-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VZfvPZfGvNZ90L4agKza22olCgeFiXjWGzN8fZqQSKTcua99VqvGUiNamX/u8hLp 8muBDvynad2i2dIjgMrUOw== 0000950152-04-007555.txt : 20041022 0000950152-04-007555.hdr.sgml : 20041022 20041022110351 ACCESSION NUMBER: 0000950152-04-007555 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20030930 FILED AS OF DATE: 20041022 DATE AS OF CHANGE: 20041022 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HMI INDUSTRIES INC CENTRAL INDEX KEY: 0000046445 STANDARD INDUSTRIAL CLASSIFICATION: METAL FORGING & STAMPINGS [3460] IRS NUMBER: 361202810 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: 1934 Act SEC FILE NUMBER: 002-30905 FILM NUMBER: 041090984 BUSINESS ADDRESS: STREET 1: 6000 LOMBARDO CENTER STREET 2: SUITE 500 CITY: SEVEN HILLS STATE: OH ZIP: 44131 BUSINESS PHONE: 2164321990 MAIL ADDRESS: STREET 1: 6000 LOMBARDO CENTER STREET 2: SUITE 500 CITY: SEVEN HILLS STATE: OH ZIP: 44131 FORMER COMPANY: FORMER CONFORMED NAME: HEALTH MOR INC DATE OF NAME CHANGE: 19920703 10-K/A 1 l10118ae10vkza.txt HMI INDUSTRIES ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K/A AMENDMENT NO. 1 (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended September 30, 2003 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____ to _____ Commission File Number 2-30905 HMI INDUSTRIES INC. (Exact name of registrant as specified in its charter) DELAWARE 36-1202810 - ------------------------------- --------------------------------- (State or other jurisdiction of (IRS Employer Identification No.) Incorporation or organization) 6000 Lombardo Center, Suite 500, Seven Hills, Ohio 44131 - -------------------------------------------------- --------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (216) 986-8008 Securities registered pursuant to Section 12(b) of the Act: None - ---------------------------------------------------------------- Securities registered pursuant to Section 12(g) of the Act: Title of class ------------------- Common Stock, $1 par value per share Indicate by check mark whether registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past ninety (90) days. Yes [ ] No [X] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12B-2 of the Exchange Act). Yes [ ] No [X] The aggregate market value of voting and non-voting common equity held by non-affiliates of the registrant, computed by reference to the average bid and asked price on the OTC Bulletin Board, as of March 31, 2003 was $1,731,782. The number of shares outstanding of the registrant's common stock was 6,745,609 as of September 30, 2004. Documents Incorporated by Reference ----------------------------------- None Index to Exhibits is found on page 43. This report consists of 82 pages. ================================================================================ INTRODUCTORY NOTE RESTATEMENT OF PRIOR FINANCIAL INFORMATION This Amendment No. 1 on Form 10-K/A is being filed to primarily restate certain amounts associated with our Distributor Development Program (See Note 2 to our Consolidated Financial Statements for a discussion of the restatement adjustments and the changes resulting from the restatement) and to revise disclosure and presentation of our consolidated financial statements for the years ended September 30, 2003, 2002, and 2001. The restatement resulted in: (1) entries to correct our accounting for our Distributor Development Program, (2) entries to correct our accounting for the loss on impairment associated with certain tooling assets, (3) related effects of the Distributor Development Program correction on our deferred tax assets, and (4) expanded disclosure in Item 1 "Business" (Products and Distribution, Major Customers), Item 6 "Selected Financial Data", Item 7 "Management's Discussion and Analysis" (Results of Operations, Liquidity), Item 8 "Financial Statements and Supplementary Data", Item 9A "Controls and Procedures", Item 13 "Certain Relationships and Related Parties", Item 15 "Exhibits, Financial Statement Schedules and Exhibit Index", and the Notes to our Consolidated Financial Statements. The cumulative effect of the adjustments on our statement of operations was a $12,010 reduction in our net earnings over the period from January 1, 2001 through September 30, 2003. As discussed in detail under the heading "Accrued Distributor Development Liabilities" we believe that these non-cash changes to our previously issued financial statements do not result in a material increase in the amount of our future obligations or our future cash needs. The restatement adjustments had no effect on our previously reported cash balances, and had no effect on our cash flows. They did however, because of the cumulative effect to our net earnings, result in violations of our debt covenants for the period ended September 30, 2003, which have been waived and the credit facility extended through December 31, 2004. See the more complete discussion of the effects of the restatement adjustments on our debt covenant compliance within the Liquidity and Capital Resources section of Management's Discussion and Analysis. AMENDED ITEMS We hereby amend the following items, financial statements, exhibits or other portions of our Annual Report on Form 10-K for the year ended September 30, 2003, as set forth herein. Each item of the financial statements and disclosures that was affected by the restatement has been amended and restated. Accordingly, this Form 10-K/A should be read in conjunction with our filings made subsequent to the filing of the original Form 10-K. Consequently, all other information not affected by the restatement is unchanged and reflects the disclosures made at the time of the original filing of the Form 10-K on February 23, 2004. The amended items are as follows: - ITEM 1. BUSINESS ~ The information set forth under the caption "Business" is amended to read in its entirety as set forth at pages 4 through 11. 1 - ITEM 6. SELECTED FINANCIAL DATA ~ The selected financial information for the five years ended September 30, 2003 is amended to read in its entirety as set forth at pages 15 through 16. - ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ~ The information set forth under the caption "Management's Discussion and Analysis" is amended to read in its entirety as set forth at pages 16 through 29. - ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ~ Our consolidated financial statements and supplementary data and the report of independent accountants thereon are amended to read in their entirety as set forth at pages 29 and 48 through 80. - ITEM 9A. CONTROLS AND PROCEDURES ~ The information set forth under the caption "Controls and Procedures" is amended to read in its entirety as set forth at pages 29 through 31. - ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ~ The information set forth under the caption "Certain Relationships and Related Transactions" is amended to read in its entirety as set forth at pages 41 through 43. - ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND EXHIBIT INDEX ~ The exhibits, financial statement schedules and reports on Form 8-K information is amended to read in its entirety as set forth at pages 43 through 45. The list of exhibits set forth in, and incorporated by reference from, the Exhibit Index, is amended to include the following exhibits, filed within this report. 2 TABLE OF CONTENTS INTRODUCTORY NOTE................................................................................................ 1 PART I........................................................................................................... 4 ITEM 1. BUSINESS............................................................................................. 4 ITEM 2. PROPERTIES........................................................................................... 11 ITEM 3. LEGAL PROCEEDINGS.................................................................................... 12 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................................................. 12 PART II.......................................................................................................... 13 ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES............................................................................................. 13 ITEM 6. SELECTED FINANCIAL DATA.............................................................................. 15 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS................ 16 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK........................................... 29 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.......................................................... 29 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE................. 29 ITEM 9A. CONTROLS AND PROCEDURES............................................................................. 29 PART III......................................................................................................... 31 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT...................................................... 31 ITEM 11. EXECUTIVE COMPENSATION.............................................................................. 34 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT .................................... 38 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...................................................... 41 PART IV.......................................................................................................... 43 ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K..................................... 43 SIGNATURES....................................................................................................... 46
3 PART I (DOLLARS IN THOUSANDS) ITEM 1. BUSINESS In this document, the words "HMI," "the Company," "we," "our," "ours," and "us" or any derivation thereof, refer only to HMI Industries Inc., and its direct or indirect subsidiaries and not any other person or entity. GENERAL DEVELOPMENT OF THE BUSINESS We are a manufacturer of high quality indoor air filtration systems whose products are sold exclusively through a worldwide direct sales channel. We provide our direct sellers an opportunity, through our quality products and educational programs, to achieve their individual objectives. Our products, a high filtration portable surface cleaner and portable room air cleaner are sold under the trade names Filter Queen(R), Princess(R), Majestic(R), Empress(R), and Defender(R) (portable room air cleaner only), and our central vacuum cleaning system is sold under the trade names Vacu-Queen(R) and Majestic II(R). Although we were known as Health-Mor Inc. until 1995, when our name was changed to HMI Industries Inc., we continue to distribute our products under the Health-Mor brand name. HMI was reorganized in 1968 in Delaware, succeeding an Illinois corporation formed originally in 1928. From 1998 through 2002 we positioned ourselves to invest in new infrastructure and pursue additional core growth opportunities by: a) directing the financial turnaround of the company while increasing product awareness and brand recognition to strengthen and grow the top line, b) divesting all non-core businesses, c) streamlining processes and lowering costs, d) successfully completing a $2,000 private offering of our common stock, e) creating a U.S. program to aid in the retention of Distributors and help with the development of their professional careers and independent businesses (see U.S. MARKET below for additional information), f) creating and developing Health-Mor at Home(TM), a direct to consumer outbound sales force designed to assist consumers in locations where Distributors are no longer located, g) more fully automating our assembly and distribution by moving all production areas to a new and more efficient facility in Strongsville, Ohio, as well as relocating our sales, marketing and executive personnel to our new corporate world headquarters at 6000 Lombardo Center, Seven Hills, Ohio, and h) obtaining approval for our manufacturing facility as both a Medical Class II facility by the Food and Drug Administration ("FDA") and as a Foreign Trade Zone. The FDA Medical Class II recognition is the medical equivalent to the ISO 9001 standards. The Foreign Trade Zone status provides dollar saving benefits on such things as duty exemption on re-exports, duty elimination on waste and scrap, no duty on rejected or defective parts, duty deferral, no duty on domestic content or value added and relief from local taxes. 4 During Fiscal 2003 we continued to strengthen our core business for the future by implementing our proven U.S. Edge Success Program into the international markets, and by adding additional sales leadership within our Asian and European markets to assist with the training and development of the Edge Success Program. In addition we continue to build our After-market-sales (AMS) program and improve lead generations for our network as it learns to work within the new Federal Do Not Call legislation. See the U.S. MARKETS, MARKETS OUTSIDE THE U.S., and MARKETING AND ADVERTISING sections below for additional information. FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS Our operations consist of a single operating segment. See Note 1 of the Notes to the Consolidated Financial Statements for further information. NARRATIVE DESCRIPTION OF BUSINESS Consumers have become increasingly aware of the potential health concerns posed by indoor air quality, as noted in the below quoted publications: - According to the U.S. Environmental Protection Agency ("EPA"), most people spend as much as 90% of their time indoors and over half of that time in their own homes. The EPA has suggested that air levels of many pollutants inside one's own home may be two to five times, and sometimes 100 times, higher than outdoor levels. In addition, studies by the EPA consistently rank indoor air pollution among the top five environmental risks to public health. - According to the March 2003 edition of the Fort Worth Star Telegram: "...what many people don't know is that indoor air pollutants and allergens play a bigger role in asthma than outdoor air pollution." - Health Magazine suggests two methods to help clear potentially harmful particles from our air are to "Get a good filter" and "Upgrade your vacuum." - In October 2003 CertifiedAllergy.com advises "Avoid reservoirs of allergens...proper filtration is extremely important to breathe healthier air." - In September 2003 John Kirkwood, President and Chief Executive Officer of the American Lung Association, stated that, "Exposure to particle pollution has been linked with deaths from heart and lung disease and with lung cancer. Particle pollution can also aggravate lung health problems such as asthma and chronic bronchitis causing those who suffer from those diseases to use more medication and visit their doctor more often." We regard ourselves as a leader in the management of indoor air quality by offering a complete solution that keeps indoor air cleaner and safer to breathe. In his 2002 study, Dr. Peter Dingle, Doctor of Environmental Toxicology at Murdoch University states that, "Filter Queen significantly reduced symptoms in asthmatic children and reduced their need for medication." We believe that people with and without respiratory problems will notice the benefits of cleaner indoor air that can be derived from using our products. Products and Distribution Our principal products include a high filtration portable surface cleaner that is marketed as a healthier alternative to the typical vacuum cleaner and a portable room air cleaner that helps to remove particles, gases and odors from the air. The two products are sold together as a complete Filter Queen Indoor Air Quality System(TM) throughout the world. 5 Filter Queen(R) uses a patented multi-filtration system consisting of Cellupure(R), MEDIPure(R), and Enviropure(R) filter cones and cartridges. The Filter Queen Indoor Air Quality System(TM) is designed and proven to reduce airborne particles and allergens such as dust, smoke, pollen, mold spores, animal dander, dust mites, and harmful fibers that may lead to allergic reactions. Independent tests confirm that the Filter Queen Indoor Air Quality System(TM), when used with the above named filters and cartridges, removes 99.98% of particles at .01 micron, which is better than HEPA (high efficiency particulate arrestance technologies), the industry standard. We believe that we offer a superior warranty in the U.S. for our high filtration portable surface cleaner compared with all other U.S. manufacturers and sellers of vacuum cleaners. We warrant our surface cleaner for a two-year period from the date of purchase and offer a lifetime service benefit for the replacement of the surface cleaner's motor at a price not to exceed $99 USD (not in thousands). We also support a five-year optional extended warranty on the portable surface cleaner offered by our U.S. Distributors to the end user as a sales promotion during an in home product demonstration. As an enticement to the end user to buy our product during that demonstration the five year optional extended warranty is offered to them at no cost; accordingly no revenue for this optional warranty is recognized by HMI. Our warranty reserve is recorded to provide for the above extended warranties. We do not allocate a portion of the product revenue to the extended warranty as there is no objective and reliable evidence associated with the fair value of the warranty, as we are not in the business of separately selling extended warranties on our products. In addition, a general right of return relative to the delivered product does not exist. Outside the U.S. we offer a two-year warranty for our high filtration portable surface cleaner. The portable room air cleaner is warranted for renewable one-year periods so long as the main air filter is replaced annually. A five-year warranty is offered for our built-in vacuum system. Our distribution system consists of approximately 340 Distributors and Importers who sell our products. Our independent authorized Distributors and Importers sell our products in more than 25 countries worldwide. Each Distributor and Importer has a defined territory in which he or she maintains the exclusive right to sell our company's products. Each Distributor and Importer sells the products to consumers through an in-home presentation given by a sales associate who, in some parts of the world, has been trained and certified by independent HMI trainers as an "Indoor Air Quality Specialist." Distributors are granted the right to market our products using the demonstration method and utilizing our trademarks. These same Distributors and Importers are responsible for providing service and replacement parts and supplies to the end-consumers in their territories, which provides them with another source of revenue and potential referral network. U.S. MARKET. In the United States, we primarily sell our high filtration portable surface cleaner and portable room air cleaner through Distributors who sell our products to end consumers through sales associates. To aid in the retention of Distributors and help with the development of their professional careers and independent businesses, we developed an award winning unique training and development program called "The Edge Success Program" (the "Edge"). The Edge is an innovative, highly 6 structured multi-step program that provides business training from the earliest level of a new recruit to the most senior level of a Premier Master Distributor. The program provides incentives at each level to promote the development and retention of quality Distributors and sales associates. Personal and professional training includes: sales and recruiting seminars, a business management correspondence course, and a week-long educational and training course called the Business Management Institute ("BMI") redesigned in conjunction with Cleveland State University in Cleveland, Ohio. BMI addresses everything from sales techniques; lead generation; personal finances; moral, legal and ethical standards; human resource compliance issues; business ownership; and more. Every Distributor that opens a Filter Queen(R) office must attend BMI. The results prove that offices operated by BMI graduates are more successful in terms of unit sales and associate retention than those operated before the inception of the program. The reward for working your way through The Edge and selling 30,000 Filter Queen(R) units is $1 million. In May of 2003 we recognized our first millionaire at our national convention. In May of 2001 we received the distinguished Education for Life Award from the Direct Selling Association for our unique and outstanding education program, The Edge Success Program. The Direct Selling Association recognizes companies in the direct selling industry that go beyond just sales training. Other companies who received this honor in the past include Tupperware, Avon and Mary Kay. In an effort to improve our customer service to end-consumers, in fiscal 2001 we created Health-Mor at Home(TM) ("HMAH"). HMAH is a revenue generating inside sales organization selling replacement parts to Filter Queen(R) owners throughout the United States who no longer have an authorized Distributor in their area. The implementation of several FQ@Home Service Center businesses in late fiscal 2003 and into fiscal 2004 will serve to complement our HMAH program. FQ@Home Service Centers, focused aftermarket businesses aimed at generating repeat business, are being set-up in territories with a high concentration of customers and no Distributor. These Service Centers will provide convenient proactive in-home replacement of parts and accessories for existing Filter Queen(R) customers. MARKETS OUTSIDE THE U.S. Success in exporting has occurred for us mostly in the last twenty years. To sell our products in a foreign market, we usually engage the services of a single Importer to represent our products in each country. We have less contact with the direct sales networks employed by Importers because we have fewer field staff outside the U.S. to support such sales networks. Since each country poses its own unique set of challenges (among others, currency fluctuations, differing political and economic systems, unique business and legal environments, inconsistent duty and tax requirements and even civil unrest and war), it can be very difficult to penetrate a new market without the help of an individual from that market. As a consequence, we are dependent on our Importers to address those challenges. In fiscal 2002 a reorganization of the management for our international market resulted in the planned introduction of the most successful U.S. programs. For example in fiscal 2003, The Edge Success Program, BMI, the "System" selling strategy, and the new power nozzle (formally sold only as an option) were introduced, with great anticipation, to some of our largest foreign markets in parts of Asia, Europe and the Middle East. 7 Marketing and Advertising Traditionally, we have relied on our Distributors to market and sell our products to consumers. A portion of the sales of our products by our Distributors and their sales associates is dependent on telemarketing as a tool for developing sales leads and arranging in-home demonstrations of our products with end-consumers who purchase these products. Regulatory efforts in Europe and the U.S. have focused on imposing more restrictions on telemarketing. In October 2003 the National Do Not Call registry became active, limiting the number of potential consumers reachable by telephone. There can be no assurance that such regulations will not further restrict telemarketing, and thereby make it increasingly difficult to sell our products with the aid of telemarketing. Because of these increased regulations and the high relative cost of telemarketing, many of the Distributors have been developing alternative methods to generate leads for in-home demonstrations. We have assisted our Distributors by creating a National Exhibit Booth Program that encourages Distributors to participate in local exhibits, tradeshows, home shows, shopping malls and fairs. As part of this program we developed a National Sweepstakes Program titled "Live Better Sweepstakes." The Sweepstakes winner will take home an automotive vehicle valued at $25 or $25 in cash. To promote the sweepstakes program, we created a portable display booth containing banners, product display pedestals, entry forms, drop boxes, posters and a "smoke machine" which demonstrates the air cleaning ability of the Defender(R). The entry forms contain a signature line that allows Distributors to contact the customer by telephone for the duration of the contest period. In addition, this program promotes brand awareness in the Distributor community. Additionally, in October 2003 we launched a national mail lead generation program in order to generate leads and provide opportunities for our distribution network to demonstrate and sell our products. This program offers consumers the chance to win prizes and an opportunity to view a Filter Queen(R) presentation. We are sponsoring the Grand Prize of $10 and the second through fourth prizes. The Distributor is responsible for the fifth and sixth place prizes. When the customer calls, the Distributor sets an appointment to verify the winning card, delivers the prize, and has the opportunity to make a presentation of the Filter Queen Indoor Air Quality System(TM). Furthermore, in fiscal 2002 we developed an alliance, which we continue today, with a medical doctor to write a book on the dangers of indoor air pollution. In his book, Every Breath You Take, Dr. Bill Loughridge explains how to reduce the negative affects of indoor air pollution. In the "solutions" section of the book, Dr. Loughridge recommends Filter Queen(R) as the best cleaning system to help maintain a healthy environment. The book was published in May 2002 and is available through Ingram Books or HMAH. Filter Queen(R) Distributors have purchased the book to educate their sales associates and consumers. Many Distributors give the book away free just for seeing a demonstration. To date nearly six thousand books have been distributed. Raw Material We assemble finished units from parts purchased from various suppliers. The raw materials used by our manufacturing operations are purchased from a number of suppliers and substantially all such materials are readily available. Patents and Trademarks We have numerous United States and foreign patents, patent and trademark applications, registered trademarks, and trade names that are used in our business. We generally own the trademarks under which our products are marketed and have registered our trademarks and will continue to register and protect them as they are developed or acquired. Trademarks are 8 registered for varying finite periods but are usually renewable for an unlimited number of periods so long as they are still in use. Patents are registered for finite periods and are not renewable. In the case of trademarks used which are owned by others, we have entered into long-term license agreements to use the trademarks. We also believe that certain of the trademarks and trade names are of material importance to the businesses/products to which they relate and may be of material importance to our company as a whole. Although protection of our patents and related technologies are important components of our business strategy, none of the individual patents is believed to be material to our company. The remaining duration of the patents and trademarks varies. Seasonality Historically we experience lower product sales in our fiscal fourth quarter, as compared to the first three fiscal quarters, resulting from fluctuations in our European product sales as the European importers adjust their inventory volumes in July/August for the standard European holiday month of August. European net product sales approximated 11.8%, 14.6%, and 19.8% for the fiscal fourth quarters in 2003, 2002, and 2001, respectively, as compared to the average of the first three fiscal quarters in 2003, 2002, and 2001 of 20.5%, 19.0%, and 23.2%, respectively. Major Customers and Dependence on Independent Distributors We are subject to risks specific to the individual customers with whom we do business. In fiscal 2003 no individual customer accounted for more than 10% of our product sales. In fiscal 2002 one international customer in Japan accounted for more than 10% of our product sales. This international customer's product sales were 11.9% of our total product sales. In fiscal 2001 three international customers, one each in Canada, Japan and Portugal, accounted for more than 10% each of our product sales with individual total product sales of 13.1%, 11.2%, and 10.2%, respectively. Our revenues, and the stability of such revenues, are dependent on our relationships with third-party distributors and their sales persons and their level of satisfaction with our products and us. The Distributors and Importers are independent third parties who are not our employees and are not directly under our control. There can be no assurance that the current relationships with Distributors and Importers will continue on acceptable terms and conditions to us, nor can there be any assurance that additional distributorship arrangements with third parties will be obtained on acceptable terms. Moreover, there can be no assurance that the Distributors and Importers will devote sufficient time and resources to our products to enable the products to be successfully marketed. Failure of some or all of our products to be successfully and efficiently distributed could have a material adverse effect on our financial condition and results of operations. In addition, our business could be adversely affected by a variety of uncontrollable and changing factors, including but not limited to: difficulty in protecting our intellectual property rights in a particular foreign jurisdiction; recessions in economies where our products are sold; longer payment cycles for and greater difficulties collecting accounts receivable; export controls, tariffs and other trade protection measures; social, economic and political instability; and changes in United States and foreign countries laws and policies affecting trade. Backlog We operate monthly with a minimal backlog (backlog at September 30, 2003, 2002, and 2001 was $-0-, $6, and $-0-, respectively). 