ITEM 1. BUSINESS.
GENERAL
Catalina Lighting, Inc. was incorporated under the laws of the state of Florida in 1974 and became a public company in 1988. The Company designs, manufactures, contracts for the manufacture of, imports and distributes a broad line of lighting fixtures and lamps under the Westinghouse(R) brand, and the Catalina(R), Dana(R) and Illuminada(R) trade names. The Company also functions as an original equipment manufacturer, selling goods under its customers' private labels. The Company sells principally in the United States through a variety of retailers including home centers, national retail chains, office superstore chains, mass merchandisers, warehouse clubs, discount department stores and hardware stores. The Company also sells its products in Europe and Canada, and, to a lesser extent, in Mexico, Asia, Latin America and Australia. Currently, its product line is comprised almost entirely of lighting fixtures and lamps. The Company has supplemented its product lines through acquisitions but has remained focused on lighting products and has no plans to materially change its sales focus in the near future.
STRATEGY
In order to expand its retail distribution network and more efficiently and profitably service its customers, the Company focuses on the following strategies:
TARGETED DISTRIBUTION. The Company distributes a diverse product line through multiple retail channels. The Company targets rapidly growing and large retailers, including leading home centers, office product superstores, mass merchandisers, warehouse clubs, discount department stores, and hardware stores. Large retailers assure a broad distribution of a variety of the Company's products while high-growth retailers provide the Company with rapid penetration of selected industry segments. Secondarily, the Company targets smaller chains within the above retail categories. The Company's distribution strategy provides it with numerous sources of demand and promotes the Company's brand names broadly throughout the residential and office lighting markets in the United States, Europe and Canada, and to a lesser extent Asia, Mexico, Latin America and Australia.
PROGRAM SELLING. In its primary domestic markets, the Company strives to be the primary source of lighting products to its retailers by offering a complete program of lighting products in a variety of categories. The availability of over 1000 styles of such products as outdoor/security lighting, table, floor and torchiere lamps, chandeliers, recessed and track lighting and wall and ceiling lights - the majority of which are available in several colors or finishes - provides retailers the opportunity to source most of their lighting products through the Company on a "one stop shopping" basis. The Company believes that its broad selection of affordable products coupled with its ability to aid its retail customers in developing a complete lighting program gives it a competitive advantage.
INTERNATIONAL EXPANSION The Company's Hong Kong based subsidiary, Go-Gro Industries Limited ("Go-Gro"), sells its products to wholesale distributors in Europe and, to a lesser extent, various customers in Asia. Go-Gro is also a major supplier to the Company's U.S. and Canadian subsidiaries. Management believes the Company's products and services are well suited for further growth in these and other markets. The Company's current plans include expansion of Go-Gro's existing sales and marketing operations in Europe, including the United Kingdom.
TURNKEY DEPARTMENTS. The Company consults with many of its domestic retail customers to establish departments which allow the Company to display its products in a customized layout designed to meet each retailer's specific merchandising and marketing goals. The Company can design, assemble and maintain these departments and provide the retailer with shelving plan-o-grams, signs, point-of-purchase promotional strategies and in-store inventory stocking programs. Turnkey departments ensure the Company's retail customers efficient and convenient management of the Company's products within their stores and allow the Company to maintain an attractive and informative presentation of its products.
WAREHOUSE SUPPLY OF IMPORTED GOODS. The Company's warehouses in the United States, Canada and Mexico enable it to provide its customers with the advantage of short delivery time. Warehouse sales allow retailers to receive products in several days as compared to several months for items shipped directly to them from Asia. Timely deliveries increase the customer's inventory turns and profits making the Company a valuable partner in the retailer's business.
PRODUCTS
The Company markets a diverse product line used primarily in residential and office settings. The Company's product line is comprised almost entirely of two main categories: lighting fixtures and lamps. Lighting fixtures consist of outdoor/security lighting, chandeliers, recessed and track lighting, and wall and ceiling lights. Lamps sold by the Company include both table and floor models and may be either functional or decorative. Functional lamps consist of halogen desk lamps, bankers lamps, swing arm desk lamps, torchiere lamps, magnifier lamps, and any other lamps generally used for task oriented functions. Decorative lamps are fashion oriented and made of such materials as metal, ceramic, stained glass, and crystal glass. The Company also sells other lighting-related products such as flashlights and ceiling fans. The Company may continue to expand its product lines internally or through acquisitions.
The Company's products are manufactured and assembled according to the Company's design specifications. The finished products are packaged and labeled under one of the Company's brand names: Westinghouse(R), Catalina(R), Dana(R) and Illuminada(R). The Company also functions as an original equipment manufacturer, selling goods under its customers' private labels.
CUSTOMERS
The Company distributes its products in North America principally through major retail outlets, including home centers, office superstore chains, mass merchandisers, discount department stores, warehouse clubs, furniture and lighting stores and hardware stores. Products are also sold to a large extent in Europe to wholesale distributors under their private labels and to selected retail customers in Europe, Australia and Asia. In fiscal 1998 and 1997, Home Depot accounted for 27.5% and 22.1%, respectively, of the Company's net sales. For the fiscal years ended September 30, 1998 and 1997, net sales to the Company's ten largest customers represented approximately 66% and 63%, respectively, of the Company's total revenues. The Company believes its relationships with its customers are good.
DISTRIBUTION METHODS
The Company utilizes two methods to sell products: warehouse sales and direct sales. The backlog of unshipped orders at September 30, 1998 and 1997 was $26.3 million and $19.2 million, respectively, and at November 30, 1998 and 1997 was $27.4 million and $20.0 million, respectively. Although these orders are subject to cancellation by the customers, the Company believes substantially all such orders are firm.
The Company purchases products overseas for its own account and warehouses the products in a 473,000 square foot Company-owned facility in Tupelo, Mississippi and in leased facilities in Toronto, Canada and in Mexico City, Mexico. The Company is responsible for costs of shipping, insurance, customs clearance and duties, storage and distribution related to such warehouse products and therefore, warehouse sales usually command higher per unit sales prices than direct sales of the same items. For the fiscal years ended September 30, 1998 and 1997, warehouse sales accounted for 33% and 39%, respectively, of net sales.
The Company's direct sales are made either by delivering lighting products to the customers' common carriers at a shipping point in Asia or by shipping the products from Asia directly to customers' distribution centers, warehouses or stores. Direct sales are made in large quantities (generally container-sized lots) to customers, who pay pursuant to their own international, irrevocable letters of credit (which may or may not be transferable depending on whether the goods are manufactured by Go-Gro) or on open credit with the Company. Upon receipt of a customer's transferable letter of credit, the Company transfers the portion of the letter of credit covering the cost of merchandise to its supplier. The terms of the transfer provide that draws may not be made by the supplier until the Company is entitled to be paid pursuant to the terms of the customer's letter of credit. The Company has the right to draw upon the customer's letter of credit once the products are inspected by the Company or its agents, delivered to the port of embarkation and the appropriate documentation has been presented to the issuing bank within the time periods established by such letter of credit. For fiscal years ended September 30, 1998 and 1997, 67% and 61%, respectively, of net sales were attributable to direct sales.
The relative proportion of the Company's sales generated by each method is dependent upon customer buying preferences and Company sales strategies. Purchasing on a direct basis allows the customer to generally pay a lower per unit price than purchasing the same items from the warehouse, but such method requires the customer to purchase in greater quantities and thus assume the costs, risks and liquidity requirements associated with holding larger inventories. Customer buying preferences are influenced by a number of business, economic and other factors. The underlying factors driving customer buying preferences often vary from customer to customer and are subject to change, thus customer buying preferences over time are inherently difficult to predict.
SOURCES OF PRODUCTS
Virtually all of the products sold by the Company are obtained from factories located in China. The Company manufactures a portion of these products and purchases the remainder from independent suppliers.
In 1994 the Company purchased Go-Gro, a lighting products manufacturer with its administrative office located in Hong Kong and production facilities located in the Guangdong Province of China. Go-Gro's production equipment is owned by Shenzhen Jiadianbao Electrical Products Co., Ltd. ("SJE"), Go-Gro's cooperative joint venture subsidiary. Approximately 50% of SJE's factory buildings are leased from the Company's joint venture partner in SJE, Shenzhen Baoanqu Fuda Industries Co. Ltd. ("Fuda"), a Chinese company, the remaining 50% is owned by SJE. Under the terms of the cooperative joint venture agreement with Fuda, Go-Gro receives 100% of the manufacturing profits and losses of SJE, while Fuda receives a yearly management fee from SJE of approximately $400,000 in addition to the rent for the factory buildings. Go-Gro manufactures an extensive product line which is sold mainly to wholesale distributors and retailers in Europe, the Company's subsidiaries and to a lesser extent, retailers in Asia and Australia. Go-Gro and its subsidiaries employ approximately 2,600 people.
SJE leased factory buildings in three separate locations in China. During 1995, the Company initiated a consolidation of its Go-Gro/SJE manufacturing facilities into one large compound in order to achieve certain manufacturing efficiencies and to control its occupancy costs in what management believes will be an inflationary business environment. In April 1995, SJE and the Bureau of National Land Planning Bao-An Branch of Shenzhen City entered into a Land Use Agreement covering approximately 467,300 square feet in Bao-An County, Shenzhen City, People's Republic of China. The agreement provides SJE with the right to use this land until January 18, 2042. The land use rights are non-transferable. Under the terms of the SJE joint venture agreement, ownership of the land and buildings of SJE is divided 70% to Go-Gro and 30% to Fuda. Land costs, including the land use rights, approximated $2.6 million of which Go-Gro has paid its 70% proportionate share of $1.8 million.
Under the terms of this agreement, as amended, SJE is obligated to construct approximately 500,000 square feet of factory buildings and 211,000 square feet of dormitories and offices, of which 40 percent was required to be and was completed by April 1, 1997. The remainder of the construction is required to be completed by December 31, 1999. The Company plans to file an application to extend the completion deadline of December 1999. The total cost for this project is estimated at $15.5 million (of which $9.9 million had been expended as of September 30, 1998) and includes approximately $1 million for a Municipal Coordination Facilities Fee (MCFF). The MCFF is based upon the square footage to be constructed. The agreement calls for the MCFF to be paid in installments beginning in January 1997. A 162,000 square foot factory, 77,000 square foot warehouse and 60,000 square foot dormitory became fully operational in June 1997.
Goods produced by Go-Gro constituted approximately 40% in 1998 and 41% in 1997, of the total products either purchased or manufactured by the Company. The raw materials and components essential to Go-Gro's manufacturing process are purchased from distributors and manufacturers located in various countries as follows: plastic resin (Germany, China, Japan and Taiwan), steel (Korea, Japan, Taiwan and China), cable (China), light bulbs (China, Taiwan, Indonesia and Hong Kong), lampholders (Taiwan, Germany, Italy and China) and other various components (China, Europe, U.S., Taiwan and others).
The Company chooses manufacturers based on price, quality of merchandise, reliability and ability to meet the Company's timing requirements for delivery. Manufacturing commitments are made on a purchase order basis. The Company or its customer is often required to post a letter of credit prior to shipment.
The Company has employees located in the U.S., Hong Kong and China who supervise the Company's manufacturing contractors. These employees' responsibilities include the establishment and ongoing development of close relationships with the manufacturers, setting product and manufacturing standards, performing quality assurance functions including inspection at various stages, tracking costs, performing and/or working with manufacturing engineering, and oversight of the manufacturing processes. The Company maintains a quality control and quality assurance program and has established inspection and test criteria for each of its products. These methods are applied by the Company or its agents regularly to product samples in each manufacturing location prior to shipment and each shipment must pass quality control inspection.
The Company expects to continue to use a limited number of contract manufacturers and accordingly will continue to be highly dependent upon sources outside the Company for timely production and quality workmanship.
In fiscal 1998 and 1997, Chinese suppliers, other than Go-Gro, accounted for approximately 57% and 53%, respectively, of the total products either purchased or manufactured by the Company. Shunde No. 1 Lamp Factory ("Shunde") accounted for approximately 26% of the total products either purchased or manufactured by the Company in 1998 and 19% in 1997 and another supplier accounted for 6% and 13% of the same total in 1998 and 1997, respectively. Purchases from the top five independent suppliers comprised 47% and 43%, respectively, of the total of the products either purchased or manufactured by the Company for fiscal 1998 and 1997. Other than Shunde, no independent supplier accounted for more than 10% of the total of the products either purchased or manufactured by the Company in 1998.
On June 21, 1996, the Company entered into an agreement with Shunde whereby Shunde agreed to manufacture lighting products for the Company to be sold in North and South America and the European Community on an exclusive basis for a three year period beginning October 1, 1996 in return for annual minimum purchase requirements from the Company. The agreement is terminable if the Company does not meet its minimum purchase requirements, at which time the exclusivity clause would cease. However, no amounts would be due Shunde for failure to meet the purchase requirements. To date, the Company has met its minimum purchase requirements under this agreement.
While the Company purchases its products from a small number of large suppliers with whom it maintains close alliances, the same products could be purchased from numerous other suppliers.
The continued importation of products from China and the Company's business could be affected by any trade issues impacting U.S. - China relations.
On June 3, 1998, the President of the United States extended to the People's Republic of China "Most Favored Nation" treatment for the entry of goods into the United States for an additional year, beginning July 3, 1998. The trade status has been renamed "Normal Trade Relations" because it applies to all but a handful of U.S. trading partners. In the context of United States tariff legislation, such treatment means that products are subject to favorable duty rates upon entry into the United States. On July 22, 1998 the House of Representatives supported the President's decision and rejected a bill to impose trade sanctions against China due to alleged human rights abuses, nuclear proliferation policies and a growing U.S. trade deficit with China. Members of Congress and the "human rights community" will continue to monitor the human rights issues in China and adverse developments in human rights and other trade issues in China could affect U.S. - China relations. As a result of various political and trade disagreements between the U.S. Government and China, it is possible restrictions could be placed on trade with China in the future which could adversely impact the Company's operations and financial position.
