restated (12,239) (12,239)
Translation adjustment -
---------
Total comprehensive income (12,239)
Cumulative translation
adjustment associated with
liquidation of foreign 905 905
subsidiary
Unearned compensation 3 3
------ ------- ------------ ----------- ---------- -------- -------- ---------
Balance at September 30, 2003 6,746 8,231 - (23,731) - - - (8,754)
NET LOSS (3,492) (3,492)
OTHER ADJUSTMENT (1) (1)
------ ------- ------------ ----------- ---------- -------- -------- ---------
BALANCE AT SEPTEMBER 30, 2004 $6,746 $ 8,230 $ - ($ 27,223) $ - - $ - ($ 12,247)
====== ======= ============ =========== ========== ======== ======== =========
See notes to consolidated financial statements.
35
HMI INDUSTRIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED SEPTEMBER 30,
Dollars in thousands 2004 2003 2002
- --------------------------------------------------------------------------- ------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (3,492) $ (12,239) $ (1,833)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Cumulative effect of accounting change - 5,451 -
Loss on impairment of asset - 1,711 -
Loss on liquidation of foreign subsidiary - 905 -
Distributor development program 3,163 3,969 2,589
Depreciation and amortization 653 744 928
Provision for loss on sale/disposal of assets 170 - 17
Provision for loss on receivables - - 59
Treasury/common shares issued, net of unearned compensation
and employee benefit stock - - (5)
Unearned compensation - 3 -
Changes in operating assets and liabilities:
(Increase) decrease in receivables (875) 115 100
Decrease (increase) in inventories 300 (518) (441)
Decrease (increase) in prepaid expenses 201 (105) (108)
Decrease (increase) in other current assets 18 (98) 309
(Decrease) increase in accounts payable (107) 186 (343)
Increase in accrued expenses and other liabilities 508 536 188
Increase in distributor development liability 200 200 -
Decrease in income taxes payable (5) (11) (18)
Other, net 168 105 (86)
------------ ------------ ------------
Net cash provided by operating activities 902 954 1,356
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (96) (176) (866)
------------ ------------ ------------
Net cash used in investing activities (96) (176) (866)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (repayments) borrowing under credit facility (421) (9) 201
Payment of long term debt (22) (302) (615)
------------ ------------ ------------
Net cash used in financing activities (443) (311) (414)
------------ ------------ ------------
Net increase in cash and cash equivalents 363 467 76
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 948 481 405
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 1,311 $ 948 $ 481
============ ============ ============
See notes to consolidated financial statements.
36
HMI Industries Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (DOLLARS IN THOUSANDS, EXCEPT
SHARES AND PER SHARE DATA)
BASIS OF CONSOLIDATION
The consolidated financial statements include all controlled subsidiaries.
Operations include the accounts of HMI Industries Inc. and the following
wholly-owned subsidiaries: AdvantEdge Credit Management Services Inc.,
Health-Mor International Inc., HMI Incorporated, Health-Mor Acceptance
Corporation, and HMI Acceptance Corporation. All significant intercompany
accounts and transactions have been eliminated.
Our principal products include a high filtration portable surface cleaner that
is marketed as a healthier alternative to the typical vacuum cleaner and a
portable room air cleaner that helps to remove particles, gases, and odors from
the air. The two products are sold together as a complete Filter Queen Indoor
Air Quality System(TM).
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and judgments that affect the reported amounts of assets and
liabilities and disclosure of any contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting periods. Actual results could differ from those estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Our financial instruments consist principally of cash and cash equivalents,
accounts receivable, accounts payable, accrued expenses and other liabilities,
line of credit, and short and long-term debt in which the fair value of these
financial instruments approximates the carrying value.
CASH EQUIVALENTS
We consider all highly liquid instruments purchased with a maturity of less than
three months to be cash equivalents. Cash equivalents are comprised primarily of
commercial paper. We believe the carrying amounts approximate fair value due to
the short maturities of these instruments.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
We maintain an allowance for doubtful accounts for estimated losses resulting
from the inability of our customers to make required payments. Quarterly, we
perform a review of all customer accounts with respect to aging of receivables,
historical payment patterns, customers' financial condition, and from this
review determine if an allowance is needed.
37
SALES RETURN AND ALLOWANCE
We record a provision for estimated sales returns and allowances on product
sales in the same period as the related revenues are recorded. These estimates
are based on historical sales returns and other known factors.
ADVERTISING COSTS
We expense the production costs of advertising the first time the advertising
takes place. Advertising expense was $50, $151, and $1,808, in fiscal 2004,
2003, and 2002, respectively.
INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined on the
last-in, first-out (LIFO) method, which provides a better matching of current
costs and revenues. The following presents the effect on inventories and income
before taxes had we used the first-in, first-out (FIFO) method of inventory
valuation.
2004 2003
---------- ----------
Percentage of total inventories on LIFO 100% 100%
Inventory amount had FIFO method been utilized to value inventory $ 4,798 $ 5,103
Decrease in net loss before taxes, due to LIFO reserve $ (6) $ (14)
EXCESS AND OBSOLESCENCE RESERVES
We evaluate our inventory quarterly to determine excess or slow moving items
based on current order activity and projections of future demand. For those
items identified, we estimate their market value or net sales value based on
current trends. An allowance is created for those items having a net sales value
less than cost.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost. Depreciation is provided on
the straight-line method over estimated useful lives of 5 years for leasehold
improvements and 3 to 10 years for machinery and equipment. Improvements, which
extend the useful life of property, plant and equipment, are capitalized, and
maintenance and repairs are expensed. When property, plant and equipment are
retired or otherwise disposed of, the cost and accumulated depreciation are
removed from the appropriate accounts and any gain or loss is included in
income.
GOODWILL AND OTHER INTANGIBLE ASSETS
Pursuant to Statement of Financial Accounting Standards ("SFAS") No. 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 year ended September
30, 2002 was $245.
SFAS No. 142 primarily addresses the accounting for goodwill and intangible
assets subsequent to their initial recognition. The provisions of SFAS No. 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.
38
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). Management does not believe that the market value of
common stock fairly reflects the value of HMI, because of, among other things,
the absence of liquidity, and the absence of analyst coverage. Accordingly, 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 three
valuations referred to above and depending on the weighting used for each
valuation, results of the valuation could be significantly changed. However, for
accounting purposes we believed that the weighting methodology used was
reasonable and resulted in an accurate and fair value of HMI.
