10-K/A 1 e10k2003a2.txt FORM 10-K/A AMENDMENT NO. 2 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K/A Amendment No. 2 (Mark One) [*]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the fiscal year ended May 31, 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: 333-93711 ICON Health & Fitness, Inc. (Exact name of registrant as specified in its charter) Delaware 87-0531206 (State or other jurisdiction of (I.R.S. Employer Identification incorporation or organization) No.) 1500 South 1000 West, Logan, Utah 84321 (Address and zip code of principal executive offices) 435 750-5000 (Registrant's telephone number, including area code) Not Applicable (Former name, former address and former fiscal year, if changed since last report) Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [*] No [ ] APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by checkmark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes [ ] No [ ] APPLICABLE ONLY TO CORPORATE ISSUERS Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: ICON Health & Fitness, Inc. 1,000 shares. Explanatory Note This Amendment No. 2 on Form 10-K/A (this Amendment) amends Amendment No. 1 to the Annual Report on Form 10-K for the fiscal year ended May 31, 2003, filed on October 14, 2003. The Company has filed this Amendment to give effect to the restatement of the Company's balance sheets as of May 31, 2003 and 2002 as discussed in Note 2 to the Consolidated Financial Statements to reflect borrowings under its credit agreement as a current liability. ICON Health & Fitness, Inc. INDEX Page No. -------- PART II Item 6. Selected Financial Data 2 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 3 Item 8. Financial Statements and Supplementary Data 12 Item 6. Selected Financial Data The selected financial data set forth below with respect to our statements of operations for the three years ended May 31, 2003 and the balance sheet data for May 31, 2003 and May 31, 2002 have been derived from our financial statements included elsewhere in this Form 10-K that have been audited by PricewaterhouseCoopers LLP, independent registered public accounting firm, as indicated in their report included elsewhere in this Form 10-K. Our statement of operations data for the years ended May 31, 2000 and 1999, and our balance sheet data as of May 31, 2001, 2000 and 1999, have been derived from the financial statements audited by PricewaterhouseCoopers LLP but not included in this Form 10-K. The data set forth should be read together with, and is qualified in its entirety by, "Management's Discussion and Analysis of Financial Condition and Results of Operations," our consolidated financial statements, and the related notes thereto appearing elsewhere in this Form 10-K.
For the Year Ended May 31, (in millions) 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- Operating Data: Net sales(1) $1,011.5 $871.4 $797.0 $712.8 $687.9 Cost of sales 713.4 635.0 580.5 531.6 514.0 ----------------------------------------------- Gross profit 298.1 236.4 216.5 181.2 173.9 Operating expenses: Selling 134.1 101.4 86.3 75.8 85.3 Research and development 11.6 10.4 10.9 8.3 7.7 General and administrative 81.8 68.1 64.5 61.3 53.4 ----------------------------------------------- Total operating expenses 227.5 179.9 161.7 145.4 146.4 ----------------------------------------------- Income from operations 70.6 56.5 54.8 35.8 27.5 Interest expense 25.1 26.2 34.8 33.9 33.1 Amortization of deferred financing fees 1.2 3.1 3.2 2.7 7.0 Net income (loss) 26.7 19.4 13.3 (6.6) (24.7) Other Financial Data: Depreciation and amortization $ 19.2 $ 19.2 $ 17.4 $ 16.7 $ 17.4 Purchases of property and equipment(2) 17.0 11.6 16.1 12.9 11.6 Net cash provided by operating activities 31.6 37.5 12.4 0.5 38.0 Net cash used in investing activities (21.8) (17.1) (22.8) (19.9) (20.1) Net cash provided by (used in) financing activities (12.3) (19.3) 8.7 21.4 (17.1) Supplemental Data: EBITDA(3) $ 89.8 $ 68.3 $ 72.1 $ 49.4 $ 44.9 Balance Sheet Data (at the end of the period): Cash $ 4.7 $ 4.8 $ 3.3 $ 5.9 $ 4.3 Working capital (as restated)(4) 100.5 65.9 (48.4) (61.3) (45.1) Total assets 465.1 423.2 405.5 368.1 331.9 Long-term obligations (as restated)(4) 162.6 157.7 47.3 48.6 100.3 ---------- (1) In November of 2001, the Emerging Issues Task Force issued EITF 01-09, "Accounting for Consideration Given by a Vendor to a Customer" ("EITF 01-09") effective for annual or interim financial statements for periods beginning after December 15, 2001. For comparative purposes, net sales are shown as if EITF 01-09 had been adopted for all periods. (2) Excludes purchases of intangibles and trademarks and acquisitions of $4.9 million for fiscal year 2003, $5.5 million for fiscal year 2002, $6.7 million for fiscal year 2001, $4.4 million for fiscal year 2000 and $8.5 million for fiscal year 1999. (3) EBITDA is a presentation of "earnings before interest, taxes, depreciation and amortization." EBITDA data is included because management understands that such information is considered by bankers and certain investors as an additional basis on evaluating a company's ability to pay interest, repay debt and make capital expenditures. EBITDA may not be comparable to similarly titled measures reported by other companies. In addition, EBITDA is a non-GAAP measure and should not be considered an alternative to operating or net income in measuring company results. Our definition of EBITDA may differ from definitions of EBITDA used by other companies. A reconciliation of net income to EBITDA can be found in Management's Discussion and Analysis of Financial Condition and Results of Operations under the heading Results of Operations. The following table includes