Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended February 28, 1997
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934 For the
transition period from _______________ to ___________
Commission File Number 0-21161
Q.E.P. CO., INC.
(Exact name of registrant as specified in its charter)
DELAWARE 13-2983807
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1081 HOLLAND DRIVE, BOCA RATON, FLORIDA 33487
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (561) 994-5550
Securities Registered Pursuant to Section 12(b) of the Act:
Name of exchange
Title of each class on which registered
NONE NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ___
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of voting stock held by nonaffiliates as of
May 19, 1997 is $11,472,399, computed by reference to the closing price for such
shares on the NASDAQ National Market System as of such date.
The number of shares outstanding of each of the registrant's classes of
common stock, as of May 19, 1997 is: 2,654,894 shares of Common Stock, par value
$0.001 per share.
DOCUMENTS INCORPORATED BY REFERENCE
Parts of the definitive Proxy Statement which the Registrant will file
with the Securities and Exchange Commission in connection with the Registrant's
Annual Meeting of Stockholders to be held on July 28, 1997, are incorporated by
reference in Part III of this Form 10-K.
PART I
ITEM 1. BUSINESS
GENERAL
Founded in 1979, Q.E.P. Co., Inc. (the "Company" or "QEP")
manufactures, markets and distributes a broad line of specialty tools and
related products for the home improvement market. Under brand names including
QEP/trademark/, O'TOOL/trademark/, MARION TOOL/trademark/ and ANDREWS
TOOLS/trademark/, the Company markets over 4,000 specialty tools and related
products used primarily for surface preparation and installation of ceramic
tile, carpet, marble, masonry, drywall and paint. QEP's products include
trowels, floats, tile cutters, wet saws, spacers, nippers, pliers, carpet
trimmers and cutters, knives and abrasives, and are sold to home improvement
retailers, including national and regional chains such as Home Depot, Lowe's and
Hechinger/Home Quarters, specialty distributors to the hardware, construction
and home improvement trades, retailers such as Ace Hardware and New York Carpet
World, and OEMs such as Stanley Tools and Red Devil. The Company's full line of
specialty tools and related products is marketed for use by do-it-yourself
consumers as well as construction and remodeling professionals.
The Company has experienced significant growth in net sales since
fiscal 1992, which management attributes to (i) the introduction of new products
and the Company's success in cross-marketing its products among its channels of
distribution, (ii) the Company's expansion of its customer base and market share
through sales to additional home improvement retailers, distributors, OEMs and
specialty retailers, (iii) growth experienced by the Company's customers within
the home improvement market, particularly among national and regional home
center retailers such as Home Depot and Lowe's, (iv) growth of the home
improvement market as a whole and (v) strategic acquisitions.
MARKET OVERVIEW
The Company currently competes in the specialty tool segment of the
tool industry which sells to the home improvement market. According to industry
information published by the National Home Center News ("NHCN"), the United
States home improvement market generated retail sales of over $132 billion in
1995 (the most recent year for which data is available to the Company), an
increase of $16 billion over 1993 retail sales of $116 billion. NHCN projects
that these sales will reach approximately $189 billion by the year 2000, which
would represent a compound annual growth rate of approximately 7.5% for the five
year period. While this data reflects the broad trend in the home improvement
market in general, the Company believes that the trends within the specialty
tool segment are similar.
The Company believes that growth in the home improvement market is
being driven by several factors, including (i) aging of the United States
housing stock, which requires greater repair and maintenance expenditures, (ii)
increased housing turnover of both new and existing homes, (iii) favorable
demographic trends, with "baby boomers" now reaching the 35 to 54 year old age
category which historically has accounted for the largest home improvement
expenditures of any age group, and (iv) changes in consumer preferences, which
have caused an increase in the median size of new homes and which have
contributed to demand for remodeling and expansion of older homes.
Within the home improvement market, distribution channels have
continued to consolidate as a result of the success of the warehouse home center
format used by large home improvement retailers such as Home Depot and Lowe's.
The increasing dominance of national home improvement retailers results from
their ability to offer broad product lines, project advice and orientation,
competitive pricing, aggressive promotions and large-format stores. Estimates
published by the NHCN indicate that from 1993 to 1995, the average size of
home improvement centers operated by the top ten retailers increased from 60,600
square feet to 62,700 square feet, while the average annual sales per store
increased from $14.8 million to $18.3 million. In 1995, the ten largest home
improvement retailers accounted for approximately 28.3% of the industry's total
sales, up from 23.6% in 1993. Based on data available to the Company, the
primary beneficiaries of this consolidation among home improvement retailers
have been the top two or three companies (ranked by annual sales volume), and
the balance of the top ten retailers have generally experienced declines in
sales and market share during the past several years. Thus, while the home
improvement market's retail sales have expanded, the market is being
increasingly dominated by the largest retailers.
The Company's two largest customers, Home Depot and Lowe's, experienced
compound annual sales growth rates of 29% and 25%, respectively, from 1993 to
1995, and have announced plans to continue increasing the number of stores each
operates. As consolidation continues among home improvement retailers, the
Company expects that sales of the largest national and regional home improvement
retailers will continue to increase at greater rates than the rate of sales
growth in the overall market. The Company expects that the growth trends in the
specialty tool segment of the home improvement market and among its customer
base will directly affect the Company's ability to generate growth in its sales
and net income, its expansion strategy and the nature of its sales and marketing
initiatives.
BUSINESS STRATEGY
The Company's strategy is to enhance its position as a leading
manufacturer of specialty tools and related products by introducing new products
and cross-selling products among its channels of distribution, expanding market
share by obtaining new customers, and capitalizing on expected growth of its
largest customers and of the home improvement market as a whole. Key elements of
the Company's strategy include:
INCREASE SALES BY EXPANDING PRODUCT LINES AND ADDING NEW CUSTOMERS. The
Company seeks to expand its product lines by adding specialty tools and related
products which can be marketed to the Company's existing customer base. For
example, during the last three fiscal years, the Company introduced a line of
carpet installation tools, three new power tools and a complete line of customer
oriented maintenance kits. The Company has also expanded its product lines
through acquisitions. The Company believes that broadening its product lines
will make the Company a more attractive supplier to the major home improvement
retailers and thereby increase the Company's sales and market penetration. The
Company also seeks to expand its market share by developing new customers
through marketing its product lines to home improvement retailers, distributors,
OEMs and specialty retailers who do not currently purchase products from the
Company.
CAPITALIZE ON CROSS-SELLING OPPORTUNITIES. A number of the products
manufactured and distributed by the Company may be used in multiple applications
and are therefore suitable for marketing to several categories of customers. For
example, floats used in the tile trades are also frequently used in drywall and
paint applications. The Company markets products with multiple applications to a
variety of customers within different channels of distribution. As part of its
acquisition strategy, the Company seeks to identify acquisition candidates with
product lines complementary to those of the Company and to "cross sell" acquired
product lines to its existing customer base and its existing product lines to
the customers of the acquired business.
EMPHASIZE CUSTOMER SERVICE. The Company has developed and implemented a
customer service program to address the requirements of its retail, distributor
and OEM customers, under which the Company maintains inventories of tools and
related products in multiple locations to permit prompt deliveries, offers a
customer service hotline, provides parts and repair service for tools, provides
education classes for store personnel and participates in cooperative promotions
and special sales events. The Company also offers certain of its customers
electronic order acceptance and billing and prepaid delivery for product
shipments with a minimum purchase. Because home improvement retailers place
considerable value on the customer service
3
provided by their vendors, the Company considers the maintenance of responsive
customer service programs to be an important facet of its business.
PURSUE ADDITIONAL STRATEGIC ACQUISITIONS. During fiscal 1995, the
Company completed the acquisitions of O'Tool Company, a distributor of hardware,
masonry, carpentry and tiling tools, Marion Tool Company, a manufacturer of
striking tools, and Andrews Tools Company, a drywall and paint tool
manufacturer. Through these acquisitions, the Company broadened its product
lines, increased its customer base and consolidated certain manufacturing and
marketing activities. The Company intends to continue to seek and evaluate
acquisitions of specialty tool and component manufacturers, distributors and
other companies whose products, distribution channels and brand names are
complementary to those of the Company and which will offer further opportunities
for product cross selling, consolidation of manufacturing and marketing
operations and the addition of new customers.
EXPAND FOREIGN MARKET PRESENCE. The Company believes that international
markets provide a significant opportunity to increase sales of its products and
has implemented a foreign sales and marketing program which is designed to
increase the Company's presence in markets such as Canada, Central America,
Mexico, Europe and South America. The Company intends to pursue international
sales opportunities through marketing initiatives focused on its broad product
line and comprehensive customer service programs.
ENHANCE MANUFACTURING CAPABILITIES. The Company expects to continue to
selectively increase its manufacturing capabilities based upon its objectives of
controlling manufacturing costs, assuring high quality of its products, and
reducing product manufacturing and shipment times. The Company reviews its
product lines with a view to identifying products for which in-house
manufacturing is appropriate based upon a comparison of purchase and
manufacturing costs, quality assurance, shipment times and product demand. The
Company used a portion of the proceeds of its initial public offering to
purchase capital equipment to increase its manufacturing capacity for certain
specialty tools formerly purchased by the Company from outside suppliers.
PRODUCTS
The Company manufactures and distributes a broad line of over 4,000
specialty tools and related products. The Company's products are offered under
brand names including QEP/trademark/, O'TOOL/trademark/, MARION TOOL/trademark/
and ANDREWS TOOLS/trademark/ and are used primarily for surface preparation and
installation of ceramic tile, carpet, marble, masonry, drywall and paint. The
following table sets forth certain information concerning the Company's
principal tool groups and their markets, distribution channels and price
positioning.
TOOL OR RELATED PRODUCT GROUP
--------------------------------------------------------------------------------------------------
TILE CARPET STRIKING TOOLS DRYWALL AND PAINT
---- ------ -------------- -----------------
MARKETS
Primary................. Do-it-yourself Do-it-yourself Contractor Contractor
Secondary............... Contractor Contractor Do-it-yourself Do-it-yourself
DISTRIBUTION CHANNELS
Primary................. Home improvement Home improvement Distributors and OEMs
retailers retailers retailers
Secondary............... Tile retailers and Carpet retailers OEMs Distributors
distributors
PRODUCT OFFERINGS......... Full line Limited line Popular products High end
PRICE POSITIONING......... Multiple price points Multiple price points Middle to high Middle to low
4
The Company believes that its products are purchased at retail
predominately by "do-it-yourself" consumers, although certain of the Company's
products are designed and priced for sale to remodeling and construction
professionals. A number of the products manufactured by the Company, such as
trowels, floats, blades and abrasives, are marketed through multiple
distribution channels for use in a variety of installation applications. For
example, floats used in tile applications are also frequently used in drywall
and paint applications. Other tools such as drywall taping knives, tile cutters,
electric wet saws, nippers, sanders, scrapers, carpet trimmers and rollers are
used in single applications. The Company's products are generally sold at retail
for prices ranging from $1 to $200, although certain types of electric wet saws
are sold at retail for up to $800. A majority of the Company's revenue is
generated by sales of products priced at less than $10 retail. Although the
Company manufactures and distributes over 4,000 products, a majority of the
Company's sales are to customers who purchase between 20 and 150 individual
stock-keeping units.
Net sales of a single product accounted for approximately 7% of the
Company's net sales in fiscal 1995 and 5% of the Company's net sales in each of
fiscal 1996 and fiscal 1997. Management anticipates that the number and type of
products which account for 5% or more of the Company's net sales will vary from
period to period. As the Company seeks to broaden its product lines, the
competition for limited shelf space available at home improvement retailers for
specialty tools and related products may limit sales of existing or newly
introduced products.