During the second quarter of fiscal 2003 we completed our initial impairment
test for October 1, 2002, resulting in a full impairment of the goodwill
recorded on HMI's books through a non-cash charge of $5,451. Such charge is
non-operational in nature and is reflected as a Cumulative Effect of Accounting
Change in the accompanying Consolidated Statements of Operations for the year
ended September 30, 2003.
A reconciliation of the reported net loss and net loss 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 years ended September 30, 2003, and
2002, respectively, had the provisions of SFAS No. 142 been applied on October
1, 2001, is as follows:
2003 2002
---------- ----------
Loss before cumulative effect of accounting change $ (6,788) $ (1,833)
Cumulative effect of accounting change 5,451 -
---------- ----------
Net loss (12,239) (1,833)
Goodwill amortization add back, net of tax - 245
---------- ----------
Adjusted net loss $ (12,239) $ (1,588)
========== ==========
Weighted average number of shares outstanding:
Basic and diluted 6,744 6,719
========== ==========
Basic and diluted per share of common stock:
Loss before cumulative effect of accounting change $ (1.01) $ (0.27)
Cumulative effect of accounting change $ (0.81) -
Goodwill amortization add back, net of tax - $ 0.04
========== ==========
Adjusted net loss $ (1.82) $ (0.23)
========== ==========
Total amortization expense for trademarks and patents was $39, $49, and $41 for
the years ended September 30, 2004, 2003, and 2002, respectively. Amortization
expense for trademarks and patents is estimated for the next five fiscal years
ending September 30, 2005, through 2009, as $17, $16, $14, $12, and $11,
respectively.
VALUATION OF LONG-LIVED ASSETS
In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" we assess potential impairments to our long-lived assets when
there is evidence that
39
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 asset is not recoverable and exceeds its fair value. The
carrying amount of a long-lived 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 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.
During the fourth quarter of fiscal 2003 we performed an analysis on the
potential impairment on certain tooling assets, and related patents and
trademarks, approximating $1,711 which related to a potential new product. Based
upon our analysis, we concluded that the tooling assets were fully impaired as
of September 30, 2003; this conclusion was based upon the held and used model
which includes significant assumptions regarding future cash flows and utilizes
a model of weighted probability cash flow projections over the estimated life of
the product. Scrap value for these assets was determined to be nominal;
accordingly a $1,711 impairment of these assets was recorded as of September 30,
2003, to write the assets down to their net realizable value. This product will
not have any additional resources devoted to its refinement and completion, nor
will the product be marketed or sold as an ongoing part of our product
portfolio. As a result the impairment is not expected to have an impact on
future revenue or net income.
ACCRUED DISTRIBUTOR DEVELOPMENT LIABILITIES
We account for the potential one million dollar award for the Edge Success
Program "Edge or Program" pursuant to Emerging Issues Task Force Consensus
("EITF") 01-9, "Accounting for Consideration Given by a Vendor to a Customer
(Including a Reseller of a Vendor's Products)"; accordingly we reflect the
accrual for this award as a reduction of revenues. We have determined that for
purposes of EITF 01-9 it is not possible to reasonably estimate breakage (the
amount of distributors who will not reach the goal) and therefore accrue such
awards assuming a maximum accrual rate whereby we assume each eligible
distributor will eventually earn the award. In other words, for each qualifying
sale, we have recorded a liability by reducing revenue. Such a liability will
only be derecognized (i.e. the accrual eliminated) when (i) the award is paid
out or (ii) when a distributor is no longer eligible for the award. For the
years ended September 30, 2004, 2003 and 2002, the accounting for this Program
decreased sales by $3,687, $4,369 and $2,589, respectively. On our Consolidated
Balance Sheets as of September 30, 2004, and 2003 we had accrued $16,321, and
$12,958, respectively, relative to this Program.
FOREIGN CURRENCY TRANSLATION
Prior to the liquidation, in the second quarter of fiscal 2003, of our remaining
foreign subsidiaries, all consolidated foreign operations used the local
currency of the country of operation as the functional currency and translated
the local currency asset and liability accounts at year-end exchange rates while
income and expense accounts were translated at weighted average exchange rates.
The resulting translation adjustments were accumulated as a separate component
of Stockholders' Equity titled "Accumulated Other Comprehensive Loss." Such
adjustments affected net income only upon sale or liquidation of the underlying
foreign investments.
Exchange gains and losses from transactions in a currency other than the local
currency of the entity involved are included in income as they occur. All of our
product sales to our customer
40
base are conducted in U.S. dollars and therefore net transaction and translation
adjustments are not significant.
During the second quarter of fiscal 2003 we recorded a write-off of $905 for
cumulative translation adjustments associated, primarily, with the liquidation
of our Canadian subsidiary. The loss on disposal solely related to cumulative
foreign currency translation adjustment as a result of the Canadian subsidiary
ceasing to function as an operating entity in a prior fiscal year and in part
the result of the goodwill impairment associated with the adoption of SFAS No.
142.
In March 1998, we changed the way we operated in Canada by engaging an importer
to assume responsibility for and manage the distribution network in that
country, similar to the way we do business in the rest of our international
markets. Consequently it was no longer necessary to maintain a physical presence
in Canada, gradually reducing the necessity for the entity. For a period of time
after we began selling to the importer in Canada and based on his sales results
in Canada, we considered the possibility of utilizing the subsidiary again.
Moreover, at the time we completed step two of our SFAS No. 142 Goodwill
implementation the only material remaining items in the financial records of the
Canadian subsidiary related to Goodwill and Cumulative Translation Adjustments
("CTA"). As discussed above, the goodwill was deemed to be fully impaired and
was written off as a cumulative change in accounting principal due to the
adoption of SFAS No. 142. In conjunction with the goodwill write off we reviewed
possible future options for our Canadian subsidiary, and we chose to liquidate
the entity. Therefore we recorded a loss on disposal of $905 associated with
cumulative translation adjustments for this subsidiary.
COMPREHENSIVE INCOME/LOSS
Prior to the liquidation in the second quarter of fiscal 2003 of our remaining
foreign subsidiaries, comprehensive income/loss combined net income/loss and
"other comprehensive items," which represented foreign currency translation
adjustments, were reported as a separate component of Stockholders' Equity in
the Consolidated Balance Sheets. We presented such information in our Statements
of Stockholders' Equity on an annual basis and in a footnote in our quarterly
reports. Subsequent to the liquidation of our Canadian subsidiary, we did not
incur foreign currency translation adjustments.