a list of unusual items that have affected EBITDA. For the Year Ended May 31, ------------------------------------- 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- (In millions) Loss on extinguishment of debt - 7.4(a) - - - Kmart bankruptcy bad debt 9.1(b) 2.4(b) - - - Excess air freight charges - - - 6.0(c) - Non-recurring recapitalization cost - - - 1.8(d) - Equity grant to senior management - - - 3.1(e) - Non-recurring costs in selling expense - - - - 10.5(f) --------------- (a) A loss of approximately $7.4 million was recorded on the extinguishment of the Company's Old 1999 Credit Facilities and the 12% Notes. (b) On January 22, 2002, Kmart filed for bankruptcy protection. On that date, we had $12.1 million of unsecured accounts receivable outstanding with Kmart. We disposed of the remaining balance of the pre-bankruptcy receivables in the third quarter of fiscal 2003. (c) We incurred $6.0 million of in-bound air freight charges (in cost of sales) in excess of normal freight costs. Due to our significant indebtedness, certain of our vendors shortened our payment terms prior to our recapitalization in September 1999. Due to liquidity constraints we had to delay the purchase of certain component parts and finished goods, and we therefore incurred additional in-bound air freight expenses related to these items that we needed to receive rapidly in order to meet our customers' delivery schedules. (d) We recorded $1.5 million of non-recurring costs (in general and administrative expense) related to management retention bonuses, paid to certain executive officers, and $0.3 million of one-time non-recurring costs associated with the redemption of our 13% senior subordinated notes due 2002, both in connection with our recapitalization in September 1999. (e) We recorded $3.1 million of non-recurring non-cash costs (in general and administrative expense) related to an equity grant made to certain members of senior management due to our recapitalization in September 1999. (f) We recorded $10.5 million of non-recurring costs (in selling expenses) related to the write-off of accounts receivable due to the bankruptcy of Service Merchandise. (4) The credit agreement, which includes our $210 million revolving credit line and our term loan ("Credit Agreement"), requires us to maintain a lockbox arrangement whereby remittances from our customers reduce the borrowings outstanding under the Credit Agreement. In January 2004, we determined that the Credit Agreement also contains a Material Adverse Effect ("MAE") clause which grants the agent and lenders having more than 66 and 2/3% of the commitment or borrowings the right to block our requests for future advances. EITF Issue 95-22 "Balance Sheet Classification of Borrowings Outstanding Under Revolving Credit Agreements That include both a Subjective Acceleration Clause and a Lockbox Arrangement" requires borrowings under credit agreements with these two provisions to be classified as current obligations. The credit agreement in place prior to the one entered into on April 9, 2002 also contained a MAE clause. Accordingly, we have classified the outstanding borrowings under these Credit Agreements, which were previously classified as long-term debt and totaled $86.3 million, $98.1 million, $206.0 million, $193.6 million and $45.1 as of May 31, 2003, 2002, 2001, 2000 and 1999; respectively, as a short-term liability.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. The following should be read in conjunction with the financial statements and the related notes thereto appearing elsewhere in this Form 10-K. Our fiscal year ends on May 31 of the corresponding calendar year. For example, fiscal 2003 ended on May 31, 2003. Recent Developments In fiscal 2003, we formed a foreign subsidiary to build a manufacturing facility in Xiamen, China. The total project cost is anticipated to be approximately $12.0 million, with $7.0 million to be funded in the form of capital contributions, and approximately $5.0 million in the form of debt. Our share of the equity investment is expected to be approximately $5.0 million. We are in the process of arranging for the debt portion of the financing, which is expected to be provided by the Bank of China. Overview We manufacture and market a broad line of cardiovascular and other equipment and strength training equipment. We are one of the largest manufacturers and marketers of home fitness equipment in the United States. In addition, we manufacture and distribute an innovative line of cardiovascular and other equipment and strength training equipment for the institutional fitness equipment market. We sell our products under a wide variety of brand names and we use our portfolio of brands to tailor our product offerings to specific distribution channels. We sell our products to department stores, mass retailers and warehouse clubs, sporting goods and specialty fitness retailers, directly to consumers, and health clubs. The following paragraphs provide a brief description of certain items that appear in our Consolidated Statements of Operations. Net sales. Net sales primarily represent our gross sales adjusted for returns and allowances. We limit our customers' ability to return merchandise to us to products sold to their customers in which defects were discovered within the warranty coverage period (usually 90 days from the time of retail sale). We do not permit our customers to return unsold merchandise. Cost of sales. Cost of sales primarily includes the cost of components that we purchase, direct manufacturing labor and overhead, inbound shipping and freight and depreciation expense related to our property, plant, equipment and tooling. Selling expense. Selling