The Company maintains an informal research and development program
through which it seeks to identify new product opportunities within its primary
markets. Methods by which the Company seeks to identify product opportunities
include soliciting product feedback from customers through its outside sales
force and manufacturers' representatives, review of product brochures and
catalogs issued by foreign and domestic manufacturers of specialty tools, review
of product concepts with buyers employed by its customers, and attendance at
industry trade shows and conventions at which new product concepts are
introduced and discussed. The Company also considers participation in joint
ventures and evaluation of product samples to be an important part of its effort
to identify new product opportunities. Although the Company does not maintain a
formal research and development department, the Company's executive officers and
sales personnel are active in identifying opportunities for the Company.
RELATIONSHIP WITH MAJOR CUSTOMERS
In 1986, the Company began selling products to Home Depot, which is
currently the largest home improvement retailer in the United States based on
annual sales volume. In 1993, the Company added Lowe's as a customer, which is
now the second largest home improvement retailer in the country. Home Depot and
Lowe's are the Company's two largest customers, accounting for 50% and 11% of
the Company's fiscal 1997 net sales, respectively.
Because of the importance of home improvement retailers (including Home
Depot and Lowe's) to the Company, the Company has, in consultation with its
major customers, developed customer service programs to ensure that the specific
needs of these customers are given a high priority with direct attention from
senior officers of the Company. Features of the Company's customer service
programs for its major customers include providing a range of in-store services,
including assistance with inventory control, maintenance of product displays and
introduction of new products; maintaining inventories of tools and related
products in multiple locations to permit rapid shipping; delivering orders
promptly; holding education classes for retail store personnel; packaging with
multilingual labels; prepaying delivery for product shipments with minimum
purchase; participating in cooperative promotions and special sales events;
providing product research for buyers; operating a customer service hotline;
providing parts and repair service; assisting in tool and product sourcing;
extension of advertising allowances and special credit terms; accepting orders
electronically and billing through electronic data interchange; bar coding for
each individual stock keeping unit; incorporating anti-theft tags in packaging;
and using slip sheets in lieu of pallets for delivery. The Company believes that
its major
5
customers place considerable value on service and promotional support and
frequently evaluates its service and promotional activities in an effort to
serve its customers more effectively.
The Company believes that the consolidation among home improvement
retailers will continue and that the national and large regional home
improvement retailers, especially Home Depot and Lowe's, will continue to
increase their market share in the near future. Each of Home Depot and Lowe's
has announced plans to increase significantly the number of stores each operates
over the next several years. While the Company is seeking to expand its customer
base, it expects that sales to Home Depot and Lowe's will continue to constitute
a major portion of the Company's total sales and that the results of operations
and business strategies of Home Depot and Lowe's will have a significant effect
on the Company's overall levels of net sales and profitability.
MANUFACTURING AND SUPPLIERS
The Company estimates that in fiscal 1997 products it manufactured
accounted for approximately 30% of net sales and finished products purchased
from outside suppliers accounted for approximately 60% of net sales. Parts and
components purchased and later assembled or finished by the Company accounted
for the remaining 10% of net sales. The Company utilizes in-house manufacturing
capabilities and manufacturing services provided by outside suppliers to (i)
reduce overall costs of goods sold by purchasing finished products and
components from suppliers able to produce such items at a lower cost than the
Company, (ii) establish domestic production of products or parts which are
critical for domestic supply due to shipping costs, frequency of deliveries or
marketing concerns, (iii) maintain a high level of quality of the Company's
products, and (iv) capitalize on the Company's production expertise in instances
where production volumes warrant in-house manufacturing. The Company reviews its
product lines to identify products for which in-house manufacturing is
appropriate based upon a comparison of purchase and manufacturing costs, quality
assurance, shipment times and product demand. The Company used a portion of the
proceeds of its initial public offering to purchase capital equipment to
increase its manufacturing capacity for certain specialty tools formerly
purchased by the Company from outside suppliers.
The Company purchased finished products and components from
approximately 75 different suppliers in fiscal 1997, of which less than 25% were
foreign sources. The Company has not entered into written agreements with any of
its suppliers. Although the Company believes that multiple sources of supply
exist for nearly all of the products and components purchased from outside
suppliers, and although the Company generally maintains at least two sources of
supply for each item purchased, interruptions in supply or price changes in the
items purchased by the Company could have a material adverse effect on the
Company's operations.
During fiscal 1997, the Company purchased approximately 14% of its
total purchases of finished products and components through a single foreign
sales agent. This foreign sales agent, together with other foreign sales agents
utilized by the Company, purchased finished products and components from a
number of manufacturers located in Taiwan, China and other countries. The
Company believes that these sales agents purchased products from 10 to 12
different manufacturers during fiscal 1997. Although the Company believes it
could purchase products directly from a number of these manufacturers, sales
agents will generally warehouse finished and unfinished products and consolidate
products to allow more cost effective shipping, and will retain title to
products pending arrival at United States ports. For these reasons, the Company
anticipates continuing to utilize foreign sales agents for the foreseeable
future. While the Company believes that there are other sales agents through
which the Company could source its supply requirements, changes in sales agents
or the refusal of any such agents to deal with the Company could disrupt product
shipments, result in manufacturing delays or otherwise adversely affect the
Company's operations until new suppliers or sales agents could be procured.
6
The Company currently relies on two foreign suppliers as the sources of
supply for two power tools which are currently among the Company's twenty best
selling products. While the Company believes that alternate sources of supply
exist for these products, an extended interruption in the supply of these
products prior to the location of alternate suppliers could adversely affect the
Company's results of operations.
Although the Company can generally obtain finished products and
components from domestic suppliers within 30 days of the date it places an
order, foreign orders must generally be placed at least 90 to 120 days in
advance of the intended finished product shipment date. Shipping from foreign
suppliers usually requires 30 additional days. The Company reviews its
production requirements weekly and updates its orders placed with foreign
suppliers. Because the Company seeks to fill customer orders promptly, the
Company must anticipate customer demand for finished products and products
manufactured with components obtained from foreign suppliers and establish its
production forecasts accordingly.
The Company has established on-line ordering and billing systems with
its largest customers which it anticipates expanding in the future to
accommodate the requirements of its other customers. The Company provides a
limited 90-day warranty on select products. During fiscal 1997, returns and
allowances totalled 4.4%.
DISTRIBUTION, SALES AND MARKETING
PRODUCT DISTRIBUTION
The Company's specialty tools and related products are currently sold
through several distinct distribution channels. Management estimates that sales
through its primary distribution channels in fiscal 1997 were as follows: 70% to
national and regional home improvement retailers, 13% to specialty distributors,
10% to chain or independent retailers in the hardware, tile, carpet and paint
markets, and 7% to OEMs, export and other specialty retailers. The following
briefly describes each of these distribution channels:
NATIONAL AND REGIONAL HOME IMPROVEMENT RETAILERS. The Company's
products are primarily sold through national and regional home improvement
retailers, including Home Depot, Lowe's and Hechinger/Home Quarters which
together accounted for over 65% of the Company's total sales during fiscal 1997.
Three regional home improvement retailers were also among the Company's ten
largest customers in fiscal 1997. Home improvement retailers market to both
do-it-yourself consumers and professionals in the construction and remodeling
trades.
SPECIALTY DISTRIBUTORS. The Company's products are sold to a variety of
specialty distributors, which in turn supply a broad range of small and
medium-sized retail accounts. Although certain of the Company's specialty
distributors supply a particular segment of the market, such as tile or carpet,
a number of these distributors provide full service distribution to their retail
customers. Products sold through specialty distributors are suitable for both
do-it-yourself consumers and professional remodelers or contractors.
CHAIN AND INDEPENDENT RETAIL STORES. The Company sells its products to
a significant number of smaller retail accounts, including chain stores and
independent hardware stores, tile centers, paint stores and lumber yards.
Customers of these retailers are typically professional contractors or
semi-professional do-it-yourself consumers.
ORIGINAL EQUIPMENT MANUFACTURERS. The Company performs contract
manufacturing of certain products in its product line for OEMs such as Stanley,
Red Devil, Color Tile and CarpetMax. The Company believes that its OEM
opportunities have expanded in recognition of its manufacturing capabilities and
due to the broadening of its product line within the last several years.
7
SALES
The Company's sales strategy is to (i) capitalize on growth among its
existing customer base, primarily among major home center retailers, (ii) add
new national and regional home improvement retailers as customers, (iii) extend
its product lines through introduction of new products, acquisitions and joint
ventures, (iv) cross-market products among its channels of distribution, and (v)
expand international sales. The Company's sales and marketing staff are
responsible for implementing marketing plans and sales programs, coordinating
with independent manufacturers' representatives which also market the Company's
specialty tools and related products, providing customer service and addressing
customer inquiries, and coordinating customer orders and shipments. Each of the
Company's sales managers is responsible for a different distribution channel and
utilizes an in-house telemarketing sales force and outside salaried and
commissioned sales representatives to generate product sales. The balance of the
Company's sales and marketing staff are employed in customer service capacities.
The Company also maintains a network of independent manufacturers'
representatives and firms, supported by the Company's sales and marketing
personnel, through which the Company's specialty tools and related products are
sold on a commission basis.
MARKETING
The Company has developed a direct mail marketing program under which
approximately 3,000 brochures are mailed to customers, usually on a monthly
basis. The Company coordinates its telemarketing sales force with direct mail
contacts. The Company utilizes extensive product catalogs, including color
catalogs covering most product lines, and has developed distinctive packaging
which uses uniform colors and stylistic letters to reinforce the Company's brand
images.
Company representatives attend two major and numerous other industry
trade shows each year. The major industry trade shows, comprised of a tile show
and a national hardware show, are attended by national home improvement
retailers, distributors, retail chains and other customers. The Company's
marketing and sales representatives, or its manufacturers' representatives,
conduct monthly visits to many customers' individual retail stores. In addition,
the Company provides product knowledge classes for retail store personnel. The
Company also evaluates the product mix at its customers' locations from time to
time with a view toward changing the product mix, if necessary, to increase
sales per square foot. When the Company secures a new customer, the Company
generally resets all displays and assists store personnel in becoming familiar
with the Company's product line.
COMPETITION
The Company believes that competition in the home improvement product
market is based primarily on the retail gross profit margin potential of
products sold to retailers, delivery capabilities, brand name recognition,
product quality and availability of retail shelf space. The Company believes
that its competitive strengths are the retail gross profit margin potential of
its products, its delivery capabilities, and the brand recognition and quality
of its products. The Company faces competition largely on a regional basis, with
its most significant competitors being Superior Featherweight Corporation and
Walton Tool Company, each of which the Company believes to have lower annual
revenues and a less extensive product line than the Company.
Participants in the home improvement industry include a number of
large, well-capitalized home improvement product manufacturers that could,
should they so choose, market products in direct competition with the Company,
many of whom have greater financial, marketing and other resources than the
Company. For example, within the drywall tool market segment, the Company
competes with Marshalltown Trowel Company and Goldblatt Tools, a brand owned by
Stanley. Should these companies determine to enter additional market segments in
which the Company currently operates, the competitive pressures experienced by
the
8
Company could be increased. The Company is aware of a number of foreign
competitors, many of which may have greater financial, marketing and other
resources than the Company. While foreign sales constituted less than 5% of the
Company's total sales during fiscal 1997, as the Company seeks to penetrate more
foreign markets, the Company may experience competition from such companies,
which could adversely affect the Company's gross margins on its foreign sales.