The Company obtained a political risk insurance policy issued by the Multilateral Investment Guarantee Agency, a member of the World Bank Group, in the amount of $14.4 million covering its purchase and expansion of SJE in China. The contract is a long-term non-cancelable guarantee covering the risks of expropriation and war and civil disturbance. The Company obtained guarantees to cover existing assets of $11.0 million and stand-by guarantees of $3.4 million on construction of its SJE facilities.
In June 1997, the Company ceased manufacturing operations at Meridian Lamps, Inc. ("Meridian"), a wholly-owned subsidiary with a manufacturing facility located in Meridian, Mississippi, which commenced operations in late December 1994. Meridian produced decorative table and floor lamps. The Meridian facility consists of 123,000 square feet. The Company leased the facility in June 1997. Meridian's operations generated $2.8 million in net sales during both fiscal 1997 and fiscal 1996.
COMPETITION
The Company's product lines span major segments within the lighting industry and, accordingly, the Company's products compete in a number of different markets with a number of different competitors. The Company competes with other independent distributors, importers, manufacturers, and suppliers of lighting fixtures and other consumer products. The lighting industry is highly competitive. Other competitors market similar products that compete with the Company on the basis of price. Some of these competitors do not maintain warehouse operations or do not perform some of the services provided by the Company which require the Company to charge higher prices. The relatively low barriers to entry into the lighting industry and the limited proprietary nature of many lighting products also permit new competitors to enter the industry easily. The ability of the Company to compete successfully in this highly competitive market depends upon its ability to manufacture and purchase quality products on favorable terms, ensure its products meet safety standards, deliver the goods promptly at competitive prices, and provide a wide range of services such as electronic data interchange and customized products, packaging, and store displays.
INDEPENDENT SAFETY TESTING
As part of its marketing strategy, the Company voluntarily submits its products to recognized product safety testing laboratories in countries in which it markets its products. Such laboratories include Underwriters Laboratories (UL) in the United States, Canadian Standards Association (CSA) in Canada, British Standards (BS) in Great Britain, Association Nacional de Normalizacion y Certification del Sector Electrico (ANCE) in Mexico and various European electrical testing organizations. If the product is acceptable, the laboratory issues a report which provides a technical description of the product. It also provides the Company's suppliers with procedures to follow in producing the products and periodically conducts inspections at such suppliers' facilities for compliance. Electrical products which are manufactured in accordance with safety certification marks are generally recognized by consumers as safe products and such certification marks are often required by various governmental authorities to comply with local codes and ordinances. The Company does not anticipate any difficulty in maintaining the right to use the listing marks of these laboratories.
PRODUCT LIABILITY
The Company is engaged in a business which could expose it to possible claims for injury resulting from the failure of its products. The Company maintains primary product liability insurance coverage of $1 million per occurrence, $2 million in the aggregate, as well as a $25 million aggregate umbrella insurance policy and $75 million excess umbrella insurance. The primary insurance coverage requires the Company to self insure for a maximum amount of $10,000 per incident occurring in calendar 1999. No assurance can be given that the claims will not exceed available insurance coverage or that the Company will be able to maintain the same level of insurance. See "Legal Proceedings".
TRADEMARKS AND PATENTS
On April 26, 1996, the Company entered into a license agreement with Westinghouse Electric Corporation to market and distribute a full range of lighting fixtures, lamps and other lighting products under the Westinghouse brand name in exchange for royalty payments. The agreement terminates on September 30, 2001. The Company has an option to extend the agreement for an additional ten years. The royalty payments are due quarterly and are based on a percent of the value of the Company's net shipments of Westinghouse branded products, subject to annual minimum payments due. Commencing September 30, 1999 either party has the right to terminate the agreement during fiscal years 1999 to 2001 if the Company does not meet the minimum net shipments of $25 million for fiscal 1999, $40 million for fiscal 2000 and $60 million for fiscal 2001. Net sales of Westinghouse branded products amounted to $10.9 million and $9.0 million for the years ended September 30, 1998 and 1997, respectively.
On December 17, 1996 White Consolidated Industries, Inc. ("White"), which has acquired certain limited trademark rights from Westinghouse to market certain household products under the White-Westinghouse trademark, notified the Company of a lawsuit against Westinghouse and the Company filed in the United States District Court, for the Northern District of Ohio. The lawsuit challenged the Company's right to use the Westinghouse trademarks on its lighting products and alleges trademark infringement. On December 24, 1996, Westinghouse and the Company served a Complaint and Motion for Preliminary Injunction against White, AB Electrolux, Steel City Vacuum Co., Inc., Salton/Maxim Housewares, Inc., Newtech Electronics Corp., and Windmere Durable Holdings, Inc. in the United States District Court, Western District of Pennsylvania, Case No. 96-2294 alleging that the defendants had violated Westinghouse's trademark rights, breached the Agreement between Westinghouse and White and sought an injunction to enjoin White against interference with their contractual arrangements. In October 1997, the cases were consolidated in the Pennsylvania case and on November 7, 1997 White filed a Counterclaim and Third Party Claims against Westinghouse, Catalina and Minami International Corporation alleging trademark infringement, trademark dilution, false designation of origin, false advertising and unfair competition and seeking injunctive relief and damages. Both the Company and Westinghouse vigorously dispute White's allegations. Pursuant to the License Agreement between Westinghouse and the Company, Westinghouse is defending and indemnifying the Company for all costs and expenses for claims, damages and losses, including the costs of litigation. A trial date of June 21, 1999 has been set by the Court.
The Company's licensed brand, Westinghouse(R) and the Company's own trademarks, Catalina(R), Dana(R) and Illuminada(R) are registered in the United States, Canada and Mexico as well as in numerous countries in the European Community and Asia. The Company is in the process of registering its trademarks in Central and South America.
EMPLOYEES
As of December 14, 1998 the Company employed approximately 215 people in the United States, Canada and Mexico. The Hong Kong and China operations, including Go-Gro's cooperative joint venture, employed approximately 2,600 people. None of the Company's employees are represented by a collective bargaining unit and the Company believes that its relationships with its employees are good.
FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES
Please see Note 13 of Notes to Consolidated Financial Statements.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information as of December 14, 1998 with respect to the executive officers of the Company:
NAME AGE POSITION WITH THE COMPANY - ------------------------- ----- ------------------------------------- Robert Hersh 52 Chairman, President, Chief Executive Officer, Director
Dean S. Rappaport 46 Executive Vice President, Chief Operating Officer, Director
William D. Stewart 50 Executive Vice President, Director
Nathan Katz 43 Executive Vice President
David W. Sasnett 42 Senior Vice President, Chief Financial Officer, Chief Accounting Officer
Thomas M. Bluth 41 Vice President, Secretary, Treasurer
None of the Company's officers has any family relationship with any director or other officer. "Family relationship" for this purpose means any relationship by blood, marriage, or adoption, not more remote than first cousin.
ROBERT HERSH has been the President and Chief Executive Officer of the Company since April 1991, Chairman of the Board since June 1991 and a Director of the Company since April 1988. Mr. Hersh served as the Executive Vice President of the Company from 1985 to April 1991 and as Secretary from June 1989 until June 1991.
DEAN S. RAPPAPORT has been Executive Vice President of the Company since January 1988 and a Director of the Company since April 1988. From January 1988 to November 1996 Mr. Rappaport was Chief Financial Officer and Treasurer of the Company. Mr. Rappaport was promoted to Chief Operating Officer of the Company in November 1996. From 1984 until he joined the Company, Mr. Rappaport was a partner with Wachsman & Rappaport, P.A., a public accounting firm located in Margate, Florida.
WILLIAM D. STEWART has been Executive Vice President of the Company since 1989, and a Director of the Company since April 1994. From 1985 until he joined the Company, Mr. Stewart was an Executive Vice President of Crest Industries, Inc., a distributor of home improvement products.
NATHAN KATZ has been Executive Vice President of the Company since October 1, 1993 and President of Catalina Industries (formerly known as Dana Lighting, Inc.), a wholly-owned subsidiary of the Company since August 1989. From October 1983 to August 1989, Mr. Katz was the Chief Executive Officer of Dana Imports, Inc., an importer of lamps located in Boston, Massachusetts.
DAVID W. SASNETT has been a Vice President of the Company since November 1994. In November 1997, Mr. Sasnett became a Senior Vice President of the Company. In November 1996, Mr. Sasnett became the Chief Financial Officer of the Company. Prior to that time, he was the Company's Controller. From 1993 until he joined the Company, Mr. Sasnett was the Vice President - Finance and Controller of Hamilton Bank, N.A. and from 1980 to 1993 was employed by the international accounting firm of Deloitte & Touche.
THOMAS M. BLUTH has been Vice President since August 1994 and Secretary of the Company since November 1994. Mr. Bluth became Treasurer of the Company in November 1996. From 1989 until he joined the Company, Mr. Bluth was Vice President and General Counsel for Ellis Diversified, Inc. From 1987 to 1989, Mr. Bluth was the Assistant Tax Director for Southwestern Bell Corporation.
ITEM 2.
ITEM 2. PROPERTIES.
The following table sets forth details about the Company's offices, manufacturing plants and warehouse facilities:
LEASED/ OWNED LOCATION FACILITY ---------------------- ------------------------ ------------- Miami, FL headquarters/office owned (1)
Dallas, TX office/warehouse leased (2)
Tupelo, MS warehouse owned (1)
warehouse leased
Easton, MA office leased
Meridian, MS manufacturing plant / owned (1) (4) warehouse
Montreal, Canada office/warehouse leased (2)
Toronto, Canada office/warehouse leased
Mexico office leased
warehouse leased
Hong Kong office leased
China office/manufacturing leased plants/warehouse
dormitories leased
manufacturing plant/ owned (3)
warehouse/dormitories
Taiwan office leased
---------------------- ----------------------- -------------
(1) Owned subject to a first mortgage.
(2) The Company has subleased all space under this lease to unrelated parties.
(3) This facility is owned by a joint venture in which the Company has a 70% interest as to ownership of the facility. The joint venture purchased land use rights which terminate in the year 2042.
(4) The Company has leased this facility to an unrelated party.
All of the Company's properties are fully utilized with the exception of the Dallas, Montreal and the Meridian facilities, which have been fully subleased or leased. All of the Company's properties are suitable for its operations, with the exception of the Meridian facility, which the Company ultimately expects to sell.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
On June 4, 1991, the Company was served with a copy of the Complaint in the matter of Browder vs. Catalina Lighting, Inc., Robert Hersh, Dean S. Rappaport and Henry Gayer, Case No. 91-23683, in the Circuit Court of the 11th Judicial Circuit in and for Dade County, Florida. The plaintiff in the action, the former President and Chief Executive Officer of the Company, contended that his employment was wrongfully terminated and as such brought action for breach of contract, defamation, slander, libel and intentional interference with business and contractual relationships, including claims for damages in excess of $5 million against the Company and $3 million against the named directors. During the course of the litigation the Company prevailed on its Motions for Summary Judgment and the Court dismissed the plaintiff's claims of libel and indemnification. On February 3, 1997, the plaintiff voluntarily dismissed the remaining defamation claims against the Company and directors. The breach of contract claim was tried in February, 1997 and the jury returned a verdict against the Company for total damages of $2.4 million (including prejudgment interest). On July 14, 1997, the Court also granted plaintiff's motion for attorney fees and costs of $1.9 million. A provision of $4.3 million was recorded by the Company during the quarter ended March 31, 1997 and a $681,000 provision for post-judgment interest was recorded through September 30, 1998. The Company is appealing the verdict and attorney fee award and the appeal was argued before the Third District Court of Appeal on December 18, 1998. The Company believes its arguments are meritorious as argued. No decision from the District Court has been received to date.
On December 17, 1996 White Consolidated Industries, Inc. ("White"), which has acquired certain limited trademark rights from Westinghouse Electric Corp. ("Westinghouse") to market certain household products under the White-Westinghouse trademark, notified the Company of a lawsuit against Westinghouse and the Company filed in the United States District Court, for the Northern District of Ohio. The lawsuit challenged the Company's right to use the Westinghouse trademarks on its lighting products and alleges trademark infringement. On December 24, 1996, Westinghouse and the Company served a Complaint and Motion for Preliminary Injunction against White, AB Electrolux, Steel City Vacuum Co., Inc., Salton/Maxim Housewares, Inc., Newtech Electronics Corp., and Windmere Durable Holdings, Inc. in the United States District Court, Eastern District of Pennsylvania, Case No. 96-2294 alleging that the defendants had violated Westinghouse's trademark rights, breached the Agreement between Westinghouse and White and sought an injunction to enjoin White against interference with their contractual arrangements. In October 1997, the cases were consolidated in the Pennsylvania case and on November 7, 1997 White filed a Counterclaim and Third Party Claims against Westinghouse, Catalina and Minami International Corporation alleging trademark infringement, trademark dilution, false designation of origin, false advertising and unfair competition and seeking injunctive relief and damages. Both the Company and Westinghouse vigorously dispute White's allegations. Pursuant to the License Agreement between Westinghouse and the Company, Westinghouse is defending and indemnifying the Company for all costs and expenses for claims, damages and losses, including the costs of litigation. A trial date of June 21, 1999 has been set by the Court.