9 Competition We experience strong competition in the sale of our high filtration portable surface cleaners, central vacuum systems, and portable room air cleaners. Not only do we compete for consumer sales but also for Distributors and Importers to sell our products. Participants in the vacuum and indoor air cleaner industries compete primarily on price, quality, brand name recognition, product availability, and product performance, including the perceived amount of particles removed by a vacuum cleaner or air filter. Economy or disposable vacuums and indoor air filters are sold through a variety of channels including department stores, discount houses, appliance stores, and catalogs, generally at substantially lower prices than our products. According to the latest survey from the Vacuum Dealers Trade Association, 75% of vacuum sales were through retail store outlets while direct-selling companies like HMI sold 25%. We believe that our high filtration portable surface cleaner is superior to other vacuum cleaners because of its outstanding performance and warranty, as described in greater detail above under "Products and Distribution." Our high filtration portable surface cleaner (The Majestic(R)) and central vacuum system (Vacu-Queen(R)) compete with many significant vacuum cleaner manufacturers and with regional and private label manufacturers, including other direct selling companies, such as Rainbow, Tristar, Kirby, Miracle Mate, Electrolux, and Water-Matic, and companies that sell through retail outlets such as Miele, Eureka, Hoover, Kenmore, and Royal. We also manufacture and distribute a portable room air cleaner (The Defender(R)) recognized as a Class II Medical Device by the FDA. There are basically two types of air cleaners. The Defender(R) is a mechanical filter that forces dirty air through a series of filters releasing only cleaner, fresher air. The second type is an electrostatic precipitator that emits an electronic charge into the air. Many electronic filters also produce ozone, a proven respiratory irritant. The portable room air cleaner market is primarily a retail and catalog business. HMI's Defender(R) competes directly with air cleaners like: Alpine, Honeywell, Bionaire, Hunter, Holmes, Hoover, and Sharper Image. The October 2003 issue of Consumer Reports states that, "Air cleaners like these are a type of electronic precipitator: They impart an electrical charge to particles that stick to oppositely charged collectors. Sharper Image, Honeywell, and Hoover precipitators are quiet and cost little to run. However, our tests show that they are not effective." Many of our competitors have greater financial, marketing, and manufacturing resources and better brand name recognition than us, and sell their products through broader and more extensive distribution channels. According to a recent U.S. Air Cleaner Market Report, published by Riedel Marketing, nearly 70% of air cleaner owners purchased through traditional retail establishments while just 5% of those who own an air cleaner purchased from a salesperson that came to their home. Research and Development Our ongoing research and development program involves creating new products and redesigning existing products to reduce manufacturing costs and to increase product quality and efficiencies. In fiscal year 2003, 2002, and 2001, we invested $74, $273, and $351, respectively, in new product development. We anticipate expending $55 on the redesigning of products in fiscal year 2004. 10 Environmental To our knowledge, we are in compliance with all applicable Federal, State, and local laws relating to the protection of the environment. While we anticipate no current expenses for environmental issues, there can be no assurance that we will not receive claims for environmental conditions in the future, nor any assurance that any such claims, if received, would not have a material adverse impact on our financial condition and results of operations. Employees We employed 115 full-time and 14 part-time employees at January 31, 2004. None of our employees are parties to a collective bargaining agreement, and we believe our relationships with all our employees to be good. FINANCIAL INFORMATION ABOUT GEOGRAPHIC AREAS Sales to international customers represented 35.8%, 43.1%, and 49.7% of net product sales for the years ending September 30, 2003, 2002, and 2001, respectively. AVAILABLE INFORMATION Our principal executive offices are located at 6000 Lombardo Center, Suite 500, Seven Hills, Ohio 44131, and its telephone number is (216) 986-8008. We regularly file reports with the Securities Exchange Commission (SEC). These reports include, but are not limited to, Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, current reports on Form 8-K, and security transaction reports on Forms 3, 4, or 5. The public may read and copy any materials that we file with the SEC at the SEC's Public Reference Room located at 450 Fifth Street NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains electronic versions of our reports on its website at http://www.sec.gov. We make our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, current reports on Form 8-K, and other reports filed or furnished with the SEC available to the public, free of charge, through our website at www.filterqueen.com. These reports are provided through our website as soon as reasonably practicable after we file or furnish these reports with the SEC. ITEM 2. PROPERTIES The following table sets forth the location, character, and size (in thousands of square feet) of the real estate we used in our operations at January 31, 2004:
Square Location Character Feet -------- --------- ---- United States of America~ Strongsville, Ohio Leased office, manufacturing, and warehouse space 73.0 Seven Hills, Ohio Leased office space 15.7
11 ITEM 3. LEGAL PROCEEDINGS Bliss Technologies, Inc. ("Bliss"), the company formed from the 1998 sale of the subsidiary of HMI, filed for bankruptcy in January 2000 in the United States Bankruptcy Court, Eastern District of Michigan. In a separate action filed in 2002, the Official Committee of Unsecured Creditors of Bliss alleges a fraudulent conveyance claim against us asserting that the sale of Bliss in 1998 was a fraudulent transfer insofar as we received more for Bliss than it was worth and that Bliss was insolvent from its inception. Former directors of Bliss, Mark Kirk and Carl Young, are also named as defendants in the action. Claims pending against them allege that in their capacity as Bliss directors they breached fiduciary duties to Bliss creditors. The complaint seeks damages in an unspecified sum. The claims against us and the claims against Mr. Kirk and Mr. Young are being vigorously defended. We believe that we will resolve this matter in a manner that will not have a material adverse effect on our consolidated financial position, results of operations, or cash flows. CONET Industries, Inc., Royal Queen Club International Limited, Chang-whan Chang and Young-so Song ("Plaintiffs") filed a complaint against HMI on or about February 18, 2001, in the Seoul, Korea District Court. It was served by Registered Mail upon HMI at our corporate offices in Seven Hills, Ohio, on or around April 10, 2002. The complaint was filed as a result of lawsuits by us against Mr. Song, a former HMI Distributor in Korea, and Royal Queen Club concerning Mr. Song's CYVAC product. In our lawsuits, we sought and were granted preliminary injunctions against Plaintiffs that prohibited Plaintiffs from manufacturing and selling the old model CYVAC for 311 days and the new model CYVAC for 209 days, until the Seoul High Court issued a declaration of suspension of the injunctions. Despite the fact that Plaintiffs had been enjoined by the Courts, Plaintiffs allege that we should compensate them for actual damages for sale discontinuance, supplemental managerial costs and new mold fabrication costs due to the interruption in the manufacturing and marketing of each product during that period. Plaintiffs also claim that we tortuously interfered with Plaintiffs' business advantages, caused irreparable harm to Plaintiffs' normal business activities, and damaged Plaintiffs' reputation and standing. Chang-whan Chang and Young-so Song allege that they have been critically damaged personally due to the accusations, improper provisional seizure, and criminal allegations alleged by us, which they assert resulted in disturbance to business, reputation, and credit. All matters are pending. The Plaintiffs originally alleged damages in excess of U.S. $21,894. After several hearings the court ruled in our favor and against the Plaintiffs on all counts. We have been notified that the Plaintiffs have appealed this decision in accordance with Korean law. We believe that we will resolve this matter in a manner that will not have a material adverse effect on our consolidated financial position, results of operations, or cash flows. Claims arising in the ordinary course of business are also pending against us. Although these are in various stages of the litigation process, we believe that none of these matters will have a material adverse effect on our consolidated financial position, results of operations, or cash flows. Included in the accompanying Consolidated Balance Sheets at September 30, 2003, and 2002, were accruals of $15 and $15, respectively, relating to various claims. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 12 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Our common stock is traded in the over-the-counter market on the OTC Bulletin Board under the symbol "HMII.OB". As of January 31, 2004, there were 222 stockholders of record. A summary of the quarterly high and low bid price of our common stock on the OTC Bulletin Board for the years ended September 30, 2003, and 2002, are as follows: 2003
High [1] Low [1] -------- ------- 1st Quarter $ 0.70 $ 0.18 2nd Quarter $ 0.65 $ 0.41 3rd Quarter $ 0.65 $ 0.51 4th Quarter $ 1.05 $ 0.55
2002
High [1] Low [1] -------- ------- 1st Quarter $ 1.01 $ 0.70 2nd Quarter $ 0.80 $ 0.51 3rd Quarter $ 0.83 $ 0.58 4th Quarter $ 0.65 $ 0.46
[1] The bid price for our common stock was received from Nasdaq Trading & Market Services. Such over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions. The declaration and payment of quarterly dividends is at the discretion of the Board of Directors, which may raise, lower, or omit the dividend in any quarter. No dividends were declared in 2003 or 2002 as the credit agreement with our lender presently prohibits us from declaring or paying any dividends. Securities Authorized for Issuance Under Equity Compensation Plans. Information about HMI equity compensation plans at September 30, 2003, was as follows (shares in thousands):
Number of shares Number of shares to remaining available be issued upon Weighted average for future issuance exercise of exercise price of under equity Plan Category outstanding options outstanding options compensation plans ------------- ------------------- ------------------- ------------------ Equity compensation plans approved by shareholders (a) 1,024 $1.21 -(b) ----- ----- ---- Equity compensation plans not approved by shareholders (c) 135 $5.91 - ----- ----- ---- Total 1,159 $1.76 -
(a) These options were issued under the 1992 Omnibus Long-Term Compensation Plan. See "Notes to Consolidated Financial Statements, Note 5 - Long-Term Compensation Plan." 13 (b) The 1992 Omnibus Long-Term Compensation Plan (the "Plan") does not contain any restriction on the number of shares that can be issued pursuant to an award under the Plan except for Incentive Stock Options ("ISO"), which are limited to 2,500 shares, as adjusted for stock splits. No new ISO grants may be made under the Plan because the Plan was adopted more than ten years ago. Regulations of the Internal Revenue Service which determine whether or not on option is an ISO require that the Plan under which an ISO is granted must have been adopted within the prior ten years. The number of shares available for grant each year is equal to 5% of the Company's outstanding Common Stock on December 31 of the prior year. To the extent that the number of awards in any year is less than 5%, this unused amount may be carried over to future years. Awards which have lapsed or been forfeited may also be reissued in future years. The maximum number of awards that can be made in any year, including carryovers and lapsed and forfeited awards, is equal to 10% of the Company's outstanding Common Stock on December 31 of the prior year. (c) Awards of non-qualified stock options were made to two outside consultants in connection with their services to HMI. The option price was the fair market value on the date of grant. One option for 100 shares expires ten years from the date of grant (2006), while the other option for 35 shares expires five years from the date of grant (2005). 14 ITEM 6. SELECTED FINANCIAL DATA The following table sets forth our selected historical financial data for each of the last five fiscal years and reflects the restatement adjustments, for the years ended September 30, 2003, 2002, and 2001, described in the introductory note to this annual report as well as in Note 2 to our Consolidated Financial Statements included in this annual report. Such data should also be read in conjunction with "Management's Discussion and Analysis" and our audited Consolidated Financial Statements included in this annual report. Please read Note 2 of the Consolidated Financial Statements for additional information about the restatements. In thousands except per share amounts, stock prices and ratios
Restated Restated Restated 2003 2002 2001 2000 1999 ---------- ---------- ---------- --------- --------- Net product sales $ 30,170 $ 34,524 $ 31,527 $ 34,621 $ 36,927 Cost of product sold and SG&A expenses $ 35,334(o) $ 35,889 $ 32,676 $ 33,515 $ 38,447 Loss on impairment of asset $ 1,711(1) $ - $ - $ - $ 2,665 Other (income) expense, net $ (105) $ 430 $ 272 $ (6) $ (60) (Loss) income from continuing operations before taxes and cumulative effect of accounting change $ (6,770) $ (1,795) $ (1,421) $ 1,112 $ (4,125) (Loss) income margin from continuing operations before taxes and cumulative effect of accounting change (22.4%) (5.2%) (4.5%) 3.2% (11.2%) Provision (benefit) for income taxes $ 18 $ 38 $ 3,672(2) $ (353) $ 116 Income tax rate (0.3%) (2.1%) (258.4%) (31.7%) (2.8%) (Loss) income from continuing operations before cumulative effect of accounting change $ (6,788) $ (1,833) $ (5,093) $ 1,465 $ (4,241) (Loss) income margin from continuing operations before cumulative effect of accounting change (22.5%) (5.3%) (16.2%) 4.2% (11.4%) Cumulative effect of accounting change $ (5,451)(3) $ - $ 4,943(4) $ - $ - Gain (loss) on disposals $ - $ - $ - $ 425 $ (375) Net (loss) income $ (12,239) $ (1,833) $ (10,036) $ 1,890 $ (4,616) Net (loss) income margin (40.6%) (5.3%) (31.8%) 5.5% (12.4%) Per Share Data - Basic and Diluted: (Loss) income from continuing operations before cumulative effect of accounting change $ (1.01) $ (0.27) $ (0.76) $ 0.24 $ (0.81) Cumulative effect of accounting change $ (0.81) $ - $ (0.74) $ - $ - Gain (loss) on disposals $ - $ - $ - $ 0.07 $ (0.07) Net (loss) income $ (1.82) $ (0.27) $ (1.50) $ 0.31 $ (0.88) Weighted Average Number of Common Shares Outstanding: Basic 6,744 6,719 6,691 6,113 5,263 Diluted 6,744 6,719 6,691 6,140 5,263 Total Assets $ 10,668 $ 17,430 $ 16,979 $ 20,843 $ 17,465 Long-Term Debt $ 11 $ 33 $ 75 $ 71 $ - Stockholders' Equity $ (8,754) $ 2,577 $ 4,419 $ 14,394 $ 10,326 Working Capital $ 1,444 $ 992 $ 580 $ 4137 $ 987 Ratio of Current Assets to Current Liabilities 1.22 1.16 1.09 1.67 1.15 (Loss) Income as a Percent of Average Stockholders'(Deficit) Equity (396.1%) (52.4%) (106.7%) 15.3% (37.8%) Stock High(a) 1 1/20 1 1/5 1 11/16 1 3/4 2 1/4 Stock Low(a) 13/50 25/49 11/16 1/2 1
15 (o) This amount includes a $905 write-off, recorded during the second quarter, relating to cumulative translation adjustments associated with the liquidation of our Canadian subsidiary. In addition it includes a $300 reserve for obsolete inventory associated with impaired tooling. See Note 1 for further information. (1) During the fourth quarter of fiscal 2003, we performed an analysis on the potential impairment of certain tooling assets, and related patents and trademarks, approximating $1,711. We concluded from our analysis, which was based upon the held and used model that the tooling assets were fully impaired and accordingly recorded an impairment charge of $1,711 as of September 30, 2003. (2) In the second quarter of fiscal 2001, we concluded that a full valuation allowance for our deferred tax assets was required. Accordingly, we recorded a non-cash charge in the second quarter of fiscal 2001 of $6,118 to increase our valuation allowance for our deferred tax assets. See Note 6 for further information. (3) As of October 1, 2002, a full impairment of the goodwill recorded on HMI's books was recorded through a non-cash charge of $5,451. Such charge is non-operational in nature. See Note 1 for further information. (4) In the second quarter of fiscal 2001 a non-cash charge of $4,943 was recorded on HMI's books to reflect the adoption of the Emerging Issues Task Force EITF 01-9, Accounting for consideration Given by a Vendor to a Customer relative to our distributor development program. (a)Represents closing price of stock ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS) RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS Item 7 of Management's Discussion and Analysis has been revised to reflect the restatement of our Consolidated Financial Statements for the years ended September 30, 2003, 2002 and 2001. Refer to the Introductory Note to this Form 10-K/A - "Restatement of Prior Financial Information" and Note 2 of our Consolidated Financial Statements for a further discussion of the restatement adjustments and changes resulting from the restatement. Accrued Distributor Development Liabilities As discussed in Note 2 to the Consolidated Financial Statements, EITF 01-9, "Accounting for Consideration Given by a Vendor to a Customer" was issued in 2001. We did not consider the implications of this accounting pronouncement to our $1,000 award associated with our Distributor Development Program, otherwise known as our Edge Success Program. Accordingly, we have restated our revenues to properly reflect the accrual for this award as a reduction of revenues, not as a selling and administrative expense. We have determined that for purposes of EITF 01-9 it is not possible to reasonably estimate such a liability. We have therefore accrued such awards assuming a maximum accrual rate. In other words, for each qualifying sale, we have recorded a liability by reducing revenue. Such a liability will only be derecognized (i.e. the accrual eliminated) when (i) the award is paid out or (ii) when a distributor is no longer eligible for the award. For the years ended September 30, 2003, 2002 and 2001, this adjustment (i) decreased sales by $4,369, $2,589 and $1,009, respectively, and (ii) decreased selling, general and administrative expenses by $713, $191 and $79, respectively. In addition, in the second quarter of fiscal 2001, $4,943 was recorded which represented the cumulative effect of the adoption of EITF 01-9 since the inception of the Program in 1997. 16 Tooling Assets In 2003, we performed an analysis on the potential impairment of certain tooling assets. We concluded from our analysis, which was based upon the held and used model, that the tooling assets were fully impaired and accordingly we recorded an impairment charge of $1,613 as of September 30, 2003. We inadvertently omitted impairment charges of $98 for patents and trademarks relating to these tooling assets and have reflected such additional impairment in the restated 2003 consolidated financial statements. Deferred Tax Asset In 2003, we provided a full valuation allowance on our deferred tax assets. As a result of the restatement related to the Distributor Development Program, our recorded income in 2001 changed to a loss and caused a significant cumulative loss for financial statement purposes. Accordingly, we determined that the impairment of our deferred tax assets should be reflected in the second quarter of fiscal 2001, when we first reflected the adoption of EITF 01-9. As a result, we reversed the original impairment recorded in fiscal 2003. Summary of Restatement Adjustments The following table summarizes the effects of the restatement adjustments on certain of our previously issued financial statements by type of adjustment and by the affected captions in our Statement of Operations. The various adjustments recorded to prior years as part of the restatement have no effect on our cash flows. Summary of Restatement Adjustments by Type
YEAR ENDED SEPTEMBER 30, 2003 2002 2001 -------- --------- -------- (Increase) decrease to net loss- DISTRIBUTOR DEVELOPMENT LIABILITIES: Revenues $ (4,369) $ (2,589) $ (1,009) Selling, general and administrative expenses 713 191 79 Interest expense - - 15 Cumulative effect of accounting change - - (4,943) TOOLING ASSET IMPAIRMENT Loss on impairment of asset (98) - - DEFERRED TAX ADJUSTMENT Provision for income taxes 4,038 227 (4,265) -------- --------- -------- Total effect of restatement on net loss $ 284 $ (2,171) $(10,123) ======== ========= ========
17 CRITICAL ACCOUNTING POLICIES Our discussion and analysis of our financial condition and results of operations are based upon the consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements required us to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of the consolidated condensed financial statements. Actual results may differ from these estimated under different assumptions or conditions. Critical accounting policies are defined as those that are reflective of significant judgment and uncertainties, and potentially may result in materially different outcomes under different assumptions and conditions. We believe that the critical accounting policies are limited to those that are described below. Allowance for Doubtful Accounts At September 30, 2003, our bad debt reserve was $194. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Quarterly, we evaluate the collectability of our accounts receivable based on a combination of factors. In cases where we are aware of circumstances that may impair a specific customer's ability to meet its financial obligations to us, we record a specific allowance against amounts due to us, and thereby reduce the net recognized receivable to the amount we reasonably believe will be collected. For all other customers, we recognize allowances for doubtful accounts based on the length of time the receivables are past due, industry and geographic concentrations, the current business environment, and our historical experience, including payment patterns. If the financial condition of our customers deteriorates or if economic conditions worsen, additional allowances may be required in the future, which could have an adverse impact on our future operating results. Sales Return and Allowance We record a provision for estimated sales returns and allowances on product sales in the same period as the related revenues are recorded. These estimates are based on historical sales returns and other known factors. If future returns do not reflect the historical data we use to calculate these estimates, additional allowances may be required. Excess and Obsolescence Reserves Quarterly we evaluate our inventory to determine excess or slow moving items based on current order activity and projections of future demand. For those items identified, we estimate their market value or net sales value based on current trends. An allowance is created for those items having a net sales value less than cost. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be necessary. Goodwill and Other Intangible Assets Pursuant to FAS 142 "Goodwill and Other Intangible Assets" we ceased amortizing goodwill in the period beginning October 1, 2002. Prior to the adoption of SFAS No. 142, we amortized goodwill on a straight-line basis over 40 years. Other intangible assets are amortized on a straight-line basis over their useful lives, ranging from ten to seventeen years. FAS 142 primarily addresses the accounting for goodwill and intangible assets subsequent to their initial recognition. The provisions of FAS 142 prohibit the amortization of goodwill and indefinite-lived intangible assets, require that goodwill and indefinite-lived intangible assets be tested annually for impairment (and in interim periods if certain events occur indicating that the 18 carrying value of goodwill and/or indefinite-lived intangible assets may be impaired), require that reporting units be identified for the purpose of assessing potential impairments of goodwill, and remove the forty-year limitation on the amortization period of intangible assets that have finite lives. During the first quarter of fiscal 2003 we completed the first step of the two-step implementation process by obtaining a valuation of HMI for comparison to the carrying value and began the process of measuring the amount of the impairment (step two). Management does not believe that the market value of common stock fairly reflects the value of HMI, because of, among other things, the absence of liquidity, and the absence of analyst coverage. Accordingly, the valuation experts employed by us utilized the market value of the common stock as of October 1, 2002, but also weighted the valuation for comparable values of peer companies, recent sales of similar types of companies, and a discounted cash flow methodology. Based on the assumptions used in any of the three valuations referred to above and depending on the weighting used for each valuation, results of the valuation could be significantly changed. However, for accounting purposes we believe that the weighting methodology used is reasonable and results in an accurate and fair value of HMI. During the second quarter of fiscal 2003 we completed our initial impairment test for October 1, 2002, resulting in a full impairment of the goodwill recorded on HMI's books through a non-cash charge of $5,451. Such charge is non-operational in nature and is reflected as a Cumulative Effect of Accounting Change in the accompanying Consolidated Statements of Operations. Valuation of Long-Lived Assets As of the beginning of fiscal 2003 we adopted Statement of Financial Accounting Standards ("FAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". The adoption of this accounting standard did not have a material impact on our operating results and financial position. We assess potential impairments to our long-lived assets when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset may not be recovered. An impairment loss is recognized when the carrying amount of the long-lived asset is not recoverable and exceeds its fair value. The carrying amount of a long-lived asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. Any required impairment loss is measured as the amount by which the carrying amount of a long-lived asset exceeds its fair value and is recorded as a reduction in the carrying value of the related asset and a charge to operating results. During the fourth quarter of fiscal 2003 we performed an analysis on the potential impairment on certain tooling assets, and related patents and trademarks, approximating $1,711 which related to a potential new product. An additional $98 for patents and trademarks was added to this impairment charge as part of our restatement. See Note 2 to the Consolidated Financial Statements. Based upon our analysis, we concluded that the tooling assets were fully impaired as of September 30, 2003; this conclusion was based upon the held and used model which includes significant assumptions regarding future cash flows and utilizes a model of weighted probability cash flow projections over the estimated life of the product. Scrap value for these assets was determined to be nominal; accordingly a $1,711 impairment of this asset was recorded as of September 30, 2003, to write the assets down to their net realizable value. This product will not have any additional resources devoted to its refinement and completion, nor will the product be marketed or sold as an ongoing part of our product portfolio. As a result the impairment is not expected to have an impact on future revenue or net income. Different assumptions or different 19 weightings of the projected cash flows could significantly impact our conclusion concerning the impairment of such assets. Income Taxes In determining income (loss) for financial statement purposes, we must make certain estimates and judgments. These estimates and judgments occur in the calculation of certain tax liabilities and in the determination of the recoverability of certain of the deferred tax assets, which arise from temporary differences between the tax and financial statement recognition of revenue and expense. SFAS 109 also requires that the deferred tax assets be reduced by a valuation allowance, if based on the weight of available evidence, it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. In evaluating our ability to recover our deferred tax assets we consider all available positive and negative evidence including our past operating results, the existence of cumulative losses in the most recent three fiscal years, and our forecast of future taxable income. In