Certain of the Company's larger customers have in the past contacted
one or more of the Company's foreign suppliers to discuss purchasing home
improvement products directly from these suppliers. Although the Company
believes that its diversified product line, brand recognition and customer
service will continue to offer benefits not otherwise available to the Company's
customers from foreign manufacturers, the Company could experience competition
from one or more foreign manufacturers which now serve as suppliers to the
Company. If one or more of the Company's larger customers were to begin
purchasing products previously supplied by the Company directly from foreign
manufacturers, the Company's business would be materially adversely affected.
Increased competition from these manufacturers or others could result in lower
sales, price reductions and loss of market share, each of which would have a
material adverse effect on the Company's results of operations.
ENVIRONMENTAL MATTERS
The Company is subject to federal, state and local laws, regulations
and ordinances governing activities or operations that may have adverse
environmental effects, such as discharges to air and water, as well as handling
and disposal practices for solid, special and hazardous wastes, and imposing
liability for the cost of cleaning up, and certain damages resulting from, sites
of past spills, disposal or other releases of hazardous substances (together,
"Environmental Laws"). Sanctions which may be imposed for violation of
Environmental Laws include the payment or reimbursement of investigative and
remediation costs, administrative penalties and, in certain cases, prosecution
under environmental criminal statutes. The Company's manufacturing facilities
are subject to environmental regulation by, among other agencies, the
Environmental Protection Agency, the Occupational Safety and Health
Administration, and various state authorities in the states where such
facilities are located. The activities of the Company, including its
manufacturing operations, at its owned and leased facilities are subject to the
requirements of Environmental Laws. The Company believes that the cost of
compliance with environmental laws to date has not been material to the Company,
nor is the Company currently aware of any situations requiring remedial or other
action which would involve a material expense to the Company, or exposing the
Company to material liability under Environmental Laws. As the operations of the
Company involve the storage, handling, discharge and disposal of substances
which are subject to regulation under Environmental Laws, there can be no
assurance that the Company will not incur any material liability under
Environmental Laws in the future or will not be required to expend funds in
order to effect compliance with applicable Environmental Laws.
MARION TOOL COMPANY. In October 1994, the Company acquired all of the
outstanding common stock of Marion Tool Company, which manufactures specialty
tools and related castings, for an acquisition price of 425,547 shares of the
Company's Series A Preferred Stock, which carries a par value and liquidation
preference of $1 per share. At the same time, the Company acquired certain real
property used for manufacturing, warehouse and foundry operations of Marion Tool
Company in Marion, Indiana. Based upon the results of a series of environmental
reports obtained by the Company prior to completing the acquisition, above
ground storage tanks from which some petroleum contamination was evident were
removed at the time of the acquisition and the Company caused contaminated soil
to be removed in accordance with applicable Environmental Laws. Because of the
proximity of soil contamination to several structures and improvements at the
site and the risk that removal could undermine the structures, not all
contaminated soil was removed. A report of the excavation results was submitted
to the Indiana Department of Environmental Management and, based upon its
discussions with such department, the Company believes that no further action
will be required
9
concerning the remaining contamination. There can be no assurance, however, that
further action with respect to the remaining contamination will not be required.
Marion Tool Company was also identified as a potentially responsible
party ("PRP") pursuant to the Comprehensive Environmental Response, Compensation
and Liability Act of 1980, as amended ("CERCLA") for the cleanup of
contamination resulting from past disposal of hazardous wastes at a certain site
to which Marion Tool Company, among others, sent wastes in the past. CERCLA
requires PRPs to pay for cleanup of sites from which there has been a release or
threatened release of hazardous substances. Courts have interpreted CERCLA to
impose strict, joint and several liability upon all persons liable for cleanup
costs. As a practical matter, however, at sites where there are multiple PRPs,
the costs of cleanup typically are allocated among the parties according to a
volumetric or other standard. Based upon, among other things, a review of the
data available to the Company regarding the site at which Marion Tool Company is
alleged to have deposited a portion of the waste located thereon, and a
comparison of the potential liability at this site to settlements reached by
other parties in similar cases, the Company believes that Marion Tool Company's
liability for this matter will not be material to the Company. While the Company
is not aware of any facts which would give rise to any other potential off-site
liability on the part of Marion Tool Company, if other disposal sites where
Marion Tool Company sent waste were determined to require cleanup under CERCLA
or other similar laws, Marion Tool Company could face similar claims in the
future. The Company has not received notice of any claims relating to disposal
of waste by Marion Tool Company at any other sites.
Pursuant to the terms of an escrow agreement by and among the Company
and the sellers of Marion Tool Company, the sellers deposited certificates
representing all 425,547 shares of Series A Preferred Stock issued in connection
with the acquisition in an escrow account at the date of closing. The escrow
agent is authorized to release the shares to the Company within 15 days after
receipt of a written statement, in form and substance satisfactory to the escrow
agent in its discretion, providing that there has been a material breach of the
representations and warranties of the sellers contained in the stock purchase
agreement for the Marion Tool Company acquisition. If a dispute arises as to the
existence of a breach of a representation or warranty, the escrow agent is
authorized to retain the certificates representing the shares of Preferred Stock
pending resolution of the dispute, or may interplead the certificates into the
registry of a court of competent jurisdiction. Upon the expiration of six years
from the closing date and in the absence of a notice from the Company of a
breach of representations and warranties by the sellers, the escrow agent is
authorized to deliver the certificates representing the shares of Preferred
Stock to the sellers. The sellers of Marion Tool Company represented and
warranted to the Company in the stock purchase agreement relating to the
acquisition that Marion Tool Company had not committed any violation of any
environmental laws or regulations and that there was no situation requiring
remedial action by Marion Tool Company under any environmental laws or
regulations. The stock purchase agreement also contains a joint and several
indemnification by Marion Tool Company and each of the selling shareholders in
favor of the Company.
To date, the Company has not notified the escrow agent of a violation
of any environmental laws or regulations, or any situation requiring remedial
action by the Company, or any other violation of a representation or warranty,
pursuant to which the Company claims the right to the return of any of the
Series A Preferred Stock. There are currently 319,158 shares of Series A
Preferred Stock remaining on deposit under the escrow agreement (106,387 of the
shares originally deposited were converted into shares of Company common stock
in connection with the Company's initial public offering), which will remain in
escrow through August 2000 and which are subject to return to the Company in
accordance with the terms of the escrow agreement. Although the Company believes
that any environmental liabilities incurred as a result of the previous
activities of Marion Tool Company will be materially less than the liquidation
preference of such shares, there can be no assurance that the value of the
shares held in escrow will be sufficient to address all environmental
liabilities incurred as a result of the prior activities of Marion Tool Company.
10
INTELLECTUAL PROPERTY
The Company markets its specialty tools and related products under
various trademarks owned by the Company or its subsidiaries, including QEP(TM),
O'TOOL(TM), MARION TOOL(TM) and ANDREWS TOOLS(TM), and has applied for
registration of the Q.E.P. and O'Tool marks, as well as the mark consisting of
the Company's stylized logo, on the Principal Register of the United States
Patent and Trademark Office. The Company has devoted substantial time, effort
and expense to the development of brand name recognition and goodwill for
products sold under its trademarks, and has not received any notice that its use
of such marks infringes upon the rights of others, and is not aware of any
activities which would appear to constitute infringement of any of its marks.
The Company does not license any trademarks and does not own or license any
patents or patent rights.
The Company has received a notice alleging that certain of its products
infringe one or more patents of a competitor. After consultation with its legal
counsel, the Company advised the complaining party that its products do not
appear to infringe the cited patents. The Company has received no further
communication concerning this matter from the complaining party.
EMPLOYEES
As of May 1, 1997, the Company had 153 full-time employees, including
22 administrative employees, 29 sales and marketing employees, 67 manufacturing
employees and 35 employees engaged in packaging and shipping. Marion Tool
Company's nine manufacturing employees are represented by the Metal Polishers,
Buffers, Platers and Allied Workers International Union. The collective
bargaining agreement which covers these employees expires, unless renewed, in
October 1997. The Company has not experienced any work stoppages since acquiring
Marion Tool Company. None of the Company's other employees are represented by a
labor union. The Company considers its relations with its employees to be good.
11
ITEM 2. PROPERTIES
The Company currently leases two facilities located in Florida and
California which consist of an aggregate of approximately 106,200 square feet.
In addition, the Company owns a 40,000 square foot manufacturing facility in
Marion, Indiana, which was purchased at the time of the acquisition of Marion
Tool Company. The following table sets forth certain information concerning
facilities leased and owned by the Company.
SQUARE ANNUALIZED LEASE RENEWAL
LOCATION USE FEET COST EXPIRATION OPTION
-------- --- ------ ---------- ---------- -------
Boca Raton, FL Executive offices;
warehouse......................... 77,000 $254,000 01/31/04 --
Marion, IN Manufacturing;
warehouse; assembly............... 40,000 N/A N/A --
Carson, CA Administrative, sales;
marketing; warehouse.............. 29,200 94,692 08/14/99 --
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in litigation from time to time in the ordinary
course of its business. In the opinion of management, no material legal
proceedings are pending to which the Company or any of its property is subject.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders of the Company
during the fourth quarter of the period covered by this report.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
On September 17, 1996, the Company completed its initial public offering
and the Common Stock commenced trading on the Nasdaq National Market System tier
of the Nasdaq Stock Market. The following table sets forth, for the periods
indicated, the high and low sales price per share for the Common Stock, as
reported on the Nasdaq National Market System.
FISCAL YEAR ENDED FEBRUARY 28, 1997 HIGH LOW
- ----------------------------------- ---- ---
Third quarter (beginning September 17, 1996) 9 5/8 7 1/8
Fourth Quarter 9 6 3/8
On May 19, 1997, the closing price of the Common Stock on the Nasdaq
National Market System was $8.50 per share. As of that date, there were 24
holders of record of the Common Stock and approximately 882 beneficial owners
of the Common Stock.
12
The Company has not paid cash dividends and does not intend for the
foreseeable future to declare or pay any cash dividends on its Common Stock and
intends to retain earnings, if any, for the future operation and expansion of
the Company's business. Any determination to declare or pay dividends will be at
the discretion of the Company's board of directors and will depend upon the
Company's future earnings, results of operations, financial condition, capital
requirements, restrictions imposed by the terms of indebtedness, considerations
imposed by applicable law and other factors deemed relevant by the board of
directors. The Company's current bank credit facility prohibits the payment of
dividends except with the lender's consent.
The Company's Certificate of Incorporation provides that the Company is
authorized to issue up to 500,000 shares of Series A Preferred Stock, 1,000,000
shares of Series B Preferred Stock and 1,000,000 shares of Series C Preferred
Stock. As of May 19, 1997, there were 319,160 shares of Series A Preferred
Stock, no shares of Series B Preferred Stock, and 17,500 shares of Series C
Preferred Stock issued and outstanding. The Company does not have any current
plans to issue any additional shares of Preferred Stock. Holders of Series A
Preferred Stock are entitled to receive out of legally available funds a
cumulative dividend at the rate of $0.035 per share per annum. Commencing
October 1, 2000, the dividend rate shall equal the prime interest rate (as
described in the Certificate of Incorporation) as of the first day of the month
in which the dividends are payable, less 1 1/4%. The Series B Preferred Stock
entitles the holders thereof to receive out of legally available funds a
noncumulative dividend at the rate of $0.05 per share per annum. The Series C
Preferred Stock entitles the holders thereof to receive out of legally available
funds a cumulative dividend at the rate of $0.035 per share per annum. All of
the foregoing dividends must be paid before any dividend may be declared or paid
on the Company's Common Stock.