GUARANTEES
We have guaranteed repayment to a finance company for certain events of default
by some of our Canadian distributors. The finance company purchases the
installment sales contracts that the distributors entered into with their
customers for the sale of products manufactured by HMI. 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. For example, we would be required to
purchase from the finance company a contract entered into by an end consumer to
finance the purchase of our product if the finance company believes that the
contract has been improperly obtained.
We require the participating Canadian distributors to provide us with cash
reserves, which are recorded as liabilities on our books, in order to provide a
fund for the payments of any defaults by the participating Canadian
distributors. We had $85 and $75 of cash reserves received from Canadian
Distributors as of September 30, 2004 and 2003, respectively. These amounts were
41
included in the accrued expenses and other liabilities line item of our
Consolidated Balance Sheets. We expect to hold the funds for at least a period
approximating the term of the finance contracts with the end consumers, which
typically have a 36 month term.
Although it is not practical for us to estimate future cash payments on possible
repurchases; the maximum potential of future payments that we could be required
to make under the guarantee is the total contracts outstanding of $679 and $843
at September 30, 2004 and 2003, respectively. However, from the commencement of
the contract in July 2002 we have repurchased only one contract for
approximately $3 under this guarantee. Moreover, we are permitted pursuant to
agreements with our Canadian distributors to be reimbursed from the cash
reserves referred to above for the costs and expenses incurred in fulfilling our
guarantee to the finance company.
In addition, we formed a wholly owned subsidiary, AdvantEdge Credit Management
Services ("ACMS") during the third quarter of fiscal 2004 to provide brokerage
services for the sourcing of consumer credit by assisting our U.S. based
independent distributor network in securing third party financing of our
products that they sell to end consumers. ACMS has guaranteed repayment to
various finance companies for certain events of default by some of our U.S.
distributors in a manner similar to our guarantee with the aforementioned
Canadian Finance Company. The maximum potential of future payments that ACMS
could be required to make under the guarantees is associated with the total
contacts outstanding at three finance companies in an aggregate amount of $3,574
at September 30, 2004. We have not been required to repurchase any contracts
pursuant to this guarantee.
Warranty
We warrant our surface cleaner for a two-year period from the date of purchase
and offer a lifetime service benefit for the replacement of the surface
cleaner's motor at a price not to exceed $99 (Dollar's not in thousands). On
occasion, we also support a five-year optional extended warranty on the portable
surface cleaner offered by our U.S. Distributors to the end consumer as a sales
promotion during an in home product demonstration. As an enticement to the end
consumer to buy our product during that demonstration, the five year optional
extended warranty is offered to them at no cost; accordingly no revenue for this
optional warranty is recognized by HMI. Outside the U.S. we offer a two-year
warranty for our high filtration portable surface cleaner. The portable room air
cleaner is warranted for renewable one-year periods so long as the main air
filter is replaced annually. A five-year warranty is offered for our built-in
vacuum system.
Our policy is to record a provision for the expected cost of warranty-related
claims at the time of the sale and adjust the provision to reflect actual
experience quarterly. The amount of warranty liability accrued reflects
management's best estimate of the expected future cost of honoring our
obligations under the warranty plans. Historically, the cost of fulfilling our
warranty obligations has principally involved replacements parts, labor and
sometimes travel. Our estimates are based on historical experience, the number
of units involved, and the extent of features/components included in product
models.
42
Changes in our warranty liability for the years ended September 30, 2004, 2003,
and 2002, were as follows:
2004 2003 2002
-------- -------- --------
Balance at beginning of period $ 193 $ 190 $ 299
Charges to expense 254 245 60
Usage (250) (242) (169)
-------- -------- --------
Balance at end of period $ 197 $ 193 $ 190
======== ======== ========
SHIPPING AND HANDLING COSTS
Costs incurred for shipping and handling are included in the cost of products
sold when incurred. Amounts billed to customers for shipping and handling are
reported as net product sales.
SEGMENT REPORTING
We conduct our business as a single reportable segment.
CONCENTRATIONS
We are subject to risks specific to the individual customers with whom we do
business. In fiscal 2004 and 2003 no individual customer accounted for more than
10% of our product sales. In fiscal 2002 one international customer in Japan
accounted for 11.9% of our product sales.
Our revenues, and the stability of such revenues, are dependent on our
relationships with third-party distributors and their sales persons and their
level of satisfaction with our products and us. The Distributors and Importers
are independent third parties who are not our employees and are not directly
under our control. There can be no assurance that the current relationships with
Distributors and Importers will continue on acceptable terms and conditions to
us, nor can there be any assurance that additional distributorship arrangements
with third parties will be obtained on acceptable terms. Moreover, there can be
no assurance that the Distributors and Importers will devote sufficient time and
resources to our products to enable the products to be successfully marketed.
Failure of some or all of our products to be successfully and efficiently
distributed could have a material adverse effect on our financial condition and
results of operations.
Sales to international customers represent 41.1%, 35.8%, and 43.1% of net
product sales for the years ended September 30, 2004, 2003, and 2002
respectively.
REVENUE RECOGNITION
Our revenue recognition policy is to recognize revenues when products are
shipped, or for certain customers when the products are received by the
customer's shipping agent, at which time title transfers to the customer. Our
sales are based on standard pricing and our product is shipped with FOB shipping
point terms (ExWorks for all but one international customer) at which time all
of the risks and rewards of ownership pass to the customer including the risk of
collection from the end consumer; accordingly, revenue is recognized at the time
of shipment. Additionally we are not required to repurchase the product nor do
we have bill and hold arrangements with any of our customers.
43
In the U.S. and Canada terms are generally prepaid or C.O.D. In some limited
cases shipments bear net 30 day terms; however, in no instances is payment ever
dependent on the distributors' sale of product to our end consumer. Therefore
the guarantee to the Canadian finance company for certain events of default by
some of our Canadian distributors does not impact the recognition of revenue for
sales made to these distributors. When the financing company finances an end
consumer purchase (and pays the distributor), we guarantee that the contract was
not fraudulently prepared or entered into only. See "Guarantees" above for
further information.