During fiscal 1998 the Company received a number of claims relating to halogen torchieres sold by the Company to various retailers. Management does not currently believe these claims will result in a material uninsured liability to the Company. However, as a result of these claims the Company experienced an increase in its liability insurance premiums effective for the 1999 calendar year and will now be self-insuring up to a maximum of $10,000 for each incident occurring in calendar 1999. It is too early to assess the impact of these changes on the Company's financial position or annual results of operations during fiscal 1999. No assurance can be given that the number of claims will not exceed historical experience or that claims will not exceed available insurance coverage or that the Company will be able to maintain the same level of insurance. See "Product Liability."
The Company is also a defendant in other legal proceedings arising in the course of business. In the opinion of management the ultimate resolution of these other legal proceedings will not have a material adverse effect on the financial position or annual results of operations of the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
During the quarter ended September 30, 1998, no matters were submitted for a vote of the Company's stockholders.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's common stock is traded on the New York Stock Exchange under the symbol LTG. The following table sets forth, for the periods indicated, the high and low closing prices of the common stock as reported by the New York Stock Exchange.
High Low
Fiscal Year Ended September 30, 1997 First Quarter 5 1/4 3 3/4 Second Quarter 5 1/2 3 5/8 Third Quarter 4 1/8 3 Fourth Quarter 6 7/16 3 7/8 Fiscal Year Ended September 30, 1998
First Quarter 6 7/16 3 3/8 Second Quarter 4 3/8 3 1/4 Third Quarter 4 5/8 3 5/8 Fourth Quarter 4 1/8 2 1/16
On December 14, 1998, the closing price of the Company's common stock as reported on the New York Stock Exchange was $2.69. As of December 28, 1998, there were approximately 2,700 holders of record of the Company's common stock, including some brokerage firms which hold shares in street name on behalf of their clients.
The Company has never paid cash dividends on its common stock. The Company intends to retain future earnings, if any, to finance the expansion of its business and does not anticipate that any cash dividends will be paid in the foreseeable future. In addition, the terms of the Company's domestic credit facility and convertible subordinated notes prohibit the payment of any cash dividends or other distribution on any shares of the Company's common stock, other than dividends payable solely in shares of common stock, unless approval is obtained from the lenders. Future dividend policy will depend on the Company's earnings, capital and financing requirements, expansion plans, financial condition and other relevant factors.
The Company's board of directors has authorized the repurchase of up to $2 million of Common Shares of the Company from time to time in the open market or in negotiated purchases.
Under the Company's Amended and Restated Bylaws, a stockholder who wishes to propose business for consideration at the Annual Meeting or to nominate persons for election to the Board of Directors must notify the Company not less than 120 days prior to the first anniversary of the preceding year's annual meeting (i.e., for the Annual Meeting to be held in 1999, not later than February 10, 1999). The notice must include information specified in the Company's Bylaws regarding such proposal or nomination. If the date of the Annual Meeting is advanced or delayed by more than 40 days from such anniversary date, a different deadline may apply. Under the SEC's Rule 14a-4, the Company may exercise discretionary voting authority under proxies it solicits to vote on any matter that is proposed by a stockholder who does not seek to include the proposal in the Company's proxy statement, unless the Company is notified about the proposal by the advance notice deadline date (i.e., for the Annual Meeting to be held in 1999, not later than February 10, 1999) and the stockholder satisfies the other requirements of Rule 14a-4(c). Separately, under SEC Rule 14a-8, a stockholder wishing to submit a proposal for inclusion in the Company's proxy statement must submit his or her proposal to the Company no later than January 10, 1999 and must satisfy the other requirements of SEC Rule 14a-8.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA (in thousands, except per share data)
Certain amounts presented above for prior years have been reclassified to conform to the current year's presentation. No cash dividends were declared during the five year period ended September 30, 1998.
(1) Includes $930,000 in plant closing costs due to the termination of manufacturing operations at Meridian and $7.5 million in litigation costs and related professional fees.
(2) Includes operating results for Meridian from December 15, 1994 to September 30, 1995.
(3) Includes assets and liabilities acquired upon the acquisition of Go-Gro on July 30, 1994 and the operating results for Go-Gro for the period July 31, 1994 to September 30, 1994.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Certain statements in this Management's Discussion and Analysis of Financial Condition and Results of Operations, including without limitation expectations as to future sales and operating results, constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 (the "Reform Act"). Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company and its subsidiaries to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, but are not limited to, the following: the highly competitive nature of the lighting industry; reliance on certain key customers; consumer demand for lighting products; dependence on imports from China; general economic and business conditions; advertising and promotional efforts; brand awareness; the existence or absence of adverse publicity; acceptance of new product offerings; changing trends in customer tastes; availability, terms and deployment of capital; availability and cost of raw materials and supplies; the costs and other effects of legal and administrative proceedings; foreign exchange rates; changes in the Company's effective tax rate (which is dependent on the Company's U.S. and foreign source income); and other factors referenced in this Form 10-K. The Company will not undertake and specifically declines any obligation to update or correct any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.
The Company's fiscal years ended September 30, 1998, 1997 and 1996 are referred to herein as "1998", "1997" and "1996", respectively.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the percentage relationship to net sales of amounts presented in the Company's consolidated statements of operations.
CATALINA LIGHTING, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
COMPARISON OF FISCAL YEARS ENDED SEPTEMBER 30, 1998 AND 1997
Net sales and gross profit for 1998 were $161.9 million and $31.1 million, respectively, as compared to $197 million and $32.5 million, respectively, for 1997. The Company generated net income of $1.1 million ($.15 per share) in 1998 compared to a net loss of $3.1 million ($.44 per share) in 1997.
The $35.1 million decrease in net sales from the prior year reflects lower unit sales and is mostly attributable to a $20.1 million decline in sales of one product class, halogen torchieres, a decrease in European sales of $10.3 million and a decline of $4 million in sales of now discontinued products, the Meridian lamps and "Hugger" flashlights. The sales decline for the halogen torchieres continues a trend of declining sales of this product which began in the first quarter of fiscal 1998 and is attributed in part to media attention focused on incidents of fire associated with this product. In 1998 halogen torchiere sales aggregated $14.6 million, as compared to $34.7 million for 1997. In 1998 sales to European customers were $19.7 million, as compared to $30 million for 1997. Lamp sales decreased by $30.5 million and net sales for the Company's other principal line of products, lighting fixtures, decreased by $4.6 million. Lamps and lighting fixtures accounted for 63% and 37%, respectively, of net sales in 1998 compared to 67% and 33%, respectively, in 1997. In 1998 and 1997, Home Depot accounted for 27.5% and 22.1%, respectively, of the Company's net sales. For the fiscal years ended September 30, 1998 and 1997, net sales to the Company's ten largest customers represented approximately 66% and 63%, respectively, of the Company's net sales.
Gross profit decreased by $1.4 million in 1998 due to the decrease in sales. The gross profit percentage increased to 19.2% in 1998 from 16.5% in 1997. The improvement in the gross profit percentage is attributable to improved margins earned on direct sales due to a more profitable product mix and favorable sales returns and incentives experience. The lower gross profit percentage for 1997 also reflects an $870,000 provision for discontinued inventory required as a result of management's decision to cease operations at Meridian.
Many of the Company's major customers (most notably Home Depot) purchase from the Company primarily on a direct basis, whereby the merchandise is shipped directly from the factory to the customer, rather than from the Company's warehouses. Approximately 67% of the Company's sales in 1998 were made on a direct basis as compared to 61% in 1997. Sales made by the Company on a direct basis typically generate lower margins per unit than sales from the Company's warehouses. The amount of the Company's sales made on a direct basis is dependent upon customer buying preferences, which are influenced by a number of factors that vary from customer to customer. Sales made from the Company's U.S. warehouses declined on a quarterly basis and in total from 1997 to 1998 and continue to decline. The Company is attempting to compensate for this decline by pursuing new channels of distribution which will be serviced out of the Company's U.S. warehouse. However, there can be no assurance these efforts will be successful, and the Company may experience further declines in sales made from its U.S. warehouse. The Company closed its Los Angeles warehouse during 1998 and consolidated these inventories into its Tupelo warehouse in part due to declining warehouse sales.
Selling, general and administrative expenses ("SG&A") increased by $662,000 due to increased costs in the Orient to support the Company's new factory's operations ($821,000) and an increase in royalties ($353,000). These increases were partially offset by a $415,000 decrease in SG&A incurred by Meridian which ceased operations in June 1997. SG&A expenses were 16.4% of sales in 1998 compared to 13.1% in 1997. The increase in SG&A as a percentage of sales is attributable to the factors mentioned above and the decline in sales.
In 1997, in conjunction with the decision to cease Meridian's operations, the Company recorded a $930,000 charge to write down the plant and related equipment to fair market value (less disposition costs) and to provide for severance payments to Meridian's employees.
Litigation charges and related professional fees in 1997 represented the amount provided for an adverse jury verdict (currently under appeal) of $4.3 million on litigation with the Company's former Chief Executive Officer, a payment of $1,000,000 to settle patent litigation with Black & Decker, and the related professional fees incurred for these two matters.
Interest expense decreased from $4.1 million to $3.8 million. A decrease in interest expense as a result of lower borrowings was offset by a $165,000 increase in the provision for interest related to the $4.3 million adverse jury verdict presently under appeal (the provision was for approximately 7 months in 1997 compared to 12 months in 1998).
Other income for 1998 includes a gain of $164,000 on the sale of marketable equity securities, with the remainder consisting primarily of rental income on the Meridian facility, interest and other miscellaneous income, partially offset by foreign exchange losses.
CATALINA LIGHTING, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
COMPARISON OF FISCAL YEARS ENDED SEPTEMBER 30, 1998 AND 1997 (CONTINUED)
The effective income tax rates for 1998 and 1997 were 24.9% and 46.9%, respectively. The higher effective tax rate for 1997 is attributable to the combination of (1) foreign pretax income, which is taxed at a significantly lower rate than U.S. income, and (2) a pretax loss for U.S. operations, on which the Company recorded a tax benefit at the applicable U.S. rates. The Company's effective income tax rate is dependent both on the total amount of pretax income generated and the relative distribution of such total income between domestic and foreign operations. Consequently, the Company's effective tax rate may vary in future periods. As a result of recent Internal Revenue Service rulings and proposed and temporary regulations, the Company is in the process of restructuring its international operations in order to retain favorable U.S. tax treatment of foreign source income. The Company believes it should be successful in this restructuring. However, in the event the Company is unsuccessful in this effort, the Company will likely experience an increase in its consolidated effective income tax rate.
MERIDIAN
The Company ceased manufacturing operations and closed its Meridian Lamps facility in June 1997. Net sales for 1997 were $2.8 million, cost of sales was $4.7 million and the pretax loss was $3.5 million.
COMPARISON OF FISCAL YEARS ENDED SEPTEMBER 30, 1997 AND 1996
Net sales and gross profit for 1997 were $197 million and $32.5 million, respectively, as compared to $184.6 million and $30.9 million, respectively, for 1996. The Company incurred a net loss of $3.1 million ($.44 per share) in 1997 due to plant closing costs and litigation costs, as compared to net income of $1.6 million ($.21 per share) in 1996.
Net sales increased by $12.3 million from the prior year due to an increase in units sold. The increase in sales reflects the benefits of the Company's strategy to strengthen its relationships with certain major U.S. and European retailers. Lamp sales increased by $10.7 million and net sales for the Company's other principal line of products, lighting fixtures, increased by $1.6 million. Lamps and lighting fixtures accounted for 67% and 33%, respectively, of net sales in 1997 as compared to 66% and 34%, respectively, in 1996. In 1997 and 1996, Home Depot accounted for 22.1% and 9.8%, respectively, of the Company's net sales. In 1996, Builders Square and its affiliate Kmart accounted for 11% of net sales. In 1997, the respective percentages of net sales represented by Kmart and Builders Square (which were no longer affiliates at September 30, 1997) were 7.1% and 4.6%. For the fiscal years ended September 30, 1997 and 1996, net sales to the Company's ten largest customers represented approximately 63% and 57%, respectively, of the Company's total revenues.
Gross profit increased by $1.5 million in 1997 due to added sales volume but decreased as a percentage of net sales from 16.8% to 16.5%. Certain major domestic retailers accounted for a larger percentage of the Company's sales in 1997 than 1996 due to the Company's sales focus on these major retailers and the consolidation of the customer base. Many of these major retailers (most notably Home Depot and Kmart) are currently purchasing from the Company primarily on a direct basis, whereby the merchandise is shipped directly from the factory to the customer, rather than from the Company's warehouses. Approximately 61% of the Company's sales in 1997 were made on a direct basis, whereby the merchandise is shipped directly from the factory to the customer, as compared to 52% in 1996. Sales made by the Company on a direct basis typically generate lower margins than sales of the same items from the Company's warehouses, and the higher relative proportion of direct sales was a contributing factor to the decline in the gross profit percentage. The relative proportion of the Company's sales made on a direct basis is dependent upon customer buying preferences, which are influenced by a number of factors that vary from customer to customer and are subject to change and thus cause the Company's gross margin percentage to be inherently difficult to predict. The lower gross profit percentage for 1997 also reflects an $870,000 provision for discontinued inventory resulting from management's decision to cease operations at its Meridian factory (see separate discussion below). The impact of these factors lowering the gross profit percentage was partially offset by lower provisions for sales incentives as a percentage of sales, stemming from favorable incentive experience and a decrease in purchasing and warehousing costs as a result of the consolidation of the Company's warehousing operations during fiscal 1996.