RECENT SALES OF UNREGISTERED SECURITIES
Effective June 30, 1996, the Company agreed to issue a total of 4,894
shares of Common Stock to certain of its then current shareholders in exchange
for a total of 166,385 shares of Preferred Stock owned by such shareholders. No
commission or other remuneration was paid or given directly or indirectly for
soliciting such exchange. The Company relied on Section 3(a)(9) of the
Securities Act of 1933 for the exemption from the registration requirements of
such Act with respect to these issuances.
13
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected consolidated financial data as
of and for each of the years in the five year period ended February 28, 1997.
This information is qualified in its entirety by, and should be read in
conjunction with, the consolidated financial statements and the notes thereto
which are included elsewhere in this report.
FISCAL YEAR ENDED FEBRUARY 28 OR 29,
--------------------------------------------------------------------------
1993 1994 1995 1996 1997
------ ------ ------ ------ -----
OPERATING DATA: (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Net sales............................................... $10,188 $13,407 $19,247 $25,272 $33,140
Cost of goods sold...................................... 6,459 8,416 12,105 15,977 20,119
------- ------- ------- ------- ------
Gross profit............................................ 3,729 4,991 7,142 9,295 13,021
Shipping................................................ 1,123 1,113 1,488 1,746 2,441
General and administrative.............................. 1,137 1,492 2,436 3,106 4,048
Selling and marketing................................... 905 1,218 1,800 2,512 3,569
Foreign exchange (gains) losses 10 153 115 --- 11
------- ------- ------- ------- ------
Total expenses................................. 3,175 3,976 5,839 7,364 10,069
------- ------- ------- ------- -------
Operating income........................................ 554 1,015 1,303 1,931 2,952
Interest expense, net................................... 123 135 149 195 7
------- ------- ------- ------- -------
Income before provision for income
taxes and cumulative effect of change
in accounting principle............................... 431 880 1,154 1,736 2,945
Provision for income taxes.............................. 176 341 429 668 1,143
------- ------- ------- ------- -------
Income before cumulative effect of change in
accounting principle.................................. 225 539 725 1,068 1,802
Cumulative effect of change in accounting for
income taxes(1) 57 --- --- --- ---
------- ------- ------- ------- -------
Net income.............................................. $ 312 $ 539 $ 725 $ 1,068 $ 1,802
======= ======= ======= ======= =======
Net income per common share(2) $ .21 $ .36 $ .47 $ .70 $ .89
======= ======= ======= ======= =======
Weighted average number of shares of common
stock outstanding..................................... 1,515 1,515 1,515 1,506 2,015
======= ======= ======= ======= =======
FISCAL YEAR ENDED FEBRUARY 28 OR 29,
--------------------------------------------------------------------------
1993 1994 1995 1996 1997
------ ------ ------ ------ -----
BALANCE SHEET DATA: (IN THOUSANDS)
Working capital......................................... $ 404 $1,019 $1,948 $2,931 $12,695
Total assets............................................ 3,535 4,133 6,000 7,971 16,434
Total liabilities....................................... 2,864 2,798 3,502 4,545 2,981
Shareholders' equity.................................... 671 1,335 2,498 3,425 13,453
- ------------------------
(1) The Company adopted in 1993 the method of accounting for income taxes
pursuant to Financial Accounting Standards Board Statement of Financial
Accounting Standards No. 109 ("SFAS No. 109"), Accounting for Income
Taxes. The Company had previously accounted for deferred income taxes
pursuant to Statement of Financial Accounting Standards No. 96, which
was superseded by SFAS No. 109. The Company elected to report the
$57,200 cumulative effect on prior years as an increase to 1993 income.
(2) Cash dividends paid on the Company's outstanding shares of Series A
Preferred Stock and Series C Preferred Stock are deducted from net
income per common share.
14
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The Company manufactures, markets and distributes a broad line of
specialty tools and related products for the home improvement market. The
Company markets over 4,000 products primarily used for surface preparation and
installation of ceramic tile, carpet, marble, masonry, drywall and paint. The
Company's products are sold through home improvement retailers, specialty
distributors, original equipment manufacturers and chain or independent
hardware, tile, carpet and painting retailers for use by the do-it-yourself
consumer as well as the construction or remodeling professional. Dollar figures
set forth below are rounded to the nearest thousand.
RESULTS OF OPERATIONS
FISCAL 1997 AS COMPARED TO FISCAL 1996
Net sales for the twelve months ended February 28, 1997 ("fiscal 1997"
or the "fiscal 1997 period") were $33,140,000, compared to $25,272,000 for the
twelve months ended February 29, 1996 ("fiscal 1996" or the "fiscal 1996
period"), an increase of $7,868,000 or 31.1%. The increase is primarily the
result of greater sales to home center retailers, specialty retailers and
independent distributors, resulting from increased market penetration, new store
openings by major home center chain customers and sales of new products.
Gross profit for fiscal 1997 was $13,021,000, compared to $9,295,000
for fiscal 1996, an increase of $3,726,000 or 40.1%. As a percentage of net
sales, gross profit increased to 39.3% in fiscal 1997 from 36.8% in fiscal 1996.
The increase in gross profit margin was primarily due to the Company's ability
to reduce its costs by purchasing from additional sources at lower prices and by
increased sales of higher margin products to its major customers.
Shipping expenses for the fiscal 1997 period were $2,441,000, compared
to $1,746,000 for the fiscal 1996 period, an increase of $695,000 or 39.8%. As a
percentage of net sales these expenses increased to 7.4% in the fiscal 1997
period from 6.9% in the fiscal 1996 period. The increase in these expenses is
primarily due to additional labor costs required to handle increased volume.
Freight costs also increased because of additional product volume and increased
freight rates charged by common carriers.
General and administrative expenses for the fiscal 1997 period were
$4,048,000, compared to $3,106,000 for the fiscal 1996 period, an increase of
$942,000 or 30.3%. As a percentage of net sales these expenses decreased to
12.2% in the fiscal 1997 period from 12.3% in the fiscal 1996 period. The
increase in these expenses was primarily due to increased administrative costs
related to the Company's continuing growth and the costs related to the
relocation of Company facilities from Mahwah, NJ, Carson City, NV, Boca Raton,
FL and Pompano Beach, FL to the Company's new headquarters facility in Boca
Raton, FL.
Selling and marketing costs for the fiscal 1997 period increased to
$3,569,000 from $2,512,000 in the fiscal 1996 period, an increase of $1,057,000
or 42.1%. As a percentage of net sales these expenses increased to 10.8% in the
fiscal 1997 period from 9.9% in the fiscal 1996 period. The increase in these
expenses is primarily the result of additional sales personnel and increased
commissions, as well as an increase in the Company's advertising and marketing
programs.
Interest expense, net, decreased from $195,000 in fiscal 1996 to $7,000
in fiscal 1997, a decrease of $188,000 or 96.4%. The primary reason for the
decrease was the application of a portion of the proceeds of the Company's
initial public offering to repay the Company's bank debt. The balance of the
proceeds has been invested resulting in interest income.
Provision for income taxes was $1,143,000 in fiscal 1997 compared to
$668,000 in the fiscal 1996 period, an increase of $475,000 or 71.1%. This
increase is a direct result of the increase in the Company's taxable income as
the Company's effective tax rate remained relatively consistent at 38.8% in
fiscal 1997 compared to 38.5% in fiscal 1996.
Net income for fiscal 1997 increased to $1,803,000, compared to
$1,068,000 in fiscal 1996, an increase of $735,000 or 68.8%. Net income as a
percentage of net sales increased to 5.4% in the fiscal 1997 period compared to
4.2% in the fiscal 1996 period for the reasons described above.
15
FISCAL 1996 COMPARED TO FISCAL 1995
Net sales for fiscal 1996 were $25,272,000, compared to $19,247,000 in
the twelve months ended February 28, 1995 ("fiscal 1995"), an increase of
$6,025,000 or 31.3%. The increase was attributable to new product offerings,
increased sales to home improvement retailers and a full year of sales by the
Company's newly acquired subsidiaries. Sales to the Company's two largest
customers increased by $4,862,000, a majority of which was attributable to an
increase in retail store locations. A portion of the increase in sales to these
customers was attributable to sales of new products introduced during the third
quarter of fiscal 1996, which on a Company-wide basis totaled $1,926,000. The
addition of a national home improvement center customer accounted for $364,000
of the net sales increase, while a full year of sales attributable to the
acquired subsidiaries increased net sales by $1,153,000. These increases were
partially offset by reduced sales to smaller customers affected by the
consolidation in the home improvement industry.
Gross profit for fiscal 1996 was $9,295,000, compared to $7,142,000 in
fiscal 1995, an increase of $2,153,000 or 30.1%. As a percentage of sales, gross
profit decreased to 36.8% in fiscal 1996 from 37.1% in fiscal 1995. The decrease
in gross profit margin was attributable to the introduction of two new products
which accounted for $1,926,000 in net sales during fiscal 1996. The lower profit
margin on these products and other shifts in the Company's product mix resulted
in a net reduction in the gross profit margin of 0.3%.
Shipping expenses for fiscal 1996 were $1,746,000, compared to
$1,488,000 in fiscal 1995, an increase of $258,000 or 17.3%. As a percentage of
sales, these expenses decreased to 6.9% in fiscal 1996 from 7.7% in fiscal 1995
due to economies of scale and more efficient use of the acquired subsidiaries'
shipping and warehouse facilities.
General and administrative expenses for fiscal 1996 were $3,106,000,
compared to $2,436,000 in fiscal 1995, an increase of $670,000 or 27.5%. As a
percentage of sales, these expenses decreased to 12.3% in fiscal 1996 from 12.6%
in fiscal 1995. Of the dollar increase, $117,000 represented increased rent and
payroll costs of the acquired subsidiaries, $173,000 primarily represented
increased professional fees in connection with financing and other corporate
matters, $81,000 represented increased bad debt expense, of which $53,000 was
due to the insolvency of two customers, and $50,000 represented increased
discretionary contributions to the employee profit sharing plan. The remaining
increase was attributable to additional general and administrative expenses of
the acquired subsidiaries.
Selling and marketing expenses for fiscal 1996 were $2,512,000,
compared to $1,800,000 for fiscal 1995, an increase of $712,000 or 39.6%. As a
percentage of sales, these expenses increased to 10.0% in fiscal 1996 from 9.4%
in fiscal 1995. The increase was primarily attributable to the Company's
integration of the sales and marketing functions of the acquired subsidiaries.
In particular, the Company incurred certain costs to publish catalogues and
sales materials for the acquired subsidiaries and to hire sales and marketing
employees during fiscal 1996 who had not yet achieved the productivity level of
existing employees.
Interest expense for fiscal 1996 was $195,000, compared to $149,000 in
fiscal 1995, an increase of $46,000 or 30.9%. As a percentage of sales, these
expenses decreased to 0.7% in fiscal 1996 from 0.8% in fiscal 1995. The dollar
increase in interest expense was attributable to increased bank borrowings
required to finance the Company's growth. The decrease as a percentage of sales
was attributable to the Company's ability to fund growth with a relatively lower
level of borrowing.