expense primarily includes our direct advertising expense, advertising allowances provided to certain customers and the costs related to our sales and marketing staff for our home fitness and institutional fitness business. Research and development expense. Research and development expense relates primarily to the activities of our product development group and external sources related to the development of new products and product enhancements. General and administrative expense. General and administrative expense primarily includes expenses related to our senior management team, all accounting and finance functions, management information systems, legal and human resources expenses and unallocated overhead expenses. Critical Accounting Policies Critical accounting policies are those that require application of management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. Our significant accounting policies are described in Note 3 to the Consolidated Financial Statements. Not all of these significant accounting policies require management to make difficult, subjective or complex judgments or estimates. However, the following accounting policies could be deemed to be critical. Inventories - Inventories consist primarily of raw materials (principally parts and supplies) and finished goods, and are valued at the lower of cost or market. Cost is determined using standard costs which approximate the first-in, first-out (FIFO) method. Intangible Assets - We adopted the provisions of SFAS No. 142, "Goodwill and Other Intangible Assets" effective June 1, 2002. SFAS No. 142 no longer requires the amortization of goodwill and other indefinite lived intangibles. As a result, results for the year ended May 31, 2003 were positively impacted by a $0.4 million elimination of such amortization. As of May 31, 2003, we had approximately $5.6 million of unamortized goodwill. Under the provisions of SFAS No. 142, we are required to test these assets for impairment at least annually. The annual impairment tests have been completed and did not result in an impairment charge. To the extent an impairment is identified in the future, we will record the amount of the impairment as an operating expense in the period in which it is identified. Long-Lived Assets - Long-lived assets are reviewed for impairment whenever events or circumstances indicate that the carrying amount of long-lived assets may not be recoverable. The carrying value of a long-lived asset is considered impaired when the anticipated cumulative undiscounted cash flows from that asset is less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair market value of the long-lived asset, which is generally based on discounted cash flows. As a result of our review, we do not believe that any impairment currently exists related to our long-lived assets. Revenue Recognition - We recognize revenue upon the shipment of product to the customer. Allowances are recognized for estimated returns, discounts, advertising programs and warranty costs associated with these sales. Income Taxes - We account for income taxes utilizing the asset and liability method as prescribed by SFAS No. 109, "Accounting for Income Taxes". Deferred tax assets and liabilities are recorded based on the differences between the financial statement and tax bases of assets and liabilities at currently enacted tax rates. If appropriate, deferred tax assets are reduced by a valuation allowance which reflects expectations of the extent to which such assets will be realized. Contingencies - We account for contingencies in accordance with SFAS No. 5, "Accounting for Contingencies". SFAS No. 5 requires that we record an estimated loss from a loss contingency when information available prior to issuance of the consolidated financial statements indicates that it is probable that an asset has been impaired or a liability can be reasonably estimated. Accounting for contingencies such as environmental, legal and income tax matters requires us to use our judgment. While we believe that our accruals for these matters are adequate, if the actual loss from a loss contingency is significantly different from the estimated loss, our results of operations will be affected in the period the contingency is resolved. Results of Operations The following table sets forth certain of our financial data, expressed as a percentage of net sales, for fiscal years ended May 31, 2003, 2002 and 2001:
For the Year Ended May 31, -------------------------- 2003 2002 2001 ---- ---- ---- Net sales 100.0% 100.0% 100.0% Cost of sales 70.5% 72.9% 72.8% ----- ----- ----- Gross profit 29.5% 27.1% 27.2% Operating expenses: Selling 13.3% 11.6% 10.8% Research and development 1.1% 1.2% 1.4% General and administrative 8.1% 7.8% 8.1% ----- ----- ----- Total operating expenses 22.5% 20.6% 20.3% ----- ----- ----- Income from operations 7.0% 6.5% 6.9% Interest expense 2.5% 3.0% 4.4% Amortization of deferred financing fees 0.1% 0.4% 0.4% Loss on debt extinguishment - 0.9% - ----- ----- ----- Income before income taxes 4.4% 2.2% 2.1% Provision for income taxes 1.7% 0.0% 0.4% ----- ----- ----- Net income 2.7% 2.2% 1.7% ===== ===== ===== EBITDA 8.9% 7.8% 9.0% ===== ===== =====