On occasion, our customers (distributors) in the United States and Canada offer
a five year extended warranty to the end consumers of our surface cleaner
product as a promotion to purchase the product during that demonstration. The
five year optional extended warranty is offered to them at no cost; accordingly
no revenue is recognized.
Discounts earned based on promotional programs in place, volume of purchases or
other factors are also estimated at the time of revenue recognition and recorded
as a reduction of that revenue.
In February 2002, the Emerging Issues Task Force codified and issued EITF 01-9,
"Accounting for Consideration Given by a Vendor to a Customer (Including a
Reseller of the Vendors Products)." The pronouncement requires that cash
consideration, including sales incentives, given by a vendor to a customer be
presumed to be a reduction of the selling prices of the vendor's products or
services and, therefore, characterized as a reduction of revenue when recognized
in the vendor's income statement. Breakage occurs when a distributor is no
longer eligible for the award; the associated accrued liability is derecognized
at that time and the resultant termination gain is netted in the contra sales
Distributor Development Program line item of our Consolidated Statements of
Operations.
RESEARCH AND DEVELOPMENT COSTS
Costs incurred in research and development are expensed as incurred and included
in SG&A expenses. In fiscal years 2004, 2003, and 2002, we invested $53, $75,
and $273, respectively, in new product development.
INCOME TAXES
We account for income taxes pursuant to the provisions of SFAS No. 109,
"Accounting for Income Taxes." Under SFAS No.109, the tax consequences in the
future years for differences between the financial and tax bases of assets and
liabilities at year-end are reflected as deferred income taxes.
Carrying value of our domestic net deferred tax assets assumes that we will be
able to generate sufficient future taxable income in certain tax jurisdictions,
based on estimates and assumptions. Management evaluates the realizability of
the deferred tax assets quarterly and assesses the need for additional valuation
allowances quarterly.
44
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest was $68, $53, and $86 for the years ended September 30,
2004, 2003, and 2002, respectively. Cash paid for income taxes was $15, $29, and
$56 for the years ended September 30, 2004, 2003, and 2002, respectively.
The following transaction has been treated as a non-cash financing item for
purposes of the Consolidated Statements of Cash Flows. During the third and
fourth quarters of fiscal 2002 we recorded $290 in debt in exchange for assets.
These vendor-financed assets consisted primarily of tools, molds, and equipment
associated with new product development.
EARNINGS PER SHARE
Earnings per share have been computed according to SFAS No. 128, "Earnings Per
Share." The following is a reconciliation of the number of shares (denominator)
used in the basic and diluted earnings per share computations (shares in
thousands) for the years ended September 30,
2004 2003 2002
----------------------- ----------------------- -----------------------
Per Per Per
Share Share Share
Shares Amount Shares Amount Shares Amount
---------- ---------- ---------- ---------- ---------- ----------
Basic EPS 6,746 $ (0.52) 6,744 $ (1.82) $ 6,719 $ (0.27)
Effect of dilutive
stock options - - - - - -
---------- ---------- ---------- ---------- ---------- ----------
Diluted EPS 6,746 $ (0.52) 6,744 $ (1.82) $ 6,719 $ (0.27)
========== ========== ========== ========== ========== ==========
Options outstanding during the years ended September 30, 2004, 2003 and 2002, to
purchase approximately 917, 1,159, and 1,147 shares of common stock,
respectively, were not included in the computation of diluted EPS because the
options' exercise prices were greater than the average market prices of the
common stock during the period and, therefore, the effect would be
anti-dilutive. The exercise prices of the options outstanding at September 30,
2004, range from $1.00 to $7.50 per share and expire between January 4, 2005,
and March 29, 2009.
LONG-TERM COMPENSATION PLAN
We apply Accounting Principles Board ("APB") Opinion No. 25, "Accounting for
Stock Issued to Employees" and related interpretations in accounting for our
stock plans as allowed under SFAS No. 123, "Accounting for Stock-Based
Compensation". Had compensation cost for the stock granted in 2004, 2003, and
2002 been determined consistent with SFAS No. 123, pro forma net loss and loss
per common share would have been as follows (dollars in thousands, except per
share data):
2004 2003 2002
---------- ---------- ----------
Net loss, as reported $ (3,492) $ (12,239) $ (1,833)
Add: Stock-based employee compensation expense included in reported
net income - 2 3
Deduct: Total stock-based employee compensation expense determined
under fair value based method for all awards 139 93 150
---------- ---------- ----------
PRO FORMA NET LOSS $ (3,631) $ (12,330) $ (1,980)
========== ========== ==========
BASIC AND DILUTED PER SHARE OF COMMON STOCK:
As reported $ (0.52) $ (1.82) $ (0.27)
Proforma $ (0.54) $ (1.83) $ (0.29)
45
2. GOING CONCERN
The accompanying financial statements have been prepared in conformity with
generally accepted accounting principles which contemplate continuation of the
Company as a going concern. During the year ended September 30, 2004, we
incurred a net loss of $3,492, had deficit equity of $12,247 at September 30,
2004, and as of the date of the audit opinion did not have an executed long-term
financing agreement. As a result of these factors, our accounting firm has
issued an audit report with a modification expressing substantial doubt about
our ability to continue as a going concern. The financial statements and
financial information do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or amounts and
classification of liabilities that might be necessary should we be unable to
continue in existence.
We are actively seeking through of the use of both internal personnel and an
outside broker, finance sources to replace the credit facility prior to its
expiration on March 31, 2005. Although no long-term debt arrangement is in place
as of the date of this filing, our current lender has been agreeable to
extending our current facility on a quarter-to-quarter basis until such time, in
the near future, as we have a new lender in place.
As of November 30, 2004, there was $847 borrowed on the $3,000 credit facility.
Management's other plans to alleviate substantial concern about the Company's
ability to continue as a going concern include, but are not limited to, the
following:
- We have generated net cash from operations of $902, $954, and $1,356
for the three years ended September 30, 2004, 2003, and 2002.
Overall since February 2004, we have reduced expenses, both in the
manufacturing environment and in administrative arenas, by
approximately $2 million on an annualized basis. It is our intention
to continue to concentrate on expense reduction with a significant
concentration on product sourcing and material costs through fiscal
2005. We currently anticipate that our operating activities will
continue to provide net cash from operations through fiscal 2005.