CATALINA LIGHTING, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
COMPARISON OF FISCAL YEARS ENDED SEPTEMBER 30, 1997 AND 1996 (CONTINUED)
Selling, general and administrative expenses ("SG&A") were 13.1% of sales in 1997 compared to 13.7% in 1996. The decrease in these expenses as a percentage of net sales is attributable to higher sales. SG&A increased by $628,000 from 1996 due to additional costs incurred in the Orient to support the Company's growth and restructuring of operations ($881,000), U.S. personnel costs ($644,000) and an increase in consulting and professional fees due to costs incurred to set up the Company's new computer system and introduce Westinghouse brand name products ($580,000). These increases were partially offset by lower depreciation expense ($600,000) principally attributable to the accelerated depreciation in the prior year of the Company's previous computer system, lower merchandising and display costs ($268,000), and lower costs incurred at the Meridian facility ($594,000) as a result of the decision to cease Meridian's operations.
Litigation charges and related professional fees aggregated $7.5 million and represent the amount provided for an adverse jury verdict (currently under appeal) of $4.3 million on litigation with the Company's former Chief Executive Officer, a payment of $1,000,000 to settle patent litigation, and the related professional fees of $2.2 million incurred for these matters.
Interest expense increased from $3.3 million in 1996 to $4.1 million in 1997 due to increased borrowings to finance capital expenditures and a $258,000 provision for interest related to the $4.3 million adverse jury verdict.
Other income of $385,000 in 1996 consisted primarily of gains on the sale of intangible assets and investment income.
Effective income tax rates for 1997 and 1996 were 46.9% and 34.6%, respectively. The higher effective tax rate for 1997 is attributable to the combination of (1) foreign pretax income, which is taxed at a significantly lower rate than U.S. income, and (2) a pretax loss for U.S. operations, on which the Company recorded a tax benefit at the applicable U.S. rates. The Company's effective income tax rate is dependent both on the total amount of pretax income generated and the relative distribution of such total income between domestic and foreign operations. Consequently, the Company's effective tax rate may vary in future periods.
MERIDIAN
In March 1997, the Company committed to a plan to cease manufacturing operations and close its Meridian Lamps, Inc. ("Meridian") facility by September 30, 1997. The pretax loss for Meridian was $3.5 million for 1997 and $2.4 million for 1996. Net sales were $2.8 million for both years.
Cost of sales in 1997 was $4.7 million and exceeded sales by $1.9 million. Gross profit during 1997 was adversely affected by a provision for discontinued inventory amounting to $870,000 as a result of management's decision to cease operations at Meridian and significant underutilization of plant capacity due to insufficient sales volume resulting in negative manufacturing variances.
Cost of sales exceeded sales by $1.2 million in 1996 mainly due to negative unplanned manufacturing variances arising principally from underutilization of plant capacity, a provision for inventory, research and development costs and additional storage expenses.
In 1997, in conjunction with the decision to cease Meridian's operations, the Company recorded a $930,000 charge to write down the plant and related equipment to fair market value (less disposition costs) and to provide for severance payments to Meridian's employees.
Other expenses for Meridian in 1997 and 1996 were $703,000 and $1,184,000, respectively, consisting mostly of administrative payroll and benefits, marketing and merchandising expenses, interest expense and the amortization of start up costs in 1996.
As of June 30, 1997, the Company had ceased operations at Meridian and subleased the facility.
CATALINA LIGHTING, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
LIQUIDITY AND CAPITAL RESOURCES
The Company meets its short-term liquidity needs through cash provided by operations, accounts payable, borrowings under various credit facilities with banks, and the use of letters of credit from customers to fund certain of its direct sales activities. Lease obligations, mortgage notes, convertible subordinated notes, bonds and capital stock are additional sources for the longer-term liquidity and financing needs of the Company. Management believes the Company's available sources of cash will enable it to fulfill its known liquidity requirements for the foreseeable future.
1998 CASH FLOWS
The Company's operating, investing and financing activities resulted in a net decrease in cash and cash equivalents of $57,000 from September 30, 1997 to September 30, 1998.
The net cash of $15.9 million provided by operating activities was used primarily to pay for capital expenditures aggregating $1.9 million, to pay down credit lines and to make sinking fund redemption payments on outstanding bonds. Such capital expenditures included $607,000 in costs incurred by Go-Gro for the purchase of machinery, molds and equipment and building improvements.
Management estimates that capital expenditures in fiscal 1999 will approximate $3 million, representing computer software and hardware, display fixtures and other miscellaneous capital additions. These capital expenditures will be financed by leasing facilities with financial institutions and cash generated from operations.
CREDIT AND LEASING FACILITIES, BONDS, MORTGAGE AND CONVERTIBLE SUBORDINATED NOTES
The Company has a $35 million credit facility with a group of commercial banks. This facility provides credit in the form of a $1.9 million non-revolving loan and $33.1 million in revolving loans, acceptances, and trade and stand-by letters of credit, matures September 30, 2000 and provides for quarterly principal payments of $950,000 on the non-revolving loan. The non-revolving loan bears interest, payable monthly, at prime plus 1% and other borrowings under the facility bear interest, payable monthly, at the Company's preference of either the prime rate or the LIBOR rate plus a variable spread based upon earnings, debt and interest expense levels defined under the credit agreement (LIBOR plus 2.5% at September 30, 1998, LIBOR + 1.8% effective October 1, 1998). The effective rates for the non-revolving loan and the other borrowings were 9.25% and 8.12%, respectively, at September 30, 1998. Obligations under this facility are secured by substantially all of the Company's U.S. assets. The Company is required to comply with various convenants in connection with this facility and borrowings are subject to a borrowing base calculated from U.S. receivables and inventory. In addition, the agreement prohibits the payment of any cash dividends or other distribution on any shares of the Company's common stock, other than dividends payable solely in shares of common stock, unless approval is obtained from the lenders. At September 30, 1998, the Company had used $13.6 million under this credit facility (loans amounted to $12.4 million of which $1.9 million was included in current notes payable-credit lines) and $9.5 million was available for additional borrowings under the borrowing base calculation.
The Company's Canadian and Hong Kong subsidiaries have credit facilities with foreign banks of 4 million Canadian dollars (approximately U.S. $2.6 million) and 35 million Hong Kong dollars (approximately U.S. $4.5 million), respectively. Borrowings under the Canadian facility are secured by substantially all of the assets of the Canadian subsidiary and are limited under a borrowing base defined as the aggregate of certain percentages of accounts receivable and inventory. Canadian dollar advances bear interest at the Canadian prime rate plus .5% (7.75% at September 30, 1998) and all U.S. dollar advances bear interest at the U.S. base rate of the bank (9% at September 30, 1998). At September 30, 1998, $2.1 million in net assets of the Company's Canadian subsidiary were restricted under the credit facility and could not be transferred to the parent Company. At September 30, 1998, total Canadian and U.S. dollar borrowings amounted to U.S. $1.5 million (included in current notes payable-credit lines) and U.S. $922,000 was available for additional borrowings under the borrowing base calculation. The Hong Kong facility provides credit in the form of acceptances, trade and stand-by letters of credit, overdraft protection and negotiation of discrepant documents presented under export letters of credit issued by banks. Advances bear interest at the Hong Kong prime rate plus .25% (10.25% at September 30, 1998). Each of these credit facilities are payable upon demand and are subject to annual reviews by the banks. At September 30, 1998, $16.2 million in net assets of Go-Gro were restricted under the agreement and could not be transferred to the parent Company. At September 30, 1998, there were no borrowings under the Hong Kong facility and U.S. $2.1 million was available for borrowings. With respect to the Canadian facility, the agreement prohibits the payment of dividends and the Company is required to comply with various covenants, which effectively restrict the amount
CATALINA LIGHTING, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
CREDIT AND LEASING FACILITIES, BONDS, MORTGAGE AND CONVERTIBLE SUBORDINATED NOTES (CONTINUED)
of funds which may be transferred from the Canadian subsidiary to the Company. The Hong Kong facility requires Go-Gro to maintain a minimum net worth, prohibits the payment of dividends by Go-Gro without the prior consent of the lender, and limits the amount of advances or loans from Go-Gro to the Company at any time to 50% of Go-Gro's pre-tax profits for the previous 12 months.
The Company has outstanding $7.6 million of 8% convertible subordinated notes due March 15, 2002. The notes are convertible into common shares of the Company's stock at a conversion price of $6.57 per share, subject to certain anti-dilution adjustments (as defined in the Note Agreement), at any time prior to maturity. The notes are subordinated in right of payment to all existing and future senior indebtedness of the Company and the notes are callable at the option of the Company with certain required premium payments. Principal payments of approximately $2.5 million are required on March 15 in each of the years 2000 and 2001. The remaining outstanding principal and interest is due in full on March 15, 2002. Interest is payable semiannually. The terms of the Note Agreement require the Company to maintain specific interest coverage ratio levels in order to increase its credit facilities or otherwise incur new debt and to maintain a minimum consolidated net worth. In addition, the Note Agreement prohibits the declaration or payment of dividends on any shares of the Company's capital stock, except dividends or other distributions payable solely in shares of the Company's common stock, and limits the purchase or retirement of any shares of capital stock or other capital distributions.
The Company arranged for the issuance in 1995 of $10.5 million in State of Mississippi Variable Rate Industrial Revenue Development Bonds to finance (along with internally generated cash flow and the Company's $1 million leasing facility) its warehouse located near Tupelo, Mississippi. The bonds have a stated maturity of May 1, 2010 and require mandatory sinking fund redemption payments, payable monthly, of $900,000 per year from 1996 to 2002, $600,000 per year in 2003 and 2004, and $500,000 per year from 2005 to 2010. The bonds bear interest at a variable rate (5.6% at September 30, 1998) that is adjustable weekly to the rate the remarketing agent for the bonds deems to be the market rate for such bonds. The bonds are secured by a lien on the land, building, and all other property financed by the bonds. Additional security is provided by an $8 million direct pay letter of credit which is not part of the Company's credit line. The unpaid balance of these bonds was $7.8 million at September 30, 1998.
The Company financed the purchase and improvements of its Meridian manufacturing facility through the issuance of a series of State of Mississippi General Obligation Bonds (Mississippi Small Enterprise Development Finance Act Issue, 1994 Series GG) with an aggregate available principal balance of $1,605,000, a weighted average coupon rate of 6.23% and a contractual maturity of November 1, 2009. The bonds are secured by a first mortgage on land, building and improvements and a $1,713,000 standby letter of credit which is not part of the Company's credit line. Interest on the bonds is payable semiannually and principal payments are due annually. In June 1997, the Company ceased manufacturing operations at Meridian and leased the facility to a non-manufacturing entity and in August 1997 made a $1.5 million payment to escrow on the bonds. The Company plans to redeem the bonds at their earliest redemption date, approximately November 1, 1999.
The Company has a $1 million facility with a U.S. financial institution to finance the purchase of equipment in the United States, of which $409,000 was available at September 30, 1998. In addition, the Company has a leasing facility for $9 million Hong Kong dollars (approximately U.S. $1.2 million) with a Hong Kong financial institution to finance the purchase of equipment for its China facilities of which $564,000 was available at September 30, 1998.
The Company financed its corporate headquarters in Miami, Florida with a loan payable monthly through 2004, based on a 15 year amortization schedule, with a balloon payment in 2004. The loan bears interest at 8% and is secured by a mortgage on the land and building. The unpaid balance of this loan was $1 million at September 30, 1998.
YEAR 2000
The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's computer programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities.
CATALINA LIGHTING, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
YEAR 2000 (CONTINUED)
The Company has developed and is currently executing a plan to make its computer systems Year 2000 ready. The plan consists of five phases: (1) an inventory of all systems and applications, including non-information technology systems; (2) an assessment of the Year 2000 readiness of these existing systems and applications; (3) remediation of Year 2000 problems identified in the assessment phase; (4) testing of all systems and applications to verify the success of the remediation phase and, if necessary (5) the implementation of contingency plans for all significant systems and applications.
Phases 1 and 2 of the Company's plan were completed as of September 1, 1998. The Company is presently engaged in phases 3 and 4 and expects to complete these phases by July 1, 1999.
The Company has determined that its non-information technology systems are not significantly affected by the Year 2000 Issue. With respect to information technology systems, in 1997 the Company, during the normal course of upgrading its systems to address its business needs and add functionality and efficiency to its business processes, began implementation of a new enterprise software to replace the business applications supporting sales, distribution, inventory management, finance and accounting for the Company's North American businesses. The majority of the remainder of the Company's North American systems will be made Year 2000 ready through purchased upgrades of commercial third-party software packages. Go-Gro's systems and applications will be made Year 2000 ready through a combination of internal reprogramming/modification and purchased upgrades of commercial third-party software packages. The internal reprogramming/modifications of Go-Gro's systems and applications are presently undergoing testing by an independent third party.
The Company has initiated communications with the customers, suppliers and other companies important to its business to attempt to determine the extent to which the Company is vulnerable to such parties' failure to resolve their own Year 2000 issues.
The Company is currently and will continue utilizing both internal and external resources to implement its Year 2000 plan. The total incremental cost to the Company for the Year 2000 project (excluding internal resources, the costs associated with the new enterprise system and scheduled hardware replacements which would have been incurred regardless of the Year 2000 Issue), all of which will be expensed as incurred, is approximately $150,000, none of which has been incurred as of September 30, 1998. The Company plans to fund these costs with cash flows from operations. The costs of the Year 2000 project and the timetable in which the Company expects to finish its Year 2000 project are based on management's best estimates and are dependent on a number of factors, including the continued availability of personnel and external resources.