Year Ended May 31, 2003 Compared to Year Ended May 31, 2002 ----------------------------------------------------------- Net sales for fiscal 2003 increased $140.1 million, or 16.1%, to $1,011.5 million from $871.4 million in the comparable period in 2002. Sales increased primarily due to increased direct consumer sales and customer demand. Sales of our cardiovascular and other equipment in fiscal 2003 increased $80.5 million, to $825.6 million. Sales of our strength training equipment in fiscal 2003 increased $59.6 million, to $185.9 million. Gross profit for fiscal 2003 was $298.1 million, or 29.5% of net sales, compared to $236.4 million, or 27.1% of net sales, in fiscal 2002. This 26.1% increase was largely due to increased direct consumer sales which have higher margins, changes in product mix and manufacturing efficiencies. Selling expenses increased $32.7 million, or 32.2%, to $134.1 million in fiscal 2003. This increase reflected increased bad debt expense related to pre-bankruptcy receivables of Kmart of $9.1 million. Increased direct consumer advertising, commissions and freight also contributed to the increase. Expressed as a percentage of net sales, selling expenses were 13.3% in fiscal 2003 and 11.6% in fiscal 2002. Absent the Kmart bad debt expense, selling expenses were 12.4% in fiscal 2003. Research and development expenses increased $1.2 million, or 11.5%, to $11.6 million in 2003. Expressed as a percentage of net sales, research and development expenses were 1.1% in fiscal 2003 and 1.2% in fiscal 2002. General and administrative expenses increased $13.7 million, or 20.1%, to $81.8 million in fiscal 2003. This increase is a factor of normal salary increases, planned additions to staff, increased insurance costs and increases attributable to performance based bonus and incentive programs. Increased rent and lease expense also contributed to the increase. Expressed as a percentage of net sales, general and administrative expenses were 8.1% in fiscal 2003 compared with 7.8% in fiscal 2002. As a result of the foregoing factors, operating income increased $14.1 million, or 25.0%, to $70.6 million in fiscal 2003. Expressed as a percentage of net sales, operating income was 7.0% in 2003 compared with 6.5% in fiscal 2002. As a result of the foregoing factors, EBITDA increased $21.5 million, or 31.5%, to $89.8 million in fiscal 2003. Expressed as a percentage of net sales, EBITDA was 8.9% in fiscal 2003 compared with 7.8% in fiscal 2002. Interest expense, including amortization of deferred financing fees, decreased $3.0 million, or 10.2%, to $26.3 million in fiscal 2003. This decrease reflects lower interest rates during fiscal 2003. In addition, deferred financing fees decreased as a result of the April 2002 debt refinancing. Expressed as a percentage of net sales, interest expense including amortization of deferred financing fees was 2.6% in fiscal 2003 compared with 3.4% in fiscal 2002. The provision for income taxes increased $17.2 million, or 4300.0%, to $17.6 million in fiscal 2003. Our effective tax rate was 39.7% in 2003 compared to 1.9% in fiscal 2002. The lower effective tax rate in fiscal 2002 is the result of adjustments pursuant to an Internal Revenue Service audit. These adjustments created a deferred tax benefit of approximately $11.5 million. No valuation allowance was recorded against this asset because we believe that we will generate sufficient future taxable income through operations to realize the net deferred asset. However, there can be no assurance that we will generate any specific level of taxable earnings or that we will be able to realize any of the deferred tax asset in future periods. If we are unable to generate sufficient taxable income in the future, an additional valuation allowance against this deferred tax asset would result in a charge to earnings. As a result of the foregoing factors, net income was $26.7 million in fiscal 2003 compared to net income in fiscal 2002 of $19.4 million. Year Ended May 31, 2002 Compared to Year Ended May 31, 2001 ----------------------------------------------------------- Net sales for fiscal 2002 increased $74.4 million, or 9.3%, to $871.4 million from $797.0 million in the comparable period in 2001. Sales increased primarily due to increased customer demand and the introduction of our new line of institutional fitness equipment which represented $11.0 million, or 14.8%, of the sales increase. Sales of our cardiovascular and other equipment in fiscal 2002 increased $57.9 million, to $745.1 million. Sales of our strength training equipment in fiscal 2002 increased $16.5 million, to $126.3 million. Gross profit for fiscal 2002 was $236.4 million, or 27.1% of net sales, compared to $216.5 million, or 27.2% of net sales in fiscal 2001. Selling expenses increased $15.1 million, or 17.5%, to $101.4 million in fiscal 2002. This increase was the result of higher selling costs associated with the increase in sales combined with the impact of the introduction of our new line of institutional fitness equipment as well as increased advertising expenses. Expressed as a percentage of net sales, selling expenses were 11.6% in fiscal 2002 compared to 10.8% in fiscal 2001. Research and development expenses decreased $0.5 million, or 4.6%, to $10.4 million in fiscal 2002. Expressed as a percentage of net sales, research and development expenses were 1.2% in fiscal 2002 and 1.4% in fiscal 2001. General and administrative expenses increased $3.6 million, or 5.6%, to $68.1 million in fiscal 2002. This increase was the result of higher costs associated with our increase in sales combined with the impact of the introduction of our new line of institutional fitness equipment. Expressed as a percentage of net sales, general and administrative expenses were 7.8% in fiscal 2002 and 8.1% in fiscal 2001. As a result of the foregoing factors, operating income increased $1.7 million, or 3.1%, to $56.5 million in fiscal 2002. Expressed as a percentage of net sales, operating income was 6.5% in fiscal 2002 compared with 6.9% in fiscal 2001. As a result of the foregoing factors, EBITDA decreased $3.8 million, or 5.3%, to $68.3 million in fiscal 2002. Expressed as a percentage of net