determining future taxable income, we are responsible for assumptions utilized including the amount of state and federal pre-tax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates we are using to manage our business. Periodically and when indicators suggest we assess the realizability of our domestic deferred tax assets, giving consideration to our actual historical results supplemented by future expected results. SFAS No. 109, "Accounting for Income Taxes" considers a historic pattern of losses as significant negative evidence that tax assets will not be realized and this consideration is not outweighed by any prospective view of management that sufficient taxable income will ultimately be available to realize the tax benefits. Given the history of losses and the results in 2003, we concluded that under the "more likely than not" criteria of SFAS No. 109 a full valuation allowance is still required against the net U.S. deferred tax assets at September 30, 2003. The valuation allowance has been subject to periodic review and can be partially or totally reversed either when income is generated that utilizes the loss or when sufficient positive evidence emerges (i.e. A sustained positive trend of U.S. income for financial accounting purposes.) Our income tax expense recorded in the future will be reduced to the extent of offsetting decreases in our valuation allowance. Warranty Reserves Our policy is to record a provision for the expected cost of warranty-related claims at the time of the sale and adjust the provision to reflect actual experience quarterly. The amount of warranty liability accrued reflects management's best estimate of the expected future cost of honoring our obligations under the warranty plans. Historically, the cost of fulfilling our warranty obligations has principally involved replacements parts, labor and sometimes travel. Our estimates are based on historical experience, the number of units involved, and the extent of features/components included in product models. If future returns and warranty settlements do not reflect the historical data we use to calculate these estimates, additional allowances may be required. RESULTS OF OPERATIONS - 2003 COMPARED WITH 2002 PRODUCT SALES- Product sales, less returns and allowances, of $34,539 for the year ended September 30, 2003, were $2,574 or 6.9% lower when compared to the prior year sales of $37,113. The decrease in sales was primarily attributable to reduced international sales, largely 20 Asia, and the cessation of the National Advertising Campaign ("NAC"), offset by increased revenues in the Americas distributor network of $2,466. The largest decline in Asia was principally attributable to lower sales to Japan. Our Japanese importer has struggled all year to realign his inventory levels in anticipation of the launch of our 75th Anniversary Majestic(R) (our portable surface cleaner), which is currently planned to occur in Japan in fiscal 2004. The reduced sales to Japan also reflect Defender(R) (our portable room air cleaner) sales that were made in the prior year with the intent of selling them with the Majestic(R) as a system similar to how our products are marketed in the U.S.; however, this program was not as successful as anticipated, resulting in lower Defender(R) sales while the importer sells through this inventory. To assist Japan with their continued inventory realignment as well as the development and execution of training and sales programs, we created a new sales position within HMI that will provide experienced dedicated sales support to this region. The NAC, a thirty-minute television infomercial which began airing in July 2001, was designed to increase brand awareness, generate sales leads, and open new territories. In August 2002 we stopped broadcasting the infomercial as anticipated profits for this program were not being achieved, and the infomercial had exceeded the industry standard expected life cycle of twelve months. NAC sales accounted for $1,495 of total revenue in fiscal 2002. The increase in the Americas distribution network was due to the growth of several of our key master distributors who have grown their business through effective recruiting, retention, and the opening of new offices. Product sales after returns and allowances were not materially impacted by changing prices. DISTRIBUTOR DEVELOPMENT PROGRAM- The reduction to product sales associated with the Distributor Development Program for the year ended September 30, 2003 was $4,369 compared to $2,589 in fiscal 2002, a $1,780 increase. This increase was primarily a result of making the international market part of the Program during the first quarter of fiscal 2003 which accounts for approximately $1,350 of the $1,780 increase in sales reduction. See Note 2 to our Consolidated Financial Statements for a further discussion of the accounting pertaining to this program. GROSS MARGIN, EXCLUSIVE OF DISTRIBUTOR DEVELOPMENT PROGRAM- The gross margin, exclusive of distributor development program costs, for the year ended September 30, 2003, was $13,514 or 39.1% of sales as compared to $15,815 or 42.6% of sales in 2002, a decrease of $2,301. Approximately $1,256 of the decrease in gross margin was associated with the cessation of the NAC. The balance of the decrease was primarily the result of an unfavorable volume variance due to lower international sales, increased Defender(R) warranty costs of $167 largely associated with certain international markets that utilize peak demand electricity transmission and control systems, and an additional charge of $299 related to obsolete inventory associated with impaired tooling, of which the unfavorable international sales volume variance was the largest. SELLING, GENERAL, AND ADMINISTRATIVE ("SG&A")- SG&A expenses of $13,404 for the year ended September 30, 2003, were favorable to fiscal 2002 expenses of $14,591 by $1,187. The reduced level of expense was driven by the absence of advertising and administrative costs associated with our aforementioned NAC of approximately $2,334, costs associated with the Form 13D that was filed by a group led by our current Chairman, Kirk W. Foley, with the Securities and Exchange Commission in the prior year of $435, and reduced outside consulting expenses of $235. These decreases were partially offset by increased costs of $1,223 associated with the 21 training, development, and retention of our Americas and International networks as well as expenses approximating $871 associated with certain growth initiatives in the Americas division. LOSS ON IMPAIRMENT OF ASSET- During the fourth quarter of fiscal 2003, we performed an analysis on the potential impairment of certain tooling assets, and related patents and trademarks. We concluded from our analysis, which was based upon the held and used model that the tooling assets were fully impaired and accordingly recorded an impairment charge of $1,711 as of September 30, 2003, as the scrap value for these assets was determined to be nominal. LOSS ON LIQUIDATION OF SUBSIDIARY- During the second quarter of fiscal 2003, after reviewing possible future options for our Canadian subsidiary, we chose to liquidate the entity and therefore recorded a loss on disposal of $905 for cumulative translation adjustments associated with this subsidiary. INTEREST EXPENSE- Interest expense for fiscal year 2003 was $53 or $33 lower than the fiscal 2002 amount of $86 due primarily to lower interest expense associated with our line of credit whose balance was on average lower than the prior year. It was also impacted by reduced interest expense on our capital lease obligations which reflects lower outstanding balances compared to those in fiscal 2002. OTHER (INCOME) EXPENSE, NET- The increase of $502 in other (income) expense, net, from $344 of expense in fiscal 2002 to $158 of income for the year ended September 30, 2003, largely resulted from the absence of goodwill amortization associated with the adoption of SFAS No. 142 (see Note 1 to the Consolidated Financial Statements). INCOME TAXES- The effective income tax rate for the year ended September 30, 2003, was (0.3%) compared to (2.1%) in fiscal 2002. This difference was driven by pre-tax earnings as the tax expense recorded was not material in either year as a result of a full valuation allowance against our deferred tax assets. CUMULATIVE EFFECT OF ACCOUNTING CHANGE- On October 1, 2002, we adopted SFAS 142. Under SFAS 142, goodwill impairment is deemed to exist if the net book value of a reporting unit exceeds its estimated fair value. During the second quarter of fiscal 2003, we completed our initial impairment test as of October 1, 2002, and recorded a non-cash charge of $5,451 to fully eliminate the carrying value of our goodwill (See Note 1 to the Consolidated Financial Statements). There was no tax effect related to this item, as this charge is a permanent difference for income tax purposes. INFLATION AND PRICING- While inflation or changing prices have not had, and we do not expect them to have, a material impact upon operating results, there can be no assurances that our business will not be affected by inflation or changing prices in the future. RESULTS OF OPERATIONS - 2002 COMPARED WITH 2001 PRODUCT SALES- Product sales, less returns and allowances, of $37,113 for the year ended September 30, 2002, were $4,577 or 14.1% higher when compared to the prior year sales of $32,536. The increase in sales was primarily attributable to increased revenues in the Americas and Asia offset by decreased sales in Canada and Europe. The Americas, backed by a stronger distribution network and our National Advertising Campaign ("NAC"), was the largest contributor to this sales increase. The opening of additional offices by several key Distributors within our existing Americas' network, as well as the switch of Distributors from a competitor in the second quarter of fiscal 22 2001, led to increased Majestic(R) (portable floor care cleaner) and Defender(R) (portable air room cleaner) sales in the Americas. Further contributing to the Americas revenue growth were sales from the NAC and Health-Mor at Home(TM). The NAC, a thirty-minute infomercial which began airing in July 2001, was designed to increase brand awareness, generate sales leads, and open new territories. In August 2002, we stopped broadcasting the infomercial as anticipated profits for this program were not being met, and the infomercial had exceeded the industry standard expected life cycle of twelve months. Health-Mor at Home(TM) created in October 2001 is a direct to consumer outbound sales force designed to assist consumers in locations where Distributors are no longer located. Defender(R) sales to Japan and Korea drove the year-to-date Asian revenue increase. They were sold to Distributors that had the intention of selling the Majestic(R) and Defender(R) together as a system rather than as stand-alone products, similar to how the products are marketed in the United States. The lack of consumer financing options and Distributor development programs led to a decline in Canadian sales over the course of fiscal 2002. This decline prompted HMI and the Canadian Importer to meet with the key Distributors in that territory after which it was decided that the Canadian network would adopt the Americas Edge Success Program effective June 2002. "The Edge Success Program" (the "Edge"), developed to aid in the retention of Distributors and help with the development of their professional careers and independent businesses, is an innovative, highly structured multi-step program that provides business training from the earliest level of a new recruit to the most senior level of a Premier Master Distributor and provides incentives at each level to promote the development and retention of quality Distributors and sales associates. Business and management training includes a business management correspondence course and a training seminar, the Business Management Institute, designed in conjunction with Baldwin Wallace College in Ohio, and addresses everything from in-home demonstration techniques to generation of sales leads, personnel training, compliance matters, ownership and operation of a distributorship, and more. The sales decline in Europe was primarily due to lower sales to Portugal and Belgium of which Portugal was the largest. Due to the relocation of some of Portugal's best Distributors to Brazil and the closing of non-performing offices, the distribution network in Portugal was going through a period of reorganization. Product sales were not materially impacted by changing prices. DISTRIBUTOR DEVELOPMENT PROGRAM- The reduction to product sales associated with the Distributor Development Program for the year ended September 30, 2002 was $2,589 compared to $1,009 in fiscal 2001, a $1,580 increase. Increased sales volume in the U.S. distribution network accounted for approximately $5,474 of the higher sales reduction, offset by $2,359 in termination gains resulting from the high routine turnover of sales associates found in the vacuum cleaner direct selling business. See Note 2 to our Consolidated Financial Statements for a further discussion of the accounting pertaining to this program. GROSS MARGIN, EXCLUSIVE OF DISTRIBUTOR DEVELOPMENT PROGRAM- The gross margin, exclusive of distributor development program costs, for the year ended September 30, 2002, was $15,815 or 42.6% of sales as compared to $13,166 or 40.5% of sales in 2001. This increase in the gross margin of $2,649 was principally attributable to the higher sales volume and improved product mix, in part driven by a higher proportion of Defender(R) versus Majestic(R) sales, over the prior 23 year, partially offset by unfavorable plant spending largely associated with increased salaries and depreciation. SELLING, GENERAL, AND ADMINISTRATIVE- SG&A expenses for the year ended September 30, 2002, of $14,591 were unfavorable to the fiscal 2001 expenses of $13,306 by $1,285. The increase in SG&A expenses was largely attributable to the $1,382 of expenses associated with our aforementioned NAC initiative and non-recurring expenses of $435 relating to the Schedule 13D that was filed with the Securities Exchange Commission on October 19, 2001, and later amended on December 24, 2001. Increased sales commissions and certain accrued benefit expenses, which followed the increased level of sales and earnings, also impacted it. Offsetting these increases were reduced professional fees of $346 relating to non-recurring expenses, incurred during fiscal 2001 associated with the evaluation of potential growth opportunities, as well as the costs associated with certain career development programs and activities and reduced outside consulting. INTEREST EXPENSE- Interest expense for fiscal year 2002 and 2001 was $86 and is primarily associated with interest from our credit facility. OTHER EXPENSE (INCOME)- The increase in other expense (income), net, from $186 in fiscal 2001 to $344 for the year ended September 30, 2002, primarily resulted from a franchise tax refund received in 2001 from a former legally dissolved subsidiary as well as a decrease of other income associated with the cessation of the financing of end user purchase contracts by HMI. INCOME TAXES- The effective income tax rate for the year ended September 30, 2002, was (2.1%) compared to (258.4%) in fiscal 2001. This difference was driven by the recording, in 2001, of a full valuation allowances against the deferred tax assets. In addition, the prior year provision was also impacted by IRS audits and settlements that were not required in the current year tax provision. The effective rate for fiscal 2001 was primarily attributable to the reversal of income tax reserves and the recording, during the second fiscal quarter of 2001, of full valuation allowances against the deferred tax assets. During the second quarter of fiscal 2001, the Internal Revenue Service informed us that examinations for fiscal years 1994 through 1997 were completed. As the examinations resulted in minimal impact to the financial statements, we recorded a benefit of $445 for the reversal of income tax reserves associated with these fiscal tax years. The effective rate absent the reversal of these income tax reserves would have been (289.7%). The valuation allowance in 2001 increased from $849 to $7,496 due to the recording of full allowances against domestic net deferred tax assets in addition to the allowance previously set up for Canadian deferred tax assets. Periodically, and when indicators suggest, we assess the realizability of our domestic deferred tax assets, giving consideration to our actual historical results supplemented by future expected results. SFAS No. 109, "Accounting for Income Taxes" considers a historic pattern of losses as significant negative evidence that tax assets will not be realized and this consideration is not outweighed by any prospective view of management that sufficient taxable income will ultimately be available to realize the tax benefits. Given the three years of cumulative losses including the results in 2001, our retained deficit and a market capitalization that is less than our book value, we concluded that under the "more likely than not" criteria of SFAS No. 109 a full valuation allowance was required against the net U.S. deferred tax assets at September 30, 2001. The valuation allowance will be subject to periodic review and can be partially or totally reversed either when income is generated that utilizes the loss or when sufficient positive evidence emerges (i.e. a sustained positive trend of U.S. income for financial 24 accounting purposes.) Our income tax expense recorded in the future will be reduced to the extent of offsetting decreases in our valuation allowance. LIQUIDITY AND CAPITAL RESOURCES OPERATING ACTIVITIES- Cash flows from operating activities provided net cash of $954 for the year ended September 30, 2003, which reflects a net loss of $12,239 offset by non-cash charges of $12,783 and an increase in operating assets and liabilities of $410. Non-cash charges consist primarily of $5,451 related to the cumulative effect of accounting change from our adoption of SFAS 142, $3,969 resulting from the new accounting associated with our distributor development program, $1,711 associated with the impairment of certain tools and molds, $905 associated with the loss on the liquidation of our Canadian subsidiary, and $744 in depreciation and amortization expense. The increase in operating assets and liabilities principally relates to increases in accrued expenses and other liabilities of $536 associated with sales contests and other distributor programs, the distributor development program liability of $200 related to the short term amount to be paid in fiscal 2004 to our first Edge Program achiever, and accounts payable of $186. Offsetting the increase in liabilities was a $518 increase in inventories. Both finished goods and raw materials were driving factors in the increase in inventories. Increases in safety stock, primarily demonstration supplies, and lower than anticipated sales in our international markets accounted for the increase in finished goods. Lower international sales in our third and fourth quarters as well as the purchase of printed materials for the international promotion of our Edge Success Program lead to increased raw materials. This increase was offset by a $300 increase in the obsolescence reserve for raw materials associated with impaired tooling assets. INVESTING ACTIVITIES- Capital expenditures of $176 represent the entire net cash used in investing activities for the year ended September 30, 2003. These expenditures mainly relate to tooling associated with new products, office furniture, and new office computer hardware. FINANCING ACTIVITIES- Net cash used in financing activities was $311, which included $302 for payment of long-term debt and $9 for net repayments under the credit facility. Our $3,000 credit facility agreement includes various covenants that limit our ability to incur additional indebtedness, restricts paying dividends and limits capital expenditures, and requires we maintain a minimum net worth. As of September 30, 2003, we were not in compliance with our interest coverage ratio, and net worth covenants; however, we obtained a waiver on these covenants which was effective until the February 20, 2004 amendment of the credit facility. We were required to maintain an interest coverage ratio of greater than or equal to 5.0 to 1.0 interest to earnings before interest, taxes, depreciation and amortization ("EBITDA") and a net worth of at least $7,400, calculated quarterly and increasing by 50% of net income annually. 25 On February 20, 2004, an amendment of our credit facility agreement was executed with our lender. The expiration date was extended to October 15, 2004. The amended agreement carried the same interest rate and similar covenants as the previous amended loan agreement, with the exception of the interest coverage ratio which was amended to exclude non-cash expenses from the 5.0 to 1.0 ratio, including but not limited to, the impairment of tooling assets and associated inventory, and the tangible net worth covenant in which the minimum amount was reset to $2,400. The cumulative effect of the adjustments on our statement of operations associated with the restatement of our financial statements was a $12,010 reduction in our net earnings over the period from January 1, 2001 through September 30, 2003. Such an earnings reduction caused us to be in default of our $2,400 tangible net worth covenant. In addition we have violated our financial reporting requirements to the bank as the restatement process has delayed any subsequent filings of our public statements with the Securities and Exchange Commission since our first fiscal quarter of 2003. Our credit agreement covenants require that our statements be filed quarterly with the bank within 45 days of the end of each quarter. On October 15, 2004, an amendment of our $3,000 credit facility agreement was executed with our lender. The bank has agreed to extend the maturity date of the loan until December 31, 2004. In addition the bank provided a waiver for the aforementioned covenant and financial reporting violations. The amended agreement carries an interest rate of prime plus one percent and covenants similar to the previous amended loan agreement, with the exception of the tangible net worth covenant which was eliminated through the maturity date of the loan. We are actively seeking finance sources to replace the credit facility prior to its expiration. If we cannot replace the credit facility prior to December 31, 2004, we currently anticipate that we will have sufficient liquidity to repay the credit facility and cover all our cash needs through March 31, 2005. As of September 30, 2004, there was $962 borrowed on the $3,000 credit facility. CASH OBLIGATIONS- Set forth below, in tabular form, is information as of September 30, 2003, for the periods indicated concerning our obligations and commitments to make future payments under long-term obligations:
Total 2004 2005 2006 2007 2008 ----- ---- ---- ---- ---- ---- Line of credit $1,383 $1,383 $ - $ - $ - $ - Long-term debt 33 22 11 - - - Operating leases 1,176 859 267 43 4 3 Earned distributor development program awards 800 200 200 200 200 - Distributor development awards earned subsequent to fiscal 2003 1,000 200 200 200 200 200 ------ ------ ---- ---- ---- ---- Total $4,392 $2,664 $678 $443 $404 $203 ====== ====== ==== ==== ==== ====
Our line of credit is solely related to our credit facility as described above. Long-term debt of $33 consists entirely of capital leases for certain plant equipment which will be fully paid by 26 March 2005. Rent associated with our manufacturing and corporate office buildings as well as monthly obligations for various office equipment, primarily a phone system and copiers, largely comprise our operating leases. These leases expire on various dates through 2008. ACCRUED DISTRIBUTOR DEVELOPMENT LIABILITIES Pursuant to EITF 01-9 "Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor's Products)" we changed the way we account for the potential one million dollar award for the Edge Success Program ("Program"). Prior to the adoption of EITF 01-9, we utilized the services of an independent actuary who developed a model based on our historical sales and other factors that identified the probability of distributors reaching the goal (in aggregate) thereby triggering our cash payment obligation. We recognized expense and recorded a liability based on that model. The original intentions of the Program were to aid the Master Distributors in their retirement/succession plan, and promote growth and retention within the new Distributor network. Because of these original intentions and the long-term nature of this Program, management did not, in 2001, consider the implications of EITF 01-9 (which deals with several aspects of revenue recognition when awards or refunds are paid to customers) to the Program and therefore EITF 01-9 was not adopted at that time. However, as we recently became aware of the implications of EITF 01-9 to us, it was determined that EITF 01-9 should have been adopted in 2001 as required. This conclusion was based on the fact that because HMI is selling to distributors, any monetary amounts that are paid to the distributors, pursuant to a program that is geared to volume of sales falls within EITF 01-9. EITF 01-9 states that any such amounts accrued must be reflected in the income statement as a reduction of sales rather than selling expense. Prior to adoption, we had been recognizing the expense associated with this obligation as a selling expense. It also sets out the standard that a liability should be recognized based on a systematic and rational allocation of the cost of honoring rebates or refunds earned and claimed to each of the underlying revenue transactions that result in progress by the customer toward earning the rebate or refund. Breakage (the amount of distributors who will not reach the goal) should be estimated only if it can be reasonably estimated. EITF 01-9 indicates that the ability to make a reasonable estimate depends on many factors. Certain factors (such as a relatively long period in which a particular rebate or refund may be claimed, as is in the case of our Program) may indicate that the liability cannot be reasonably estimated. Related guidance states that if recurring variances between the actual and estimated amount of refunds are immaterial to either revenue or net income in quarterly or annual financial statements then the item is considered reasonably estimable. Over eleven quarters ended September 30, 2003 to which EITF 01-9 applies, our average actuarial gain (loss) may or may not be deemed material; however, on an individual quarter-by-quarter basis the significant volatility of the actuarial gains/loss to pre-tax income was deemed material to our financial results. Therefore we concluded breakage from that perspective may not be reasonably estimated and we could not use our actuarial method. This results in our recording a liability related to every qualifying sale and only derecognizing such liability (i.e. the accrual is eliminated) when (i) the award is paid out or (ii) when a distributor is no longer eligible for the award. The application of EITF 01-9 requires a $12,958 accrual at September 30, 2003, to reflect the future obligation associated with the Program since the effective adoption of EITF 01-9. This amount was determined by multiplying the percentage 27 of attainment of the 30,000 unit goal for every eligible distributor by the present value of five payments of $200,000, discounted at a risk adjusted interest rate. We have been operating with a distributor network for over seventy years and we implemented the Program in 1997. During those periods we have closely monitored the distributor network and the turnover rate in the network. Based on that accumulated knowledge, we believe that application of EITF 01-9, which requires accruing on each sale as if every distributor involved with the sale was going to earn the $1 million award, results in the recognition of an obligation we believe will be significantly in excess of the payouts from the Program for the foreseeable future. This is due to the assumption inherent in the maximum accrual calculation that every distributor involved with a sale will qualify to earn the award. Our history shows this not to be the case. During the twelve quarters ended September 30, 2003, our turnover rate was, on average, more than 50%. For example, the participants in the Program from the Americas network who left the Program during the twelve months ended September 30, 2003 represented an accrual of over $2,000 and that period was not a period of extraordinary turnover. Because we measure the accrual quarterly, departures may cause quarterly results to vary greatly. In addition, the criteria for derecognizing the accrual for any distributor requires that the distributor has lost eligibility to participate in the Program. We have been funding the actuarially determined present value of total award payouts calculated on an aggregate basis under this program since September 2000 and such fund had a balance of $946 as of September 30, 2003. It is our intention to continue to fund the projected stream of cash payouts subject to our cash flow model based on our aggregate actuarial model, which will continue to be updated annually by our independent actuaries based on our experience. These funds are maintained in a short term investment account and recorded as cash and cash equivalents in our Consolidated Balance Sheets. FUTURE ACCOUNTING REQUIREMENTS FASB Interpretation No. 46, Consideration of Variable Interest Entities (FIN No. 46): This statement was issued in January 2003 and requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The provisions of FIN 46 are effective immediately for all arrangements entered into after January 31, 2003. For those arrangements entered into prior to February 1, 2003, we are required to adopt the provisions of FIN No. 46 at the end of the first quarter of fiscal 2004, in accordance with the FASB Staff Position 46-R which delayed the effective date of FIN No. 46 for those arrangements. We are in the process of determining the effect, if any, the adoption of FIN No. 46-R will have on our financial statements. SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (SFAS No. 150): This statement, issued in May 2003, establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. SFAS No. 150 has been deferred indefinitely related to certain measurement and disclosure components of the standard; however, certain disclosure provisions are still required if applicable to us. The final adoption of SFAS 28 No. 150 is not expected to have a significant impact, if any, on our financial statements; however, a formal assessment will be performed. CAUTIONARY STATEMENT FOR "SAFE HARBOR" PURPOSES UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 This report, including Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of the federal securities laws. As a general matter, forward-looking statements are those focused upon future plans, objectives, or performance as opposed to historical items and include statements of anticipated events or trends and expectations and beliefs relating to matters not historical in nature, including by way of example, but not limited to, the statements made in "Net Product Sales" regarding our ability to influence the Japan network through training and development programs and "Liquidity" regarding anticipated cash requirements and the adequacy of our current ability to meet those requirements. Such forward-looking statements are subject to uncertainties such as difficulty in protecting our intellectual property rights in a particular foreign jurisdiction; dependency on key personnel and the ability to retain them; recessions in economies where we sell our products; longer payment cycles for and greater difficulties collecting accounts receivable; export controls, tariffs and other trade protection measures; social, economic and political instability; changes in United States and foreign countries laws and policies affecting trade; anticipated sales trends; the ability to attract and retain Distributors and Importers; improved lead generation and recruiting; and the ability to obtain financing for the end consumer through consumer financing companies, including VCL. Such uncertainties are difficult to predict and could cause our actual results of operation to differ materially from those matters expressed or implied by such forward-looking statements. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (DOLLARS IN THOUSANDS) Our exposure to interest rate risk is related to our borrowings. Fixed rate borrowings may have their fair market value adversely impacted from changes in interest rates. Variable rate borrowings will lead to additional interest expense if interest rates increase. As of September 30, 2003, we had $1,383 outstanding under our credit facility bearing interest at the prime rate. If interest rates were to increase 50 basis points (0.5%) from the September 30, 2003, rates and assuming no changes in outstanding debt levels from the September 30, 2003, levels, we would realize an increase in our annual interest expense of approximately $7. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Reference is made to the Index to Financial Statements included in this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 9A. CONTROLS AND PROCEDURES (A) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES As a result of questions from the Division of Corporation Finance of the Securities and Exchange Commission ("SEC"), we decided to restate our previously issued financial statements. In preparation of our response to the SEC, our Principal Executive Officer and Chief Financial Officer, after conducting an evaluation, together with other members of our senior management, 29 conducted a re-evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. As a result of that re-evaluation, we have concluded that our disclosure controls and procedures (as defined in Exchange Act Rule 13a-14 (c)) were not effective to ensure that information required to be disclosed by us in our reports filed or submitted under the Securities Exchange Act of 1934 (the "Exchange Act') were recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the SEC. Specifically, our disclosure controls and procedures were found to be ineffective in identifying the proper accounting treatment for recording reductions in sales, resulting from credits earned by our distributors toward payment under the Program. With respect to these reductions, we were not aware of the provisions of EITF 01-9 that required recognition of such credits for payments to our distributors as reduction of sales. In addition, as originally recorded prior to the effective implementation of EITF 01-9, we believed such charges were reasonably estimable, and accordingly, had not recorded the maximum liability. Primarily in response to the matters identified as restatement adjustments resulting from the adoption of EITF 01-9, management has taken significant steps to strengthen control processes and procedures in order to identify and rectify past accounting errors and prevent the recurrence of the circumstances that resulted in the need to restate prior period financial statements. In 2004, we corrected the identified weaknesses in our disclosure controls and procedures that led to the above errors by taking the following steps, among others: - Creation of a position within the Finance department with a prime responsibility being the ongoing research and analysis of all new accounting pronouncements and their implications to our Company. The analysis of the new pronouncements will be reviewed with the Chief Financial Officer, Corporate Controller and outside accountants to assess their applicability to the financial statements and disclosure requirements necessary to meet the requirements of the SEC and generally accepted accounting principles. - Quarterly, our disclosure committee, which includes a cross functional team of senior personnel from the legal and finance areas, meets to review SEC periodic filings for adequacy of disclosure and communicates material findings to the executive management. To complement this committee, we have instituted enhanced processes with our new independent accountants to better ensure that all levels of recently issued Generally Accepted Accounting Principles, including new EITF's, are communicated to finance management so that their applicability to our financial disclosure and related statements can be timely evaluated. There can be no assurances; however, that new problems will not be found in the future. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within HMI have been detected. Subsequent to the end of the period covered by this report, after the need for a restatement of our previously issued financial statements was determined, an evaluation was performed of the effectiveness of the design and operation of our disclosure controls and procedures by senior management. Based on that evaluation, our management, including the Principal Executive Officer and Chief Financial Officer, concluded that these procedures and controls are effective, given the cautions stated above. 30 (B) CHANGES IN INTERNAL CONTROLS Since the end of the period covered by this report, we have made the changes in our internal controls described above. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their last evaluation. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT DIRECTORS Robert Breadner, age 48, is a private investor. He was President and Chief Executive Officer of Breadner Trailer Sales Ltd., a distributor of transport trailers for the trucking industry, for over five years until the sale of the company in 2001. Kirk W. Foley, age 61, became a director in 2002 and Chairman of the Board in 2004. Mr. Foley has been the Chairman and Chief Executive Officer of Tube Fab Ltd., a company that shapes, bends, and machines metal tubing since 1997. From 1989 to 1997 Mr. Foley served as Chairman or President and as Chief Executive Officer of the Company. He also served as a director of the Company from 1988 to 1997. He is the father of Wesley Eric Foley, a director of HMI. Wesley Eric Foley, age 34, became a director in 2003. He has been director of sales and marketing for Tube Fab Ltd., a company that shapes, bends, and machines metal tubing since 2000. From 1993 to 2000 he held several international sales and marketing positions with the Company. He is the son of Kirk W. Foley, Chairman of the Board and a director of HMI. John A. Pryor, age 60, became a director in 2001. He has served as President and Chief Operating Officer of the Company since 2001. From 1996 to 2000 he was President and Chief Executive Officer of Valley Innovative Services, a food services management company. From 1992 to 2001, he was President of Pryor and Associates, which provides consulting services to the food service industry. Murray Walker, age 54, became a director in 1998. He has been President of Isetan Management Ltd., a private investment company, since 1988. He has been Chairman of Simcoe Coach Lines Ltd., a school and charter bus service company, since 2001 and served as President of Simcoe from 1989 to 2001. Ivan J. Winfield, age 69, became a director in 1995. He is an independent business and financial consultant and since 1995 also has been an Associate Professor at Baldwin-Wallace College in Berea, Ohio. Mr. Winfield was a partner of Coopers & Lybrand, a predecessor firm to PricewaterhouseCoopers (the Company's auditors) from 1970 to 1994. Mr. Winfield is a director of Boykin Lodging Company. 31 EXECUTIVE OFFICERS Name Age Position and Terms of Service as Officer - ------------------ --- -------------------------------------------------- Kirk W. Foley 61 Chairman (1) John A. Pryor 60 President and Chief Operating Officer (2) Julie A. McGraw 39 Vice President, Chief Financial Officer, Treasurer and Assistant Secretary (3) Joseph Najm 45 Vice President-Operations (4) Daniel J. Duggan 43 Vice President (5) Darrell Weeter 47 Vice President (6) John S. Meany, Jr. 57 Vice President and Secretary (7) 1) Mr. Foley was elected Chairman in 2004. He also serves as Chairman and Chief Executive Officer of Tube Fab Ltd., a company that shapes, bends, and machines metal tubing since 1997. 2) Mr. Pryor was elected President and Chief Operating Officer in 2001. From 1992 to 2001 he was President of Pryor & Associates, which provided consulting services to the food service industry. From 1996 to 2000 he was President and Chief Executive Officer of Valley Innovative Services, a food services management company. 3) Ms. McGraw was elected Chief Financial Officer and Treasurer in 2000 and Vice President in 1999. She served as Corporate Controller from 1998 to 2001 and as Assistant Corporate Controller from 1996 until 1998. 4) Mr. Najm was elected Vice President-Operations in March 1999. He previously was employed by the Kirby Company as Vice President-Manufacturing from 1995 to 1999. The Kirby Company is a manufacturer of vacuum cleaners. 5) Mr. Duggan has served in various executive capacities with the Company since 1990. He was elected Vice President in 2001 and has served as President of the International Sales Division since 2002. From 1997 to 2002 he was President of the Asia-Pacific Sales Division. 6) Mr. Weeter was elected Vice President in 2001. He has also served as President of the Americas Sales Division since 2000 and was Vice President of the Americas Sales Division from 1998 to 2000. He has also served as President of FVS Inc., a Distributor of products manufactured by the Company, since 1985. (See Item 13 "Certain Relationships and Related Transactions") 7) Mr. Meany was elected Vice President in March 2002 and also has served as Corporate Secretary since 1995. He was an attorney in private practice from 1991 to 2002. 32 AUDIT COMMITTEE FINANCIAL EXPERT The Board of Directors has determined that one of the Audit Committee members, Ivan J. Winfield, is a "financial expert" as defined in Regulation S-K 401(h) adopted under the Securities Exchange Act of 1934, as amended and deemed "independent" in accordance with that term used in Item 7(d)(3)(iv) of Schedule 14A under the Exchange Act, based upon the definition of independence contained in Rule 4200(a)(15) of the listing standards of the National Association of Securities Dealers IDENTIFICATION OF THE AUDIT COMMITTEE Two members of our Board of Directors, Mr. Murray Walker and Mr. Ivan Winfield, currently serve on our Audit Committee established in accordance with Section 3 (a)(58)(A) of the Exchange Act. A third member resigned from the Audit Committee effective February 3, 2004. COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT Section 16(a) of the Exchange Act requires that our directors, officers, and owners of more than 10% of our common stock file reports of ownership and changes in ownership of our securities with the Securities and Exchange Commission and to furnish us with a copy of all such reports that they file. Specific due dates have been established and we are required to disclose any failure to file the reports by the due dates. Based solely on a review of its files, we believe that all of our directors, executive officers, and 10% shareholders complied with all filing requirements applicable to them with respect to transactions occurring during the fiscal year ended September 30, 2003. CODE OF ETHICS We have adopted a code of ethics for all our employees including our senior financial officers that comprise the Principal Executive Officer, the Chief Financial Officer, and other members of our financial leadership team. This Code of Ethics has been provided as an exhibit to this report (Exhibit 14). This Code of Ethics is also available on our website at www.filterqueen.com. We intend to satisfy the disclosure requirement regarding any amendment to, or a waiver of, a provision of our Code of Ethics by posting such information on our website. 33 ITEM 11. EXECUTIVE COMPENSATION (NOT IN THOUSANDS) SUMMARY COMPENSATION TABLE
Long Term All Other Annual Compensation Compensation Awards (4) Compensation ----------------------------------------- ---------------------- ------------ Other Annual Compensation Restricted Stock Name and Principal Position Year Salary (1) Bonus (2) ($) (3) Stock ($) Options (#) (5) --------------------------- ---- ---------- ------------ ------------ ---------- --------------- John A. Pryor (9) 2003 $ 240,254 $ 51,639 - - - $ 6,591 (10) President 2002 $ 227,559 $ 79,174 - - - $ 5,784 (10) 2001 $ 13,641 - - - 150,000 $ 1,608 (10) Joseph L. Najm(11) 2003 $ 149,368 $ 26,197 - - - $ 4,226 (10) Vice President-Operations 2002 $ 143,825 $ 56,846 - - - $ 4,096 (10) 2001 $ 132,392 - - - 50,000 $ 3,780 (10) Darrell Weeter (12) 2003 $ 488,087 - - - - $ 5,185 (10) Vice President; President, 2002 $ 411,715 $ 16,729 - - - $ 5,409 (10) Americas Sales Division 2001 $ 317,505 $ 11,667 - - 40,000 $ 5,250 (10) Daniel J. Duggan (13) 2003 $ 365,087 - - - - $ 4,800 (10) Vice President; President, 2002 $ 312,569 $ 16,729 - - - $ 4,053 (10) International Sales Division 2001 $ 226,606 - - - 40,000 $ 3,603 (10) James R. Malone (6) 2003 $ 209,661 $ 44,685 $ 59,320 - - $30,742 (7) Chairman and Chief 2002 $ 211,711 $ 73,650 $ 60,020 - - $28,300 (8) Executive Officer 2001 $ 343,986 - $ 70,597 - 100,000 $28,300 (8)
(1) Salary amounts include automobile expense and for Mr. Weeter and Mr. Duggan commissions on sales in their geographic areas of responsibility. (2) Amounts paid were pursuant to our management incentive bonus plan. Beginning in 2002, participants in our incentive bonus plan may elect to receive a portion of the bonus in common stock of our Company. Mr. Malone and Mr. Pryor were the only named executive officers to make this election in 2002. No named executive officers made this election in 2003. (3) No executive officer received perquisites or other benefits required to be disclosed under applicable regulations except for James R. Malone. He received a total of $50,000 to be spent in his discretion on such perquisites and benefits as he desired. The amount for 2001, 2002, and 2003 also includes additional amounts for payment of taxes on certain perquisites. (4) We maintain plans under which stock options may be awarded. We do not, however, make "long term compensation awards" as that term is used in applicable SEC rules because the amount of our incentive awards is not measured by our performance over longer than a one-year period. 34 (5) Reflects the number of shares of our common stock covered by stock options granted during the year. No stock appreciation rights ("SAR"), either in conjunction with or separate from stock options, were granted to the named executives during the years shown. (6) Mr. Malone was elected as our Chairman in 1996 and Chief Executive Officer in 1997. Mr. Malone resigned as Chairman and Chief Executive Officer effective February 2, 2004. (7) Includes life insurance premium ($28,300) and the cost of an executive physical examination ($2,442). (8) Life insurance premium. (9) Mr. Pryor has served as President since 2001. From 1992 to 2001 he was President of Pryor & Associates, which provided consulting services to the food service industry. From 1996 to 2000 he was President and Chief Executive Officer of Valley Innovative Services, a food services management company. (10) Matching contribution to our Salary Deferral Plan. (11) Mr. Najm was elected Vice President-Operations in March 1999. From 1995 to 1999 he served as Vice President-Manufacturing of The Kirby Company, a vacuum cleaner manufacturer. (12) Mr. Weeter was elected Vice President in 2001. He has also served as President of the Americas Sales Division since 2000 and was Vice President of the Americas Sales Division from 1998 to 2000. He has also served as President of FVS Inc., a Distributor of products manufactured by the Company, since 1985. (13) Mr. Duggan has served in various executive capacities with us since 1990. He was elected Vice President in 2001 and has served as President of the International Sales Division since 2002. From 1997 to 2002 he was President of the Asia-Pacific Sales Division. OPTION GRANTS There were no options granted to any of the named executive officers in 2003. 35 AGGREGATED OPTION EXERCISES AND FISCAL YEAR END OPTION TABLE The following table sets forth information regarding stock options held at the end of the fiscal year by the named executive officers. There were no stock option exercises in 2003 by any named executive officer.
NUMBER OF SHARES OF COMMON STOCK UNDERLYING VALUE OF UNEXERCISED UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS AT SEPTEMBER 30, 2003 (1) SEPTEMBER 30, 2003 (2) ---------------------- ---------------------- NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ---- ----------- ------------- ----------- ------------- John A. Pryor 100,000 50,000 $0 $0 Joseph L. Najm 43,333 16,667 $0 $0 Darrell Weeter 64,166 13,334 $0 $0 Daniel Duggan 86,666 13,334 $0 $0 James R. Malone 343,332 58,334 $0 $0
1) There were no SARs outstanding at September 30, 2003, and none were granted during the year. 2) The "value of unexercised in-the-money options at September 30, 2003" was calculated by determining the difference between the fair market value of the underlying shares of common stock at September 30, 2003, ($.81 per share) and the exercise price of the option. An option is "in-the-money" when the fair market value of the underlying shares of common stock exceeds the exercise price of the option. None of the options held by the named executive officers were "in-the-money" on September 30, 2003. COMPENSATION OF DIRECTORS A director who is an employee of ours is not separately compensated for service as a director. Each non-employee director receives a retainer of $20,000 per year, payable quarterly. Each non-employee director also receives $1,000 per meeting for each committee meeting attended and for each Special Board of Directors meeting attended. Members of the Audit Committee receive an additional retainer of $5,000 per year and a meeting fee of $1,500 for each Audit Committee meeting attended. Pursuant to our Omnibus Long-Term Compensation Plan, on the first business day of each calendar year each non-employee director automatically receives an option to purchase 6,000 shares of our common stock (as adjusted for stock splits). EMPLOYMENT CONTRACTS, TERMINATION OF EMPLOYMENT AND CHANGE IN CONTROL ARRANGEMENTS We have employment agreements with each of the named executive officers, except our former Chairman, under which they are to receive one year's salary in the event of termination of employment without cause. Certain of our executives also have agreements which provide that in the event of termination of employment without cause (other than for death or disability or voluntary termination by the employee) in the twelve months following a change in control (as defined in the agreement); the executives are to receive compensation equal to one years' base salary. 36 COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION During 2003, Kirk W. Foley was on the Compensation Committee. Mr. Foley previously served as our Chief Executive Officer from 1989 to 1997. In 2002, we agreed to reimburse Mr. Foley in the amount of $80,000 for a portion of the legal expenses incurred in his capacity as Designated Agent in connection with a Stockholders' Voting Agreement (and related filing of Schedule 13D) (the "Agreement") entered into by several stockholders pursuant to which Mr. Foley was given an irrevocable proxy to vote their shares on all matters to come before stockholders for a vote, including any vote relating to a sale or merger of the Company or the purchase or sale of assets by the Company. The Agreement also restricts the ability of the participating shareholders from selling or transferring their shares other than in accordance with the Agreement. The Agreement is valid until October 19, 2004, unless terminated sooner in accordance with the terms of the Agreement. BOARD COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION The Compensation Committee of the Board of Directors is responsible for recommending to the Board of Directors the compensation of our executive officers and key employees. The Compensation Committee periodically reviews compensation of the Chief Executive Officer, other of our executive officers, and key employees. The Compensation Committee also monitors performance and fixes awards based on performance standards. The Committee's policy in evaluating and compensating executive officers and key employees is to consider our performance as a whole and the individual's contribution toward our attainment of our established and individual goals. The composition of compensation varies broadly among our executive officers and key employees based on their responsibilities. Generally, base salary is targeted at competitive rates believed by the Committee members to be necessary in their experience to retain qualified personnel. We maintain an Incentive Bonus Plan under which participating employees may be eligible for a bonus if we meet certain financial targets. For 2003, maximum bonus payable to an individual was a percentage of base salary ranging from 10% to 60% with both quarterly and annual targets. Bonuses were based on our sales (25% of the bonus) and on our earnings before interest, taxes, depreciation, and amortization (EBITDA) (75% of the bonus). Participants could elect to take part of their bonus in our common stock. From time to time, we engage outside compensation consultants to provide information and advice about competitive levels of compensation and particular compensation techniques. Compensation of the Chief Executive Officer Mr. Malone's base salary in 2003 was set by the Compensation Committee at $200,000 per year, an amount which the Committee believed was competitive with other consumer goods companies of similar size and taking into account Mr. Malone's reduced involvement with us while he retained his titles of Chairman and Chief Executive Officer. Mr. Malone received other benefits available generally to all executives and was also given a total of $50,000 to be spent in his discretion for other benefits. Mr. Malone participated in the Incentive Bonus Plan for management employees at a maximum bonus rate of 60% of salary. His bonus for 2003 was $44,685, or 37% of his maximum bonus. We also paid a life insurance premium for Mr. Malone and an additional amount to cover income taxes due on such benefits provided to him. 37 On February 2, 2004, the Board of Directors accepted the resignation of Mr. Malone. Consequently, compensation expense approximating $200,000 will be recorded in the second quarter of fiscal 2004 in accordance with Mr. Malone's provisions of resignation. For the Compensation Committee Ivan J. Winfield Kirk W. Foley PERFORMANCE GRAPH The following chart compares the cumulative shareholder return of our stock for the five years ended September 30, 2003, to the NASDAQ National Market Composite Index and a peer group of companies that we selected. There are two peer groups shown due to a change in the companies that make up the peer group. One company that was in the previous year's peer group was sold, so two other companies were added for this year's peer group. Our common stock is traded on the OTC Bulletin Board. The chart assumes the investment of $100 on September 30, 1998, and the immediate reinvestment of all dividends. [PERFORMANCE GRAPH]
1998 1999 2000 2001 2002 2003 ------- ------- ------- ------- ------- ------- HMI Industries Inc. $100.00 $100.00 $ 64.29 $ 65.71 $ 29.14 $ 46.29 New Peer Group $100.00 $117.99 $ 89.74 $ 71.72 $ 91.72 $122.81 Old Peer Group $100.00 $213.87 $172.14 $117.25 $104.14 $123.85 NASDAQ Market Index $100.00 $163.15 $216.67 $ 88.55 $ 69.59 $106.64
The new peer group companies, which are in similar lines of business as us, are AB Electrolux, Applica Incorporated, Maytag Corporation, National Presto Industries, Inc. and Salton, Inc. Last year's peer group did not include Electrolux and Maytag. Royal Appliance Mfg. Co., which was sold earlier this year, was in last year's peer group. Some of our direct competitors are divisions of larger corporations, privately held corporations or foreign corporations and are not included in the peer comparisons since the pertinent information is not available to the public. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (NOT IN THOUSANDS) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS The following table sets forth the names and share ownership as of January 31, 2004, of those persons who, to our knowledge, are the beneficial owners of more than 5% of our outstanding common stock based upon information furnished to us by such person or through a Schedule 13D, 13G or Form 4. Each beneficial owner has sole power to vote and dispose of the shares indicated, except as otherwise stated. 38
Name & Address of Beneficial Owners as of Number of Shares % of Common September 30, 2003 Beneficially Owned Stock - ----------------------------------------------- ------------------ ----------- Barry L. Needler 1,860,000(1)(2) 27.57% P.O. Box 2463, Station B Richmond Hill, Ontario L4E 1A5 Steeplechase Corp. (3) 1,709,250 25.34% P.O. Box 2463, Station B Richmond Hill, Ontario L4E 1A5 Kirk. W. Foley 2,894,044(4) 42.90% 2045 Lakeshore Blvd., #3507 Toronto, Ontario M8V 2Z6 Amherst Tanti U.S. Inc. (5) 520,148 7.71% 2045 Lakeshore Blvd., #3507 Toronto, Ontario M8V 2Z6 James R. Malone 621,738(6) 8.77% 5150 N. Tamiami Trail Suite 600 Naples, FL 34103 U.S. Bancorp 546,015(7) 8.09% 800 Nicollet Mall Minneapolis, MN 55402 John S. Meany, Jr. 528,479(8) 7.83% 9200 S. Winchester Ave. Chicago, Illinois 60620 Robert J. Williams 466,937 6.92% 50 Midtown Park East Mobile, AL 36606 Thomas N. Davidson 378,692(9) 5.61% 7 Sunrise Cay Drive Key Largo, FL 33037
1) Includes shares owned of record and beneficially by Fairway Inc. (150,750 shares) and Steeplechase Corp. (1,709,250 shares). Mr. Needler controls these corporations and serves as a Director and Chief Executive Officer of these corporations. 2) Under the terms of the Agreement Barry Needler has surrendered his right to vote or transfer the shares except in accordance with the Agreement. 3) Mr. Needler is the President and Chief Executive Officer of Steeplechase Corp. 39 4) Includes 520,148 shares owned of record by Amherst Tanti U.S. Inc. and 10,300 shares in a retirement fund. Also includes 2,339,028 shares for which Mr. Foley holds an irrevocable proxy pursuant to the Agreement. 5) Amherst Tanti U.S. Inc. is owned by Kirk W. Foley and his wife. Mr. Foley serves as President of this corporation. 6) Includes 343,332 shares subject to issuance upon the exercise of stock options exercisable within 60 days hereof. Also includes 11,000 shares owned by his wife, beneficial ownership of which is disclaimed. 7) These shares are included in the total for Mr. Foley. US Bancorp does not have power to dispose of or vote these shares. 8) Includes 6,750 shares owned by his wife, beneficial ownership of which is disclaimed. 9) Includes 4,500 shares subject to issuance upon the exercise of stock options exercisable with 60 days hereof. SECURITY OWNERSHIP OF MANAGEMENT The following table sets forth, as of January 31, 2004, information concerning the number of shares of common stock beneficially owned by each director, each named executive officer, and by all executive officers and directors as a group. The totals shown below for each person and for the group include shares held personally, shares held by immediate family members, and shares acquirable within sixty days of the date hereof by the exercise of stock options.