The Company expects to be Year 2000 compliant by October 1, 1999 and has established contingency plans in the event remediation and testing efforts indicate any of the Company's planned systems and applications will not be Year 2000 ready. The Company's new enterprise software has been represented as Year 2000 ready by its manufacturer but should such software prove to have Year 2000 problems, the existing legacy systems will be made Year 2000 compliant through the upgrade of the underlying database product and a limited amount of additional programming. Contingency plans for the Company's other systems and applications contemplate additional purchases of third-party software packages and expanded use of external resources in remediation efforts.
Year 2000 compliance is critical to the Company due to the importance of its computer systems and applications to its business. The Company may also be vulnerable to the failure of significant third parties with which the Company does business to resolve their own Year 2000 issues. The impact on the Company of failure by either the Company or the significant third parties with which it does business to achieve Year 2000 compliance is not reasonably estimable, however, the Year 2000 Issue could have a material impact on the operations of the Company.
CATALINA LIGHTING, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
OTHER
Shenzhen Jiadianbao Electrical Products Co., Ltd. ("SJE"), a cooperative joint venture subsidiary of Go-Gro, and the Bureau of National Land Planning Bao-An Branch of Shenzhen City entered into a Land Use Agreement covering approximately 467,300 square feet in Bao-An County, Shenzhen City, People's Republic of China on April 11, 1995. The agreement provides SJE with non-transferable rights to use this land until January 18, 2042. Under the terms of the SJE joint venture agreement, ownership of the land and buildings of SJE is divided 70% to Go-Gro and 30% to the other joint venture partner. Land costs, including the land use rights, approximated $2.6 million of which Go-Gro has paid its 70% proportionate share of $1.8 million. Under the terms of this agreement, as amended, SJE is obligated to construct approximately 500,000 square feet of factory buildings and 211,000 square feet of dormitories and offices, of which 40 percent was required to be and was completed by April 1, 1997. The remainder of the construction is required to be completed by December 31, 1999. The Company plans to file an application to extend the completion deadline of December 1999. The total cost for this project is estimated at $15.5 million (of which $9.9 million had been expended as of September 30, 1998) and includes approximately $1 million for a Municipal Coordination Facilities Fee (MCFF).
The MCFF is based upon the square footage to be constructed. The agreement calls for the MCFF to be paid in installments beginning in January 1997 of which $163,659 had been paid as of September 30, 1998. A 162,000 square foot factory, 77,000 square foot warehouse and 60,000 square foot dormitory became fully operational in June 1997.
On April 26, 1996, the Company entered into a license agreement with Westinghouse Electric Corporation to market and distribute a full range of lighting fixtures, lamps and other lighting products under the Westinghouse brand name in exchange for royalty payments. The agreement terminates on September 30, 2001. Catalina has an option to extend the agreement for an additional ten years. The royalty payments are due quarterly and are based on a percent of the value of the Company's net shipments of Westinghouse branded products, subject to annual minimum payments due. Commencing September 30, 1999 either party has the right to terminate the agreement during fiscal years 1999 to 2001 if the Company does not meet the minimum net shipments of $25 million for fiscal 1999, $40 million for fiscal 2000, and $60 million for fiscal 2001. Net sales of Westinghouse branded products amounted to $10.9 million and $9 million for 1998 and 1997, respectively. The Company's contractual rights to use the Westinghouse brand name have been challenged by a third party. See also Item 1, "Trademarks and Patents" and Item 3, "Legal Proceedings."
As a result of recent Internal Revenue Service rulings and proposed and temporary regulations, the Company is in the process of restructuring its international operations in order to retain favorable U.S. tax treatment of foreign source income. The Company believes it should be successful in this restructuring. However, in the event the Company is unsuccessful in this effort, the Company will likely experience an increase in its consolidated effective income tax rate
On June 3, 1998, the President of the United States extended to the People's Republic of China "Most Favored Nation" ("MFN") treatment for the entry of goods into the United States for an additional year, beginning July 3, 1998. The MFN trade status has been renamed "Normal Trade Relations" because it applies to all but a handful of U.S. trading partners. In the context of United States tariff legislation, such treatment means that products are subject to favorable duty rates upon entry into the United States. On July 22, 1998 the House of Representatives supported the President's decision and rejected a bill to impose trade sanctions against China due to alleged human rights abuses, nuclear proliferation policies and a growing U.S. trade deficit with China. Members of Congress and the "human rights community" will continue to monitor the human rights issues in China and adverse developments in human rights and other trade issues in China could affect U.S. - China relations. As a result of various political and trade disagreements between the U.S. Government and China, it is possible restrictions could be placed on trade with China in the future which could adversely impact the Company's operations and financial position.
During fiscal 1998 the Company received a number of claims relating to halogen torchieres sold by the Company to various retailers. Management does not currently believe these claims will result in a material uninsured liability to the Company. However, as a result of these claims the Company experienced an increase in its liability insurance premiums effective for the 1999 calendar year and will now be self-insuring up to a maximum of $10,000 for each incident occurring in calendar 1999. It is too early to assess the impact of these changes on the Company's financial position or annual results of operations during fiscal 1999. No assurance can be given that the number of claims will not exceed historical experience or that claims will not exceed available insurance coverage or that the Company will be able to maintain the same level of insurance. See "Legal Proceedings."
The Company's board of directors has authorized the repurchase of up to $2 million of common shares of the Company from time to time in the open market or in negotiated purchases.
CATALINA LIGHTING, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
FOREIGN EXCHANGE FLUCTUATIONS
The Company expects to continue to obtain most of its products from China. Large fluctuations in currency exchange rates could have a material effect on the Company's cost of products, thereby decreasing the Company's ability to compete. All purchases of finished goods are made in U.S. dollar-denominated letters of credit which limit the Company's exposure to foreign currency fluctuations with respect to fluctuations that would impact existing outstanding purchase commitments. However, the Company is subject to foreign currency fluctuations to the extent such fluctuations affect the cost of products purchased (or manufactured) or the Company's ability to sell into domestic or foreign markets. The Company's Canadian and Mexican subsidiaries are subject to fluctuations between the U.S. dollar currency in which they purchase goods and the Canadian dollar and Mexican peso currencies in which they sell goods.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, SFAS No. 130, "Reporting Comprehensive Income," was issued. SFAS No. 130 establishes standards for the reporting and display of comprehensive income and its components (revenues, expenses, gains, and losses) in a full set of general-purpose financial statements. SFAS No. 130 requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. SFAS No. 130 requires that a company (a) classify items of other comprehensive income by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of the balance sheet. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997. Reclassification of financial statements for earlier periods provided for comparative purposes is required. The Company has not determined the effect, if any, that SFAS No. 130 will have on its consolidated financial statements.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," was also issued in June 1997. SFAS No. 131 establishes standards for the way that public companies report selected information about operating segments in financial statements and requires that those companies report selected information about segments in interim and annual financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. SFAS No. 131, which supersedes SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise", but retains the requirement to report information about major customers, requires that a public company report financial and descriptive information about its reportable operating segments. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. Generally, financial information is required to be reported on the basis that it is used internally for evaluating segment performance and deciding how to allocate resources to segments. SFAS No. 131 requires that a public company report a measure of segment profit or loss, certain specific revenue and expense items, and segment assets. However, SFAS No. 131 does not require the reporting of information that is not prepared for internal use if reporting it would be impracticable. SFAS No. 131 also requires that a public company report descriptive information about the way that the operating segments were determined, the products and services provided by the operating segments, differences between the measurements used in reporting segment information and those used in the enterprise's general-purpose financial statements, and changes in the measurement, of segment amounts from period to period. SFAS No. 131 is effective for financial statements for periods beginning after December 15, 1997. The Company has not determined the effects, if any, that SFAS No. 131 will have on the disclosures in its consolidated financial statements.
CATALINA LIGHTING, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
IMPACT OF INFLATION AND ECONOMIC CONDITIONS
In the past Go-Gro experienced price increases in the costs of raw materials, which reduced Go-Gro's profitability due to an inability to immediately pass on such price increases to its customers. The Company believes that increased prices could have an initial adverse impact on the Company's net sales and income from continuing operations but that, over time, increased prices can be passed on to its customers.
During late 1997 various countries in Southeast Asia (including Thailand, South Korea, Malaysia, the Philippines and Indonesia) became involved in an emerging crisis impacting their economies and characterized by currency devaluations, rising interest rates, deteriorating economic growth and declining capital markets. The Company does not conduct business with, or have a significant investment in, any of these countries. However, this crisis continued in 1998 and had serious adverse repercussions on the financial stability of all countries in the region, including Hong Kong and China. In 1998, the economies of Russia and Latin America also experienced serious difficulties and Japan's economy continued its decline. The Company is presently unable to determine what impact, this global economic crisis will have on its business in the future.
CATALINA LIGHTING, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENTS SCHEDULE
PAGE ----
Independent Auditors' Report................................................ 25
Consolidated Balance Sheets - September 30, 1998 and 1997................... 26
Consolidated Statements of Operations - Years Ended September 30, 1998, 1997 and 1996..................................... 27
Consolidated Statements of Stockholders' Equity - Years Ended September 30, 1998, 1997 and 1996..................................... 28
Consolidated Statements of Cash Flows - Years Ended September 30, 1998, 1997 and 1996................................. 29-30
Notes to Consolidated Financial Statements............................... 31-55
Schedule II - Valuation and Qualifying Accounts - Years ended September 30, 1998, 1997 and 1996..................................... 56
(All other schedules have been omitted as the related information is not required or applicable)
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders Catalina Lighting, Inc. Miami, Florida
We have audited the accompanying consolidated balance sheets of Catalina Lighting, Inc. and its subsidiaries as of September 30, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended September 30, 1998. Our audits also included the financial statement schedule listed in Item 14 a(2). These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule 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, such consolidated financial statements present fairly, in all material respects, the financial position of Catalina Lighting, Inc. and its subsidiaries as of September 30, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 1998 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ Deloitte & Touche LLP Certified Public Accountants Miami, Florida
December 18, 1998
CATALINA LIGHTING, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
CATALINA LIGHTING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
See accompanying notes to consolidated financial statements.
CATALINA LIGHTING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (IN THOUSANDS, EXCEPT SHARE DATA)
See accompanying notes to consolidated financial statements.
CATALINA LIGHTING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
(Continued on page 30)
CATALINA LIGHTING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (IN THOUSANDS)
SUPPLEMENTAL CASH FLOW INFORMATION
During the years ended September 30, 1998, 1997 and 1996 capital lease obligations aggregating approximately $438,000, $781,000 and $573,000, respectively, were incurred when the Company entered into leases for new office, computer, machinery and warehouse equipment.
In 1997 and 1996, the Company issued 5,000 common shares to an employee as salary pursuant to an employment agreement.
See accompanying notes to consolidated financial statements.
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS
(a) The Business
Catalina Lighting, Inc. ("the Company") is a United States-based wholesaler, distributor and manufacturer of lamps, lighting fixtures and other lighting related products. The Company sells principally in the U.S. to a variety of retailers including home centers, national retail chains, office superstore chains, warehouse clubs, discount department stores and catalog showrooms. The Company also sells its products in Europe, Canada and other foreign markets.
(b) Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. The consolidated statements include the results of the wholly-owned subsidiaries Catalina Industries, Inc., Go-Gro Industries Limited ("Go-Gro"), Meridian Lamps, Inc. ("Meridian"), a subsidiary formed by the Company that commenced operations in fiscal 1995 and ceased operations in June 1997, Catalina Canada, Catalina Mexico and other wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
(c) Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management 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 the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
(d) Geographic Risks
Substantially all of the Company's products are obtained from suppliers located in China. Any inability by the Company to continue to obtain its products from China could significantly disrupt the Company's business. In addition, in the Company's consolidated balance sheet at September 30, 1998 are net assets of $17.3 million of Company subsidiaries located in China and Hong Kong, a sovereign territory of China. The Company maintains approximately $14 million in noncancelable political risk insurance.
(e) Cash and Cash Equivalents
Cash on hand and in banks, money market funds and other short-term securities with maturities of three months or less when purchased are considered cash and cash equivalents.
(f) Accounts Receivable
Pursuant to an agreement between the Company and a bank, the bank assumes the credit risk of certain of the Company's U.S. and Canadian receivables. The Company pays a fee of .50 percent of billings to customers covered by the arrangement. In addition, the Company insures certain of its foreign receivables with an insurance company. Gross accounts receivable secured under such agreements at September 30, 1998 and 1997 amounted to $11.3 million and $15.3 million, respectively. In addition, certain of the Company's sales are made to customers who pay pursuant to their own international, irrevocable, transferable letters of credit. Gross accounts receivable secured by such letters of credit at September 30, 1998 and 1997 amounted to $12.5 million and $8.7 million, respectively.
The Company provides allowances against accounts receivable for doubtful accounts, sales returns and sales incentives.
(g) Inventories
Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out (FIFO) method.
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS (CONTINUED)
(h) Property and Equipment
Property and equipment are stated at cost, less accumulated depreciation and amortization. Interest expense incurred for the construction of facilities is capitalized until such facilities are ready for use. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets. Amortization of leasehold improvements is computed using the straight-line method over the shorter of the lease term or estimated useful lives of the related assets.
(i) Restricted Cash Equivalents and Short-Term Investments
The Company's restricted cash equivalents and short term investments at September 30, 1998 and 1997 represented sinking fund payments on bonds issued to finance the Company's U.S. warehouse and investment income earned on such payments and a $1.5 million escrow payment made on the bonds which financed the Meridian facility.