Provision for income taxes in fiscal 1996 was $668,000, compared to
$429,000 in fiscal 1995, an increase of $239,000 or 55.7%. The effective tax
rate increased to 38.5% in fiscal 1996 from 37.2% in fiscal 1995. The increase
in the effective tax rate was primarily attributable to the incurrence of
nondeductible expenses.
16
As a result of the above, net income in fiscal 1996 was $1,068,000,
compared to $725,000 in fiscal 1995, an increase of $343,000 or 47.3%. This
represents an increase in net income as a percentage of net sales to 4.2% in
fiscal 1996 from 3.8% in fiscal 1995.
LIQUIDITY AND CAPITAL RESOURCES
Working capital for the fiscal 1997 period increased from $2,931,000 at
February 29, 1996 to $12,695,000 at February 28, 1997, an increase of $9,764,000
or 333.1%, primarily as a result of the completion of the Company's initial
public offering in September 1996. The Company invests cash in excess of
anticipated current operational requirements in short term commercial paper
rated AA or higher and states the value of such investments at market price.
Net cash used in operating activities was approximately $605,000 in
fiscal 1997, compared to $1,079,000 in fiscal 1996. The reason for the decrease
was a slower increase in inventory and accounts receivable from fiscal 1996 to
fiscal 1997 as compared to the increase in net income from fiscal 1996 to fiscal
1997.
The Company utilized approximately $214,000 in cash for capital
expenditures during fiscal 1997 compared to approximately $46,000 in fiscal
1996.
On September 17, 1996 the Company completed an initial public offering
of 1,000,000 shares of its common stock, par value $.001 per share ("Common
Stock"), at a price of $8.50 per share (less underwriting discount) and 120,000
warrants to purchase Common Stock at an exercise price of $10.20 per share with
an offering price of $.001 per warrant (the "Offering"). On November 6, 1996 the
underwriters exercised their over-allotment option and purchased an additional
150,000 shares of Common Stock at a price of $8.50 per share (less underwriting
discount). The net proceeds from the Offering and the exercise of the
over-allotment option were approximately $8,238,000. The Company used $2,448,000
of the proceeds from the Offering to retire existing bank debt. As a result, net
cash provided by financing activities was $5,541,000 in fiscal 1997 compared to
$1,189,000 in fiscal 1996. Net cash provided by financing activities during
fiscal 1996 was predominately the result of increased borrowings. The Company
has used a portion of the Offering proceeds to finance the growth in inventory
and accounts receivable, purchase additional manufacturing equipment and fund
capital improvements to expand and upgrade existing facilities. Other potential
uses of such funds include the possible investment in, strategic acquisition of,
or joint venture with, other businesses, as well as the possible acquisition of
other product lines. There can be no assurances that any acquisition will become
available on terms acceptable to the Company.
The Company has a bank line of credit facility (the "Facility") which
permits borrowings of up to $3,250,000 as revolving credit against a fixed
percentage of eligible accounts receivable and inventory, as defined in the
Facility. Interest is charged on the outstanding principal balance at the bank's
base lending rate plus 1/2% or the LIBOR plus 225 basis points. Subsequent to
fiscal 1997 year end the rate was reduced to LIBOR plus 175 basis points. The
Company presently has no outstanding balance under the Facility, and the
Facility terminates on June 30, 1998. The Company believes that its existing
cash balances, cash flow from operations and the borrowings available to it
under the Facility will be sufficient to fund its working capital needs and
other capital requirements for the foreseeable future.
FORWARD-LOOKING STATEMENTS
This Report contains forward-looking statements which are made pursuant
to the safe harbor provisions of the Securities Litigation Reform Act of 1995.
Statements as to what the Company "believes," "intends", "expects" or
"anticipates", and other similarly anticipatory expressions, are generally
forward-looking and are
17
made only as of the date of this Report. Readers of this Report are cautioned
not to place undue reliance on such forward-looking statements, as they are
subject to risks and uncertainties which could cause actual results to differ
materially from those discussed in the forward-looking statements and from
historical results of operations. Among the risks and uncertainties which could
cause such a difference are those relating to the Company's dependence upon a
limited number of customers for a substantial portion of its sales, the
Company's reliance upon suppliers and sales agents for the purchase of finished
products which are then resold by the Company (which during fiscal 1997
constituted approximately 60% of the Company's total sales), the Company's
dependence upon certain key personnel, the Company's ability to manage its
growth, and the risks of economic and market factors affecting the Company or
its customers.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY FINANCIAL DATA
The response to this item is submitted in a separate section of this
Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None required to be reported.
18
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this item regarding directors and officers is
incorporated by reference from the definitive Proxy Statement to be filed by the
Company for the Annual Meeting of Stockholders to be held July 28, 1997.
ITEM 11. EXECUTIVE COMPENSATION
Information required by this item regarding compensation of officers
and directors is incorporated by reference from the definitive Proxy Statement
to be filed by the Company for the Annual Meeting of Stockholders to be held
July 28, 1997.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this item is incorporated by reference from the
definitive Proxy Statement to be filed by the Company for the Annual Meeting of
Stockholders to be held July 28, 1997.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item is incorporated by reference from the
definitive Proxy Statement to be filed by the Company for the Annual Meeting of
Stockholders to be held July 28, 1997.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of the report:
1. and 2. The financial statements filed as part of this
report are listed separately in the index to Financial
Statements beginning on page F-1 of this report.
3. For Exhibits see Item 14(c), below. Exhibit Nos. 10.1 and
10.1.1 consist of management contracts or compensatory plans
or arrangements required to be filed as exhibits to this
report.
(b) No reports on Form 8-K have been filed by the Company during
the final quarter of the period covered by this report.
(c) List of Exhibits:
EXHIBIT NO. DESCRIPTION
2.1 Form of Agreement and Plan of Merger regarding the change
in incorporation of the Company from a New York corporation to
a Delaware Corporation*
3.1.1 Certificate of Incorporation of the Company*
3.1.2 Bylaws of the Company+
19
3.3 Form of Indemnification Agreement executed by Officers and Directors
of the Company and the Company*
4.1 Form of specimen certificate for Common Stock of the Company*
4.1.1 Form of Warrant issued by the Company to the representative of the
underwriters of the Company's initial public offering*
9 Voting Trust Agreement, dated August 3, 1996, by and between Lewis
Gould and Susan J. Gould*
10.1 Employment Agreement, dated August 3, 1996, by and between Lewis
Gould and the Company*
10.1.1 Q.E.P. Co., Inc. Omnibus Stock Plan of 1996+
10.2.5 Lease Agreement, dated June 1993, by and between Leo M. Rutten,
Alice J. Rutten and the Company*
10.2.6 Lease Agreement, dated September 17, 1996, by and among the
Company and Lawrence Z. Crockett, as Trustee of the Lawrence
Z. Crockett Trust dated March 31, 1994 and Marilyn M.
Crockett, as Trustee of the Marilyn M. Crockett Trust dated
March 31, 1994, including amendment thereto dated January 22,
1997+
10.2.7 Industrial Lease, dated August 1, 1996, by and between
JMB/Pennsylvania Associates - IV, L.P., and the Company+
10.3.1 Revolving Loan and Security Agreement and Assignment of
Leases, dated October 13, 1995, by and between Shawmut Bank
Connecticut, N.A., a national banking association, and the
Company, including Promissory Note dated October 13, 1995,
Limited Guaranty of Lewis Gould dated October 13, 1995, and
form of Guaranty executed by the Company's subsidiaries*
21 Subsidiaries of the Company*
27 Financial Data Schedule+
- --------------------
* Incorporated by reference to Exhibit of the same number filed with the
Company's Registration Statement on Form S-1 (Reg. No. 333-07477).
+ Filed herewith.
(d) The financial statement schedule filed as part of this report is
listed separately in the Index to Financial Statements beginning on page F-1 of
this report.
20
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 to be signed on
its behalf by the undersigned, thereto duly authorized, in the City of Boca
Raton, State of Florida, on May 23, 1997.
Q.E.P. CO., INC.
By:/S/ LEWIS GOULD
-----------------------
Lewis Gould
President
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons on behalf of the registrant
and in the capacities and on the dates indicated.
/S/ LEWIS GOULD President, Chief Executive Officer May 23, 1997
- ----------------------------- and Director (Principal
Lewis Gould Executive Officer)
/S/ MARC APPLEBAUM Senior Vice President and Chief May 23, 1997
- ----------------------------- Financial Officer (Principal
Marc P. Applebaum Financial and Accounting Officer)
/S/ MICHAEL ACTIS-GRANDE Director May 23, 1997
- -----------------------------
Michael Actis-Grande
/S/ EDWARD RONAN Director May 23, 1997
- -----------------------------
Edward Ronan
- ----------------------------- Director May 23, 1997
Mervyn D. Fogel
/S/ NORMAN SNESIL Director May 23, 1997
- -----------------------------
Norman Snesil
21
FINANCIAL STATEMENTS AND REPORT OF
INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Q.E.P. CO., INC. AND SUBSIDIARIES
February 28, 1997 and February 29, 1996
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND
FINANCIAL STATEMENT SCHEDULES
PAGE
Report of Independent Certified Public Accountants F-2
Financial Statements
Consolidated Balance Sheets F-3
Consolidated Statements of Income F-4
Consolidated Statement of Shareholders' Equity F-5
Consolidated Statements of Cash Flows F-6
Notes to Consolidated Financial Statements F-7-F-24
Schedule II - Valuation and Qualifying Accounts F-25
F-1
REPORT OF INDEPENDENT CERTIFIED
PUBLIC ACCOUNTANTS
To the Shareholders
Q.E.P. Co., Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Q.E.P. Co., Inc.
and Subsidiaries (the "Company") as of February 28, 1997 and February 29, 1996,
and the related consolidated statements of income, shareholders' equity, and
cash flows for each of the three years in the period ended February 28, 1997.
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 in accordance with generally accepted auditing
standards. 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 audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Q.E.P. Co., Inc.
and Subsidiaries as of February 28, 1997 and February 29, 1996, and the
consolidated results of their operations and their consolidated cash flows for
each of the three years in the period ended February 28, 1997, in conformity
with generally accepted accounting principles.
We have also audited Schedule II of Q.E.P. Co. Inc. and Subsidiaries for each
of the three years in the period ended February 28, 1997. In our opinion, this
schedule presents fairly, in all material respects, the information required to
be set forth therein.