AMOUNT AND NATURE OF BENEFICIAL OWNERSHIP (1) - ------------------------------------------------------------------------------------------------------- Direct Exercisable Name of Beneficial Owner Ownership Options (2) Total Percent (3) ------------------------ ------------ ---------- ------- ---------- Robert Breadner 2,700 0 2,700 * Daniel J. Duggan 216,550 86,666 303,216 4.44% Kirk W. Foley 2,894,044 (4) 0 2,894,044 42.90% Wesley Eric Foley 3,437 0 3,437 * James R. Malone 278,406 (5) 343,332 621,738 8.77% Joseph L. Najm 22,000 43,333 65,333 * John A. Pryor 53,752 (6) 100,000 153,752 2.25% Murray Walker 258,100 (7) 15,000 273,100 4.04% Darrell Weeter 85,625 64,166 149,791 2.20% Ivan J. Winfield 15,000 (8) 115,000 130,000 1.89% All Executive Officers and Directors as a Group 4,111,493 826,663 4,938,156 65.21%
1) Each person has sole voting and investment power with respect to all shares shown except as indicated below. 40 2) Represents shares subject to stock options that are exercisable as of January 31, 2004, or became exercisable prior to March 31, 2004. 3) Unless otherwise indicated, the percentage of Common Stock owned is less than one percent of the Common Stock outstanding. 4) Includes 520,148 shares owned of record by Amherst Tanti U.S. Inc. and 10,300 shares in a retirement fund. Also includes 2,339,028 shares for which Mr. Foley holds an irrevocable proxy pursuant to the Agreement. 5) Includes 11,000 shares owned by his wife, beneficial ownership of which is disclaimed. 6) Includes 34,900 shares held in a retirement fund. 7) A portion of these shares (253,100) are subject to the Agreement. 8) Includes 12,200 shares held in a retirement plan. SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS Refer to Part II, Item 5 above for information relating to securities authorized for issuance under equity compensation plans. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (DOLLARS IN THOUSANDS) James R. Malone, our former Chairman and Chief Executive Officer, Darrell Weeter, President of the Company's Americas division, and John Glomb, a Regional Vice President of the Company, each own 31.67% of the membership interests in a Company called Vision Capital Logistics, LLC ("VCL"). VCL, a brokerage service provider for sourcing consumer credit, assists its clients in securing third party financing for its clients' customers to purchase products, including products manufactured by us and sold by our Distributors. VCL charges additional fees to our Distributors for these financing services. VCL's client list also includes a number of other "direct sales" companies, including other floor care companies. In securing such financing, VCL may guarantee the legal compliance obligations (but not any payment obligations) of our Distributors to a third party lender. The third party lender pays VCL a participation fee for such financing services, a part of which (twelve percent (12%)) VCL pays to us. During the fiscal years ended September 30, 2003, 2002 and 2001, VCL paid us $24, $17 and $10, respectively in connection with such financing services. Additionally, in certain cases a Distributor may not be able to complete a sale because of the substandard credit status of the retail customer. In such cases VCL may provide the Distributor with financing for this sale. We entered into an arrangement with VCL known as a Swap Program under which VCL will purchase the contract of the retail customer from the Distributor and arrange for the financing of the contract at a significant discount. To replace the product sold by our Distributor and for which the Distributor received only a portion of the consumer sale price, VCL will purchase a replacement product from us at the same price paid by our Master Distributors and we will ship it to the Distributor to replace the product the Distributor just sold. During the fiscal years ended September 30, 2003, 2002 and 2001, VCL purchased an aggregate of $35, $19 and $19, respectively of our products under the Swap Program. Under the terms of our credit facility in place from time to time, we were prohibited from engaging in certain of the financing activities provided by VCL. 41 From June 2000 until January 2003 we sublet to VCL a portion of our office space in Naples, Florida. During the fiscal years ended September 30, 2003, 2002, and 2001 VCL paid us $8, $24 and $13, respectively, in rent for such space, which amount was based upon an allocation of our total monthly lease payments to the amount of space utilized by VCL. In February, 2003 a new lease was entered into for office space with VCL as the tenant. We began subleasing space from VCL for $3 per month, which amount was based upon an allocation of VCL's total monthly lease payments to the amount of space that we utilized. In the fiscal year ended September 30, 2003 we paid VCL a total of $21 in lease payments. The sublease was terminated in February, 2004. We have had a long standing relationship with Ametek Inc. by which we have purchased motors for our products. James R. Malone, our former Chairman and Chief Executive Officer, is a director of Ametek, Inc. During the fiscal years ended September 30, 2003, 2002 and 2001 our purchases from Ametek were $1,973, $1,704 and $1,633, respectively. We believe the terms of these purchases were as favorable to us as those which could have been obtained from unrelated parties. Darrell Weeter has served for many years as President of FVS, Inc. a distributor of products manufactured by us and which is owned by Mr. Weeter and his wife. For the fiscal years ended September 30, 2003, 2002 and 2001, FVS, Inc. purchased, at Master Distributor pricing, a total of $78, $100 and $107 respectively in products from us. Mr. Weeter also received amounts due to him under our Career Development Program of $132, $126 and $165 for the fiscal years ended September 30, 2003, 2002 and 2001, respectively. The amounts paid were Distributor paid overrides ("DPO's") collected by us from Distributors that were brought into the business by Mr. Weeter. DPO's are a unit price override charged on top of our standard unit sales price for which we, HMI, act as a pass through, meaning that we collect the DPO from the promoted distributor and disburse it to the promoting distributor upon their request; accordingly these DPO's are not reflected in our income statement as revenue. The total DPO's still owed to Mr. Weeter were $3 and $12 as of September 30, 2003, and 2002, respectively. This payable to Mr. Weeter was recorded on the other accrued expense and liabilities line item of our Consolidated Balance Sheets as of September 30, 2003, and 2002. Derek Hookom, became an employee of HMI on January 1, 2003. Mr. Hookom is also a distributor of products manufactured by HMI. For the fiscal years ended September 30, 2003, 2002 and 2001, Summit Air purchased, at Master Distributor pricing, a total of $254, $604 and $1,133 respectively in products from us. Under the terms of Mr. Hookom's employment agreement, Mr. Hookom remains eligible to receive the Millionaires Club Award associated with the Edge Success Program through sales generated by his personally developed sales network. The Company incurred $173 of distributor development program revenue reduction associated with Mr. Hookom's participation in the Program for the fiscal year ended September 30, 2003. Mr. Hookom also received DPO's due to him under our Career Development Program of $102, $58 and $1, for the fiscal years ended September 30, 2003, 2002 and 2001, respectively. The amounts paid were Distributor paid overrides collected by us from Distributors that were brought into the business by Mr. Hookom. The total DPO's still owed to Mr. Hookom was $38 as of September 30, 2003. This payable to Mr. Hookom was recorded on the other accrued expense and liabilities line item of our Consolidated Condensed Balance Sheets as of September 30, 2003. 42 The above amounts are not considered to be significant to the financial statements as a whole and therefore have not separately identified in the Consolidated Condensed Balance Sheets, Statements of Operations or Statements of Cash Flow. For information regarding a transaction involving Kirk Foley, please see "Compensation Committee Interlocks and Insider Participation" in Item 11 above. PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (A) DOCUMENTS FILED AS PART OF THIS REPORT. 1. FINANCIAL STATEMENTS AND RELATED SCHEDULES:
Page Number ------ Report of Independent Registered Public Accounting Firm 47 Consolidated Balance Sheets as of September 30, 2003, and 2002 48 Consolidated Statements of Operation for the years ended September 30, 2003, 2002, and 2001 49 Consolidated Statements of Stockholders' Equity for the years ended September 30, 2003, 2002, and 2001 50 Consolidated Statements of Cash Flow for the years ended September 30, 2003, 2002, and 2001 51 Notes to Consolidated Financial Statements 52 Schedule II - Valuation and Qualifying Accounts and Reserves 82
Schedules other than those listed above are omitted because they are not required or are not applicable, or the required information is shown in the consolidated financial statements, the notes thereto, or in Management's Discussion and Analysis of Financial Condition and Results of Operations. 2. EXHIBIT LIST:
Exhibit Number Description - ------ --------------------------------------------------------------------------------- 3.1 Certificate of Incorporation~ Incorporated by reference from Annual Report on form 10-K for the year ended September 30, 1995 3.2 Bylaws~ Incorporated by reference from Form 10-Q for the quarter ended June 30, 2003
43
9.0 Voting Trust Agreement~ Stockholders Voting Agreement, incorporated by reference from Form 13-D filed on October 19, 2001 10.00 Material Contracts~ U.S. Bank N.A. $2,000,000 Revolving Credit Note, incorporated by reference from Form 10-Q for the quarter ended June 30, 2001 10.01 Material Contracts~ U.S. Bank N.A.$1,000,000 Revolving Credit Note, incorporated by reference from Form 10-Q for the period ended March 31, 2002 10.02 Material Contracts~ Amendment to U.S. Bank N.A. $1,000,000 Revolving Credit Note, incorporated by reference from Form 10-K for the year ended September 30, 2002 10.03 Material Contracts~ Amendment to U.S. Bank N.A. $2,000,000 Revolving Credit Note, incorporated by reference from Form 10-Q for the quarter ended December 31, 2002 10.04 Material Contracts~ Amendment to U.S. Bank N.A. $2,000,000 Revolving Credit Note, incorporated by reference from Form 10-K for the year ended September 30, 2003 10.05 Material Contracts~ U.S. Bank N.A. Waiver Letter and Amendment to Revolving Credit Note, dated February 20, 2004, incorporated by reference from Form 10-K for the year ended September 30, 2003. 10.06 Material Contracts~ U.S. Bank N.A. Waiver Letter and Amendment to Revolving Credit Note, dated October 15, 2004, incorporated by reference from Form 8-K filed on October 21, 2004. 10.07 Material Contracts~ 13-D Settlement Agreement incorporated by reference from Form 8-K filed on February 19, 2002 10.08 Material Contracts~ Change of Control Agreement - Weeter, incorporated by reference from Form 10-K for the year ended September 30, 2003. 10.09 Material Contracts~ Change of Control Agreement - Duggan, incorporated by reference from Form 10-K for the year ended September 30, 2002 10.10 Material Contracts~ Change of Control Agreement - Pryor, incorporated by reference from Form 10-K for the year ended September 30, 2001 10.11 Material Contracts~ Change of Control Agreements - McGraw and Malone, incorporated by reference from Form 10-K/A3 for the year ended September 30, 1997 10.12 Material Contracts~ Employment Agreement - Pryor, incorporated by reference from Form 10-K for the year ended September 30, 2001
44 10.13 Material Contacts~ Accelerated Incentive Stock Option Agreements, incorporated by reference from Form 10-K for the year ended September 30, 2000 10.14 Material Contracts~ Incentive Stock Option Agreement - Pryor, incorporated by reference from Form 10-K for the year ended September 30, 2001 10.15 Material Contracts~ Incentive Stock Option Agreements, incorporated by reference from Form 10-K for the year ended September 30, 2001 10.16 Material Contracts~ Incentive Stock Option Agreements, incorporated by reference from Form 10-K for the year ended September 30, 2000 10.17 Material Contracts~ Incentive Stock Option Agreements incorporated by reference from Form 10-Q for the quarter ended March 31, 1999 11 Statement re: Computation of per share earnings~ See Note 1 on Page 60 of the Financial Statements 14 Code of Ethics~ incorporated by reference from Form 10-K for the year ended September 30, 2003. 21 Subsidiaries of Registrant~ Note 1 on Page 52 of this report 23 Consent of Independent Accountants~ Attached 31.1 Rule 13a-14(a)/15d-14(a) Certification~ Certification Pursuant to 15 U.S.C. Section 7241 for Kirk. W. Foley, attached 31.2 Rule 13a-14(a)/15d-14(a) Certification~ Certification Pursuant to 15 U.S.C. Section 7241 for Julie A. McGraw, attached 32.1 Section 1350 Certification~ Certification for Kirk W. Foley Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350), attached 32.2 Section 1350 Certification~ Certification for Julie A. McGraw Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350), attached
(B) REPORTS ON FORM 8-K. No report on Form 8-K was filed during the last quarter of fiscal 2003. (C) EXHIBITS. Reference is made to the above Exhibit List table. 45 (D) FINANCIAL STATEMENT SCHEDULES. Schedules required to be filed in response to this Item are listed above in the Financial Statements and Related Schedules table. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. HMI INDUSTRIES INC. (Registrant) by /s/ Julie A. McGraw ------------------- Julie A. McGraw Vice President, Chief Financial Officer and Treasurer October 22, 2004 Pursuant to the requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. /s/ Kirk W. Foley /s/ John A. Pryor - ------------------------------------ ---------------------------------- ---------------------------- Kirk W. Foley John A. Pryor Robert Breadner Chairman of the Board and President and Chief Operating Director Director Officer and Director October 22, 2004 October 22, 2004 October 22, 2004 /s/ Wesley E. Foley /s/ Murray Walker /s/ Ivan J. Winfield - ------------------------------------ ---------------------------------- ---------------------------- Wesley E. Foley Murray Walker Ivan J. Winfield Director Director Director October 22, 2004 October 22, 2004 October 22, 2004 /s/ Earl J. Watson - ------------------------------------ Earl J. Watson Corporate Controller October 22, 2004
46 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, stockholders' equity, and cash flows present fairly, in all material respects, the financial position of HMI Industries, Inc. and its subsidiaries at September 30, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2003, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for goodwill and other intangible assets to comply with the provisions of Statement of Financial Accounting Standard No. 142, "Goodwill and Other Intangible Assets," effective October 1, 2002, and changed its method of revenue recognition to adopt EITF 01-9 "Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor's Products)," effective January 1, 2001. As discussed in Note 5 and Note 12, the Company's credit facility agreement expires on December 31, 2004. As described in Note 2, the Company restated its consolidated financial statements for the years ended September 30, 2003, 2002 and 2001. /s/ PricewaterhouseCoopers LLP Cleveland, Ohio February 13, 2004 (except for Note 2, Note 5, and Note 12, as to which the date is October 20, 2004) 47 HMI INDUSTRIES INC. CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, September 30, 2003 2002 Dollars and shares in thousands, except par values RESTATED Restated - ------------------------------------------------------------------------------------------------------------------------------ ASSETS CURRENT ASSETS: Cash and cash equivalents $ 948 $ 481 Trade accounts receivable (net of allowance of $194 and $482) 1,892 2,007 Inventories: Finished goods 2,555 2,076 Work-in-progress, raw material and supplies 2,153 2,113 Deferred income taxes - - Prepaid expenses 397 292 Other current assets 152 54 - ------------------------------------------------------------------------------------------------------------------------------ Total current assets 8,097 7,023 - ------------------------------------------------------------------------------------------------------------------------------ PROPERTY, PLANT AND EQUIPMENT, NET 2,178 4,310 - ------------------------------------------------------------------------------------------------------------------------------ OTHER ASSETS: Cost in excess of net assets of acquired businesses (net of accumulated amortization of $-0- and $3,739) - 5,451 Deferred income taxes - - Trademarks (net of accumulated amortization of $202 and $162) 272 375 Other 121 271 - ------------------------------------------------------------------------------------------------------------------------------ Total other assets 393 6,097 - ------------------------------------------------------------------------------------------------------------------------------ Total assets $ 10,668 $ 17,430 ============================================================================================================================== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Line of credit $ 1,383 $ 1,392 Trade accounts payable 2,143 1,957 Income taxes payable 506 517 Accrued expenses and other liabilities 2,399 1,863 Distributor Development Liability due within one year 200 - Long-term debt due within one year 22 302 - ------------------------------------------------------------------------------------------------------------------------------ Total current liabilities 6,653 6,031 - ------------------------------------------------------------------------------------------------------------------------------ LONG-TERM LIABILITIES: Long-term debt (less amounts due within one year) 11 33 Distributor Development Liability (less amounts due within one year) 12,758 8,789 - ------------------------------------------------------------------------------------------------------------------------------ Total long-term liabilities 12,769 8,822 - ------------------------------------------------------------------------------------------------------------------------------ STOCKHOLDERS' (DEFICIT) EQUITY: Preferred stock, $5 par value; authorized, 300 shares; issued, none - - Common stock, $1 par value; authorized, 10,000 shares; issued and outstanding, 6,746 shares 6,746 6,746 Capital in excess of par value 8,231 8,231 Unearned compensation, net - (3) Accumulated deficit (23,731) (11,492) Accumulated other comprehensive loss (Note 1) - (905) - ------------------------------------------------------------------------------------------------------------------------------ Total stockholders' (deficit) equity (8,754) 2,577 - ------------------------------------------------------------------------------------------------------------------------------ Total liabilities and stockholders' (deficit) equity $ 10,668 $ 17,430 ==============================================================================================================================
See notes to consolidated financial statements. 48 HMI INDUSTRIES INC. CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED SEPTEMBER 30, 2003 2002 2001 Dollars and shares in thousands, except per share data RESTATED Restated Restated - --------------------------------------------------------------------------------------------------------------------------- REVENUES: Product sales, less returns and allowances 34,539 37,113 32,536 Distributor development program (4,369) (2,589) (1,009) - --------------------------------------------------------------------------------------------------------------------------- Net product sales $ 30,170 $ 34,524 $ 31,527 - ---------------------------------------------------------------------------------------------------------------------------- OPERATING COSTS AND EXPENSES: Cost of products sold 21,025 21,298 19,370 Selling, general and administrative expenses 13,404 14,591 13,306 Loss on impairment of asset 1,711 - - Loss on liquidation of subsidiary 905 - - Interest expense 53 86 86 Other (income) expense, net (158) 344 186 - --------------------------------------------------------------------------------------------------------------------------- Total operating costs and expenses 36,940 36,319 32,948 - --------------------------------------------------------------------------------------------------------------------------- Loss before income taxes and cumulative effect of accounting change (6,770) (1,795) (1,421) Provision for income taxes 18 38 3,672 - --------------------------------------------------------------------------------------------------------------------------- Loss before cumulative effect of accounting change (6,788) (1,833) (5,093) Cumulative effect of accounting change 5,451 - 4,943 - --------------------------------------------------------------------------------------------------------------------------- NET LOSS $ (12,239) $ (1,833) $ (10,036) =========================================================================================================================== Weighted average number of shares outstanding: Basic 6,744 6,719 6,691 Diluted 6,744 6,719 6,691 =========================================================================================================================== BASIC AND DILUTED PER SHARE OF COMMON STOCK (NOTE 1): Loss before cumulative effect of accounting change $ (1.01) $ (0.27) $ (0.76) Cumulative effect of accounting change $ (0.81) $ - $ (0.74) - --------------------------------------------------------------------------------------------------------------------------- NET LOSS $ (1.82) $ (0.27) $ (1.50) ==========================================================================================================================
See notes to consolidated financial statements. 49 HMI INDUSTRIES INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002, AND 2001
Capital in Accumulated Excess Other Treasury Total Common of Par Unearned Accumulated Comprehensive Treasury Stock Stockholders' Dollars in thousands Stock Value Compensation Deficit Loss Shares Amount Equity ------- ------- ------------- ----------- ------------- -------- -------- ------------- Balance at September 30, 2000 $ 6,658 $ 8,279 ($41) $ 377 ($879) $ - $ - $ 14,394 Comprehensive income: Net loss, restated (10,036) (10,036) Translation adjustment (21) (21) ------------- Total comprehensive income (10,057) Issuance of common stock 50 50 Unearned compensation 33 33 ------- ------- ------------ ----------- ------------- -------- -------- ------------- Balance at September 30, 2001, Restated 6,708 8,279 (8) (9,659) (900) - - 4,420 Comprehensive income: Net loss, restated (1,833) (1,833) Translation adjustment (5) (5) ------------- Total comprehensive income (1,838) Issuance of common stock 38 38 Unearned compensation 5 5 Employee benefit stock (48) (48) ------- ------- ------------ ----------- ------------- -------- -------- ------------- Balance at September 30, 2002, Restated 6,746 8,231 (3) (11,492) (905) - - 2,577 COMPREHENSIVE INCOME: NET LOSS, RESTATED (12,239) (12,239) TRANSLATION ADJUSTMENT - - ------------- TOTAL COMPREHENSIVE LOSS (12,239) CUMULATIVE TRANSLATION ADJUSTMENT ASSOCIATED WITH LIQUIDATION OF FOREIGN SUBSIDIARY 905 905 UNEARNED COMPENSATION 3 3 ------- ------- ------------ ----------- ------------- -------- -------- ------------- BALANCE AT SEPTEMBER 30, 2003, RESTATED $ 6,746 $ 8,231 - ($ 23,731) - - - ($ 8,754) ======= ======== ============ =========== ============= ======== ======== =============
See notes to consolidated financial statements. 50 HMI INDUSTRIES INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED SEPTEMBER 30, 2003 2002 2001 Dollars in thousands RESTATED Restated Restated - -------------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) income $ (12,239) $ (1,833) $ (10,036) Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities: Cumulative effect of accounting change 5,451 - 4,943 Loss on impairment of asset 1,711 - - Loss on liquidation of foreign subsidiary 905 - - Distributor development program 3,969 2,589 1,033 Depreciation and amortization 744 928 913 Provision for loss on sale/disposal of assets - 17 - Provision for loss on receivables - 59 - Treasury/common shares issued, net of unearned compensation and employee benefit stock - (5) 83 Unearned compensation 3 - - Deferred income taxes - - 4,036 Changes in operating assets and liabilities: Decrease in receivables 115 100 1,181 Increase in inventories (518) (441) (532) (Increase) decrease in prepaid expenses (105) (108) 227 (Increase) decrease in other current assets (98) 309 (73) Increase (decrease) in accounts payable 186 (343) (258) Increase (decrease) in accrued expenses and other liabilities 536 188 (943) Increase in distributor development liability 200 - - Decrease in income taxes payable (11) (18) (431) Other, net 105 (86) (169) - -------------------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) operating activities 954 1,356 (26) - -------------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (176) (866) (2,278) - -------------------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (176) (866) (2,278) - -------------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net (repayments) borrowing under credit facility (9) 201 1,191 Payment of long term debt (302) (615) (17) - -------------------------------------------------------------------------------------------------------------------------------- Net cash (used in) provided by financing activities (311) (414) 1,174 - -------------------------------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents 467 76 (1,130) CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 481 405 1,535 - -------------------------------------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 948 $ 481 $ 405 ================================================================================================================================
See notes to consolidated financial statements. 51 HMI INDUSTRIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (DOLLARS IN THOUSANDS, EXCEPT SHARES AND PER SHARE DATA) BASIS OF CONSOLIDATION The consolidated financial statements include all controlled subsidiaries. Operations include the accounts of HMI Industries Inc. and the following wholly-owned subsidiaries: Health-Mor International Inc., HMI Incorporated, Health-Mor Acceptance Corporation, HMI Acceptance Corporation, and Health-Mor Acceptance Pty. Ltd. All significant intercompany accounts and transactions have been eliminated. Our principal products include a high filtration portable surface cleaner that is marketed as a healthier alternative to the typical vacuum cleaner and a portable room air cleaner that helps to remove particles, gases, and odors from the air. The two products are sold together as a complete Filter Queen Indoor Air Quality System(TM). RECLASSIFICATION Certain amounts in the fiscal 2001 consolidated financial statements have been reclassified to conform to the fiscal 2003 and 2002 presentation. USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of any contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. FAIR VALUE OF FINANCIAL INSTRUMENTS Our financial instruments consist principally of cash and cash equivalents, accounts and notes receivable, accounts payable, accrued expenses and other liabilities, line of credit, and short and long-term debt in which the fair value of these financial instruments approximates the carrying value. CASH EQUIVALENTS We consider all highly liquid instruments purchased with a maturity of less than three months to be cash equivalents. Cash equivalents are comprised primarily of commercial paper. We believe the carrying amounts approximate fair value due to the short maturities of these instruments. ALLOWANCE FOR DOUBTFUL ACCOUNTS We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Quarterly, we perform a review of all customer accounts with respect to aging of receivables, historical payment patterns, customers' financial condition, and from this review determine if an allowance is needed. 52 SALES RETURN AND ALLOWANCE We record a provision for estimated sales returns and allowances on product sales in the same period as the related revenues are recorded. These estimates are based on historical sales returns and other known factors. ADVERTISING COSTS We expense the production costs of advertising the first time the advertising takes place. Advertising expense was $151, $1,808, and $591, in fiscal 2003, 2002, and 2001, respectively. INVENTORIES Inventories are stated at the lower of cost or market. Cost is determined principally on the last-in, first-out (LIFO) method, which provides a better matching of current costs and revenues. The following presents the effect on inventories and income before taxes had we used the first-in, first-out (FIFO) method of inventory valuation.