sales, EBITDA was 7.8% in fiscal 2002 compared with 9.0% in fiscal 2001. Interest expense, including amortization of deferred financing fees, decreased $8.7 million, or 22.9%, to $29.3 million in fiscal 2002. This decrease reflects our lower borrowing levels during the period combined with lower interest rates on our borrowings. A loss of $7.4 million was recorded on the extinguishment of the existing credit facility and the 12% Notes. The provision for income taxes decreased $3.0 million, or 88.2%, to $0.4 million in fiscal 2002. Our effective tax rate was 1.9% in fiscal 2002 compared to 20.7% in fiscal 2001. The lower effective tax rate in fiscal 2002 was the result of adjustments pursuant to an Internal Revenue Service audit. These adjustments created a deferred tax benefit of approximately $11.5 million. As a result of the foregoing factors, our net income was $19.4 million in fiscal 2002 compared to net income in fiscal 2001 of $13.3 million. Seasonality The market for exercise equipment is highly seasonal, with peak periods occurring from late fall through February. As a result, the first and fourth quarters of every year are generally the Company's weakest periods in terms of sales. During these periods, ICON builds product inventory to prepare for the heavy demand anticipated during the upcoming peak season. This operating strategy helps ICON to realize the efficiencies of a steady pace of year-round production. The following are the net sales, operating income (loss) and net income (loss) of our Company by quarter for fiscal years 2003, 2002 and 2001:
First Second Third Fourth Quarter(1) Quarter(2) Quarter(3) Quarter(4) ---------- ---------- ---------- ---------- (in millions) Net Sales(5) 2003 $170.2 $292.7 $344.0 $204.6 2002 134.2 264.6 296.0 176.6 2001 125.9 267.6 247.6 155.9 Operating Income (Loss) 2003 $ 2.0 $ 28.8 $ 37.5 $ 2.3 2002 (4.5) 26.9 33.8 0.3 2001 (2.3) 31.9 29.4 (4.2) Net Income (Loss) 2003 $ (3.4) $ 13.7 $ 20.3 $ (3.9) 2002 (7.5) 11.1 25.5 (9.7) 2001 (8.2) 11.7 10.8 (1.0)
The following is a reconciliation of net income (loss) to EBITDA by quarter (6):
First Second Third Fourth Quarter Quarter Quarter Quarter Total ---------------------------------------------------------------- 2003 Net income (loss) $ (3.4) $ 13.7 $ 20.3 $ (3.9) $ 26.7 Add back: Depreciation and amortization 4.2 4.0 5.0 6.0 19.2 Provision (benefit) for income tax (1.2) 8.3 10.7 (0.2) 17.6 Interest expense 6.4 6.5 6.3 5.9 25.1 Amortization of deferred financing fees 0.3 0.2 0.2 0.5 1.2 ------ ------ ------ ------ ------ EBITDA $ 6.3 $ 32.7 $ 42.5 $ 8.3 $ 89.8 ====== ====== ====== ====== ======
First Second Third Fourth Quarter Quarter Quarter Quarter Total ---------------------------------------------------------------- 2002 Net income (loss) $ (7.5) $ 11.1 $ 25.5 $ (9.7) $ 19.4 Add back: Depreciation and amortization 4.5 4.3 4.9 5.5 19.2 Provision (benefit) for income tax (4.8) 8.2 1.4 (4.4) 0.4 Interest expense 6.8 6.8 6.0 6.6 26.2 Amortization of deferred financing fees 0.9 0.9 0.9 0.4 3.1 ------ ------ ------ ------ ------ EBITDA $ (0.1) $ 31.3 $ 38.7 $ (1.6) $ 68.3 ====== ====== ====== ====== ====== 2001 Net income (loss) $ (8.2) $ 11.7 $ 10.8 $ (1.0) $ 13.3 Add back: Depreciation and amortization 4.0 4.0 4.3 5.1 17.4 Provision (benefit) for income tax (3.2) 8.0 7.0 (8.4) 3.4 Interest expense 8.2 9.7 9.3 7.6 34.8 Amortization of deferred financing fees 0.8 0.8 0.8 0.8 3.2 ------ ------ ------ ------ ------ EBITDA $ 1.6 $ 34.2 $ 32.2 $ 4.1 $ 72.1 ====== ====== ====== ====== ====== The following is a reconciliation of net loss to EBITDA for the fiscal years ended May 31, 2000 and 1999. 2000 1999 ----------------------------- Net loss $ (6.6) $(24.7) Add back: Depreciation and amortization 16.7 17.4 Provision for income tax 2.7 12.1 Interest expense 33.9 33.1 Amortization of deferred financing fees 2.7 7.0 ----------------------------- EBITDA $ 49.4 $ 44.9 ============================= (1) Our first quarter ended August 31, September 1, and September 2 for fiscal years 2003, 2002 and 2001, respectively. (2) Our second quarter ended November 30, December 1, and December 2 for fiscal years 2003, 2002 and 2001, respectively. (3) Our third quarter ended March 1, March 2, and March 3 for fiscal years 2003, 2002 and 2001, respectively. (4) Our fourth quarter ended May 31 for the fiscal years 2003, 2002 and 2001, respectively. (5) In November of 2001, the Emerging Issues Task Force issued EITF 01-09, "Accounting for Consideration Given by a Vendor to a Customer" ("EITF 01-09") effective for annual or interim financial statements for periods beginning after December 15, 2001. EITF 01-09 provides guidance on the accounting treatment of various types of consideration given by a vendor to a customer. We adopted EITF 01-09 in fiscal 2003. Net sales are shown as if EITF 01-09 were adopted for all periods presented. Net sales without the adjustment for EITF 01-09 were as follows: First Second Third Fourth Quarter Quarter Quarter Quarter ---------------------------------------------- (in millions) Net Sales 2003 $175.8 $301.5 $354.8 $210.9 2002 138.1 272.1 304.9 181.0 2001 129.5 276.0 254.6 160.4 (6) EBITDA is a presentation of "earnings before interest, taxes, depreciation and amortization." EBITDA data is included because management understands that such information is considered by bankers and certain investors as an additional basis on evaluating a company's ability to pay interest, repay debt and make capital expenditures. EBITDA may not be comparable to similarly titled measures reported by other companies. In addition, EBITDA is a non-GAAP measure and should not be considered an alternative to operating or net income in measuring company results.