Grant Thornton LLP
New York, New York
April 30, 1997
F-2
Q.E.P. Co., Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
February 29, FEBRUARY 28,
ASSETS 1996 1997
--------------- ----------------
CURRENT ASSETS
Cash and cash equivalents $ 179,138 $ 4,901,131
Accounts receivable, less allowance for doubtful
accounts of $54,500 as of February 29, 1996 and
$61,100 as of February 28, 1997 3,671,302 5,507,809
Inventories 3,138,681 4,696,400
Other current assets 350,443 425,578
---------- ------------
Total current assets 7,339,564 15,530,918
PROPERTY AND EQUIPMENT, net 266,610 415,064
DEFERRED INCOME TAXES 84,000 248,000
OTHER ASSETS 280,538 240,005
---------- ------------
$7,970,712 $16,433,987
========= ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued liabilities $1,911,303 $ 2,792,049
Loans payable 2,447,887
Other current liabilities 49,109 43,968
----------- -------------
Total current liabilities 4,408,299 2,836,017
OTHER LIABILITIES 137,088 144,893
COMMITMENTS
SHAREHOLDERS' EQUITY
Preferred stock, $1 par value; 2,500,000 shares authorized, $1 par value;
503,047 shares issued and outstanding at February 29, 1996 and 336,660
shares issued and outstanding at February 28, 1997, respectively 503,047 336,660
Common stock; 10,000,000 shares authorized, $.001
par value; 1,500,000 shares issued and outstanding
at February 29, 1996 and 2,654,894 shares issued
and outstanding February 28, 1997, respectively 1,500 2,655
Additional paid-in capital 30,762 8,433,719
Retained earnings 2,947,916 4,737,943
Cost of stock held in treasury (57,900) (57,900)
----------- -------------
3,425,325 13,453,077
--------- ----------
$7,970,712 $16,433,987
========= ==========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
F-3
Q.E.P. Co., Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
Year ended
------------------------------------------------------------
February 28, February 29, FEBRUARY 28,
1995 1996 1997
---- ---- ----
Net sales $19,247,549 $25,271,715 $33,140,273
Cost of goods sold 12,105,099 15,976,971 20,118,824
---------- ---------- ----------
Gross profit 7,142,450 9,294,744 13,021,449
Costs and expenses
Shipping 1,488,243 1,745,745 2,440,535
General and administrative 2,435,574 3,105,861 4,048,358
Selling and marketing 1,799,822 2,511,898 3,568,908
Foreign exchange losses, net 114,635 472 11,080
------------ --------------- -------------
5,838,274 7,363,976 10,068,881
----------- ----------- ----------
Operating income 1,304,176 1,930,768 2,952,568
Interest expense, net 149,414 194,565 7,250
------------ ------------ --------------
Income before provision
for income taxes 1,154,762 1,736,203 2,945,318
Provision for income taxes 429,312 668,452 1,142,577
------------ ------------ -----------
NET INCOME $ 725,450 $ 1,067,751 $ 1,802,741
============ ========== ===========
Primary and fully diluted net income per
common share $.47 $.70 $.89
=== === ===
Weighted average number of shares
outstanding 1,515,152 1,505,682 2,015,168
========= ========= ===========
Pro forma net income per common
share $.67 $.89
=== ===
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
F-4
Q.E.P. Co., Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
ADDITIONAL
PREFERRED STOCK COMMON STOCK PAID-IN RETAINED TREASURY
SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS STOCK
------ ------ ------ ------ ------- -------- -----
Balance at March 1, 1994 125,000 $ 125,000 200 $ 12,037 $ 20,225 $1,178,229
Issuance of preferred stock 443,047 443,047
Dividends (6,250)
Net income 725,450
--------- ---------- --------- ---------- ---------- ---------- -------
Balance at February 28, 1995 568,047 568,047 200 12,037 20,225 1,897,429
Redemption of preferred stock (65,000) (65,000)
Stock split - 7,575.76 for 1 and
change in par value 1,514,952 (10,522) 10,522
Dividends (17,264)
Purchase of treasury stock (15,152) (15) 15 $(57,900)
Net income 1,067,751
--------- ---------- --------- ---------- ---------- ---------- -------
Balance at February 29, 1996 503,047 503,047 1,500,000 1,500 30,762 2,947,916 (57,900)
Conversion of preferred stock to
common stock (166,387) (166,387) 4,894 5 166,382
Proceeds from initial public offering 1,150,000 1,150 8,236,575
Dividends (12,714)
Net income 1,802,741
--------- ---------- --------- ---------- ---------- ---------- -------
Balance at February 28, 1997 336,660 $ 336,660 2,654,894 $ 2,655 $8,433,719 $4,737,943 $ (57,900)
========= ========== ========= ========== ========== ========== =======
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THIS STATEMENT.
F-5
Q.E.P. Co., Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended
--------------------------------------------------------
February 28, February 29, FEBRUARY 28,
1995 1996 1997
------------ ------------ ------------
Cash flows from operating activities
Net income $ 725,450 $1,067,751 $ 1,802,741
Adjustments to reconcile net income to net cash
used in operating activities
Depreciation and amortization 52,209 85,131 77,228
Amortization of fair market value in
excess of cost of business acquired (22,500) (30,000) (30,000)
Deferred income taxes (69,500) 20,000 (164,000)
Changes in assets and liabilities
Accounts receivable 39,494 (1,223,019) (1,836,507)
Inventories (465,224) (434,520) (1,557,719)
Other current assets (13,820) (228,744) (75,135)
Other assets (1,929) 11,673 29,016
Accounts payable and accrued liabilities (342,780) (347,220) 1,149,519
-------- ---------- ----------
Net cash used in operating activities (98,600) (1,078,948) (604,857)
-------- ---------- ----------
Cash flows from investing activities
Capital expenditures (90,501) (45,671) (214,165)
Acquisitions, net of cash acquired (366,115)
-------- ---------- -----------
Net cash used in investing activities (456,616) (45,671) (214,165)
-------- ---------- -----------
Cash flows from financing activities
Proceeds from initial public offering 8,237,725
Redemption of preferred stock (65,000)
Net borrowings (payments) under line of credit 328,329 1,051,496 (2,447,887)
Net borrowings (payments) of debt (14,393) 8,885 32,664
Cash overdraft 275,392 268,773 (268,773)
Dividends (6,250) (17,264) (12,714)
Purchase of treasury stock (57,900)
--------- ----------- -----------
Net cash provided by financing activities 583,078 1,188,990 5,541,015
--------- ----------- -----------
NET INCREASE IN CASH 27,862 64,371 4,721,993
Cash and cash equivalents at beginning of year 86,905 114,767 179,138
--------- ----------- -----------
Cash and cash equivalents at end of year $ 114,767 $ 179,138 $ 4,901,131
========= =========== ===========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
F-6
Q.E.P. Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
February 28, 1995, February 29, 1996 and February 28, 1997
NOTE A - DESCRIPTION OF BUSINESS
Q.E.P. Co., Inc. (the "Company") manufactures and distributes, principally
through major home center chains predominantly located throughout the
United States, tools and related products used in the ceramic tile,
masonry, dry wall and carpeting trades.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
1. PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Q.E.P.
Co., Inc. and its wholly-owned subsidiaries after eliminating all
significant intercompany accounts and transactions.
2. INITIAL PUBLIC OFFERING
On September 17, 1996, the Company completed an initial public offering
of 1,000,000 shares of its common stock, par value $.001 per share
("Common Stock"), at an initial offering price of $8.50 per share and
120,000 warrants to purchase Common Stock at an exercise price of
$10.20 per share with an offering price of $.001 per warrant (the
"Offering"). On November 6, 1996, the underwriters exercised their
overallotment rights and purchased an additional 150,000 shares of
Common Stock of the Company at a price of $8.50 per share. The net
proceeds from the Offering and the exercise of the overallotment option
were approximately $8,238,000.
3. REINCORPORATION
The Company was originally incorporated in New York in 1979. In
connection with the Offering, the Company reincorporated as a Delaware
corporation with the same name and the New York corporation was merged
into it, continuing the business of the Company.
4. INVENTORIES
Inventories are stated at the lower of average cost or market.
F-7
Q.E.P. Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
February 28, 1995, February 29, 1996 and February 28, 1997
NOTE B (CONTINUED)
5. INCOME TAXES
Deferred income taxes are recorded to reflect the tax consequences on
future years of differences between the tax basis of assets and
liabilities and their financial reporting amounts at each year-end.
6. INTANGIBLE ASSETS
Intangible assets are recorded at cost and are amortized over the
estimated periods of related benefit using the straight-line method.
7. LEASES
Leases which meet certain criteria are classified as capital leases.
For such leases, assets and obligations are recorded initially at the
fair market values of the leased assets. The capitalized leases are
amortized using the straight-line method over the assets' estimated
economic lives. Interest expense relating to the lease liabilities is
recorded to effect a constant rate of interest over the terms of the
obligations. Leases not meeting capitalization criteria are classified
as operating leases and related rentals are charged to expense as
incurred.
8. REVENUE
Sales are recognized when merchandise is shipped.
9. PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation and
amortization are provided by straight-line methods in amounts
sufficient to relate the cost of depreciable assets to operations over
their estimated service lives. Leasehold improvements are amortized
over their expected useful life or the life of the respective lease,
whichever is shorter.
F-8
Q.E.P. Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
February 28, 1995, February 29, 1996 and February 28, 1997
NOTE B (CONTINUED)
The following are the estimated lives of the Company's fixed assets:
Machinery and warehouse equipment 3 to 10 years
Furniture and equipment 3 to 5 years
Capital leases 3 to 5 years
Building 30 to 33 years
Leasehold improvements 5 to 10 years
Maintenance and repairs are charged to expense, while significant
renewals and betterments are capitalized. When property is sold or
otherwise disposed of, the cost and related depreciation are removed
from the accounts, and any resulting gain or loss is reflected in
operations for the period.
10. ADVERTISING COST
All costs related to advertising are expensed in the period incurred.
11. NET INCOME PER COMMON SHARE
Primary and fully diluted net income per common share is computed using
the weighted average number of common shares outstanding and common
stock equivalents. The computation reduces the net income available per
common share by the amount of preferred stock dividends.
12. USE OF ESTIMATES
In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements and revenues and expenses during the reporting
period. Actual results could differ from those estimates.
F-9
Q.E.P. Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
February 28, 1995, February 29, 1996 and February 28, 1997
NOTE B (CONTINUED)
13. CASH EQUIVALENTS
The Company considers all highly liquid debt instruments purchased with
a maturity of three months or less to be cash equivalents.
14. STOCK-BASED COMPENSATION
The Company grants stock options for a fixed number of shares to
employees and directors with an exercise price equal to or greater than
the fair value of the shares at the date of grant. The Company has
adopted the disclosure-only provision of SFAS No. 123, "Accounting for
Stock-Based Compensation," which permits the Company to account for
stock option grants in accordance with APB Opinion No. 25, "Accounting
for Stock Issued to Employees." Accordingly, the Company recognizes no
compensation expense for the stock option grants.
15. RECLASSIFICATIONS
Certain amounts in 1996 have been reclassified to conform with the 1997
presentation.
16. NONCASH INVESTING AND FINANCING ACTIVITIES
In fiscal 1995, the Company purchased three companies. In conjunction
with the acquisitions, liabilities were assumed as follows:
Fair value of assets acquired $ 1,087,094
Less
Cash paid 400,000
Notes issued 230,000
Preferred stock issued 443,047
-----------
Liabilities assumed $ 14,047
============
F-10
Q.E.P. Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
February 28, 1995, February 29, 1996 and February 28, 1997
NOTE C - ACQUISITIONS
1. ANDREWS ENTERPRISES
Effective January 1, 1995, the Company purchased all of the assets of
Andrews Enterprises, which manufactures drywall and paint tools for
$50,000 in notes and 17,500 shares of $1 par value preferred stock for
a total purchase price of $67,500. The acquisition has been accounted
for as a purchase, and, accordingly, the operating results since the
date of the acquisition of Andrews have been included in the
accompanying financial statements. The purchase price was allocated to
assets acquired based on their estimated fair values. The excess of the
total acquisition cost over the fair value of net assets acquired in
the amount of $17,400 (included in other assets) is being amortized on
a straight-line basis over fifteen years. Accumulated amortization at
February 29, 1996 and February 28, 1997, was $1,400 and $2,500,
respectively.