- We have approximately $1,370 invested in 90-day treasury bills. This
investment, although segregated for our Edge Program, can be
utilized for working capital needs. If we cannot replace the credit
facility prior to March 31, 2005, we currently anticipate that we
will have sufficient liquidity to repay the credit facility and
cover all our cash needs through September, 2005 without use of the
treasury bill investment, and, if we were to use the treasury bill
investment, we believe we will have sufficient liquidity to cover
our cash needs through December, 2005.
3. PROPERTY, PLANT AND EQUIPMENT
2004 2003
---------- ----------
Leasehold improvements $ 288 $ 288
Machinery and equipment 7,314 7,747
---------- ----------
7,602 8,035
Accumulated depreciation 6,076 5,857
----------
46
---------- ----------
Net property, plant and equipment $ 1,526 $ 2,178
========== ==========
Depreciation expense relating to operations for the years ended September 30,
2004, 2003, and 2002, was $625, $695, and $639, respectively.
47
4. ACCRUED EXPENSES AND OTHER LIABILITIES
Accrued expenses and other liabilities consist of the following:
2004 2003
---------- ----------
Distributor fund payable $ 902 $ 1,020
Accrued compensation 637 544
Accrued litigation 515 15
Other 853 820
---------- ----------
$ 2,907 $ 2,399
========== ==========
The distributor fund payable represents the accumulation of distributor price
overrides ("DPO's") such as those that are paid by promoted distributors to
promoting distributors. The promoted distributors represent individuals who are
recruited as sales associates and subsequently promoted to become distributors
themselves. DPO's are a unit price override charged on top of our standard unit
sales price for which we, HMI, act as a pass through, meaning that we collect
the DPO from the promoted distributor and disburse it to the promoting
distributor upon their request; accordingly these DPO's are not reflected in our
income statement as revenue, but rather are recorded as an accrual when the cash
is received.
The decrease in the Distributor Fund Payable is a result of the decreased sales
volume in the Americas and payments on behalf of our Americas distribution
network associated with liabilities previously recorded in fiscal 2003.
5. DEBT AND CREDIT FACILITY
Our $3,000 credit facility agreement includes various covenants that limit our
ability to incur additional indebtedness, restricts paying dividends and limits
capital expenditures, and requires we maintain a minimum net worth. As of
September 30, 2003, we were not in compliance with our interest coverage ratio,
and net worth covenants; however, we obtained a waiver on these covenants which
was effective until the February 20, 2004 amendment of the credit facility. We
were required to maintain an interest coverage ratio of greater than or equal to
5.0 to 1.0 interest to earnings before interest, taxes, depreciation and
amortization ("EBITDA") and a net worth of at least $7,400, calculated quarterly
and increasing by 50% of net income annually.
On February 20, 2004, an amendment of our credit facility agreement was executed
with our lender. The expiration date was extended to October 15, 2004. The
amended agreement carried the same interest rate and similar covenants as the
previous amended loan agreement, with the exception of the interest coverage
ratio which was amended to exclude non-cash expenses from the 5.0 to 1.0 ratio,
including but not limited to, the impairment of tooling assets and associated
inventory, and the tangible net worth covenant in which the minimum amount was
reset to $2,400.
On October 15, 2004, an amendment of our $3,000 credit facility agreement was
executed with our lender. The bank agreed to extend the maturity date of the
loan until December 31, 2004. The amended agreement carries an interest rate of
prime plus one percent and covenants similar to the previous amended loan
agreement, with the exception of the tangible net worth covenant which was
eliminated through the maturity date of the loan. On December 16, 2004, we
received a letter from our current lender which outlined their commitment to
amend the maturity date of our credit facility until March 31, 2005.
Additionally, we agreed to reduce the
48
facility availability from $3,000 to the original $2,000 credit limit. The
purpose of the additional $1,000 availability, to assist with the build-up of
inventory associated with new product launches, has been fulfilled and
consequently the borrowing capacity is no longer necessary.
We are actively seeking; through of the use of both internal personnel and an
outside broker, finance sources to replace the credit facility prior to its
expiration. If we cannot replace the credit facility prior to March 31, 2005, we
currently anticipate that we will have sufficient liquidity to repay the credit
facility and cover all our cash needs through September, 2005.
As of November 30, 2004, there was $847 borrowed on the $3,000 credit facility.
Long-term debt consists of the following:
2004 2003
---------- ----------
Bank line of credit - see above $ 962 $ 1,383
Capitalized lease obligations 11 33
bearing interest at 2.62% to 12.00% due in
monthly installments of $2 (including interest)
through March 2005
---------- ----------
973 1,416
Less amounts due within one year 973 1,405
---------- ----------
$ - $ 11
========== ==========
The principal amount of long-term debt payable in the five years ending
September 30, 2005, through 2009, is $973, $-0-, $-0-, $-0-, and $-0-. The
weighted average interest rate on short-term borrowings at September 30, 2004,
and 2003, was 4.80% and 4.08%, respectively.
6. LONG-TERM COMPENSATION PLAN
We adopted the Health-Mor Inc. 1992 Omnibus Long-Term Compensation Plan in 1992.
The Plan provides for the granting of stock options, stock appreciation rights,
restricted stock awards, phantom stock, and/or performance shares ("Awards") to
our key employees and stock options for our non-employee directors. Options
granted under the Plan expire up to ten years after the date of grant if not
exercised and may be exercisable in whole or in part at the discretion of the
Committee established by the Board of Directors. Shares available for issuance
under the Plan may be authorized and unissued shares or treasury shares. The
maximum number of shares of common stock available for grant of Awards under the
Plan are limited on an annual and cumulative basis as further defined in the
Plan.
Stock options under the Plan generally have exercise prices equal to the fair
market values at dates of grant, otherwise, if the option price is less than the
fair market value at the date of the grant, compensation expense is recorded for
the difference. For restricted or phantom stock, we record compensation expense
as the excess of the quoted market price of the unrestricted share of stock at
the award date over the purchase price, if any.
No options or awards were granted during fiscal 2003 or 2002 to key employees.
49
During fiscal 2004 the Board of Directors granted 250,000 stock options to Kirk
W. Foley, Chairman. These non-qualified options were not issued under the Plan.
All 250,000 options vested immediately and expire in 2009. No compensation
expense was recorded related to the stock options as the exercise price was
higher than the fair market value at the grant date.