Liquidity and Capital Resources Net cash provided by operating activities was $31.6 million in fiscal 2003, as compared to $37.5 million of cash provided by operating activities in fiscal 2002. In fiscal 2003, major sources of funds were net income of $26.7 million, non-cash provisions of $19.2 million for depreciation and amortization and an increase in accounts payable and accrued expenses of $18.5 million. These changes were offset by increases in accounts receivable of $22.0 million, due partially to increased direct response receivables, and inventories of $28.0 million, due primarily to building inventory levels to meet anticipated sales levels. In fiscal 2002, major sources of funds were net income of $19.4 million, non-cash provisions of $19.2 million for depreciation and amortization, and a decrease in inventories of $12.2 million. These changes were offset by an increase in accounts receivable of $20.0 million. Net cash used in investing activities was $21.8 million in fiscal 2003, compared to $17.1 million of cash used in investing activities in fiscal 2002. Investing activities in fiscal 2003 consisted primarily of capital expenditures of $17.0 million related to upgrades in plant and tooling and purchases of additional manufacturing equipment and purchases of intangible assets of $4.9 million. Cash used in investing activities in fiscal 2002 consisted primarily of capital expenditures of $11.6 million related to upgrades in plant and tooling and purchases of additional manufacturing equipment and purchases of intangible assets of $5.2 million. Net cash used in financing activities was $12.3 million in fiscal 2003, compared to $19.3 million of cash used in financing activities in fiscal 2002. Cash used in financing activities in fiscal 2003 resulted from payments on the revolving credit facility, payments on the April 2002 term notes, payment of debt issuance fees and payments on other long-term debt. Cash used in financing activities in fiscal 2002 resulted from the issuance in April 2002 of the 11.25% Senior Subordinated Notes, borrowings on our new credit facility, repayment of our old credit facility and the redemption of our 12% subordinated notes. Net cash provided by operating activities was $37.5 million in fiscal 2002, as compared to $12.4 million of cash provided by operations in fiscal 2001. In fiscal 2002, major sources of funds were net income of $19.4 million, non-cash provisions of $19.2 million for depreciation and amortization, and a decrease in inventories of $12.2 million. These changes were offset by increases in accounts receivable of $20.0 million. In fiscal 2001, major sources of funds were net income of $13.3 million, non-cash provisions of $17.4 million for depreciation and amortization, and increases in accounts payable and accrued expenses of $10.0 million. These increases were offset by increases in accounts receivable of $14.1 million and inventories of $14.8 million. Such increases were due to the aforementioned factors relating to sales increases. Net cash used in investing activities was $17.1 million in fiscal 2002, compared to $22.8 million in fiscal 2001. Investing activities in fiscal 2002 consisted primarily of capital expenditures of $11.6 million related to upgrades in plant and tooling and purchases of additional manufacturing equipment and purchases of intangible assets of $5.2 million. Cash used in investing activities in fiscal 2001 was primarily for capital expenditures of $16.1 million, acquisitions of $4.0 million and purchases of intangible assets of $2.7 million. Net cash used in financing activities was $19.3 million in fiscal 2002, compared to $8.7 million of cash provided by financing activities in fiscal 2001. Cash used in financing activities in fiscal 2002 resulted from the issuance in April 2002 of the 11.25% Senior Subordinated Notes, borrowings on our new credit facility, repayment of our old credit facility and the redemption of our 12% subordinated notes. Cash provided by financing activities in fiscal 2001 resulted from borrowings on the revolving credit facility, payments on the September 1999 term notes, payments of debt issuance fees and payments on other long-term debt. We made capital expenditures of approximately $17.0 million during fiscal 2003 and expect to make capital expenditures of approximately $15.0 million in fiscal 2004. Capital expenditures are primarily for expansion of physical plant, purchases of additional or replacement manufacturing equipment and revisions and upgrades in plant tooling. On January 22, 2002, Kmart, a customer for over a decade, filed for bankruptcy protection. At the time of the bankruptcy filing, we had $12.1 million of unsecured accounts receivable outstanding with Kmart. We disposed of the remaining balance of the pre-bankruptcy receivable in the third quarter of fiscal 2003. We had net sales to Kmart of $26.7 million in fiscal 2003, representing approximately 2.6% of total net sales for that period. In fiscal 2002, we had net sales to Kmart of approximately $28.9 million, representing approximately 3.3% of total net sales for that period. We resumed shipments to Kmart on February 5, 2002 and continue with payment terms of 30 days. Kmart emerged from Chapter 11 protection on May 6, 2003. Our primary short-term liquidity needs consist of financing seasonal merchandise inventory buildups and paying cash interest expense under our existing credit facilities and on the 11.25% subordinated notes due in April 2012. Our principal source of financing for our seasonal merchandise inventory buildup and increased accounts receivable is revolving credit borrowings under the existing credit facilities. At May 31, 2003, we had $110.7 million of availability under these facilities. Our working capital borrowing needs are typically at their lowest level from April through June, increase somewhat through the summer and sharply increase from September through November to finance accounts receivable and purchases of inventory in advance of the Christmas and