2. MARION TOOL AND WESTPOINT FOUNDRY
Effective October 31, 1994, the Company purchased all the common stock
of Marion Tool Company, which manufactures grey iron castings, trowels,
other small hand tools, and assembles striking tools and garden tools,
for 425,547 shares of $1 par value preferred stock for a total purchase
price of $425,547 (see Note L). The acquisition has been accounted for
as a purchase, and, accordingly, the operating results of Marion Tool
have been included in the accompanying financial statements since the
date of acquisition. The purchase price was allocated to assets
acquired based on their estimated fair values. The excess total
acquisition cost over the fair value of net assets acquired of
approximately $52,000 (included in other assets) is to be amortized on
a straight-line basis over fifteen years. Accumulated amortization at
February 29, 1996 and February 28, 1997 was $3,600 and $8,000,
respectively.
3. O'TOOL COMPANY
On June 9, 1994, the Company purchased all the assets and assumed
certain liabilities of O'Tool Company, which distributes masonry and
carpentry tiling tools, for $580,000, consisting of $400,000 in cash
and $180,000 in notes, which have since been paid in full. The
acquisition has been accounted for as a purchase, and, accordingly, the
operating results of O'Tool since the acquisition have been included in
the accompanying financial statements.
F-11
Q.E.P. Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
February 28, 1995, February 29, 1996 and February 28, 1997
NOTE C (CONTINUED)
The excess of the fair value of net assets over the acquisition cost in
the amount of $150,000 (included in other liabilities) is being
amortized on a straight-line basis over five years. Accumulated
amortization at February 29, 1996 and February 28, 1997 was $52,500 and
$82,500, respectively.
The following unaudited pro forma consolidation shows the results of
operations assuming that the above purchases occurred on March 1, 1994.
The unaudited pro forma results for the year ended February 28, 1995
are not necessarily indicative of what actually would have occurred if
the acquisition had been in effect for the entire periods presented. In
addition, they are not intended to be a projection of future results.
Net sales $22,259,245
Net income 267,936
NOTE D - INVENTORIES
Inventories consisted of the following:
February 29, FEBRUARY 28,
1996 1997
----------- -----------
Raw materials and work-in-progress $ 376,433 $ 580,767
Finished goods 2,762,248 4,115,633
--------- ---------
$3,138,681 $ 4,696,400
========= =========
F-12
Q.E.P. Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
February 28, 1995, February 29, 1996 and February 28, 1997
NOTE E - PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
February 29, FEBRUARY 28,
1996 1997
----------- -----------
Land $ 7,509 $ 7,509
Machinery and warehouse equipment 292,278 406,448
Office furniture and equipment 178,069 180,472
Capital leased equipment 48,300 68,280
Building and leasehold improvements 132,727 205,305
-------- --------
658,883 868,014
Less accumulated depreciation and
amortization (392,273) (452,950)
-------- --------
$ 266,610 $ 415,064
======== ========
NOTE F - LOANS PAYABLE
The Company has a bank credit facility which permits borrowings of up to
$3,250,000 as revolving credit against a fixed percentage of eligible
accounts receivable and inventory, as defined. Interest is payable monthly
at the bank's base lending rate (8.25% at February 28, 1997) plus 1/2%, or
the LIBOR plus 2.25% (7.69% at February 28, 1997). Subsequent to year-end,
the rate was reduced to LIBOR plus 1.75%. The loan agreement is through
June 30, 1998. Under the most restrictive covenants of the loan agreement,
the Company is required to maintain a minimum tangible net worth of
$2,600,000. The Company is also required to maintain a minimum interest
coverage ratio, and a specified debt to tangible net worth ratio for each
fiscal year. As of February 29, 1996 and February 28, 1997, the Company was
in compliance with these covenants.
The line of credit is collateralized by substantially all of the assets of
the Company and is guaranteed up to $500,000, by the Company's majority
shareholder.
F-13
Q.E.P. Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
February 28, 1995, February 29, 1996 and February 28, 1997
NOTE F (CONTINUED)
The terms of the Company's bank credit facility prohibit the payment of
dividends, except with the lender's consent. The Company is obligated to
pay cumulative dividends, for which lender's consent has been obtained, in
varying amounts on the Series A and Series C Preferred Stock and a fixed,
noncumulative dividend on the Series B Preferred Stock (see Note L).
Letters of credit are issued by the Company during the ordinary course of
business through major domestic banks as required by certain vendor
agreements. The Company had approximately $67,000 and $552,000 as of
February 29, 1996 and February 28, 1997, respectively, of outstanding
letters of credit.
Interest paid for all debt was approximately $152,000, $218,000 and
$137,000 in fiscal 1995, 1996 and 1997, respectively.
NOTE G - ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consisted of the following:
February 29, FEBRUARY 28,
1996 1997
----------- -----------
Accounts payable $1,055,759 $1,153,983
Accrued payroll and employee
benefits 399,127 223,302
Accrued liabilities 365,669 779,856
Accrued volume and advertising
discount 90,748 408,804
Accrued income taxes 226,104
---------- ----------
$1,911,303 $2,792,049
========== ==========
F-14
Q.E.P. Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
February 28, 1995, February 29, 1996 and February 28, 1997
NOTE H - COMMITMENTS AND CONTINGENCIES
1. FUTURE MINIMUM OBLIGATION
The Company conducts its operations from various leased facilities.
Future minimum payments under noncancellable operating leases consist
of the following in fiscal years ending after February 28, 1997:
1998 $ 513,606
1999 488,491
2000 404,896
2001 369,855
2002 384,572
Thereafter 780,390
----------
$2,941,810
==========
Total rent expense under noncancellable operating leases approximated
$350,000, $404,000 and $701,000 in fiscal 1995, 1996 and 1997,
respectively.
2. MARION TOOL COMPANY
In October 1994, the Company acquired all of the outstanding common
stock of Marion Tool Company which manufactures specialty tools and
related castings (see Note C). In connection with this acquisition, the
Company also acquired the land underlying the Marion Tool facility and
warehouse and the foundry operations known as Westpoint Foundry in
Marion, Indiana. Prior to undertaking the acquisition, the Company
commissioned a series of environmental reports by an independent
consulting firm of both the Marion Tool Company and Westpoint Foundry
facilities and the associated real estate. The consultant's
environmental report stated that samples of foundry sand and slag
deposited on the real estate were tested and determined not to
constitute hazardous
F-15
Q.E.P. Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
February 28, 1995, February 29, 1996 and February 28, 1997
NOTE H (CONTINUED)
waste. Based on the testing, the consultant indicated that such
deposits were unlikely to threaten ground water resources. In addition,
the consultant noted the presence of above ground storage tanks from
which some petroleum contamination was evident. The above ground
storage tanks were removed at the time of the acquisition and the
Company caused the contaminated soil to be removed in accordance with
applicable environmental laws. Because of the proximity of soil
contamination to several structures and improvements at the site and
the risk that removal could undermine the structures, all contaminated
soil was not removed. A report of the excavation results were submitted
to the Indiana Department of Environmental Management and, based upon
its discussions with such department, the Company believes that no
further action will be required concerning the remaining contamination.
The environmental reports prepared by the consultant also noted that
Marion Tool Company was identified as a potentially responsible party
("PRP"), pursuant to the Comprehensive Environmental Response,
Compensation and Liability Act of 1980 as amended ("CERCLA"), for the
cleanup of contamination resulting from past disposal of hazardous
wastes at certain sites to which Marion Tool Company, among others,
sent wastes in the past. CERCLA requires PRPs to pay for cleanup of
sites from which there has been a release or threatened release of
hazardous substances. Based upon, among other things, a review of the
data available to the Company regarding the site at which Marion Tool
Company is alleged to have deposited a portion of the waste located
thereon, and a comparison of the potential liability at this site to
settlements reached by other parties in similar cases, the Company
believes that Marion Tool Company's liability for this matter will not
have a material adverse effect on the Company's financial condition or
results of operations. Although the Company does not believe that
Marion Tool Company has other potential offsite liability, if other
disposal sites where Marion Tool Company sent waste are determined to
require cleanup under CERCLA or other similar laws, Marion Tool Company
could face similar claims in the future. The Company has not received
notice of any claims relating to disposal of waste by Marion Tool
Company at any other site.
Pursuant to the terms of an escrow agreement by and among the Company
and the sellers of the Marion Tool Company, the sellers agreed to
deposit certificates representing the 425,547 shares of Series A
Preferred Stock in an escrow account at the date of closing. The escrow
agent is
F-16
Q.E.P. Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
February 28, 1995, February 29, 1996 and February 28, 1997
NOTE H (CONTINUED)
authorized to release the shares of preferred stock to the Company
within 15 days after receipt of a written statement, in form and
substance satisfactory to the escrow agent in its discretion, providing
that there has been a material breach of the representations and
warranties of the sellers contained in the stock purchase agreement. In
the event of a dispute as to the existence of a breach of a
representation or warranty, the escrow agent is authorized to retain
the certificates representing the shares of a preferred stock pending
resolution of a dispute among the parties, or may interplead the
certificates into the registry of a court of competent jurisdiction.
Upon the expiration of six years from the closing date and in the
absence of a notice of breach of representations and warranties by the
sellers, the escrow agent is authorized to deliver the certificates
representing the shares of preferred stock to the sellers. The stock
purchase agreement between the Company and the sellers of Marion Tool
Company provided that Marion Tool Company had not committed any
violation of any environmental laws or regulations, and further
represented that there was no situation requiring remedial action by
Marion Tool Company under any environmental laws or regulations. The
stock purchase agreement also contained a joint and several
indemnification by Marion Tool Company and each of its shareholders in
favor of the Company.
To date, the Company has not notified the escrow agent of a violation
of any environmental laws or regulations, or any situation requiring
remedial action by the Company, or any other violation of a
representation or warranty, pursuant to which the Company claims the
right to the return of any of the Series A Preferred Stock. After
taking into account 106,387 shares of Series A Preferred Stock
converted into shares of common stock, there are issued and outstanding
319,160 shares of Series A Preferred Stock, par value $1.00 per share,
which will be held in escrow through August 2000 and which are subject
to return to the Company in accordance with the terms of the escrow
agreement (see Note L).
NOTE I - PENSION PLAN
PROFIT SHARING AND 401(K) PLAN
Effective March 1, 1995, the Company merged, and amended and restated, its
prior defined contribution profit sharing plan and its prior 401(k) plan
into a revised plan to provide retirement income to substantially all
employees. Matching contributions to the plan are discretionary and are
determined annually by the Board of Directors. For the years ended February
28, 1995, February 29, 1996 and February 28, 1997, the Company contributed
$172,000, $225,000 and $155,000, respectively.
F-17
Q.E.P. Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
February 28, 1995, February 29, 1996 and February 28, 1997
NOTE J - INCOME TAXES
The components of the provision for taxes on income are as follows:
February 28, February 29, FEBRUARY 28,
1995 1996 1997
----------- ----------- -----------
U. S. Federal
Current tax provision $420,150 $558,118 $1,120,682
Deferred tax (benefit) provision (60,000) 15,500 (144,000)
-------- -------- ----------
360,150 573,618 976,682
-------- -------- ----------
State
Current tax provision 78,662 90,334 185,895
Deferred tax (benefit) provision (9,500) 4,500 (20,000)
-------- -------- ----------
69,162 94,834 165,895
-------- -------- ----------
Total income tax provision $429,312 $668,452 $1,142,577
======== ======== ==========
The provision for income taxes reflects the use of the liability method
under SFAS No. 109.
Cash paid for income taxes was $300,352, $897,364 and $998,644 in fiscal
1995, 1996 and 1997, respectively.