There were no shares issued and no non-vested shares forfeited pursuant to the
Plan in fiscal 2004, 2003, and 2002. Unamortized deferred compensation amounted
to $-0-, $-0-, and $3 at September 30, 2004, 2003, and 2002, respectively. Total
compensation expense, in conjunction with the Plan was $-0-, $3, and $5 in
fiscal 2004, 2003, and 2002, respectively.
The fair value for all options granted in 2004, 2003, and 2002 were estimated at
the date of grant using a Black-Scholes option pricing model with the following
weighted-average assumptions:
2004 2003 2002
OPTIONS OPTIONS OPTIONS
--------------- ----------- -------
Risk free interest rate 2.0% to 2.7% 3.8% 4.5%
Expected life of option 3 yrs. to 4 yrs. 4 yrs. 4 yrs.
Expected dividend yield of stock 0.0% 0.0% 0.0%
Expected volatility of stock 114.0% to 112.2% 108.8% 102.2%
A summary of our incentive stock option activity and related information for the
years ended September 30, 2004, 2003, and 2002, is shown in the following table.
Shares subject Weighted
to option average option
(in thousands) price per share
-------------- ---------------
September 30, 2001, Outstanding 1,603 $ 2.18
Granted 46 1.08
Canceled (537) 2.84
--------------
September 30, 2002, Outstanding 1,112 1.81
Granted 24 1.00
Canceled (12) 3.63
--------------
September 30, 2003, Outstanding 1,124 1.77
--------------
Granted 280 1.00
Canceled (522) 1.24
--------------
September 30, 2004, Outstanding 882 $ 1.84
==============
Options exercisable and shares available for future grant on September 30 (in
thousands except per share data):
2004 2003 2002
-------- -------- --------
Options exercisable 840 898 704
Weighted-average option price per share
of options exercisable $ 1.88 $ 1.92 $ 2.16
Weighted-average fair value of options
granted during the year $ 0.52 $ 0.49 $ 0.47
50
The ranges of exercise prices and the remaining contractual life of options as
of September 30, 2004, were:
Range of exercise prices $1-$1.25 $1.25-$8
Options outstanding:
Outstanding as of September 30, 2004 (in thousands) 622 260
Weighted-average remaining contractual life 2.80 1.80
Weighted-average exercise price $ 1.06 $ 3.69
Options exercisable:
Outstanding as of September 30, 2004 (in thousands) 580 260
Weighted-average remaining contractual life 2.75 1.80
Weighted-average exercise price $ 1.07 $ 3.69
7. INCOME TAXES
The provision for income taxes consists of the following:
2004 2003 2002
---------- ---------- ----------
Current:
Federal and state $ 7 $ 18 $ 38
Foreign - - -
---------- ---------- ----------
7 18 38
Deferred expense - - -
---------- ---------- ----------
$ 7 $ 18 $ 38
========== ========== ==========
A reconciliation of the provision for income taxes at the federal statutory rate
to that included in the Consolidated Statements of Operation related to earnings
from continuing operations is as follows:
2004 2003 2002
---------- ---------- ----------
Tax at federal statutory rate of 34% $ (1,187) $ (2,302) $ (611)
Increases in taxes resulting from:
Valuation allowances against deferred tax assets 1,187 2,302 611
Other - net 7 18 38
---------- ---------- ----------
$ 7 $ 18 $ 38
========== ========== ==========
As a result of the full valuation allowance on all deferred tax assets, an
insignificant state provision constituted the entire tax provision for fiscal
2004, 2003, and 2002.
51
The components of deferred tax assets and liabilities are comprised of the
following at September 30,
2004 2003
---------- ----------
Gross deferred tax assets:
Operating loss carryforwards $ 4,354 $ 4,434
Receivable and inventory reserves 898 859
Accrued compensation 337 161
Distributor development accruals 6,284 4,989
Other 139 126
---------- ----------
12,012 10,569
---------- ----------
Gross deferred tax liabilities: Depreciation 68 106
Valuation allowances on net deferred tax assets 11,944 10,463
---------- ----------
Net deferred tax asset $ - $ -
========== ==========
The valuation allowance increased from $10,463 to $11,944 due to an increase in
deferred tax assets for which a full allowance had previously been established.
Periodically and when indicators suggest, we assess the realizability of our
domestic deferred tax assets, giving consideration to our actual historical
results supplemented by future expected results. SFAS No. 109, "Accounting for
Income Taxes" considers a historic pattern of losses as significant negative
evidence that tax assets will not be realized and this consideration is not
outweighed by any prospective view of management that sufficient taxable income
will ultimately be available to realize the tax benefits. Given the history of
losses and the results in 2004, we concluded that under the "more likely than
not" criteria of SFAS No. 109 a full valuation allowance is still required
against the net U.S. deferred tax assets at September 30, 2004. The valuation
allowance will be subject to periodic review and can be partially or totally
reversed either when income is generated that utilizes the loss or when
sufficient positive evidence emerges (i.e. A sustained positive trend of U.S.
income for financial accounting purposes.) Our income tax expense recorded in
the future will be reduced to the extent of offsetting decreases in our
valuation allowance.
Net operating loss carryforwards of approximately $11,550 for tax are available
to offset future taxable income. The carryforwards expire in 2005 through 2021.
8. EMPLOYEE BENEFIT PLANS
We have a qualified profit sharing plan that covers substantially all employees.
The overall contribution to our plan and the allocation method is at the
discretion of our Board of Directors. The allocation to the participants is
based on a fixed amount per participant, a percentage of eligible wages, or a
combination of a fixed amount and a percentage of eligible wages. There was no
profit sharing expense for the plan for the years ended September 30, 2004,
2003, and 2002.
In addition, we offer a 401(K) savings plan to all of our employees. We match
50% of the first 6% of the employee's contribution to the plan. Employees may
currently contribute up to 50% of compensation to the plan. Amounts expensed for
the years ended September 30, 2004, 2003, and 2002, were $130, $134, and $91,
respectively, of which the Company match in fiscal 2002 was reduced in the
second quarter as the match was funded by forfeitures of prior matches from
unvested former participant/employees.