2003 2002 ------------- ------------ Percentage of total inventories on LIFO 100% 100% Inventory amount had FIFO method been utilized to value inventory $ 5,103 $ 4,599 (Decrease) increase in net income before taxes due to LIFO $ (14) $ (11)
EXCESS AND OBSOLESCENCE RESERVES We evaluate our inventory quarterly to determine excess or slow moving items based on current order activity and projections of future demand. For those items identified, we estimate their market value or net sales value based on current trends. An allowance is created for those items having a net sales value less than cost. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment are recorded at cost. Depreciation is provided on the straight-line method over estimated useful lives of 5 years for leasehold improvements and 3 to 10 years for machinery and equipment. Improvements, which extend the useful life of property, plant and equipment, are capitalized, and maintenance and repairs are expensed. When property, plant and equipment are retired or otherwise disposed of, the cost and accumulated depreciation are removed from the appropriate accounts and any gain or loss is included in income. GOODWILL AND OTHER INTANGIBLE ASSETS Pursuant to SFAS 142 "Goodwill and Other Intangible Assets" we ceased amortizing goodwill in the period beginning October 1, 2002. Prior to the adoption of SFAS No. 142, we amortized goodwill on a straight-line basis over 40 years. Other intangible assets are amortized on a straight-line basis over their useful lives, ranging from ten to seventeen years. Goodwill amortization for the years ended September 30, 2002, and 2001, was $245 and $245, respectively. FAS 142 primarily addresses the accounting for goodwill and intangible assets subsequent to their initial recognition. The provisions of FAS 142 prohibit the amortization of goodwill and indefinite-lived intangible assets, require that goodwill and indefinite-lived intangible assets be tested annually for impairment (and in interim periods if certain events occur indicating that the carrying value of goodwill and/or indefinite-lived intangible assets may be impaired), require that reporting units be identified for the purpose of assessing potential impairments of goodwill, and remove the forty-year limitation on the amortization period of intangible assets that have finite lives. 53 During the first quarter of fiscal 2003 we completed the first step of the two-step implementation process by obtaining a valuation of HMI for comparison to the carrying value and began the process of measuring the amount of the impairment (step two). Management does not believe that the market value of common stock fairly reflects the value of HMI, because of, among other things, the absence of liquidity, and the absence of analyst coverage. Accordingly, the valuation experts employed by us utilized the market value of the common stock as of October 1, 2002, but also weighted the valuation for comparable values of peer companies, recent sales of similar types of companies, and a discounted cash flow methodology. Based on the assumptions used in any of the three valuations referred to above and depending on the weighting used for each valuation, results of the valuation could be significantly changed. However, for accounting purposes we believe that the weighting methodology used is reasonable and results in an accurate and fair value of HMI. During the second quarter of fiscal 2003 we completed our initial impairment test for October 1, 2002, resulting in a full impairment of the goodwill recorded on HMI's books through a non-cash charge of $5,451. Such charge is non-operational in nature and is reflected as a Cumulative Effect of Accounting Change in the accompanying Consolidated Statements of Operations for the year ended September 30, 2003. A reconciliation of the reported net (loss) income and net (loss) income per share to the amounts adjusted for the exclusion of amortization of goodwill and the cumulative effect of a change in accounting principle for the years ended September 30, 2003, 2002, and 2001, respectively, had the provisions of SFAS 142 been applied on October 1, 2000, is as follows:
2003 2002 2001 - ---------------------------------------------------------------------------------------------------------------- Loss before cumulative effect of accounting change $ (6,788) $ (1,833) $ (5,093) Cumulative effect of accounting change 5,451 - 4,943 - ---------------------------------------------------------------------------------------------------------------- Net loss (12,239) (1,833) (10,036) Goodwill amortization add back, net of tax - 245 245 - ---------------------------------------------------------------------------------------------------------------- Adjusted net loss $ (12,239) $ (1,588) $ (9,791) ================================================================================================================ Weighted average number of shares outstanding: Basic 6,744 6,719 6,691 Diluted 6,744 6,719 6,691 ================================================================================================================ Basic and diluted per share of common stock: Loss before cumulative effect of accounting change $ (1.01) $ (0.27) $ (0.76) Cumulative effect of accounting change (0.81) $ - $ (0.74) Goodwill amortization add back, net of tax - $ 0.04 $ 0.04 ================================================================================================================ Adjusted net loss $ (1.82) $ (0.23) $ (1.46) ================================================================================================================
Total amortization expense for trademarks and patents was $49, $41, and $40 for the years ended September 30, 2003, 2002, and 2001, respectively. Amortization expense for trademarks and patents is estimated for the next five fiscal years ending September 30, 2004, through 2008, as $41, $19, $19, $17, and $15. 54 VALUATION OF LONG-LIVED ASSETS As of the beginning of fiscal 2003 we adopted Statement of Financial Accounting Standards ("FAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". The adoption of this accounting standard did not have a material impact on our operating results and financial position. We assess potential impairments to our long-lived assets when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset may not be recovered. An impairment loss is recognized when the carrying amount of the long-lived asset is not recoverable and exceeds its fair value. The carrying amount of a long-lived asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. Any required impairment loss is measured as the amount by which the carrying amount of a long-lived asset exceeds its fair value and is recorded as a reduction in the carrying value of the related asset and a charge to operating results. During the fourth quarter of fiscal 2003 we performed an analysis on the potential impairment on certain tooling assets, and related patents and trademarks, approximating $1,711 which related to a potential new product. An additional $98 was added to this impairment as part of our restatement. See Note 2 to the Consolidated Financial Statements. Based upon our analysis, we concluded that the tooling assets were fully impaired as of September 30, 2003; this conclusion was based upon the held and used model which includes significant assumptions regarding future cash flows and utilizes a model of weighted probability cash flow projections over the estimated life of the product. Scrap value for these assets was determined to be nominal; accordingly a $1,711 impairment of this asset was recorded as of September 30, 2003, to write the assets down to their net realizable value. This product will not have any additional resources devoted to its refinement and completion, nor will the product be marketed or sold as an ongoing part of our product portfolio. As a result the impairment is not expected to have an impact on future revenue or net income. FOREIGN CURRENCY TRANSLATION Prior to the liquidation, in the second quarter of fiscal 2003, of our remaining foreign subsidiaries, all consolidated foreign operations used the local currency of the country of operation as the functional currency and translated the local currency asset and liability accounts at year-end exchange rates while income and expense accounts were translated at weighted average exchange rates. The resulting translation adjustments were accumulated as a separate component of Stockholders' Equity titled "Accumulated Other Comprehensive Loss." Such adjustments will affect net income only upon sale or liquidation of the underlying foreign investments. Exchange gains and losses from transactions in a currency other than the local currency of the entity involved are included in income as they occur. Significantly all of our product sales to our customer base are conducted in U.S. dollars and therefore net transaction and translation adjustments are not significant. During the second quarter of fiscal 2003 we recorded a write-off of $905 for cumulative translation adjustments associated, primarily, with the liquidation of our Canadian subsidiary. The loss on disposal solely related to cumulative foreign currency translation adjustment as a result of the Canadian subsidiary ceasing to function as an operating entity in a prior fiscal year and in part the result of the goodwill impairment associated with the adoption of FAS 142. In March 1998, we changed the way we operated in Canada by engaging an importer to assume responsibility for and manage the distribution network in that country, similar to the way we do 55 business in the rest of our international markets. Consequently it was no longer necessary to maintain a physical presence in Canada, gradually reducing the necessity for the entity. For a period of time after we began selling to the importer in Canada and based on his sales results in Canada, we considered the possibility of utilizing the subsidiary again. Moreover, at the time we completed step two of our FAS 142 Goodwill implementation the only material remaining items in the financial records of the Canadian subsidiary related to Goodwill and Cumulative Translation Adjustments ("CTA"). As discussed in Note 1 to the Consolidated Financial Statements, the goodwill was deemed to be fully impaired and was written off as a cumulative change in accounting principal due to the adoption of FAS 142. In conjunction with the goodwill write off we reviewed possible future options for our Canadian subsidiary, and we chose to liquidate the entity. Therefore we recorded a loss on disposal of $905 associated with cumulative translation adjustments for this subsidiary. COMPREHENSIVE INCOME/LOSS Prior to the liquidation in the second quarter of fiscal 2003 of our remaining foreign subsidiaries, comprehensive income/loss combined net income/loss and "other comprehensive items," which represented foreign currency translation adjustments, were reported as a separate component of Stockholders' Equity in the accompanying Consolidated Balance Sheets. We present such information in our Statements of Stockholders' Equity on an annual basis and in a footnote in our quarterly reports. Subsequent to the liquidation of our Canadian subsidiary, we do not incur foreign currency translation adjustments. GUARANTEES During the second quarter of fiscal 2003 we adopted Financial Accounting Standards Board Interpretation No. 45 ("FIN 45") "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN 45 requires that a liability be recorded in the guarantor's balance sheet upon issuance of a guarantee. In addition, FIN 45 requires disclosures about the guarantees that an entity has issued, including a reconciliation of changes in the entity's product warranty liabilities. The disclosure requirements are effective for financial statements for interim or annual periods ended after December 15, 2002, while the recognition and measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. We have guaranteed repayment to a finance company for certain events of default by some of our Canadian distributors. The finance company purchases the installment sales contracts that the distributors entered into with their customers for the sale of products manufactured by HMI. Our obligation to repurchase any contracts is limited to situations in which the borrower has any valid defense, right of set-off or counterclaim regarding the loan; the loan does not comply with all applicable laws and regulations; or the loan is not a binding obligation of the borrower. For example, we would be required to purchase from the finance company a contract entered into by an end consumer to finance the purchase of our product if the finance company believes that the contract has been improperly obtained. We require the participating Canadian distributors to provide us with cash reserves, which are held as liabilities on our records, in order to provide a fund for the payments of any defaults by the participating Canadian distributors. As of September 30, 2003, we had $75 of cash reserves we had received from Canadian Distributors. The amount was included in the accrued expenses and other liabilities line item of our Consolidated Balance Sheets and we expect to hold them for 56 at least a period approximating the term of the finance contracts with the end consumers, which typically have a 36 month term. Although it is not practical for us to estimate future cash payments on possible repurchases; the maximum potential of future payments that we could be required to make under the guarantee is the total contacts outstanding of $843 at September 30, 2003. However, from the commencement of the contract in July 2002 we have repurchased only one contract approximating $2 under this guarantee. Moreover, we are permitted pursuant to agreements with our Canadian distributors to be reimbursed from the cash reserves referred to above for the costs and expenses incurred in fulfilling our guarantee to the finance company. Warranty We warrant our surface cleaner for a two-year period from the date of purchase and offer a lifetime service benefit for the replacement of the surface cleaner's motor at a price not to exceed $99 (Dollar's not in thousands). On occasion, we also support a five-year optional extended warranty on the portable surface cleaner offered by our U.S. Distributors to the end user as a sales promotion during an in home product demonstration. As an enticement to the end user to buy our product during that demonstration, the five year optional extended warranty is offered to them at no cost; accordingly no revenue for this optional warranty is recognized by HMI. Outside the U.S. we offer a two-year warranty for our high filtration portable surface cleaner. The portable room air cleaner is warranted for renewable one-year periods so long as the main air filter is replaced annually. A five-year warranty is offered for our built-in vacuum system. Our policy is to record a provision for the expected cost of warranty-related claims at the time of the sale and adjust the provision to reflect actual experience quarterly. The amount of warranty liability accrued reflects management's best estimate of the expected future cost of honoring our obligations under the warranty plans. Historically, the cost of fulfilling our warranty obligations has principally involved replacements parts, labor and sometimes travel. Our estimates are based on historical experience, the number of units involved and the extent of features/components included in product models. Changes in our warranty liability for the years ended September 30, 2003, 2002, and 2001, were as follows:
2003 2002 2001 --------- --------- ---------- Balance at beginning of period $ 190 $ 299 $ 368 Charges to expense 245 60 164 Usage (242) (169) (233) ----------- ----------- ------------ Balance at end of period $ 193 $ 190 $ 299 =========== =========== ============
SHIPPING AND HANDLING COSTS Costs incurred for shipping and handling are included in the cost of products sold when incurred. Amounts billed to customers for shipping and handling are reported as net product sales. SEGMENT REPORTING We conduct our business as a single reportable segment. CONCENTRATIONS We are subject to risks specific to the individual customers with whom we do business. In fiscal 2003 no individual customer accounted for more than 10% of our product sales. In fiscal 2002 57 one international customer in Japan accounted for more than 10% of our product sales. This international customers product sales were 11.9% of our total product sales. In fiscal 2001 three international customers, one each in Canada, Japan and Portugal, accounted for more than 10% each of our product sales with individual total product sales of 13.1%, 11.2%, and 10.2%, respectively. Our revenues, and the stability of such revenues, are dependent on our relationships with third-party distributors and their sales persons and their level of satisfaction with our products and us. The Distributors and Importers are independent third parties who are not our employees and are not directly under our control. There can be no assurance that the current relationships with Distributors and Importers will continue on acceptable terms and conditions to us, nor can there be any assurance that additional distributorship arrangements with third parties will be obtained on acceptable terms. Moreover, there can be no assurance that the Distributors and Importers will devote sufficient time and resources to our products to enable the products to be successfully marketed. Failure of some or all of our products to be successfully and efficiently distributed could have a material adverse effect on our financial condition and results of operations. In addition, our business could be adversely affected by a variety of uncontrollable and changing factors, including but not limited to: difficulty in protecting our intellectual property rights in a particular foreign jurisdiction; recessions in economies where we sell our products; longer payment cycles for and greater difficulties collecting accounts receivable; export controls, tariffs and other trade protection measures; social, economic and political instability; and changes in United States and foreign countries laws and policies affecting trade. Sales to international customers represent 35.8%, 43.1%, and 49.7% of net product sales for the years ending September 30, 2003, 2002, and 2001, respectively. REVENUE RECOGNITION Our revenue recognition policy is to recognize revenues when products are shipped, or for certain customers when the products are received by the customer's shipping agent, at which time title transfers to the customer. Our sales are based on standard pricing and our product is shipped with FOB shipping point terms (ExWorks for all but one international customer) at which time all of the risks and rewards of ownership pass to the customer including the risk of collection from the end user; accordingly, revenue is recognized at the time of shipment. Additionally we are not required to repurchase the product nor do we have bill and hold arrangements with any of our customers. In the U.S. and Canada terms are generally prepaid or C.O.D. In some limited cases shipments bear net 30 day terms; however, in no instances is payment ever dependent on the distributors' sale of product to end user. Therefore the guarantee to the Canadian finance company for certain events of default by some of our Canadian distributors does not impact the recognition of revenue for sales made to these distributors. When the financing company finances an end consumer purchase (and pays the distributor), we guarantee that the contract was not fraudulently prepared or entered into only. See "Guarantees" above for further information. On occasion, our customers (distributors) in the United States and Canada offer a five year extended warranty to the end users of our surface cleaner product as a promotion to purchase the product during that demonstration. The five year optional extended warranty is offered to them at no cost; accordingly no revenue is recognized. 58 Discounts earned based on promotional programs in place, volume of purchases or other factors are also estimated at the time of revenue recognition and recorded as a reduction of that revenue. In February 2002, the Emerging Issues Task Force codified and issued EITF 01-9, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendors Products). The pronouncement requires that cash consideration, including sales incentives, given by a vendor to a customer be presumed to be a reduction of the selling prices of the vendor's products or services and, therefore, characterized as a reduction of revenue when recognized in the vendor's income statement. We adopted this pronouncement effective in the second quarter of fiscal 2001 and accordingly recorded a $4,943 cumulative effect of accounting change related to our Distributor Development Program, from inception in 1997. Breakage occurs when a distributor is no longer eligible for the award; the associated accrued liability is derecognized at that time and the resultant termination gain is netted in the contra sales Distributor Development Program line item of our Consolidated Statement of Operations. See Note 2 "Restatement" for further information. RESEARCH AND DEVELOPMENT COSTS Costs incurred in research and development are expensed as incurred and included in SG&A expenses. In fiscal year 2003, 2002, and 2001, we invested $74, $273, and $351, respectively, in new product development. INCOME TAXES We account for income taxes pursuant to the provisions of Statement of Financial Accounting Standards No. 109 ("SFAS 109"), "Accounting for Income Taxes." Under SFAS 109, the tax consequences in the future years for differences between the financial and tax bases of assets and liabilities at year-end are reflected as deferred income taxes. Carrying value of our domestic net deferred tax assets assumes that we will be able to generate sufficient future taxable income in certain tax jurisdictions, based on estimates and assumptions. Management evaluates the realizability of the deferred tax assets quarterly and assesses the need for additional valuation allowances quarterly. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid for interest was $53, $86, and $96 for the years ended September 30, 2003, 2002, and 2001, respectively. Cash paid for income taxes was $29, $56, and $70 for the years ended September 30, 2003, 2002, and 2001. Each of the following transactions has been treated as non-cash financing items for purposes of the Consolidated Statements of Cash Flows. During the third and fourth quarter of fiscal 2002 we recorded $290 in debt in exchange for assets. These vendor-financed assets consisted primarily of tools, molds, and equipment associated with new product development. During the fourth quarter of fiscal 2001, we recorded $588 in debt in exchange for assets. These assets were vendor-financed and consisted primarily of tools, molds, and production equipment also related to new product development. 59 EARNINGS PER SHARE Earnings per share have been computed according to Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share." The following is a reconciliation of the number of shares (denominator) used in the basic and diluted earnings per share computations (shares in thousands) for the year ended September 30,
2003 2002 2001 ------------------ ------------------- ------------------------- Per Per Per Share Share Share Shares Amount Shares Amount Shares Amount ------ ---------- ----- ----------- ----------- ----------- Basic EPS 6,744 $ (1.82) 6,719 $ (0.27) $ 6,691 $ (1.50) Effect of dilutive stock options - - - - - - ----- ---------- ----- ----------- ----------- ----------- Diluted EPS 6,744 $ (1.82) 6,719 $ (0.27) $ 6,691 $ (1.50) ===== ========== ===== =========== =========== ===========
Options outstanding during the years ended September 30, 2003, 2002 and 2001, to purchase approximately 1,164, 1,147, and 1,322 shares of common stock, respectively, were not included in the computation of diluted EPS because the options' exercise prices were greater than the average market prices of the common stock during the period and, therefore, the effect would be anti-dilutive. The exercise prices of the options outstanding at September 30, 2003, range from $1.00 to $7.50 per share and expire between the period January 4, 2004, and August 29, 2010. LONG-TERM COMPENSATION PLAN We apply APB Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations in accounting for our stock plans as allowed under SFAS Statement No. 123, "Accounting for Stock-Based Compensation" (SFAS 123). Had compensation cost for the stock granted in 2003, 2002, and 2001 been determined consistent with SFAS 123, pro forma net (loss) 60 income and earnings per common share would have been as follows (dollars in thousands, except per share data):
2003 2002 2001 -------- -------- --------- Net loss as reported $(12,239) $ (1,833) $ (10,036) Add: Stock-based employee compensation expense included in reported net income, net of related tax effects 2 3 20 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects 93 150 240 -------- -------- --------- PRO FORMA NET LOSS $(12,330) $ (1,980) $ (10,256) ======== ======== ========= BASIC AND DILUTED PER SHARE OF COMMON STOCK: As reported $ (1.82) $ (0.27) $ (1.50) Proforma $ (1.83) $ (0.29) $ (1.53)
FUTURE ACCOUNTING REQUIREMENTS FASB Interpretation No. 46, Consideration of Variable Interest Entities (FIN No. 46): This statement was issued in January 2003 and requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The provisions of FIN 46 are effective immediately for all arrangements entered into after January 31, 2003. For those arrangements entered into prior to February 1, 2003, we are required to adopt the provisions of FIN No. 46 at the end of the first quarter of fiscal 2004, in accordance with the FASB Staff Position 46-R which delayed the effective date of FIN No. 46 for those arrangements. We are in the process of determining the effect, if any, the adoption of FIN No. 46-R will have on our financial statements. SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (SFAS No. 150): This statement, issued in May 2003, establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. SFAS No. 150 has been deferred indefinitely related to certain measurement and disclosure components of the standard; however, certain disclosure provisions are still required if applicable to us. The final adoption of SFAS No. 150 is not expected to have a significant impact, if any, on our financial statements; however, a formal assessment will be performed. 2. RESTATEMENT The accompanying balance sheets as of September 30, 2003 and 2002, and the accompanying statements of operations and of cash flows for the years ended September 30, 2003, 2002 and 2001 have been restated. The adjustments associated with the restatement related to the following: 61 Accrued Distributor Development Liabilities Pursuant to EITF 01-9, "Accounting for Consideration Given by a Vendor to a Customer", which was issued in 2001, we changed the way we account for the potential one million dollar award for the Program. Prior to the adoption of EITF 01-9, we utilized the services of an independent actuary who developed a model based on our historical sales and other factors that identified, in aggregate, the probability of distributors reaching the goal (earning 30,000 credits for sales of our product units) thereby triggering our cash payment obligation. We recognized expense and recorded a liability based on that model. The original intentions of the Program were to aid Master Distributors in their retirement/succession plan and promote growth and retention within the new distributor network. Because of these original intentions and the long-term nature of this Program (fifteen years), management did not consider the implications of EITF 01-9 to the Program and therefore EITF 01-9 was not adopted in 2001 as required. Accordingly, we have restated our revenues to properly reflect the accrual for this award as a reduction of revenues, not as a selling and administrative expense. We have determined that for purposes of EITF 01-9 it is not possible to reasonably estimate such a liability. We have therefore accrued such awards assuming a maximum accrual rate whereby we assume each eligible distributor will earn the award. In other words, for each qualifying sale, we have recorded a liability by reducing revenue. Such a liability will only be derecognized (i.e. the accrual eliminated) when (i) the award is paid out or (ii) when a distributor is no longer eligible for the award. For the years ended September 30, 2003, 2002 and 2001, this adjustment (i) decreased sales by $4,369, $2,589 and $1,009, respectively, and (ii) decreased selling, general and administrative expenses by $713, $191 and $79, respectively. In addition, in the second quarter of fiscal 2001, $4,943 was recorded which represented the cumulative effect of the adoption of EITF 01-9 since the inception of the Program in 1997. Tooling Assets In 2003, we performed an analysis on the potential impairment of certain tooling assets. We concluded from our analysis, which was based upon the held and used model that the tooling assets were fully impaired and accordingly we recorded an impairment charge of $1,613 as of September 30, 2003. We inadvertently omitted impairment charges of $98 for patents and trademarks relating to these tooling assets and have reflected such additional impairment in the restated 2003 consolidated financial statements. Deferred Tax Asset In 2003, we provided a full valuation allowance on our deferred tax assets. As a result of the restatement related to the Distributor Development Program, our recorded income in 2001 changed to a loss and caused a significant cumulative loss for financial statement purposes. Accordingly, we determined that the impairment of our deferred tax assets should be reflected in the second quarter of fiscal 2001, when we first reflected the adoption of EITF 01-9. As a result we reversed the original impairment recorded in fiscal 2003. 62 Summary of Restatement Adjustments The following table summarizes the effects of the restatement adjustments on certain of our previously issued financial statements by type of adjustment and by the affected captions in our Statement of Operations. The various adjustments recorded to prior years as part of the restatement have no effect on our cash flows.