(j) Goodwill
Goodwill represents the excess of cost over fair value of net assets acquired and is being amortized on a straight-line basis over periods from twenty to forty years. The Company periodically evaluates the recoverability of recorded costs for goodwill based upon estimations of future undiscounted operating income from the related acquired companies. Should the Company determine it probable that future estimated undiscounted operating income from any of its acquired companies will be less than the carrying amount of the associated goodwill, an impairment of goodwill would be recognized, and goodwill would be reduced to the amount estimated to be recoverable. Accumulated amortization of goodwill amounted to $2.4 million and $2 million at September 30, 1998 and 1997, respectively.
(k) Capital Leases
Leases that transfer substantially all of the benefits and risks of ownership to the Company are accounted for as the acquisition of assets and assumption of obligations under the capital lease standards issued by the Financial Accounting Standards Board. Accordingly, capitalized leased assets are recorded as property and equipment and the present values of the minimum lease payments are recorded as capital lease obligations under other long-term debt. Depreciation of such assets is computed using the shorter of the lease terms or estimated useful lives of the assets and is included in depreciation expense.
(l) Income Taxes
The Company and its wholly-owned domestic subsidiaries file consolidated federal and state tax returns in the United States. Separate foreign tax returns are filed for the Company's Hong Kong, Canadian and Mexican subsidiaries and China joint venture. The Company follows the asset and liability method of accounting for income taxes prescribed by Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes". Under the asset and liability method, deferred income taxes are recognized for the tax consequences of "temporary differences" by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. The effect on deferred taxes of a change in tax rates is recognized in income in the year that includes the enactment date.
(m) Earnings (Loss) Per Share
The Company adopted Statement of Financial Accounting Standards No. 128 "Earnings per Share" ("SFAS 128") during fiscal 1998. SFAS 128 requires the presentation of "basic" earnings per share and "diluted" earnings per share on the face of the statement of operations. Basic earnings per share is computed by dividing net income or loss attributable to common shareholders by the weighted average number of common shares outstanding during the year. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Upon adoption, earnings per share data for prior years are required to be restated. Earnings per share information presented in the accompanying financial statements for years ended September 30, 1997 and 1996 have been restated to comply with SFAS No. 128.
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS (CONTINUED)
(n) Foreign Currency Translation
The accounts of the Company's foreign subsidiaries are translated into U.S. dollars in accordance with Statement of Financial Accounting Standards No. 52, "Foreign Currency Translation". For subsidiaries where the functional currency is the U.S. dollar, monetary balance sheet accounts are remeasured at the current exchange rate and nonmonetary balance sheet accounts are remeasured at historical exchange rates. For subsidiaries where the functional currency is other than the U.S. dollar, all balance sheet accounts are remeasured at the current exchange rate. Income and expense accounts are translated at the average exchange rates in effect during the year. Adjustments resulting from the translation of these entities are included in the statements of operations. Gains and losses arising from foreign currency transactions are included in net income.
(o) Stock-Based Compensation
The Company adopted Statement of Financial Accounting Standards No. 123. "Accounting for Stock-Based Compensation" ("SFAS 123"), in fiscal 1997. As permitted by SFAS 123, the Company continues to measure compensation costs in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," but provides pro forma disclosures of net income (loss) and earnings (loss) per share as if the fair value method (as defined in SFAS 123) had been applied beginning in fiscal 1996.
(p) Long-Lived Assets
Effective October 1, 1996, the Company adopted the provisions of Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." This statement requires companies to write down to estimated fair value long-lived assets that are impaired. The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. In performing the review for recoverability the Company estimates the future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future cash flows is less than the carrying amount of the assets, an impairment loss is recognized. In 1997, in conjunction with the decision to cease Meridian operations, the Company recorded a $735,000 charge to write down the plant and equipment to fair market value (less disposition costs). The Company determined that no other impairment loss needed to be recognized.
(q) Impact of Recently Issued Accounting Standards
In June 1997, SFAS No. 130, "Reporting Comprehensive Income," was issued. SFAS No. 130 establishes standards for the reporting and display of comprehensive income and its components (revenues, expenses, gains, and losses) in a full set of general-purpose financial statements. SFAS No. 130 requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. SFAS No. 130 requires that a company (a) classify items of other comprehensive income by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of the balance sheet. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997. Reclassification of financial statements for earlier periods provided for comparative purposes is required. The Company has not determined the effects, if any, that SFAS No. 130 will have on its consolidated financial statements.
In June 1997, SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," was issued. SFAS No. 131 establishes standards for the way that public companies report selected information about operating segments in financial statements and requires that those companies report selected information about segments in interim and annual financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. SFAS No. 131, which supersedes SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise", but retains the requirement to report information about major customers, requires that a public company report financial and descriptive information about its reportable operating segments. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. Generally, financial information is required to be reported on the basis that it is used internally for evaluating segment performance and deciding
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS (CONTINUED)
(q) Impact of Recently Issued Accounting Standards (continued)
how to allocate resources to segments. SFAS No. 131 requires that a public company report a measure of segment profit or loss, certain specific revenue and expense items, and segment assets.
However, SFAS No. 131 does not require the reporting of information that is not prepared for internal use if reporting it would be impracticable. SFAS No. 131 also requires that a public company report descriptive information about the way that the operating segments were determined, the products and services provided by the operating segments, differences between the measurements used in reporting segment information and those used in the enterprise's general-purpose financial statements, and changes in the measurement, of segment amounts from period to period. SFAS No. 131 is effective for financial statements for periods beginning after December 15, 1997. The Company has not determined the effects, if any, that SFAS No. 131 will have on the disclosures in its consolidated financial statements.
(r) Reclassifications
Certain amounts presented in the financial statements of prior years have been reclassified to conform to the current year presentation.
2. ACQUISITION
On July 30,1994, the Company acquired all of the issued and outstanding capital stock of two Hong Kong companies, Go-Gro Industries Limited ("Go-Gro") and Lamp Depot Limited ("Lamp Depot"), for an aggregate consideration of $7.5 million and 750,000 shares of the Company's common stock. The stock of Go-Gro was purchased by the Company from selling stockholders who represented at the closing that they were, in fact, the actual stockholders of Go-Gro. Subsequent to the date of the closing, the Company discovered that part of the Go-Gro stock acquired had been conveyed to one of the selling stockholders prior to closing by a former officer of a subsidiary of the Company, who ceased employment with such subsidiary in 1993. The Company made a claim for indemnification and return of $1,904,000 of the consideration from Go-Gro, such funds were returned to the Company in November 1994 and the Company filed a lawsuit against the former officer in May 1995. The purchase price and resulting goodwill recorded for the Go-Gro acquisition were reduced accordingly for the return of these funds. The Company settled all litigation relating to this matter in June 1997 by payment of $600,000 which was recorded as an increase in the purchase price and goodwill recorded for the Go-Gro acquisition.
3. INVENTORIES
Inventories consisted of the following:
The Company capitalizes certain costs in finished goods inventory associated with acquiring, storing and preparing inventory for distribution. Such costs aggregated approximately $8.2 million, $9.5 million and $9.9 million for the years ended September 30, 1998, 1997 and 1996, respectively, of which $2.2 million and $2.6 million remained in inventory at September 30, 1998 and 1997, respectively.
Inventory allowances amounted to $1.7 million and $2.4 million at September 30, 1998 and 1997, respectively.
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (CONTINUED)
4. PROPERTY AND EQUIPMENT
Property and equipment and related depreciable lives were as follows:
Property held for sale consists of the Meridian facility. In conjunction with the decision to cease Meridian's operations, the Company recorded a $930,000 charge in 1997 to write down the plant and related equipment to fair market value (less disposition costs) and to provide for severance payments to Meridian's employees.
Depreciation expense for the years ended September 30, 1998, 1997 and 1996 was approximately $4,376,000, $4,061,000 and $4,045,000, respectively.
Interest capitalized during the construction of the manufacturing facilities in China and Mississippi was $463,000 during the year ended September 30, 1996.
5. NOTES PAYABLE - CREDIT LINES
The Company has a $35 million credit facility with a group of commercial banks. This facility provides credit in the form of a $1.9 million non-revolving loan and $33.1 million in revolving loans, acceptances, and trade and stand-by letters of credit, matures September 30, 2000 and provides for quarterly principal payments of $950,000 on the non-revolving loan. As the non-revolving loan is reduced, the remaining facility is increased by a similar amount. The non-revolving loan bears interest, payable monthly, at the prime rate plus 1% and other borrowings under the facility bear interest, payable monthly, at the Company's preference of either the prime rate or the LIBOR rate plus a variable spread based upon earnings, debt and interest expense levels defined under the credit agreement (LIBOR plus 2.5% at September 30, 1998 and LIBOR plus 1.8% effective October 1, 1998). The effective rates for the non-revolving loan and the other borrowings were 9.25% and 8.12%, respectively, at September 30, 1998. Obligations under the facility are secured by substantially all of the Company's U.S. assets, including 100% of the common stock of the Company's U.S. subsidiaries and 49% of the stock of the Company's Canadian subsidiary. The agreement contains covenants requiring that the Company maintain a minimum level of equity and meet certain debt to equity and interest coverage ratios and borrowings are limited by a borrowing base defined as the aggregate of certain percentages of the Company's U.S. receivables and inventory. The agreement prohibits the payment of
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (CONTINUED)
5. NOTES PAYABLE - CREDIT LINES (CONTINUED)
cash dividends or other distribution on any shares of the Company's common stock, other than dividends payable solely in shares of common stock, unless approval is obtained from the lenders. The Company pays a quarterly commitment fee of .25% based on the unused portion of the facility. At September 30, 1998, the Company had used $13.6 million under this credit facility (loans amounted to $12.4 million of which $1.9 million was included in current notes payable-credit lines) and $9.5 million was available for additional borrowings under the borrowing base calculation.
The Company has a credit facility with a Canadian bank which provides four million Canadian dollars or U.S. equivalent (approximately U.S. $2.6 million) in revolving demand credit. Canadian dollar advances bear interest at the Canadian prime rate plus .5% (7.75% at September 30, 1998) and U.S. dollar advances bear interest at the U.S. base rate of the bank (9% at September 30, 1998). The credit facility is secured by substantially all of the assets of the Company's Canadian subsidiary. The agreement contains certain minimum covenants to be met by the Canadian subsidiary, prohibits the payment of dividends, and limits advances by the bank to a borrowing base calculated based upon receivables and inventory. At September 30, 1998, $2.1 million in net assets of the Company's Canadian subsidiary were restricted under the credit facility and could not be transferred to the parent Company. This facility is payable upon demand and is subject to an annual review by the bank. The Company pays a monthly commitment fee of .25% based on the unused portion of the facility. At September 30, 1998, total Canadian and U.S. dollar borrowings amounted to U.S. $1.5 million (included in current notes payable-credit lines) and U.S. $922,000 was available for additional borrowings under the borrowing base calculation.
Go-Gro has a $35 million Hong Kong dollars (approximately U.S. $4.5 million) credit facility with a Hong Kong bank. The facility provides credit in the form of acceptances, trade and stand-by letters of credit, overdraft protection, and negotiation of discrepant documents presented under export letters of credit issued by banks. Advances bear interest at the Hong Kong prime rate plus .25% (10.25% at September 30, 1998). The facility is secured by a guarantee issued by the Company and requires Go-Gro to maintain a minimum level of equity. This agreement prohibits the payment of dividends without the consent of the bank and limits the amount of loans or advances from Go-Gro to the Company at any time to 50% of Go-Gro's pre-tax profits for the previous 12 months. At September 30, 1998, $16.2 million in net assets of Go-Gro were restricted under the agreement and could not be transferred to the parent Company. This facility is repayable upon demand and is subject to an annual review by the bank. At September 30, 1998, there were no borrowings under this facility and U.S. $2.1 million was available for borrowings.
The Company's availability under its credit lines consisted of the following:
The weighted average interest rate on the current portion of notes payable - credit lines was 9.1% and 8.0% at September 30, 1998 and 1997, respectively.
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (CONTINUED)
6. BONDS PAYABLE - REAL ESTATE RELATED
The Company financed the purchase and improvements of its Meridian manufacturing facility through the issuance of a series of State of Mississippi General Obligation Bonds (Mississippi Small Enterprise Development Finance Act Issue, 1994 Series GG) with an aggregate available principal balance of $1,605,000, a weighted average coupon rate of 6.23% and a contractual maturity of November 1, 2009. The bonds are secured by a first mortgage on land, building and improvements and a $1,713,000 standby letter of credit, which is not part of the Company's credit lines. Interest on the bonds is payable semiannually and principal payments are due annually. In June 1997, the Company ceased manufacturing operations at Meridian and leased the facility to a non-manufacturing entity. As a result, the Company made a $1.5 million payment to escrow on the bonds which was included in restricted cash equivalents and short-term investments in the September 30, 1998 and 1997 balance sheets. The Company plans to redeem the bonds at their earliest redemption date, approximately November 1, 1999. The outstanding balance of these bonds was $1.4 million and $1.5 million, at September 30, 1998 and 1997, respectively.
The Company arranged for the issuance in 1995 of $10.5 million in State of Mississippi Variable Rate Industrial Revenue Development Bonds to finance (along with internally generated cash flow and the Company's $1 million leasing facility) a warehouse located near Tupelo, Mississippi. The bonds have a stated maturity of May 1, 2010 and require mandatory sinking fund redemption payments, payable monthly, aggregating $900,000 per year, from 1996 to 2002, $600,000 per year in 2003 and 2004, and $500,000 per year from 2005 to 2010. The bonds bear interest at a variable rate (5.6% at September 30, 1998) that is adjustable weekly to the rate the remarketing agent for the bonds deems to be the market rate for such bonds. The bonds are secured by a lien on the land, building, and all other property financed by the bonds. Additional security is provided by an $8.0 million direct pay letter of credit which is not part of the Company's credit line. The outstanding balance of these bonds was $7.8 million and $8.7 million, at September 30, 1998 and 1997, respectively.