52
9. COMMITMENTS AND CONTINGENCIES, GUARANTEES AND LEASES
We are obligated under certain operating leases for facilities and equipment
which expire on various dates through 2014. The minimum annual lease payments
under these agreements, including renewal options, if exercised, are $524, $421,
$390, $396, and $402 for the years ending September 30, 2005, 2006, 2007, 2008,
and 2009, respectively. Rent expense was $894, $956, and $1,035 for the years
ended September 30, 2004, 2003, and 2002, respectively.
LITIGATION
Bliss Technologies, Inc. ("Bliss"), the company formed from the 1998 sale of the
subsidiary of HMI, filed for bankruptcy in January 2000 in the United States
Bankruptcy Court, Eastern District of Michigan. In a separate action filed in
2002, the Official Committee of Unsecured Creditors of Bliss alleges a
fraudulent conveyance claim against us asserting that the sale of Bliss in 1998
was a fraudulent transfer insofar as we received more for Bliss than it was
worth and that Bliss was insolvent from its inception. Former directors of
Bliss, Mark Kirk and Carl Young, are also named as defendants in the action.
Claims pending against them allege that in their capacity as Bliss directors
they breached fiduciary duties to Bliss creditors. The complaint seeks damages
in an unspecified sum. In September 2004 the parties conducted a mediation
session with an agreed-upon mediator which did not result in a settlement.
Although we may continue to pursue the settlement discussions that began at the
mediation we are also continuing to move forward in court with the vigorous
defense of the claims against us and the claims against Mr. Kirk and Mr. Young.
Claims arising in the ordinary course of business are also pending against us.
In the third quarter of fiscal 2004 we increased reserves by $500 to provide for
any contingent liabilities associated with various litigation and contingent
claims. There can be no assurance that an unfavorable outcome in these various
litigation and contingent claims would not have a material adverse effect on our
consolidated financial position, results of operations, or cash flow. Included
in the accompanying Consolidated Balance Sheets at September 30, 2004, and 2003,
were accruals of $515 and $15, respectively, relating to litigation and
contingent reserves.
10. QUARTERLY FINANCIAL DATA (UNAUDITED)
Fiscal 2004
----------------------------------------------------------
December 31, March 31, June 30, September 30,
------------ ------------ ------------ -------------
Product revenues $ 8,383 $ 10,775 $ 8,275 $ 8,158
Distributor development program $ (1,044) $ (653) $ (974) $ (1,016)
Other revenue $ - $ - $ 25 $ 61
Net product revenues $ 7,339 $ 10,122 $ 7,326 $ 7,203
Gross margin, exclusive of distributor
development program $ 3,297 $ 4,502 $ 2,773 $ 3,540
Net (loss ) income $ (1,026) $ 68 $ (1,929) $ (605)
Basic and diluted (loss) income per
share of common stock: $ (0.15) $ 0.01 $ (0.29) $ (0.09)
53
Fiscal 2003
----------------------------------------------------------
December 31, March 31, June 30, September 30,
------------ ------------ ------------ -------------
Product revenues $ 8,826 $ 9,295 $ 8,873 $ 7,545
Distributor development program $ (819) $ (1,409) $ (1,072) $ (1,069)
Net product revenues $ 8,007 $ 7,886 $ 7,801 $ 6,476
Gross margin, exclusive of distributor
development program $ 3,584 $ 3,703 $ 3,617 $ 2,610
Loss before cumulative effect of
accounting change $ (549) $ (2,122) $ (785) $ (3,332)
Cumulative effect of accounting change $ 5,451 $ - $ - $ -
Net loss $ (6,000) $ (2,122) $ (785) $ (3,332)
Basic and diluted per share of common stock:
Loss before cumulative effect of
accounting change $ (0.08) $ (0.31) $ (0.12) $ (0.50)
Cumulative effect of accounting change $ (0.81) $ - $ - $ -
Net loss $ (0.89) $ (0.31) $ (0.12) $ (0.50)
As of October 1, 2002, a full impairment of the goodwill recorded on HMI's books
was recorded through a non-cash charge of $5,451. Such charge is non-operational
in nature and is reflected as a Cumulative Effect of Accounting Change in the
accompanying Consolidated Statements of Operations for the year ended September
30, 2003. See Note 1 for further information.
During the second quarter of fiscal 2003 we recorded a write-off of $905 for
cumulative translation adjustments associated with the liquidation of our
Canadian subsidiary.
During the fourth quarter of fiscal 2003, we performed an analysis on the
potential impairment of certain tooling assets, and related patents and
trademarks, approximating $1,711. We concluded from our analysis, which was
based upon the held and used model that the tooling assets were fully impaired
and accordingly recorded an impairment charge of $1,711 as of September 30,
2003, as the scrap value for these assets was determined to be nominal.
11. RELATED PARTY TRANSACTIONS
James R. Malone, our former Chairman and Chief Executive Officer, Darrell
Weeter, President of the Company's Americas division, and John Glomb, a Regional
Vice President of the Company, each owned 31.67% of the membership interests in
a Company called Vision Capital Logistics, LLC ("VCL"). VCL, was a brokerage
service provider for sourcing consumer credit, and assisted its clients in
securing third party financing for its clients' customers to purchase products,
including products manufactured by us and sold by our Distributors. VCL charged
additional fees to our Distributors for these financing services. VCL's client
list also included a number of other "direct sales" companies, including other
floor care companies. In securing such financing, VCL may have guaranteed the
legal compliance obligations (but not any payment obligations) of our
Distributors to a third party lender. The third party lender paid VCL a
participation fee for such financing services, a part of which (twelve percent
(12%)) VCL paid to us. During the fiscal years ended September 30, 2004, 2003,
and 2002, VCL paid
54
us $5, $24, and $17, respectively, in connection with such financing services.
Additionally, in certain cases a Distributor may not have been able to complete
a sale because of the substandard credit status of the retail customer. In such
cases VCL provided the Distributor with financing for this sale. We entered into
an arrangement with VCL known as a Swap Program under which VCL would purchase
the contract of the retail customer from the Distributor and arrange for the
financing of the contract at a significant discount. To replace the product sold
by our Distributor and for which the Distributor received only a portion of the
consumer sale price, VCL would purchase a replacement product from us at the
same price paid by our Master Distributors and we would ship it to the
Distributor to replace the product the Distributor just sold. During the fiscal
years ended September 30, 2004, 2003, and 2002, VCL purchased an aggregate of
$25, $35, and $19, respectively, of our products under the Swap Program. Under
the terms of our credit facility in place from time to time, we were prohibited
from engaging in certain of the financing activities provided by VCL. During the
third quarter of fiscal 2004 we ended our arrangement with VCL. At such time Mr.