post-holiday selling season. Generally, in the period from November through February, our working capital borrowings remain at their highest level and then are paid down to their lowest annual levels from April through August. In connection with our debt refinancing in April 2002, we entered into our existing credit facility totaling $235.0 million of revolving and term loans with a syndicate of banks and financial services companies. The revolving and term loans are due in 2007. Proceeds of our existing credit facility were used to refinance our then existing credit facility and 12% senior subordinated notes due 2005, to fund transaction fees and expenses and to provide general working capital. As of May 31, 2003 the balance outstanding under the existing credit facility consisted of (in millions): Revolver $ 72.6 Term Loan 18.7 ------ $ 91.3 ====== As of May 31, 2003, our consolidated indebtedness was approximately $244.2 million, of which approximately $91.3 million was senior indebtedness. Based on our current level of operations, management believes that cash flow from operations and available cash, together with available borrowings under our existing credit facility, will be adequate to meet future liquidity needs for at least the next few years. We may, however, need to refinance all or a portion of the principal amount of the notes on or prior to maturity. As of May 31, 2003, our contractual cash obligations and commercial commitments were as follows:
Payments Due by Period (in millions) ----------------------------------------------------- Less Than 1 After 5 Total Year 2-3 Years 4-5 Years Years ----------------------------------------------------- Credit facilities (as restated) $ 91.3 $ 91.3 $ - $ - $ - Senior subordinated notes 152.9 - - - 152.9 Operating leases 36.4 9.1 18.7 6.2 2.4 ----------------------------------------------------- Total contractual cash obligations $280.6 $100.4 $ 18.7 $ 6.2 $155.3 =====================================================
As part of our cash management activities, we seek to manage accounts receivable credit risk, collections and accounts payable and payments thereof to maximize our free cash at any given time. Careful management of credit risk has allowed us to avoid (except for Kmart, as discussed above) significant accounts receivable losses in light of the poor financial condition of many of our potential and existing customers. In light of current and prospective global regional economic conditions, we cannot assure you that we will not be materially adversely affected by accounts receivable losses in the future. Recent Accounting Pronouncements In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations," which establishes accounting standards for the recognition and measurement of an asset retirement obligation and its associated asset retirement cost. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The adoption of SFAS No. 143 effective June 1, 2003 did not have a material effect on our financial position or results of operations. In August 2001, the FASB issued SFAS No. 144, "Accounting for Impairment of Disposal of Long-Lived Assets" which supercedes SFAS No. 121 and requires that one accounting model be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired. SFAS No. 144 also broadens the presentation of discontinued operations to include more disposal transactions. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The adoption of SFAS No. 144 did not have a material effect on our financial position or results of operations. In April 2002, the FASB issued SFAS No. 145, "Rescission of FAS Nos. 4, 44 and 64, Amendment of FAS 13 and Technical Corrections as of April 2002", which rescinds FAS Nos. 4, 44 and 64 and amends other existing authoritative pronouncements to make various technical corrections, clarify meaning or describe their applicability under changed conditions. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002 and resulted in the 2002 loss on debt extinguishment being reclassified from an extraordinary item to income from continuing operations. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities", which addresses significant issues relating to the recognition, measurement and reporting of costs associated with exit and disposal activities. SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002 and is not expected to have a material effect on our financial position or results of operations. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of FASB 123". This statement provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends disclosure requirements of SFAS No. 123 to ensure that fair value disclosures are prominent in both annual and interim financial statements. We have adopted the disclosure provisions of SFAS No. 148, but will continue to account for our stock-based compensation plans in accordance with APB 25. In November 2001, the Emerging Issues Task Force issued EITF 01-09, "Accounting for Consideration Given by a Vendor to a Customer". EITF 01-09 provides guidance on the accounting treatment of various types of consideration given by a vendor to a customer. The Company has adopted EITF 01-09 effective June 1, 2002 which reduced net sales for the fiscal year ended May 31, 2003 by approximately $31.5 million with a corresponding reduction of selling, general and administrative expenses. This change has no effect on income from operations or net income. For comparative purposes, net sales for fiscal years ended May 31, 2002 and 2001 have been reduced by approximately $24.7 million and $23.5 million, respectively, with a corresponding reduction of selling, general and administrative expenses. In November 2002, the FASB issued FASB Interpretation No. ("FIN") 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others". FIN 45 elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. It also clarifies that at the time a company issues a guarantee, the Company must recognize an initial liability for the fair value, or market value, of the obligations