The aggregate maturities and sinking fund requirements of bonds payable at September 30, 1998, were as follows (in thousands):
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (CONTINUED)
7. OTHER LONG-TERM DEBT
Other long-term debt consisted of the following:
The aggregate maturities of other long-term debt at September 30, 1998, were as follows (in thousands):
1999 $ 485 2000 464 2001 444 2002 234 2003 101 Thereafter 666 ======== $ 2,394 ========
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (CONTINUED)
8. CONVERTIBLE SUBORDINATED NOTES
The Company has outstanding $7.6 million of 8% convertible subordinated notes due March 15, 2002. The notes are convertible at the option of the holders into common shares of the Company's stock at a conversion price of $6.57 per share subject to certain anti-dilution adjustments (as defined in the note agreement), at any time prior to maturity. The notes are subordinated in right of payment to all existing and future senior indebtedness of the Company. The notes are callable at the Company's option with certain required premium payments. Principal payments of approximately $2.5 million are required on March 15 in each of the years 2000 and 2001. The remaining outstanding principal and interest is due in full on March 15, 2002. Interest is payable semiannually. The terms of the note agreement require the Company to maintain specific interest coverage ratio levels in order to increase its credit facilities or otherwise incur new debt and to maintain a minimum consolidated net worth. In addition, the note agreement prohibits the declaration or payment of dividends on any shares of the Company's capital stock, except dividends or other distributions payable solely in shares of the Company's common stock, and limits the purchase or retirement of any shares of capital stock or other capital distributions.
9. INCOME TAXES
The following table summarizes the differences between the Company's effective income tax rate and the statutory federal income tax rate:
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (CONTINUED)
9. INCOME TAXES (CONTINUED)
The income tax provision (benefit) consisted of the following:
Income (loss) before income taxes by source consisted of the following:
The tax effects of each type of temporary difference that gave rise to the Company's current net deferred tax asset are as follows:
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (CONTINUED)
9. INCOME TAXES (CONTINUED)
The tax effects of each type of temporary difference that gave rise to the Company's net long term deferred tax asset (included in other long term assets) are as follows:
The Company has not provided for possible U.S. income taxes on $14.7 million in undistributed earnings of foreign subsidiaries that are considered to be reinvested indefinitely. Calculation of the unrecognized deferred tax liability related to these foreign earnings is not practicable.
10. COMMON STOCK, STOCK OPTIONS, WARRANTS AND RIGHTS
COMMON STOCK
The Company's board of directors has authorized the repurchase of up to $2 million of common shares of the Company from time to time in the open market or in negotiated purchases.
STOCK OPTIONS UNDER PLANS
In August 1987, the Company adopted the Stock Option/Stock Appreciation Rights Plan (Employee Plan), which provides for the granting of options to officers and other key employees. Under the Employee Plan, the Company and its shareholders authorized the granting of options for up to 1,750,000 shares of common stock to be granted as either incentive or nonstatutory options at a price of 100% of the fair market value of the shares at the date of grant, 110% in the case of a holder of more than 10% of the Company's stock. As of September 30, 1998, options for approximately 28,643 shares of common stock remained available for future grants. Options generally vest ratably over a three-year period commencing on October 1 following the date of grant and are exercisable with cash or previously acquired common stock of the Company, no later than 10 years from the grant date.
In March 1989, the Company adopted the Non-Employee Director Stock Option Plan (Director Plan), which provides for the granting of options for up to 50,000 shares of common stock to non-employee directors. Under the Director Plan, options to purchase 2,000 common shares are granted annually to non-employee directors automatically upon their election to the Board of Directors which vest upon the serving of a one year term. The exercise price is the fair market value of the common stock on the date the options are granted. As of September 30, 1998, no shares of common stock remained available for future grants. These options are generally exercisable no later than ten years from the date of grant.
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (CONTINUED)
10. COMMON STOCK, STOCK OPTIONS, WARRANTS AND RIGHTS (CONTINUED)
Transactions and related information for each plan are as follows:
*On October 27, 1995, the exercise price of 170,750 outstanding options issued to non-executive officers was restated to $4.125, the market value on such date.
**On December 11, 1998, the exercise price of 784,733 outstanding options was restated to $2.4375, the market value on such date.
OTHER STOCK OPTIONS
The exercise price of all other stock options discussed below was the fair market value of the common stock on the date the options were granted. On December 11, 1998, the exercise price of 290,000 outstanding options issued to employees was restated to $2.4375, the market value on such date.
The Company has outstanding options for 55,000 shares at an exercise price of $1.75 per share issued to one of the former shareholders of a subsidiary in connection with the acquisition of such subsidiary. The options were fully exercisable at September 30, 1998 and expire on January 1, 2000.
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (CONTINUED)
10. COMMON STOCK, STOCK OPTIONS, WARRANTS AND RIGHTS (CONTINUED)
OTHER STOCK OPTIONS (CONTINUED)
In August 1990, the Company issued options outside its Director Plan to its non-employee directors to purchase an aggregate of 200,000 shares of common stock, of which 132,000 remained outstanding on September 30, 1998. The options have an exercise price of $1.75 per share, were fully exercisable at September 30, 1998 and expire August 24, 2000.
On October 1, 1991, the Company issued options to purchase 20,000 shares at $3.38 to an employee. The options were fully exercisable at September 30, 1998 and expire on October 1, 2001.
On January 3, 1992, the Company issued to certain of its executives and non-employee directors options to purchase 275,000 shares at $4.88 per share. The options were fully exercisable at September 30, 1998 and expire January 3, 2002.
On January 15, 1993, the Company issued to one of its executives options to purchase 50,000 shares of common stock at an exercise price of $5.25 per share. The options were fully exercisable at September 30, 1998. The options expire on January 14, 2003.
At various dates during fiscal 1995, the Company granted to certain new employees options to purchase 91,000 shares of common stock at prices ranging from $6.75 to $6.875. In most cases, one-third of the options became exercisable on October 1, 1995, with one-third vesting on October 1 of each of the following two years. The options expire in 10 years from the grant date. On October 27, 1995, the exercise price of these options was restated to $4.125, the market value on such date. As of September 30, 1998, 53,500 options remained to be exercised and all options were excisable.
On March 4, 1996, the Company issued options to purchase 10,000 shares at $5.38 to a consultant. The options were fully exercisable at September 30, 1998 and expire on March 4, 2006.
On August 27, 1996, the Company issued to one of its executives options to purchase 5,000 shares of common stock at $3.75 per share. The options were fully exercisable at September 30, 1998 and expire on August 26, 2006.
On March 7, 1997, the Company entered into an option agreement with a consultant. Under the agreement, the Company issued options to purchase 100,000 shares at $3.875. Such options were to vest upon the consultant meeting certain minimum sales targets (which were not met) and expired on March 7, 2007. This agreement was terminated and the options cancelled effective September 30, 1998.
On March 12, 1997, the Company issued options to purchase 20,000 shares of common stock at $3.75 per share to new members of the Company's Board of Directors. The options were fully exercisable at September 30, 1998 and expire on March 11, 2007.
During fiscal 1998, the Company granted to certain new employees options to purchases 18,000 shares of common stock at prices ranging from $2.44 to $3.75. One third of the options becomes exercisable on October 1, 1999 with one-third vesting on October 1 of each of the following two years. The options expire in 10 years from the grant.
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (CONTINUED)
10. COMMON STOCK, STOCK OPTIONS, WARRANTS AND RIGHTS (CONTINUED)
OTHER STOCK OPTIONS (CONTINUED)
Transactions and related information relating to other stock options are summarized as follows:
*On October 27, 1995, the exercise price of 91,000 outstanding options issued to non-executive officers was restated to $4.125, the market value on such date.
**On December 11, 1998, the exercise price of 290,000 outstanding options was restated to $2.4375, the market value on such date.
The following table summarizes information about all stock options outstanding at September 30, 1998:
For purposes of the following proforma disclosures, the weighted-average fair value of each option has been estimated on the date of grant using the Black-Scholes options-pricing model with the following weighted-average assumptions used for grants in 1998 and 1997, respectively: no dividend yield; expected volatility of 58% and 56%; risk-free interest rate of 5.4% and 6.4%; and an expected term of six and a half years. The weighted average fair value at date of grant of options granted during 1998 and 1997 was $1.89 and $2.05 per option, respectively. Had the compensation cost been determined based on the fair value at the grant date consistent with the provisions of SFAS 123, the Company's net income (loss) and basic and diluted earnings (loss) per share would have been reduced to the pro forma amounts indicated below (in thousands, except per share amounts):
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (CONTINUED)
10. COMMON STOCK, STOCK OPTIONS, WARRANTS AND RIGHTS (CONTINUED)
STOCK RIGHTS
On November 20, 1990, as amended on January 24, 1991, and on March 16, 1992, the Company adopted a Shareholders' Rights Plan, and 6,002,278 rights were distributed as a dividend at the rate of one right for each share of the Company's common stock. Each right entitles the registered holder to purchase from the Company one share of common stock at a purchase price of $20 per share, subject to adjustment. The rights may be exercised beginning 10 days after a person or group acquires 21 percent or more of the Company's common stock or announces a tender offer that could result in the person or group owning at least 21 percent of the Company's common stock. Subject to possible extensions, the rights may be redeemed by the Company at $0.001 per right at any time until 10 days after 21 percent or more of Catalina's stock is acquired by a person or group. The rights are also redeemable upon a vote by the stockholders of the Company if the proposed purchase price for the shares is deemed fair by a recognized investment banker. In the event the Company is acquired in a merger or other business combination transaction, the holder of each right would be entitled to receive common stock of the acquiring company having a value equal to two times the exercise price of the right. Unless redeemed earlier, the rights expire on November 30, 2000.
STOCK WARRANTS
In connection with the Company's initial public offering of common stock in May 1988, warrants to purchase 92,000 common shares at $4.20 a share were issued. The warrants are exercisable through December 31, 1999. The Company registered the shares underlying the warrants effective May 24, 1995. No common stock has been issued pursuant to these warrants through September 30, 1998.
11. COMMITMENTS
The Company leases offices, warehouse facilities and equipment under non-cancelable operating leases that expire at various dates through 2008. Certain leases provide for increases in minimum lease payments based upon increases in annual real estate taxes and insurance. Future minimum lease payments under non-cancelable operating leases and minimum rentals to be received under non-cancelable subleases as of September 30, 1998 by fiscal year, were as follows (in thousands):
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (CONTINUED)
11. COMMITMENTS (CONTINUED)
Total rental expense for all operating leases (including month-to-month leases) amounted to approximately $1.8 million, $3.1 million and $3.1 million for the years ended September 30, 1998, 1997 and 1996, respectively. In connection with its warehouse consolidation, the Company subleased its Dallas facility in 1995 for the remainder of the lease term and recognized a pretax loss relating to this sublease in 1995.
Shenzhen Jiadianbao Electrical Products Co., Ltd. ("SJE"), a cooperative joint venture subsidiary of Go-Gro, and the Bureau of National Land Planning Bao-An Branch of Shenzhen City entered into a Land Use Agreement covering approximately 467,300 square feet in Bao-An County, Shenzhen City, People's Republic of China on April 11, 1995. The agreement provides SJE with the right to use the above land until January 18, 2042. The land use rights are non-transferable. Under the terms of the SJE joint venture agreement, ownership of the land and buildings of SJE is divided 70% to Go-Gro and 30% to the other joint venture partner. Land costs, including the land use rights, approximated $2.6 million of which Go-Gro has paid its 70% proportionate share of $1.8 million. Under the terms of this agreement, as amended, SJE is obligated to construct approximately 500,000 square feet of factory buildings and 211,000 square feet of dormitories and offices, of which 40 percent was required to be and was completed by April 1, 1997. The remainder of the construction is required to be completed by December 31, 1999. The Company plans to file an application to extend the completion deadline of December 1999. The total cost for this project is estimated at $15.5 million (of which $9.9 million had been expended as of September 30, 1998) and includes approximately $1 million for a Municipal Coordination Facilities Fee (MCFF). The MCFF is based upon the square footage to be constructed. The agreement calls for the MCFF to be paid in installments beginning in January 1997 of which $163,659 had been paid as of September 30, 1998. A 162,000 square foot factory, 77,000 square foot warehouse and 60,000 square foot dormitory became fully operational in June 1997.
On April 26, 1996, the Company entered into a license agreement with Westinghouse Electric Corporation to market and distribute a full range of lighting fixtures, lamps and other lighting products under the Westinghouse brand name in exchange for royalty payments. The agreement terminates on September 30, 2001. The Company has an option to extend the agreement for an additional ten years. The royalty payments are due quarterly and are based on a percent of the value of the Company's net shipments of Westinghouse branded products, subject to annual minimum payments due. Commencing September 30, 1999 either party has the right to terminate the agreement during fiscal years 1999 to 2001 if the Company does not meet the minimum net shipments of $25 million for fiscal 1999, $40 million for fiscal 2000 and $60 million for fiscal 2001. Net sales of Westinghouse branded products amounted to $10.9 million and $9.0 million for the years ended September 30, 1998 and 1997, respectively. The Company's contractual rights ro use the Westinghouse brand name have been challenged by a third party.
In 1998, the Company entered into a consulting agreement with a former employee for a two-year period ending March 31, 2000, for an annual fee of $140,000, payable monthly.