Weeter and Mr. Glomb sold their membership interests to Mr. Malone.
From June 2000 until January 2003 we sublet to VCL a portion of our office space
in Naples, Florida. During the fiscal years ended September 30, 2003 and 2002,
VCL paid us $8 and $24, respectively, in rent for such space, which amount was
based upon an allocation of our total monthly lease payments to the amount of
space utilized by VCL. In February 2003 a new lease was entered into for office
space with VCL as the tenant, and we began subleasing the office space in
Naples, Florida from VCL for $3 per month, which amount was based upon an
allocation of VCL's total monthly lease payments to the amount of space that we
utilize. For the fiscal years ended September 30, 2004, and 2003, we paid VCL a
total of $11 and $21 in lease payments. The sublease was terminated in February
2004.
Darrell Weeter, an executive officer of the Company, has served for many years
as President of FVS, Inc., a distributor of products manufactured by HMI, and
which is owned by Mr. Weeter and his wife. For the fiscal years ended September
30, 2004, 2003, and 2002, FVS, Inc. purchased, at Master Distributor pricing, a
total of $56, $78, and $100, respectively, in products from us. Mr. Weeter also
received amounts due to him under our Career Development Program of $63, $129,
and $126 for the fiscal years ended September 30, 2004, 2003, and 2002,
respectively. The amounts paid were distributor paid overrides ("DPO's")
collected by us from distributors that were brought into the Filter Queen
business by Mr. Weeter. DPO's are a unit price override charged on top of our
standard unit sales price for which we, HMI, act as a pass through, meaning that
we collect the DPO from the promoted distributor and disburse it to the
promoting distributor upon their request; accordingly these DPO's are not
reflected in our income statement as revenue. The total DPO's still owed to Mr.
Weeter were $7 and $3 as of September 30, 2004, and 2003, respectively. This
payable to Mr. Weeter was recorded on the other accrued expense and liabilities
line item of our Consolidated Balance Sheets as of September 30, 2004 and 2003.
Derek Hookom, an employee of HMI, is President of Summit Air, a distributor of
products manufactured by HMI. For the fiscal years ended September 30, 2004,
2003, and 2002, Summit Air purchased, at Master Distributor pricing, a total of
$24, $254, and $604, respectively, in products from us. Mr. Hookom became an
employee of HMI on January 1, 2003, and under the terms of his employment
agreement; Mr. Hookom remains eligible to receive the Millionaires Club Award
associated with the Edge Success Program through sales
55
generated by his personally developed sales network. The Company incurred $152
and $173, respectively, of distributor development program revenue reduction
associated with Mr. Hookom's participation in the Program for the fiscal years
ended September 30, 2004, and 2003, respectively. Mr. Hookom also received DPO's
due to him under our Career Development Program of $82, $102, and $58 for the
fiscal years ended September 30, 2004, 2003, and 2002, respectively. The amounts
paid were distributor paid overrides collected by us from distributors that were
brought into the Filter Queen business by Mr. Hookom. The total DPO's still owed
to Mr. Hookom were $30 and $38 as of September 30, 2004, and 2003, respectively.
This payable to Mr. Hookom was recorded on the other accrued expense and
liabilities line item of our Consolidated Balance Sheets as of September 30,
2004, and 2003.
Kirk W. Foley, our current Chairman and Principal Executive Officer, owns
Tube-Fab Ltd. a manufacturing company specializing in fluid delivery systems for
aerospace and other commercial applications. In fiscal 2004, Tube-Fab Ltd.
invoiced HMI $5 per month for corporate services performed for Mr. Foley at
Tube-Fab Ltd. facilities for work done on HMI's behalf. This amount is intended
to cover office space, cell phone bills, supplies, equipment use, clerical and
secretarial help, professional assistance with planning and management of
information technology needs, procurement activities, and quality systems. We
incurred $40 of expense associated with these services for the year ended
September 30, 2004, and $6 for certain other out of pocket expenses.
The above related party amounts are not considered to be significant to the
financial statements as a whole and therefore have not been separately
identified in the Consolidated Balance Sheets, Statements of Operations or
Statements of Cash Flow.
56
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON
FINANCIAL STATEMENT SCHEDULE
To the Board of Directors and Stockholders of HMI Industries Inc.
We have audited in accordance with the standards of the Public Company
Accounting Oversight Board (United States) the consolidated financial statements
of HMI Industries Inc. and its subsidiaries referred to in our report dated
December 16, 2004, which is included in this Annual Report on Form 10-K and
incorporated by reference in Part II of this form. Our report on the
consolidated financial statements includes an explanatory paragraph which
discusses factors that raise substantial doubt about the Company's ability to
continue as a going concern, as discussed in Note 2 to the consolidated
financial statements. Our audit was conducted for the purpose of forming an
opinion on the basic financial statements taken as a whole. Schedule II is
presented for purposes of additional analysis and is not a required part of the
basic financial statements. This schedule has been subjected to the auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, is fairly stated in all material respects in relation to the basic
financial statements taken as a whole.
/s/ Grant Thornton LLP
Cleveland, Ohio
December 16, 2004
57
HMI INDUSTRIES INC.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
Dollars in thousands Balance at Additions Balance at
-------------------- Beginning of Charged to End of
Description Period Costs and Expense Deductions Period
- ------------------------------------------ ------------ ----------------- ------------ ------------
Valuation account for accounts receivable:
Year ended September 30, 2004 $ 194 $ - $ 62 $ 132
Year ended September 30, 2003 $ 482 $ - $ 288 $ 194
Year ended September 30, 2002 $ 464 $ 59 $ 41 $ 482
Valuation account for inventory:
Year ended September 30, 2004 $ 411 $ 328 $ 162 $ 577
Year ended September 30, 2003 $ 109 $ 477 $ 175 $ 411
Year ended September 30, 2002 $ 199 $ 56 $ 146 $ 109
Valuation for deferred tax asset:
Year ended September 30, 2004 $ 10,463 $ 1,481 $ - $ 11,944
Year ended September 30, 2003 $ 7,909 $ 2,554 $ - $ 10,463
Year ended September 30, 2002 $ 7,496 $ 763 $ 350 $ 7,909
58