The tax effects of temporary differences which gave rise to deferred tax
assets and liabilities are as follows:
February 29, FEBRUARY 28,
1996 1997
Provision for doubtful accounts $ 20,745 $ 22,716
Accrued expenses 10,456 206,240
Fixed assets 61,654 23,385
Inventory (8,855) (4,341)
Net operating loss carryforward 137,000 137,000
-------- --------
221,000 385,000
Valuation allowance (137,000) (137,000)
-------- --------
Net deferred tax asset $ 84,000 $ 248,000
========= ========
F-18
Q.E.P. Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
February 28, 1995, February 29, 1996 and February 28, 1997
NOTE J (CONTINUED)
On October 31, 1994, the Company acquired Marion Tool Company ("Marion")
(see Note C). Marion has a $356,000 net operating loss carryforward that
begins to expire in February 2006 and is subject to two limitations: first,
IRC Section 382 limits the Company's utilization of its net operating
losses to an annual amount; second, the separate return limitation year
("SRLY") limitation permits an offset to the current consolidated taxable
income only to the extent of taxable income attributable to the member with
the SRLY loss. Since the potential utilization of the net operating loss is
uncertain, a valuation allowance has been established to reduce this
deferred tax asset to zero.
The Company's Federal tax returns have been examined by the Internal
Revenue Service through February 28, 1991.
The following is a reconciliation of the statutory Federal income tax rate
to the effective rate reported in the financial statements:
YEAR ENDED
--------------------------------------------------------------------------------
FEBRUARY 28, 1995 FEBRUARY 29, 1996 FEBRUARY 28, 1997
--------------------- --------------------- ---------------------
PERCENT PERCENT PERCENT
OF OF OF
AMOUNT INCOME AMOUNT INCOME AMOUNT INCOME
------ ------ ------ ------ ------ ------
Provision for Federal
income taxes at the
statutory rate $392,619 34.0% $590,309 34.0% $1,001,597 34.0%
State and local income
taxes, net of Federal
income tax benefit 51,917 4.5 59,620 3.4 122,691 4.2
Other (15,224) (1.3) 18,523 1.1 18,289 .6
-------- ----- -------- ----- ----------- ------
Actual provision for
income taxes $429,312 37.2% $668,452 38.5% $1,142,577 38.8%
======== ===== ======== ===== =========== ======
F-19
Q.E.P. Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
February 28, 1995, February 29, 1996 and February 28, 1997
NOTE K - SIGNIFICANT CUSTOMER AND VENDOR INFORMATION
1. SIGNIFICANT CUSTOMER INFORMATION
The Company performs ongoing credit evaluations of its customers'
financial condition and, generally, requires no collateral from its
customers. The Company's customer base includes a high concentration of
home center chains with two customers. One customer representing 46%,
51% and 50% and the other customer 9%, 10% and 11% of sales in fiscal
1995, 1996 and 1997, respectively. These same two customers represented
42%, 55% and 37% and 6%, 11% and 10% of accounts receivable at February
28, 1995, February 29, 1996 and, February 28, 1997, respectively.
Although the Company is directly affected by the well-being of the home
center industry, management does not believe significant credit risk
exists at February 28, 1997.
2. SIGNIFICANT VENDOR INFORMATION
The Company purchased 26%, 19% and 14% and 13%, 10% and 9% for the
years ended February 28, 1995, February 29, 1996 and February 28, 1997,
respectively, of total purchases through two vendors. The Company
believes that alternative sources of supply are readily available and
that the loss of any vendor would not materially affect the Company's
operations.
NOTE L - SHAREHOLDERS' EQUITY - PREFERRED STOCK
The Company is authorized to issue a maximum of 2,500,000 shares of $1
preferred stock.
SERIES A
500,000 of the Company's 2,500,000 authorized shares of preferred stock, $1
par value per share, shall be designated as Series A Preferred Stock. The
holders of each share of Series A Preferred Stock shall be entitled to
receive, before any dividends shall be declared or paid on or set aside for
the Company's common stock, out of funds legally available for that
purpose, cumulative dividends in cash at the rate of $.035 per share per
annum for a period ending September 30, 2000, payable in semiannual
installments, accruing from the date of issuance of the shares. Commencing
October 1, 2000, the rate of dividends will equal the prime interest rate
on the first day of the month in which the dividends are payable, less
1-1/4%. The Company may redeem any or all of the shares of Series A
Preferred Stock
F-20
Q.E.P. Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
February 28, 1995, February 29, 1996 and February 28, 1997
NOTE L (CONTINUED)
outstanding at a price per share of $1.07 plus an amount equal to any
accrued but unpaid dividends thereon during the first year following the
issuance of such shares and such price shall be reduced by one percent (1%)
each year thereafter until $1.00 per share is reached. The Series A
Preferred Stock has no voting rights. During fiscal 1995, the Company
issued 425,547 shares of Series A preferred stock in connection with a
business acquisition (see Note C). In fiscal 1997, 106,387 of these shares
were converted to 3,129 shares of common stock. At February 28, 1997, there
were 319,160 shares of Series A Preferred Stock issued and outstanding. The
value of the preferred stock available for return to the Company under the
escrow agreement was reduced by 106,387 (see Note H). There were $0,
$13,653 and $12,103 dividends declared and paid during the fiscal years
1995, 1996 and 1997, respectively.
SERIES B
1,000,000 of the Company's 2,500,000 authorized shares of preferred stock,
$1 par value per share, shall be designated as Series B Preferred Stock.
The holder of each share of Series B Preferred Stock shall be entitled to
receive, out of the surplus of the Company, a noncumulative dividend at the
rate of $.05 per share per annum, payable annually before any dividend
shall be set apart for or paid on the common shares for such years. The
Series B Preferred Stock has no voting rights. The Company may redeem any
or all of the shares of Series B Preferred Stock then outstanding at a
price per share of $1.00. During fiscal 1994, 125,000 shares of Series B
Preferred Stock were issued for $125,000 to three suppliers. In 1996, the
Company bought back 65,000 shares at a price of $1.00 per share from one
supplier. In fiscal 1997, the remaining preferred stock were converted to
1,765 shares of common stock. There were $6,250, $3,000 and $-0- of
dividends declared and paid in fiscal years 1995, 1996 and 1997,
respectively.
SERIES C
1,000,000 of the Company's 2,500,000 authorized shares of preferred stock,
$1 par value per share, shall be designated as Series C Preferred Stock.
The holder of each share of Series C Preferred Stock shall be entitled to
receive, before any dividends shall be declared or paid on or set aside for
the Company's common stock, out of funds legally available for that
purpose, cumulative dividends at the
F-21
Q.E.P. Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
February 28, 1995, February 29, 1996 and February 28, 1997
NOTE L (CONTINUED)
rate of $.035 per share per annum, payable in annual installments, accruing
from the date of issuance of the shares. The Series C Preferred Stock has
no voting rights. The Company may redeem any or all of the shares of Series
C Preferred Stock then outstanding at a price per share of $1.00. During
fiscal year 1995, 17,500 shares of Series C Preferred Stock were issued in
connection with a business acquisition (see Note C). No dividends were
declared or due in fiscal year 1995 on these shares. In fiscal year 1996
and 1997, dividends of approximately $600 and $1,200, respectively, in
aggregate at $.035 per share were in arrears. In fiscal year 1997, a
dividend of approximately $600 was declared and paid.
TREASURY STOCK
Total common shares purchased in fiscal year 1996 and held in treasury were
15,152 shares for an aggregate cost of $57,900.
NOTE M - STOCK OPTION PLAN
The Company has adopted a stock option plan (the "Plan") for employees,
consultants and directors of the Company. Stock options granted pursuant to
the Plan shall be authorized by the Board of Directors. The aggregate
number of shares which may be issued under the Plan shall not exceed
250,000 shares of common stock.
Stock options are granted at prices not less than 85% of the fair market
value on the date of the grant. Option terms, vesting and exercise periods
vary, except that the term of an option may not exceed five years.
The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock Based Compensation." Accordingly, no compensation
cost has been recognized for the stock options granted to employees and
directors. Had compensation cost been determined based on the fair value at
the grant date for stock option awards in fiscal 1997 consistent with the
provisions of SFAS No. 123, the Company's net income and earnings per share
for the year ended February 28, 1997 would have been decreased by
approximately $301,000 or $0.15 per share, respectively.
F-22
Q.E.P. Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
February 28, 1995, February 29, 1996 and February 28, 1997
NOTE M (CONTINUED)
During the initial phase-in period of SFAS No. 123, such compensation may
not be representative of the future effects of applying this statement. The
weighted average fair value at date of grant for options granted during
1997 was $1.94 per option. The fair value of each option at date of grant
was estimated using the Black-Scholes option pricing model with the
following weighted average assumptions for grants in 1997:
1997
----
Expected stock price volatility 23.9%
Expected lives of options
Directors and officers 3 years
Employees 3 years
Risk-free interest rate 6.3%
Expected dividend yield 0%
Information regarding these option plans for the year ended February 28,
1997 is as follows:
Weighted
average
exercise
Shares price
------ -----
Options outstanding at beginning of year -0-
Exercised -0-
Granted 175,550 $7.38
Cancelled or forfeited (600) 7.23
-------
Options outstanding at end of year 174,950 7.38
=======
Exercisable 174,950
F-23
Q.E.P. Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
February 28, 1995, February 29, 1996 and February 28, 1997
NOTE M (CONTINUED)
The following table summarizes information about stock options outstanding
as of February 28, 1997:
Weighted
average Weighted Weighted
remaining average average
Range of Number contractual exercise Number exercise
exercise prices outstanding life price exercisable price
--------------- ----------- ----------- -------- ----------- -----
7.23 - 8.625 174,950 4.4 7.38 174,950 7.38
NOTE N - FUTURE EFFECTS OF RECENTLY ISSUED
ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards No. 128, "Earnings Per Share," which is effective for
financial statements issued after December 15, 1997. Early adoption of the
new standard is not permitted. The new standard eliminates primary and
fully diluted earnings per share and requires presentation of basic and
diluted earnings per share together with disclosure of how the per share
amounts were computed. The effect of adopting this new standard is not
expected to have a material impact on the disclosure of earnings per share
in the financial statements.
F-24
Q.E.P. Co., Inc. and Subsidiaries
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Column A Column B Column C Column D Column E
-------- -------- -------- -------- --------
Additions
----------------------------
Balance at Charged to Charged to Balance at
beginning costs and other Deductions end
Description of period expenses accounts (a) of period
----------- ---------- ---------- ---------- ---------- ----------
Year ended February 28, 1995
Deducted from asset accounts
Allowance for doubtful accounts $17,500 $ 30,748 $ 3,448 $44,800
Year ended February 29, 1996
Deducted from asset accounts
Allowance for doubtful accounts 44,800 101,830 92,130 54,500
Year ended February 28, 1997
Deducted from asset accounts
Allowance for doubtful accounts 54,500 58,755 52,155 61,100
(a) Accounts written off as uncollectible, net of recoveries.
F-25
EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------- -----------
3.1.2 Bylaws of the Company
10.1.1 Q.E.P. Co., Inc. Omnibus Stock Plan of 1996
10.2.6 Lease Agreement, dated September 17, 1996, by and among the Company
and Lawrence Z. Crockett, as Trustee of the Lawrence Z. Crockett
Trust dated March 31, 1994 and Marilyn M. Crockett, as Trustee of the
Marilyn M. Crockett Trust dated March 31, 1994, including
amendment thereto dated January 22, 1997
10.2.7 Industrial Lease, dated August 1, 1996, by and between
JMB/Pennsylvania Associates - IV, L.P., and the Company
27 Financial Data Schedule