12. RELATED PARTY TRANSACTIONS
The Company leased two facilities located in Massachusetts from entities in which an officer and a former officer had an ownership interest. One of the leases expired in 1996 and the other one expires in June 1999. Rent expense related to these leases was approximately $159,000, $164,000 and $540,000 for the years ended September 30, 1998, 1997 and 1996, respectively.
Notes and advances receivable from Executive Vice Presidents of the Company aggregated $259,160 and $87,996 at September 30, 1998 and 1997, respectively. At September 30, 1998 notes and advances included $220,000 in notes bearing interest at LIBOR plus 250 basis points which were collaterized by stock option agreements to purchase 195,000 shares of the Company. Notes amounting to $120,000 mature in January 1999 and the remainder $100,000 note matures in December 1999.
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (CONTINUED)
13. GEOGRAPHIC INFORMATION AND MAJOR CUSTOMERS
The Company operates exclusively in the lighting industry with operations based in three principal geographic areas, the United States, Asia and Canada. Net sales to unaffiliated customers by U.S.-based operations are made primarily into the United States. Net sales to unaffiliated customers by Asia-based operations are made primarily into Europe and net sales to unaffiliated customers by Canada-based operations are made primarily into Canada. Transfers to other geographic areas primarily represent shipments of finished goods made at prices determined by management. All transfers have been eliminated from consolidated net sales. Financial information, summarized by geographic area, is as follows:
MAJOR CUSTOMERS
During the years ended September 30, 1998, 1997 and 1996 one customer (included in U.S.-based operations) accounted for 27.5%, 22.1% and 9.8%, respectively, of the Company's net sales. One other customer and its affiliate accounted for 11% of the Company's net sales during the year ended September 30, 1996.
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (CONTINUED)
14. EMPLOYMENT AGREEMENTS
The Company has employment agreements with four executive officers. The agreements expire on September 30, 2001. All such officers receive compensation with minimum annual cost of living increases of 5% and acceleration of payments due under the agreements should there be a change in control of the Company. These officers participate equally in a bonus pool equal to 6.7% of the Company's consolidated pretax income. These bonuses for fiscal 1998 and 1996 totaled $105,000, and $175,000, respectively. There was no bonus for fiscal 1997 due to a pretax loss.
Future commitments under employment agreements at September 30, 1998, by fiscal year, excluding the possible effect of bonuses are as follows (in thousands):
1999 1,162 2000 1,220 2001 1,281 ========= $ 3,663 =========
15. CONTINGENCIES
LITIGATION
On June 4, 1991, the Company was served with a copy of the Complaint in the matter of Browder vs. Catalina Lighting, Inc., Robert Hersh, Dean S. Rappaport and Henry Gayer, Case No. 91-23683, in the Circuit Court of the 11th Judicial Circuit in and for Dade County, Florida. The plaintiff in the action, the former President and Chief Executive Officer of the Company, contended that his employment was wrongfully terminated and as such brought action for breach of contract, defamation, slander, libel and intentional interference with business and contractual relationships, including claims for damages in excess of $5 million against the Company and $3 million against the named directors. During the course of the litigation the Company prevailed on its Motions for Summary Judgment and the Court dismissed the plaintiff's claims of libel and indemnification. On February 3, 1997, the plaintiff voluntarily dismissed the remaining defamation claims against the Company and Directors. The breach of contract claim was tried in February 1997 and the jury returned a verdict against the Company for total damages of $2.4 million (including prejudgment interest). On July 14, 1997, the Court also granted plaintiff's motion for attorney fees and costs of $1.9 million. A provision of $4.3 million was recorded by the Company during the quarter ended March 31, 1997 and a $681,000 provision for post-judgment interest was recorded through September 30, 1998. The Company is appealing the verdict and attorney fee award and the appeal was argued before the Third District Court of Appeal on December 18, 1998. The Company believes its arguments are meritorious as argued. No decision from the District Court has been received to date.
On December 17, 1996 White Consolidated Industries, Inc. ("White"), which has acquired certain limited trademark rights from Westinghouse Electric Corp. ("Westinghouse") to market certain household products under the White-Westinghouse trademark, notified the Company of a lawsuit against Westinghouse and the Company filed in the United States District Court, for the Northern District of Ohio. The lawsuit challenged the Company's right to use the Westinghouse trademarks on its lighting products and alleges trademark infringement. On December 24, 1996, Westinghouse and the Company served a Complaint and Motion for Preliminary Injunction against White, AB Electrolux, Steel City Vacuum Co., Inc., Salton/Maxim Housewares, Inc., Newtech Electronics Corp., and Windmere Durable Holdings, Inc. in the United States District Court, Eastern District of Pennsylvania, Case No. 96-2294 alleging that the defendants had violated Westinghouse's trademark rights, breached the Agreement between Westinghouse and White and sought an injunction to enjoin White against interference with their contractual arrangements. In October 1997, the cases were consolidated in the Pennsylvania case and on November 7, 1997 White filed a Counterclaim and Third Party Claims against Westinghouse, Catalina and Minami International Corporation alleging trademark infringement, trademark dilution, false designation of origin, false advertising and unfair competition and seeking injunctive relief and damages. Both the Company and Westinghouse vigorously dispute White's allegations. Pursuant to the License Agreement between Westinghouse and the Company, Westinghouse is defending and indemnifying the Company for all costs and expenses for claims, damages and losses, including the costs of litigation. A trial date of June 21, 1999 has been set by the Court.
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (CONTINUED)
15. CONTINGENCIES (CONTINUED)
During fiscal 1998 the Company received a number of claims relating to halogen torchieres sold by the Company to various retailers. Management does not currently believe these claims will result in a material uninsured liability to the Company. However, as a result of these claims the Company experienced an increase in its liability insurance premiums effective for the 1999 calendar year and will now be self-insuring up to a maximum of $10,000 for each incident occurring in calendar 1999. It is too early to assess the impact of these changes on the Company's financial position or annual results of operations during fiscal 1999. No assurance can be given that the number of claims will not exceed historial experience or that claims will not exceed available insurance coverage or that the Company will be able to maintain the same level of insurance.
The Company is also a defendant in other legal proceedings arising in the course of business. In the opinion of management, the ultimate resolution of these other legal proceedings will not have a material adverse effect on the Company's financial position or annual results of operations.
YEAR 2000
The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's computer programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities.
The Company has developed and is currently executing a plan to make its computer systems Year 2000 ready. The plan consists of five phases: (1) an inventory of all systems and applications, including non-information technology systems; (2) an assessment of the Year 2000 readiness of these existing systems and applications; (3) remediation of Year 2000 problems identified in the assessment phase; (4) testing of all systems and applications to verify the success of the remediation phase and, if necessary (5) the implementation of contingency plans for all significant systems and applications.
Phases 1 and 2 of the Company's plan were completed as of September 1, 1998. The Company is presently engaged in phases 3 and 4 and expects to complete these phases by July 1, 1999.
The Company has determined that its non-information technology systems are not significantly affected by the Year 2000 Issue. With respect to information technology systems, in 1997 the Company, during the normal course of upgrading its systems to address its business needs and add functionality and efficiency to its business processes, began implementation of a new enterprise software to replace the business applications supporting sales, distribution, inventory management, finance and accounting for the Company's North American businesses. The majority of the remainder of the Company's North American systems will be made Year 2000 ready through purchased upgrades of commercial third-party software packages. Go-Gro's systems and applications will be made Year 2000 ready through a combination of internal reprogramming/modification and purchased upgrades of commercial third-party software packages. The internal reprogramming/modifications of Go-Gro's systems and applications are presently undergoing testing by an independent third party.
The Company has initiated communications with the customers, suppliers and other companies important to its business to attempt to determine the extent to which the Company is vulnerable to such parties' failure to resolve their own Year 2000 issues.
The Company is currently and will continue to utilize both internal and external resources to implement its Year 2000 plan. The total incremental cost to the Company for the Year 2000 project (excluding internal resources, the costs associated with the new enterprise system and scheduled hardware replacements which would have been incurred regardless of the Year 2000 Issue), all of which will be expensed as incurred, is approximately $150,000, none of which has been incurred as of September 30, 1998. The Company plans to fund these costs with cash flows from operations. The costs of the Year 2000 project and the timetable in which the Company expects to finish its Year 2000 project are based on management's best estimates and are dependent on a number of factors, including the continued availability of personnel and external resources.
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (CONTINUED)
15. CONTINGENCIES (CONTINUED)
Year 2000 compliance is critical to the Company due to the importance of its computer systems and applications to its business. The Company may also be vulnerable to the failure of significant third parties with which the Company does business to resolve their own Year 2000 issues. The impact on the Company of failure by either the Company or the significant third parties with which it does business to achieve Year 2000 compliance is not reasonably estimable, however, the Year 2000 issue could have a material impact on the operations of the Company.
OTHER
As a result of recent Internal Revenue Service rulings and proposed and temporary regulations, the Company is in the process of restructuring its international operations in order to retain favorable U.S. tax treatment of foreign source income. The Company believes it should be successful in this restructuring. However, in the event the Company is unsuccessful in this effort, the Company will likely experience an increase in its consolidated effective income tax rate.
16. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
CASH AND CASH EQUIVALENTS AND RESTRICTED CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS:
The carrying amount approximates fair value due to the short maturity of those instruments.
BONDS PAYABLE AND OTHER LONG-TERM DEBT:
The fair value of the Company's bonds payable and other long-term debt is estimated based on the current rates offered to the Company for borrowings with similar terms and maturities.
Estimated fair values of the Company's financial instruments are as follows (in thousands):
It is not practicable to estimate the fair value of the Company's $7.6 million in convertible subordinated notes.
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (CONTINUED)
17. CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (CONTINUED)
17. CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY (CONTINUED)
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (CONTINUED)
17. CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY (CONTINUED)
(Continued on page 54)
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (CONTINUED)
17. CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY (CONTINUED)
During the years ended September 30, 1998, 1997 and 1996 capital lease obligations aggregating approximately $314,000, $111,000 and $573,000, respectively, were incurred when the Company entered into leases for new office, computer, machinery and warehouse equipment.
In 1997 and 1996, the Company issued 5,000 common shares to an employee as salary pursuant to an employment agreement.
CATALINA LIGHTING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 (CONTINUED)
18. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) (IN THOUSANDS EXCEPT PER SHARE DATA)
(A) Includes $930,000 in plant closing costs due to the termination of manufacturing operations at Meridian and $6.3 million in litigation costs and related professional fees.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this item is incorporated by reference from the definitive proxy statement for the Company for its 1999 Annual Meeting of Stockholders or the Company's Form 10K/A, which will be filed within 120 days of September 30, 1998.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item is incorporated by reference from the definitive proxy statement for the Company for its 1999 Annual Meeting of Stockholders or the Company's Form 10K/A, which will be filed within 120 days of September 30, 1998.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this item is incorporated by reference from the definitive proxy statement for the Company for its 1999 Annual Meeting of Stockholders or the Company's Form 10K/A, which will be filed within 120 days of September 30, 1998.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item is incorporated by reference from the definitive proxy statement for the Company for its 1999 Annual Meeting of Stockholders or the Company's Form 10K/A, which will be filed within 120 days of September 30, 1998.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) 1. DOCUMENTS FILED AS PART OF THIS REPORT. The following consolidated financial statements of the Company and its subsidiaries are filed as part of this Report:
Independent Auditors' Report
Consolidated Balance Sheets as of September 30, 1998 and 1997
Consolidated Statements of Operations for the years ended September 30, 1998, 1997 and 1996
Consolidated Statements of Stockholders' Equity for the years ended September 30, 1998, 1997 and 1996
Consolidated Statements of Cash Flows for the years ended September 30, 1998, 1997 and 1996
Notes to Consolidated Financial Statements
2. FINANCIAL STATEMENT SCHEDULES. The following financial statement schedule is included in this Report:
Schedule II - Valuation and Qualifying Accounts for the years ended September 30, 1998, 1997 and 1996
(b) REPORTS ON FORM 8-K:
None.
(c) UNDERTAKING:
For the purposes of complying with the amendments to the rules governing Form S-8 (effective July 13, 1990) under the Securities Act of 1933 (the "1933 Act"), the undersigned Registrant hereby undertakes as follows, which understanding shall be incorporated by reference into Registrant's Registration Statements on Form S-8 Nos. 33-23900, 33-33292, 33-62378 and 33-94016.
Insofar as indemnification for liabilities arising under the 1933 Act may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the 1933 Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit of proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the 1933 Act and will be governed by the final adjudication of such issue.
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
CATALINA LIGHTING, INC.
By: /S/ ROBERT HERSH --------------------------------- Robert Hersh, Chairman, President, Chief Executive Officer and Director
December 24, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons of behalf of the Company and in the capacities and on the dates indicated.
By:/S/ DEAN S. RAPPAPORT December 24, 1998 --------------------------------- Dean S. Rappaport, Director, Executive Vice President, and Chief Operating Officer
By:/S/ WILLIAM D. STEWART December 24, 1998 --------------------------------- William D. Stewart, Director, Executive Vice President
By:/S/ DAVID W. SASNETT December 24, 1998 --------------------------------- David W. Sasnett, Chief Financial Officer, Senior Vice President, Chief Accounting Officer
By:/S/ RYAN BURROW December 24, 1998 --------------------------------- Ryan Burrow, Director
By:/S/ HENRY LATIMER December 24, 1998 --------------------------------- Henry Latimer, Director
By:/S/ JEFFREY SILVERMAN December 24, 1998 --------------------------------- Jeffrey Silverman, Director
By:/S/ LEONARD SOKOLOW December 24, 1998 --------------------------------- Leonard Sokolow, Director