YEAR ENDED SEPTEMBER 30, Summary of Restatement Adjustments by Type 2003 2002 2001 ------------------------------------------ -------- --------- -------- (Increase) decrease to net loss- DISTRIBUTOR DEVELOPMENT LIABILITIES: Revenues $ (4,369) $ (2,589) $ (1,009) Selling, general and administrative expenses 713 191 79 Interest expense - - 15 Cumulative effect of accounting change - - (4,943) TOOLING ASSET IMPAIRMENT Loss on impairment of asset (98) - - DEFERRED TAX ADJUSTMENT Provision for income taxes 4,038 227 (4,265) -------- --------- -------- Total effect of restatement on net loss $ 284 $ (2,171) $(10,123) ======== ========= ========
63 Summary of Restated Financial Data The following tables present a summary of our balance sheet, statements of operations and of cash flows as previously reported, and as restated as a result of the restatement adjustments summarized above. CONSOLIDATED BALANCE SHEETS
Previously Previously RESTATED Reported RESTATED Reported SEPTEMBER 30, September 30, SEPTEMBER 30, September 30, Dollars and shares in thousands, except par values 2003 2003 2002 2002 -------------------------------------------------- ------------- ------------- ------------- ------------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 948 $ 948 $ 481 $ 481 Trade accounts receivable (net of allowance of $194 and $482) 1,892 1,892 2,007 2,007 Inventories: Finished goods 2,555 2,555 2,076 2,076 Work-in-progress, raw material and supplies 2,153 2,153 2,113 2,113 Deferred income taxes - - - 1,476 Prepaid expenses 397 397 292 292 Other current assets 152 152 54 54 -------- -------- -------- -------- Total current assets 8,097 8,097 7,023 8,499 -------- -------- -------- -------- PROPERTY, PLANT AND EQUIPMENT, NET 2,178 2,178 4,310 4,310 -------- -------- -------- -------- OTHER ASSETS: Cost in excess of net assets of acquired businesses (net of accumulated amortization of $-0- and $3,739) - - 5,451 5,451 Deferred income taxes - - - 2,550 Trademarks (net of accumulated amortization of $202 and $162) 272 370 375 375 Other 121 121 271 271 -------- -------- -------- -------- Total other assets 393 491 6,097 8,647 -------- -------- -------- -------- Total assets $ 10,668 $ 10,766 $ 17,430 $ 21,456 ======== ======== ======== ======== LIABILITIES AND STOCKHOLDERS'(DEFICIT) EQUITY CURRENT LIABILITIES: Line of credit $ 1,383 $ 1,383 $ 1,392 $ 1,392 Trade accounts payable 2,143 2,143 1,957 1,957 Income taxes payable 506 506 517 506 Accrued expenses and other liabilities 2,399 3,445 1,863 2,395 Distributor Development Liability due within one year 200 - - - Long-term debt due within one year 22 22 302 302 -------- -------- -------- -------- Total current liabilities 6,653 7,499 6,031 6,552 -------- -------- -------- -------- LONG-TERM LIABILITIES: Long-term debt (less amounts due within one year) 11 11 33 33 Distributor Development Liability (less amounts due within one year) 12,758 - 8,789 - -------- -------- -------- -------- Total long-term liabilities 12,769 11 8,822 33 -------- -------- -------- -------- STOCKHOLDERS' (DEFICIT) EQUITY: Preferred stock, $5 par value; authorized, 300 shares; issued, none - - - - Common stock, $1 par value; authorized, 10,000 shares; issued and outstanding, 6,746 shares 6,746 6,746 6,746 6,746 Capital in excess of par value 8,231 8,231 8,231 8,231 Unearned compensation, net - - (3) (3) (Accumulated deficit) Retained earnings (23,731) (11,721) (11,492) 802 Accumulated other comprehensive loss (Note 1) - - (905) (905) -------- -------- -------- -------- Total stockholders' (deficit) equity (8,754) 3,256 2,577 14,871 -------- -------- -------- -------- Total liabilities and stockholders' (deficit) equity $ 10,668 $ 10,766 $ 17,430 $ 21,456 ======== ======== ======== ========
64 CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED SEPTEMBER 30, 2003 2002 2001 Dollars and shares in thousands, 2003 Previously 2002 Previously 2001 Previously except per share data RESTATED Reported RESTATED Reported RESTATED Reported -------------------------------- -------- ---------- -------- ---------- -------- ---------- REVENUES: Product sales, less returns expenses and allowances 34,539 34,539 37,113 37,113 32,536 32,536 Distributor development program (4,369) - (2,589) - (1,009) - -------- -------- -------- -------- -------- -------- Net product sales $ 30,170 $ 34,539 $ 34,524 $ 37,113 $ 31,527 $ 32,536 -------- -------- -------- -------- -------- -------- OPERATING COSTS AND EXPENSES: Cost of products sold 21,025 21,025 21,298 21,298 19,370 19,370 Selling, general and administrative expenses 13,404 14,117 14,591 14,782 13,306 13,385 Loss on impairment of asset 1,711 1,613 - - - - Loss on liquidation of subsidiary 905 905 - - - - Interest expense 53 53 86 86 86 101 Other (income) expense, net (158) (158) 344 344 186 186 -------- -------- -------- -------- -------- -------- Total operating costs and expenses 36,940 37,555 36,319 36,510 32,948 33,042 -------- -------- -------- -------- -------- -------- (Loss) income before income taxes and cumulative effect of accounting change (6,770) (3,016) (1,795) 603 (1,421) (506) Provision (benefit) for income taxes 18 4,056 38 265 3,672 (593) -------- -------- -------- -------- -------- -------- (Loss) income before cumulative effect of accounting change (6,788) (7,072) (1,833) 338 (5,093) 87 Cumulative effect of accounting change 5,451 5,451 - - 4,943 - -------- -------- -------- -------- -------- -------- NET (LOSS) INCOME $(12,239) $(12,523) $ (1,833) $ 338 $(10,036) $ 87 ======== ======== ======== ======== ======== ======== Weighted average number of shares outstanding: Basic 6,744 6,744 6,719 6,719 6,691 6,691 Diluted 6,744 6,744 6,719 6,719 6,691 6,724 ======== ======== ======== ======== ======== ======== BASIC AND DILUTED PER SHARE OF COMMON STOCK (NOTE 1): (Loss) income before cumulative effect of accounting change $ (1.01) $ (1.05) $ (0.27) $ 0.05 $ (0.76) $ 0.01 Cumulative effect of accounting change $ (0.81) $ (0.81) $ - $ - $ (0.74) $ - -------- -------- -------- -------- -------- -------- NET (LOSS) INCOME $ (1.82) $ (1.86) $ (0.27) $ 0.05 $ (1.50) $ 0.01 ======== ======== ======== ======== ======== ========
65 CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED SEPTEMBER 30, 2003 2002 2001 2003 Previously 2002 Previously 2001 Previously Dollars in thousands RESTATED Reported RESTATED Reported RESTATED Reported -------------------- -------- ---------- -------- ---------- -------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) income $(12,239) $(12,523) $ (1,833) $ 338 $(10,036) $ 87 Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities: Cumulative effect of accounting change 5,451 5,451 - - 4,943 - Loss on impairment of asset 1,711 1,613 - - - - Loss on liquidation of foreign subsidiary 905 905 - - - - Distributor development program 3,969 - 2,589 - 1,033 - Depreciation and amortization 744 744 928 928 913 913 Provision for loss on sale/disposal of assets - - 17 17 - - Provision for loss on receivables - - 59 59 - - Treasury/common shares issued, net of unearned compensation and employee benefit stock - - (5) (5) 83 83 Unearned compensation 3 3 - - - - Deferred income taxes - 4,026 - 235 4,036 (230) Changes in operating assets and liabilities: Decrease in receivables 115 115 100 100 1,181 1,181 Increase in inventories (518) (518) (441) (441) (532) (532) (Increase) decrease in prepaid expenses (105) (105) (108) (108) 227 227 (Increase) decrease in other current assets (98) (98) 309 309 (73) (73) Increase (decrease) in accounts payable 186 186 (343) (343) (258) (258) Increase (decrease) in accrued expenses and other liabilities 536 1,050 188 379 (943) (824) Increase in distributor development liability 200 - - - - - Decrease in income taxes payable (11) - (18) (26) (431) (431) Other, net 105 105 (86) (86) (169) (169) -------- -------- -------- -------- -------- -------- Net cash provided by (used in) operating activities 954 954 1,356 1,356 (26) (26) -------- -------- -------- -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (176) (176) (866) (866) (2,278) (2,278) -------- -------- -------- -------- -------- -------- Net cash used in investing activities (176) (176) (866) (866) (2,278) (2,278) -------- -------- -------- -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net (repayments) borrowing under credit facility (9) (9) 201 201 1,191 1,191 Payment of long term debt (302) (302) (615) (615) (17) (17) -------- -------- -------- -------- -------- -------- Net cash (used in) provided by financing activities (311) (311) (414) (414) 1,174 1,174 -------- -------- -------- -------- -------- -------- Net increase (decrease) in cash and cash equivalents 467 467 76 76 (1,130) (1,130) CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 481 481 405 405 1,535 1,535 -------- -------- -------- -------- -------- -------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 948 $ 948 $ 481 $ 481 $ 405 $ 405 ======== ======== ======== ======== ======== ========
3. PROPERTY, PLANT AND EQUIPMENT
2003 2002 ------ ------ Leasehold improvements $ 288 $ 288 Machinery and equipment 7,747 7,564 Construction in progress - 1,620 ------ ------ 8,035 9,472 Accumulated depreciation 5,857 5,162 ------ ------ Net property, plant and equipment $2,178 $4,310 ====== ======
Depreciation expense relating to continuing operations for the years ended September 30, 2003, 2002, and 2001, was $695, $639, and $608, respectively. 66 During the fourth quarter of fiscal 2003, we performed an analysis on the potential impairment of certain tooling assets approximating $1,613. We concluded from our analysis, which was based upon the held and used model that the tooling assets were fully impaired and accordingly recorded an impairment charge of $1,613 as of September 30, 2003, as the scrap value for these assets was determined to be nominal. Additionally $98 of patents and trademarks relating to these tooling assets were deemed impaired as of September 30, 2003 and accordingly recorded as an addition to the impairment charge as part of our restatement (refer to Note 2). 4. ACCRUED EXPENSES AND OTHER LIABILITIES Accrued expenses and other liabilities consist of the following:
2003 2002 ------ ------ Distributor fund payable $1,020 $ 630 Accrued compensation 544 579 Other 835 654 ------ ------ $2,399 $1,863 ====== ======
The distributor fund payable represents the accumulation of distributor price overrides ("DPO's") such as those that are paid by promoted distributors to promoting distributors. The promoted distributors represent individuals who are recruited as sales associates and subsequently promoted to become distributors themselves. DPO's are a unit price override charged on top of our standard unit sales price for which we, HMI, act as a pass through, meaning that we collect the DPO from the promoted distributor and disburse it to the promoting distributor upon their request; accordingly these DPO's are not reflected in our income statement as revenue, but rather are recorded as an accrual when the receivable is paid The increase in Accrued Distributor Development Costs and Distributor Fund Payable is primarily driven by the increased sales volume in the Americas direct sales network as well as the inception of the Distributor Development (Edge Program) in the International market during the first quarter of fiscal 2003. 5. DEBT AND CREDIT FACILITY In June 2001 we terminated our credit facility of $3,500 with Finova Capital and entered into a $2,000 revolving line of credit with US Bank consisting of loans against our eligible receivables and inventory. The credit agreement calls for interest to accrue at the prime rate (4.00% at September 30, 2003). The facility provided us with an improved interest rate, increased availability and more favorable eligibility requirements, lower annual fees, and less restrictive covenants than the Finova arrangement. The credit facility agreement includes various covenants that include, but are not limited to, restrictions on paying dividends, limitations on our ability to incur additional indebtedness, and minimal requirements on tangible net worth, interest coverage ratio and capital expenditures. On March 1, 2002, we entered into an additional $1,000 revolving line of credit with our current lender consisting of loans against our eligible receivables and inventory. This additional line, which expired on May 31, 2002, carried the same interest rate and covenants as our existing $2,000 revolving line of credit and was obtained to assist, if necessary, with the build-up of 67 inventory associated with the launch of our new product and other strategic initiatives. In July 2002 our lender approved the extension of the expiration date of this additional line to January 31, 2003. In addition, we reset the capital expenditure covenant in anticipation of exceeding the previously established levels during our fiscal year ending September 30, 2002. In January 2003 we entered into an amendment to our credit facility agreement with our current lender. This amendment, which expired January 31, 2004, increased our revolving line of credit from $2,000 to $3,000 and carried the same interest rate and similar covenants as the original loan agreement. As of September 30, 2003, we were not in compliance with our interest coverage ratio and net worth covenants; however, we obtained a waiver on these covenants which was effective until the February 20, 2004 amendment of the credit facility. We were required to maintain an interest coverage ratio of greater than or equal to 5.0 to 1.0 interest to earnings before interest, taxes, depreciation and amortization ("EBITDA") and a net worth of never less than $7,400, calculated quarterly and increasing by 50% of net income annually. On February 20, 2004, an amendment of our $3,000 credit facility agreement was executed with our lender. The credit facility expired October 15, 2004. The amended agreement carries the same interest rate and similar covenants as the previous amended loan agreement, with the exception of the interest coverage ratio which was amended to exclude non-cash expenses from the 5.0 to 1.0 ratio, including but not limited to, the impairment of tooling assets and associated inventory, and the tangible net worth covenant in which the minimum amount was reset to $2,400. The cumulative effect of the adjustments on our statement of operations associated with the restatement of our financial statements was a $12,010 reduction in our net earnings over the period from January 1, 2001 through September 30, 2003. Such an earnings reduction caused us to be in default of our $2,400 tangible net worth covenant. In addition we have violated our financial reporting requirements to the bank as the restatement process has delayed any subsequent filings of our public statements with the Securities and Exchange Commission since our first fiscal quarter of 2003. Our credit agreement covenants require that our statements be filed quarterly with the bank within 45 days of the end of each quarter. On October 15, 2004, an amendment of our $3,000 credit facility agreement was executed with our lender. The bank has agreed to extend the maturity date of the loan until December 31, 2004. In addition the bank provided a waiver for the aforementioned covenant and financial reporting violations. The amended agreement carries an interest rate of prime plus one percent and covenants similar to the previous amended loan agreement, with the exception of the tangible net worth covenant which was eliminated through the maturity date of the loan. As of September 30, 2004, there was $962 borrowed on our $3,000 amended credit facility. During the fourth quarter of fiscal 2001 we recorded $588 in obligations relating to vendor-financed assets. These assets consisted primarily of tools, molds, and production equipment associated with new product development. These obligations required monthly payments, including principal and interest, of $67 with the nominal annual interest rates on these leases ranging from 0.0% to 11.5% compounding monthly. The remaining terms of the obligations ranged from 6 to 13 months and are no longer outstanding at September 30, 2003. 68 During the third and fourth quarters of fiscal 2002 we recorded $290 in obligations relating to vendor-financed assets. These assets consisted primarily of tools, molds, and equipment associated with new product development. These obligations required monthly payments, including interest, of $21 with the nominal annual interest rates on this debt ranging from 0.0% to 2.0% compounding monthly. The remaining terms of the obligations ranged from 6 to 12 months and are no longer outstanding at September 30, 2003. Long-term debt consists of the following:
2003 2002 ------ ------ Bank line of credit - see above $1,383 $1,392 Vendor-finance obligations - 282 bearing interest at 0.00% to 11.50% through October 2002 adjusting to 2.00% thereafter, due in monthly installments of $43 (including interest) through September 2003 Capitalized lease obligations 33 53 bearing interest at 2.62% to 12.00% due in monthly installments of $2 (including interest) through March 2005 ------ ------ 1,416 1,727 Less amounts due within one year 1,405 1,694 ------ ------ $ 11 $ 33 ====== ======
The principal amount of long-term debt payable in the five years ending September 30, 2004, through 2008, is $1,405, $11, $-0-, $-0-, and $-0-. The weighted average interest rate on short-term borrowings at September 30, 2003, and 2002, was 4.08% and 4.50%, respectively. 6. LONG-TERM COMPENSATION PLAN We adopted the Health-Mor Inc. 1992 Omnibus Long-Term Compensation Plan in 1992. The Plan provides for the granting of stock options, stock appreciation rights, restricted stock awards, phantom stock, and/or performance shares ("Awards") to our key employees and stock options for our non-employee directors. Options granted under the Plan expire up to ten years after the date of grant if not exercised and may be exercisable in whole or in part at the discretion of the Committee established by the Board of Directors. Shares available for issuance under the Plan may be authorized and unissued shares or treasury shares. The maximum number of shares of common stock available for grant of Awards under the Plan are limited on an annual and cumulative basis as further defined in the Plan. Stock options under the Plan generally have exercise prices equal to the fair market values at dates of grant, otherwise, if the option price is less than the fair market value at the date of the grant, compensation expense is recorded for the difference. For restricted or phantom stock, we record compensation expense as the excess of the quoted market price of the unrestricted share of stock at the award date over the purchase price, if any. 69 During fiscal 2000 the Board of Directors granted 415,000 incentive stock options (215,000 at $1.0625 per share and 200,000 at $1.25 per share) and 10,000 restricted shares to certain of our key employees in accordance with the Plan. Vesting immediately were 215,000 options. The remaining options, 200,000 options, vest over a 48-month period with the vesting subject to acceleration clauses based upon our company's stock price. No compensation expense was recorded related to the stock options during fiscal 2000 as the exercise price was equal to the fair market value at the grant date. During fiscal 2001 the Board of Directors granted 560,000 incentive stock options (410,000 at $1.15 per share and 150,000 at $1.30 per share) to certain of our key employees in accordance with the Plan. All 560,000 options vest over a three-year period. No compensation expense was recorded related to the stock options as the exercise price was equal to the fair market value at the grant date. No options or awards were granted during fiscal 2003 or 2002 to key employees. There were -0-, -0-, and -0- shares issued and -0-, -0-, and -0- non-vested shares forfeited pursuant to the Plan in fiscal 2003, 2002, and 2001, respectively. Unamortized deferred compensation amounted to $-0-, $3, and $8 at September 30, 2003, 2002, and 2001, respectively. Total compensation expense, in conjunction with the Plan was $3, $5, and $33 in fiscal 2003, 2002, and 2001, respectively. The fair value for all options granted in 2003, 2002, and 2001 were estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions:
2003 2002 2001 OPTIONS OPTIONS OPTIONS ------- ------- ------- Risk free interest rate 3.8% 4.5% 3.9% to 4.9% Expected life of option 4 yrs. 4 yrs. 3 yrs. to 4 yrs. Expected dividend yield of stock 0.0% 0.0% 0.0% Expected volatility of stock 108.8% 102.2% 95.3% to 102.5%
A summary of our stock option activity and related information for the years ended September 30, 2003, 2002, and 2001, is shown in the following table. 70
Shares subject Weighted to option average option (in thousands) price per share -------------- --------------- September 30, 2000, Outstanding 1,061 $ 2.89 Granted 596 1.18 Canceled (54) 5.14 ----- September 30, 2001 1,603 2.18 Granted 46 1.08 Canceled (537) 2.84 ----- September 30, 2002 1,112 1.81 Granted 24 1.00 Canceled (12) 3.63 ----- September 30, 2003, Outstanding 1,124 $ 1.77 =====
Options exercisable and shares available for future grant on September 30 (in thousands except per share data):
2003 2002 2001 ---- ---- ---- Options exercisable 898 704 784 Weighted-average option price per share of options exercisable $1.92 $2.16 $3.16 Weighted-average fair value of options granted during the year $0.49 $0.47 $0.77
The ranges of exercise prices and the remaining contractual life of options as of September 30, 2003, were: Range of exercise prices $1-$2 $2-$8 Options outstanding: Outstanding as of September 30, 2003 (in thousands) 1,024 100 Weighted-average remaining contractual life 2.55 2.72 Weighted-average exercise price $1.21 $7.50 Options exercisable: Outstanding as of September 30, 2003 (in thousands) 798 100 Weighted-average remaining contractual life 2.31 2.72 Weighted-average exercise price $1.22 $7.50
71 7. INCOME TAXES The provision for income taxes relating to continuing operations consists of the following:
2003 2002 2001 ---- ---- ---- Current: Federal and state $ 18 $ 38 $ (314) Foreign - - - ------ ------- -------- 18 38 (314) Deferred expense - - 3,986 ------ ------- -------- $ 18 $ 38 $ 3,672 ====== ======= ========
A reconciliation of the provision for income taxes at the federal statutory rate to that included in the Consolidated Statements of Operation related to earnings from continuing operations is as follows:
2003 2002 2001 ---- ---- ---- Tax at federal statutory rate of 34% $ (2,302) $ (611) $ (2,163) Increases (reductions) in taxes resulting from: Tax expense relating to Internal Revenue Service audits and settlements - - (445) Cumulative translation adjustment write-off with no tax benefit - - - Amortization of cost in excess of net assets of acquired businesses - - 84 Valuation allowances against deferred tax assets 2,302 611 6,118 Other - net 18 38 78 -------- ------- --------- $ 18 $ 38 $ 3,672 ======== ======= =========
The decrease in the effective tax rate from fiscal 2002 to fiscal 2003 is the result of the decrease in pre-tax earnings in fiscal 2003. As a result of the full valuation allowance on all deferred tax assets, an insignificant state provision constituted the entire tax provision for both fiscal 2003 and 2002. The components of deferred tax assets and liabilities are comprised of the following at September 30,
2003 2002 ---- ---- Gross deferred tax assets: Operating loss carryforwards $ 4,434 $ 4,174 Receivable and inventory reserves 859 230 Accrued compensation 161 85 Distributor Development Accruals 4,989 3,384 Other 126 127 ---------- ---------- 10,569 8,000 ---------- ---------- Gross deferred tax liabilities: Depreciation 106 91 Valuation allowances on net deferred tax assets 10,463 7,909 ---------- ---------- Net deferred tax asset $ - $ - ========== ==========
72 The valuation allowance increased from $7,932 to $10,375 due to an increase in deferred tax assets for which a full allowance had previously been established. Periodically and when indicators suggest, we assess the realizability of our domestic deferred tax assets, giving consideration to our actual historical results supplemented by future expected results. SFAS No. 109, "Accounting for Income Taxes" considers a historic pattern of losses as significant negative evidence that tax assets will not be realized and this consideration is not outweighed by any prospective view of management that sufficient taxable income will ultimately be available to realize the tax benefits. Given the history of losses and the results in 2003, we concluded that under the "more likely than not" criteria of SFAS No. 109 a full valuation allowance is still required against the net U.S. deferred tax assets at September 30, 2003. The valuation allowance will be subject to periodic review and can be partially or totally reversed either when income is generated that utilizes the loss or when sufficient positive evidence emerges (i.e. A sustained positive trend of U.S. income for financial accounting purposes.) Our income tax expense recorded in the future will be reduced to the extent of offsetting decreases in our valuation allowance. Net operating loss carryforwards of approximately $12,075 for tax are available to offset future taxable income. The carryforwards will expire in 2005 through 2020. 8. EMPLOYEE BENEFIT PLANS We have a qualified profit sharing plan that covers substantially all employees. The overall contribution to our plan and the allocation method is at the discretion of our Board of Directors. The allocation to the participants is based on a fixed amount per participant, a percentage of eligible wages, or a combination of a fixed amount and a percentage of eligible wages. There was no profit sharing expense for the plan for the years ended September 30, 2003, 2002, and 2001. In addition, we offer a 401(K) savings plan to all of our employees. We match 50% of the first 6% of the employee's contribution to the plan up to a maximum of 6% of compensation. Employees may currently contribute up to 50% of compensation to the plan. Amounts expensed for the years ended September 30, 2003, 2002, and 2001, were $134, $91, and $110, respectively, of which the company match in fiscal 2002 was reduced in the second quarter as the match was funded by forfeitures of prior matches from unvested former participant/employees. 9. COMMITMENTS AND CONTINGENCIES, GUARANTEES AND LEASES We are obligated under certain operating leases for facilities and equipment which expire on various dates through 2008. The minimum annual lease payments under these agreements, including renewal options, if exercised, are $859, $267, $43, $4, and $3 for the years ending September 30, 2004, 2005, 2006, 2007, and 2008, respectively. Rent expense was $956, $1,035, and $1,104 for the years ended September 30, 2003, 2002, and 2001, respectively. LITIGATION Bliss Technologies, Inc. ("Bliss"), the company formed from the 1998 sale of the subsidiary of HMI, filed for bankruptcy in January 2000 in the United States Bankruptcy Court, Eastern District of Michigan. In a separate action filed in 2002, the Official Committee of Unsecured Creditors of Bliss alleges a fraudulent conveyance claim against us asserting that the sale of Bliss in 1998 was a fraudulent transfer insofar as we received more for Bliss than it was worth and that Bliss was insolvent from its inception. Former directors of Bliss, Mark Kirk and Carl Young, are also named as defendants in the action. Claims pending against them allege that in their capacity 73 as Bliss directors they breached fiduciary duties to Bliss creditors. The complaint seeks damages in an unspecified sum. The claims against us and the claims against Mr. Kirk and Mr. Young are being vigorously defended. We believe that we will resolve this matter in a manner that will not have a material adverse effect on our consolidated financial position, results of operations, or cash flows. CONET Industries, Inc., Royal Queen Club International Limited, Chang-whan Chang and Young-so Song ("Plaintiffs") filed a complaint against HMI on or about February 18, 2001, in the Seoul, Korea District Court. It was served by Registered Mail upon HMI at our corporate offices in Seven Hills, Ohio, on or around April 10, 2002. The complaint was filed as a result of lawsuits by us against Mr. Song, a former HMI Distributor in Korea, and Royal Queen Club concerning Mr. Song's CYVAC product. In our lawsuits, we sought and were granted preliminary injunctions against Plaintiffs that prohibited Plaintiffs from manufacturing and selling the old model CYVAC for 311 days and the new model CYVAC for 209 days until the Seoul High Court issued a declaration of suspension of the injunctions. Despite the fact that Plaintiffs had been enjoined by the Courts, Plaintiffs allege that we should compensate them for actual damages for sale discontinuance, supplemental managerial costs, and new mold fabrication costs due to the interruption in the manufacturing and marketing of each product during that period. Plaintiffs also claim that we tortuously interfered with Plaintiffs' business advantages, caused irreparable harm to Plaintiffs' normal business activities, and damaged Plaintiffs' reputation and standing. Chang-whan Chang and Young-so Song allege that they have been critically damaged personally due to the accusations, improper provisional seizure and criminal allegations alleged by us, which they assert resulted in disturbance to business, reputation, and credit. All matters are pending. The Plaintiffs originally alleged damages in excess of U.S. $21,894. After several hearings the court ruled in our favor and against the Plaintiffs on all counts. We have been notified that the Plaintiffs have appealed this decision in accordance with Korean law. We believe that we will resolve this matter in a manner that will not have a material adverse effect on our consolidated financial position, results of operations, or cash flows. Claims arising in the ordinary course of business are also pending against us. Although these are in various stages of the litigation process, we believe that none of these matters will have a material adverse effect on our consolidated financial position, results of operations, or cash flows. Included in the accompanying Consolidated Balance Sheets at September 30, 2003, and 2002, were accruals of $15 and $15, respectively, relating to various claims. 74 10. QUARTERLY FINANCIAL DATA (UNAUDITED) The below quarterly financial data has been restated to reflect the adoption of the Emerging Issues Task Force issued EITF 01-9, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendors Products). See Note 2 for further information.
2003, Restated ----------------------------------------------------------- December 31, March 31, June 30, September 30, ------------ ---------- --------- ------------- Product revenues $ 8,826 $ 9,295 $ 8,873 $ 7,545 Distributor development program $ (819) $ (1,409) $ (1,072) $ (1,069) Net product revenues $ 8,007 $ 7,886 $ 7,801 $ 6,476 Gross margin, exclusive of distributor development program $ 3,584 $ 3,703 $ 3,617 $ 2,610 Loss before cumulative effect of accounting change $ (549) $ (2,122) $ (785) $ (3,332) Cumulative effect of accounting change $ 5,451 $ - $ - $ - Net loss $ (6,000) $ (2,122) $ (785) $ (3,332) Basic and diluted per share of common stock: Loss before cumulative effect of accounting change $ (0.08) $ (0.31) $ (0.12) $ (0.50) Cumulative effect of accounting change $ (0.81) $ - $ - $ - Net loss $ (0.89) $ (0.31) $ (0.12) $ (0.50)
2003, Previously Reported ---------------------------------------------------------- December 31, March 31, June 30, September 30, ------------ ----------- ---------- ------------- Product revenues $ 8,826 $ 9,295 $ 8,873 $ 7,545 Distributor development program $ - $ - $ - $ - Net product revenues $ 8,826 $ 9,295 $ 8,873 $ 7,545 Gross margin, exclusive of distributor development program $ 3,584 $ 3,703 $ 3,617 $ 2,610 Income (loss) before cumulative effect of accounting change $ 88 $ (893) $ 74 $ (6,341) Cumulative effect of accounting change $ 5,451 $ - $ - $ - Net (loss) income $ (5,363) $ (893) $ 74 $ (6,341) Basic and diluted per share of common stock: Income (loss) before cumulative effect of accounting change $ 0.01 $ (0.13) $ 0.01 $ (0.94) Cumulative effect of accounting change $ (0.81) $ - $ - $ - Net (loss) income $ (0.80) $ (0.13) $ 0.01 $ (0.94)
As of October 1, 2002, a full impairment of the goodwill recorded on HMI's books was recorded through a non-cash charge of $5,451. Such charge is non-operational in nature and is reflected as 75 a Cumulative Effect of Accounting Change in the accompanying Consolidated Statements of Operations for the year ended September 30, 2003. See Note 1 for further information. During the second quarter of fiscal 2003 we recorded a write-off of $905 for cumulative translation adjustments associated with the liquidation of our Canadian subsidiary. During the fourth quarter of fiscal 2003, we performed an analysis on the potential impairment of certain tooling assets, and related patents and trademarks, approximating $1,711. We concluded from our analysis, which was based upon the held and used model that the tooling assets were fully impaired and accordingly recorded an impairment charge of $1,711 as of September 30, 2003, as the scrap value for these assets was determined to be nominal.
2002, Restated ------------------------------------------------------ December 31, March 31, June 30, September 30, ------------ --------- -------- ------------- Product revenues $ 9,371 $ 10,598 $ 9,307 $ 7,837 Distributor development program $ (301) $ (556) $ (714) $ (1,018) Net product revenues $ 9,070 $ 10,042 $ 8,593 $ 6,819 Gross margin, exclusive of distributor development program $ 4,344 $ 4,655 $ 3,862 $ 2,954 Net income (loss) $ 66 $ (504) $ (410) $ (985) Basic and diluted income per share of common stock $ 0.01 $ (0.08) $ (0.06) $ (0.14)
2002, Previously Reported ------------------------------------------------------- December 31, March 31, June 30, September 30, ------------ --------- -------- ------------- Product revenues $ 9,371 $ 10,598 $ 9,307 $ 7,837 Distributor development program $ - $ - $ - $ - Net product revenues $ 9,371 $ 10,598 $ 9,307 $ 7,837 Gross margin, exclusive of distributor development program $ 4,344 $ 4,655 $ 3,862 $ 2,954 Net income (loss) $ 184 $ (9) $ 156 $ 7 Basic and diluted income per share of common stock $ 0.03 $ - $ 0.02 $ -
76
2001, Restated --------------------------------------------------- December 31, March 31, June 30, September 30, ------------ --------- -------- ------------- Product revenues $ 7,446 $ 8,956 $ 8,980 $ 7,154 Distributor development program - $ (292) $ 50 $ (767) Net product revenues $ 7,446 $ 8,664 $ 9,030 $ 6,387 Gross margin, exclusive of distributor development program $ 3,097 $ 3,780 $ 3,556 $ 2,733 Income (loss) before cumulative effect of accounting change $ (117) $ (3,974) $ 88 $ (1,090) Cumulative effect of accounting change $ - $ 4,943 $ - $ - Net (loss) income $ (117) $ (8,917) $ 88 $ (1,090) Basic and diluted per share of common stock: Income (loss) before cumulative effect of accounting change $ (0.02) $ (0.59) $ 0.01 $ (0.16) Cumulative effect of accounting change $ - $ (0.74) $ - $ - Net (loss) income $ (0.02) $ (1.33) $ 0.01 $ (0.16)
2001, Previously Reported ----------------------------------------------------- December 31, March 31, June 30, September 30, ------------ ---------- --------- ------------- Product revenues $ 7,442 $ 9,032 $ 9,033 $ 7,029 Distributor development program $ - $ - $ - $ - Net product revenues $ 7,442 $ 9,032 $ 9,033 $ 7,029 Gross margin, exclusive of distributor development program $ 3,097 $ 3,780 $ 3,556 $ 2,733 Income (loss) before cumulative effect of accounting change $ (117) $ 392 $ 49 $ (237) Cumulative effect of accounting change $ - $ - $ - $ - Net (loss) income $ (117) $ 392 $ 49 $ (237) Basic and diluted per share of common stock: Income (loss) before cumulative effect of accounting change $ (0.02) $ 0.06 $ 0.01 $ (0.04) Cumulative effect of accounting change $ - $ - $ - $ - Net (loss) income $ (0.02) $ 0.06 $ 0.01 $ (0.04)
In February 2002, the Emerging Issues Task Force issued EITF 01-9, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendors Products). The pronouncement requires that cash consideration, including sales incentives, given by a vendor to a customer be presumed to be a reduction of the selling prices of the vendor's products or services and, therefore, characterized as a reduction of revenue when recognized in the vendor's income statement. We adopted this pronouncement in the second quarter of fiscal 2001 and accordingly recorded a $4,943 cumulative effect of accounting change related to our Distributor Development Programs. 77 In the second quarter of fiscal 2001 we concluded that a full valuation allowance for our deferred tax assets was required. Accordingly, we have recorded a non-cash charge in the second quarter of fiscal 2001 of $6,647 to increase our valuation allowance for our deferred tax assets. 11. Related Party Transactions James R. Malone, our former Chairman and Chief Executive Officer, Darrell Weeter, President of the Company's Americas division, and John Glomb, a Regional Vice President of the Company, each own 31.67% of the membership interests in a Company called Vision Capital Logistics, LLC ("VCL"). VCL, a brokerage service provider for sourcing consumer credit, assists its clients in securing third party financing for its clients' customers to purchase products, including products manufactured by us and sold by our Distributors. VCL charges additional fees to our Distributors for these financing services. VCL's client list also includes a number of other "direct sales" companies, including other floor care companies. In securing such financing, VCL may guarantee the legal compliance obligations (but not any payment obligations) of our Distributors to a third party lender. The third party lender pays VCL a participation fee for such financing services, a part of which (twelve percent (12%)) VCL pays to us. During the fiscal years ended September 30, 2003, 2002 and 2001, VCL paid us $24, $17 and $10, respectively in connection with such financing services. Additionally, in certain cases a Distributor may not be able to complete a sale because of the substandard credit status of the retail customer. In such cases VCL may provide the Distributor with financing for this sale. We entered into an arrangement with VCL known as a Swap Program under which VCL will purchase the contract of the retail customer from the Distributor and arrange for the financing of the contract at a significant discount. To replace the product sold by our Distributor and for which the Distributor received only a portion of the consumer sale price, VCL will purchase a replacement product from us at the same price paid by our Master Distributors and we will ship it to the Distributor to replace the product the Distributor just sold. During the fiscal years ended September 30, 2003, 2002 and 2001, VCL purchased an aggregate of $35, $19 and $19, respectively of our products under the Swap Program. Under the terms of our credit facility in place from time to time, we were prohibited from engaging in certain of the financing activities provided by VCL. From June 2000 until January 2003 we sublet to VCL a portion of our office space in Naples, Florida. During the fiscal years ended September 30, 2003, 2002, and 2001 VCL paid us $8, $24 and $13, respectively, in rent for such space, which amount was based upon an allocation of our total monthly lease payments to the amount of space utilized by VCL. In February, 2003 a new lease was entered into for office space with VCL as the tenant. We began subleasing space from VCL for $3 per month, which amount was based upon an allocation of VCL's total monthly lease payments to the amount of space that we utilized. In the fiscal year ended September 30, 2003 we paid VCL a total of $21 in lease payments. The sublease was terminated in February, 2004. We have had a long standing relationship with Ametek Inc. by which we have purchased motors for our products. James R. Malone, our former Chairman and Chief Executive Officer, is a director of Ametek, Inc. During the fiscal years ended September 30, 2003, 2002 and 2001 our purchases from Ametek were $1,973, $1,704 and $1,633, respectively. We believe the terms of these purchases were as favorable to us as those which could have been obtained from unrelated parties. 78 Darrell Weeter, has served for many years as President of FVS, Inc. a distributor of products manufactured by us and which is owned by Mr. Weeter and his wife. For the fiscal years ended September 30, 2003, 2002 and 2001, FVS, Inc. purchased, at Master Distributor pricing, a total of $78, $100 and $107 respectively in products from us. Mr. Weeter also received amounts due to him under our Career Development Program of $132, $126 and $165 for the fiscal years ended September 30, 2003, 2002 and 2001, respectively. The amounts paid were Distributor paid overrides ("DPO's") collected by us from Distributors that were brought into the business by Mr. Weeter. DPO's are a unit price override charged on top of our standard unit sales price for which we, HMI, act as a pass through, meaning that we collect the DPO from the promoted distributor and disburse it to the promoting distributor upon their request; accordingly these DPO's are not reflected in our income statement as revenue. The total DPO's still owed to Mr. Weeter were $3 and $12 as of September 30, 2003, and 2002, respectively. This payable to Mr. Weeter was recorded on the other accrued expense and liabilities line item of our Consolidated Balance Sheets as of September 30, 2003, and 2002. Derek Hookom, became an employee of HMI on January 1, 2003. Mr. Hookom is also a distributor of products manufactured by HMI. For the fiscal years ended September 30, 2003, 2002 and 2001, Summit Air purchased, at Master Distributor pricing, a total of $254, $604 and $1,133 respectively in products from us. Under the terms of Mr. Hookom's employment agreement, Mr. Hookom remains eligible to receive the Millionaires Club Award associated with the Edge Success Program through sales generated by his personally developed sales network. The Company incurred $173 of distributor development program revenue reduction associated with Mr. Hookom's participation in the Program for the fiscal year ended September 30, 2003. Mr. Hookom also received DPO's due to him under our Career Development Program of $102, $58 and $1, for the fiscal years ended September 30, 2003, 2002 and 2001, respectively. The amounts paid were Distributor paid overrides collected by us from Distributors that were brought into the business by Mr. Hookom. The total DPO's still owed to Mr. Hookom was $38 as of September 30, 2003. This payable to Mr. Hookom was recorded on the other accrued expense and liabilities line item of our Consolidated Condensed Balance Sheets as of September 30, 2003. The above amounts are not considered to be significant to the financial statements as a whole and therefore have not separately identified in the Consolidated Condensed Balance Sheets, Statements of Operations or Statements of Cash Flow. 12. SUBSEQUENT EVENTS On February 2, 2004, the Board of Directors accepted the resignation and retirement of James R. Malone, the Chairman and Chief Executive Officer. Consequently, compensation expense of approximately $200 was recorded in the second quarter of fiscal 2004 in accordance with Mr. Malone's provisions of his resignation. Our credit facility agreement includes, but is not limited to, various covenants that limit our ability to incur additional indebtedness, restrict paying dividends, maintain a minimum net worth, and limit the ability for capital expenditures. As of September 30, 2003, we were not in compliance with our interest coverage ratio and net worth covenants; however, we obtained a waiver on this covenant which was effective until the February 20, 2004 amendment of the credit 79 facility. We were required to maintain an interest coverage ratio of greater than or equal to 5.0 to 1.0 interest to earnings before interest, taxes, depreciation and amortization ("EBITDA") and a net worth of never less than $7,400, calculated quarterly and increasing by 50% of net income annually. On February 20, 2004, an amendment of our $3,000 credit facility agreement was executed with our lender. The credit facility expired October 15, 2004. The amended agreement carries the same interest rate and similar covenants as the previous amended loan agreement, with the exception of the interest coverage ratio which was amended to exclude non-cash expenses from the 5.0 to 1.0 ratio, including but not limited to, the impairment of tooling assets and associated inventory, and the tangible net worth covenant in which the minimum amount was reset to $2,400. The cumulative effect of the adjustments on our statement of operations associated with the restatement of our financial statements was a $12,010 reduction in our net earnings over the period from January 1, 2001 through September 30, 2003. Such an earnings reduction caused us to be in default of our $2,400 tangible net worth covenant. In addition we have violated our financial reporting requirements to the bank as the restatement process has delayed any subsequent filings of our public statements with the Securities and Exchange Commission since our first fiscal quarter of 2003. Our credit agreement covenants require that our statements be filed quarterly with the bank within 45 days of the end of each quarter. On October 15, 2004, an amendment of our $3,000 credit facility agreement was executed with our lender. The bank has agreed to extend the maturity date of the loan until December 31, 2004. In addition the bank provided a waiver for the aforementioned covenant and financial reporting violations. The amended agreement carries an interest rate of prime plus one percent and covenants similar to the previous amended loan agreement, with the exception of the tangible net worth covenant which was eliminated through the maturity date of the loan. 80 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON FINANCIAL STATEMENT SCHEDULE To the Board of Directors and Stockholders of HMI Industries Inc. Our audits of the consolidated financial statements referred to in our report dated February 13, 2004, except for Note 2, Note 5, and Note 12, as to which the date is October 20, 2004, appearing in the 2003 Annual Report to Shareholders of HMI Industries, Inc. (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K/A) also included an audit of the financial statement schedule listed in Item 15(a)(2) of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. /s/ PricewaterhouseCoopers LLP - ------------------------------ Cleveland, Ohio February 13, 2004 (except for Note 2, Note 5, and Note 12, as to which the date is October 20, 2004) 81 HMI INDUSTRIES INC. SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS AND RESERVES Dollars in thousands
Balance at Additions Balance at Beginning of Charged to End of Description Period Costs and Expense Deductions Period ----------- ------ ----------------- ---------- ------ Valuation account for accounts receivable: Year ended September 30, 2003 $ 482 $ - $ 288 $ 194 Year ended September 30, 2002 $ 464 $ 59 $ 41 $ 482 Year ended September 30, 2001 $ 507 $ - $ 43 $ 464 Valuation account for inventory: Year ended September 30, 2003 $ 109 $ 177 $ 175 $ 111 Year ended September 30, 2002 $ 199 $ 56 $ 146 $ 109 Year ended September 30, 2001 $ 235 $ 90 $ 126 $ 199 Valuation for deferred tax asset: Year ended September 30, 2003 $ 7,909 $ 2,554 $ - $ 10,463 Year ended September 30, 2002 $ 7,496 $ 763 $ 350 $ 7,909 Year ended September 30, 2001 $ 849 $ 6,647 $ - $ 7,496
82 EX-23 2 l10118aexv23.txt CONSENT OF INDEPENDENT ACCOUNTANTS Exhibit 23 Consent of Independent Accountants We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (File No. 333- 47153) of HMI Industries Inc. of our report dated February 13, 2004 (except for Note 2, Note 5 and Note 12, as to which the date is October 20, 2004), relating to the consolidated financial statements, which appears in this Annual Report on Form 10-K/A. We also consent to the incorporation by reference of our report dated February 13, 2004 (except for Note 2, Note 5 and Note 12, as to which the date is October 20, 2004) relating to the Financial Statement Schedule, which appears in this Form 10-K/A. PricewaterhouseCoopers LLP Cleveland, Ohio October 22, 2004 EX-31.1 3 l10118aexv31w1.txt CERTIFICATION Exhibit 31.1 CERTIFICATIONS I, Kirk W. Foley, certify that: 1. I have reviewed this Form 10-K/A of HMI Industries Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's Board of Directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ Kirk W. Foley ----------------- Kirk W. Foley Principal Executive Officer and Chairman October 22, 2004 EX-31.2 4 l10118aexv31w2.txt CERTIFICATION Exhibit 31.2 CERTIFICATIONS I, Julie A. McGraw, certify that: 1. I have reviewed this Form 10-K/A of HMI Industries Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's Board of Directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ Julie A. McGraw ------------------- Julie A. McGraw Chief Financial Officer and Treasurer October 22, 2004 EX-32.1 5 l10118aexv32w1.txt CERTIFICATION Exhibit 32.1 CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 ( 18 U.S.C. SECTION 1350) In connection with the accompanying Annual Report of HMI Industries Inc. (the "Company") on Form 10-K/A (the "Report") for the fiscal year ended September 30, 2003 as filed with the Securities and Exchange Commission, I, Kirk W. Foley, Principal Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Kirk W. Foley ----------------- Kirk W. Foley Principal Executive Officer October 22, 2004 EX-32.2 6 l10118aexv32w2.txt CERTIFICATION Exhibit 32.2 CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 ( 18 U.S.C. SECTION 1350) In connection with the accompanying Annual Report of HMI Industries Inc. (the "Company") on Form 10-K/A (the "Report") for the fiscal year ended September 30, 2003 as filed with the Securities and Exchange Commission, I, Julie A. McGraw, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Julie A. McGraw ------------------- Julie A. McGraw Chief Financial Officer October 22, 2004 -----END PRIVACY-ENHANCED MESSAGE-----