it assumes under that guarantee and must disclose that information in its interim and annual financial statements. FIN 45 is effective on a prospective basis for guarantees issued or modified after December 31, 2002. The disclosure requirements of FIN 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. We do not expect FIN 45 to have a material effect on our consolidated financial statements. In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest Entities", which clarifies the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements" to certain entities in which equity investors 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. FIN 46 is applicable immediately for variable interest entities created after January 31, 2003. For variable interest entities created prior to January 31, 2003, the provisions of FIN 46 are applicable no later than July 1, 2003. We do not expect FIN 46 to have a material effect on our consolidated financial statements. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity". SFAS No. 150 establishes standards on the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. The provisions of SFAS No. 150 are effective for financial instruments entered into or modified after May 31, 2003 and to all other instruments that exist as of the beginning of the first interim financial reporting period beginning after June 15, 2003. We are currently evaluating the effects SFAS No. 150 may have on our financial statements. Item 8. Financial Statements and Supplementary Data Index to Consolidated Financial Statements and Schedule Page ---- Report of Independent Auditors 46 Consolidated Financial Statements: Consolidated Balance Sheets as of May 31, 2003 and 2002 47 Consolidated Statements of Operations and Comprehensive Income for the Years Ended May 31, 2003, 2002 and 2001 48 Consolidated Statement of Stockholder's Equity (Deficit) for the Years Ended May 31, 2003, 2002 and 2001 49 Consolidated Statements of Cash Flows for the Years Ended May 31, 2003, 2002 and 2001 50 Notes to Consolidated Financial Statements 51 Financial Statement Schedule: Schedule II - Valuation and Qualifying Accounts for the Three Years Ended May 31, 2003 79 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, ICON Health & Fitness, Inc. has duly caused this report to be signed on its behalf by the undersigned, there unto duly authorized. ICON HEALTH & FITNESS, INC. By: /s/ David J. Watterson ---------------------------- Name: David J. Watterson Title: Chairman of the Board and Chief Executive Officer Date: August 27, 2004 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated. Signatures Capacity Date ---------- -------- ---- /s/ David J. Watterson -----------------------Chairman of the Board of August 27, 2004 David J. Watterson Directors and Chief Executive Officer (principal Executive Officer) /s/ S. Fred Beck -----------------------Vice President, Chief Financial August 27, 2004 S. Fred Beck and Accounting Officer, and Treasurer /s/ Ronald P. Mika -----------------------Director August 27, 2004 Ronald P. Mika /s/ W. Steve Albrecht -----------------------Director August 27, 2004 W. Steve Albrecht /s/ Stan Tuttleman -----------------------Director August 27, 2004 Stan Tuttleman /s/ Gregory Benson -----------------------Director August 27, 2004 Gregory Benson Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholder of ICON Health & Fitness, Inc.: In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations and comprehensive income, of stockholder's equity (deficit) and of cash flows present fairly, in all material respects, the financial position of ICON Health & Fitness, Inc. and its subsidiaries at May 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended May 31, 2004 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 miss tatement. 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 2 to the consolidated financial statements, the Company has restated its balance sheets as of May 31, 2003 and 2002 to reflect borrowings under its revolving credit line as a current liability. As discussed in Note 3 to the consolidated financial statements, effective June 1, 2002, the Company adopted the provisions of EITF 01-09, "Accounting for Consideration Given by a Vendor to a Customer", Statement of Financial accounting Standards No. 142, "Goodwill and Other Intangible Assets", and Statement of Financial Accounting Standards No. 145, "Rescission of FAS Nos. 4, 44 and 64, Amendment of FAS 13 and Technical Corrections as of April 2002". /s/ PricewaterhouseCoopers LLP Salt Lake City, Utah July 17, 2003, except for Notes 2, 9 and 17 for which the date is January 12, 2004 ICON Health & Fitness, Inc. CONSOLIDATED BALANCE SHEETS (In Thousands)
May 31, 2003 May 31, 2002 ------------ ------------ ASSETS (as restated) (as restated) Current assets: Cash $ 4,650 $ 4,773 Accounts receivable, net 175,164 153,178 Inventories, net 161,708 133,753 Deferred income taxes 7,323 4,807 Other current assets 9,830 18,675 -------- -------- Total current assets 358,675 315,186 Property and equipment, net 48,777 44,985 Intangible assets, net 29,069 30,201 Deferred income taxes 8,379 12,084 Other assets, net 20,214 20,768 -------- -------- Total assets $465,114 $423,224 ======== ======== LIABILITIES AND STOCKHOLDER'S EQUITY Current liabilities: Current portion of long-term debt $ 91,313 $103,106 Accounts payable 121,177 113,927 Accrued expenses 33,964 23,751 Income taxes payable 4,228 5,421 Interest payable 7,484 3,045 -------- -------- Total current liabilities 258,166 249,250 Long-term debt 152,919 152,831 Other liabilities 9,691 4,934 -------- -------- Total liabilities 420,776 407,015 -------- -------- Commitments and contingencies (Notes 9 and 13) Stockholder's Equity Common stock and additional paid-in capital 204,155 204,155 Receivable from Parent (2,200) (2,200) Accumulated deficit (157,252) (183,941) Accumulated other comprehensive loss (365) (1,805) -------- -------- Total stockholder's equity 44,338 16,209 -------- -------- Total liabilities and stockholder's equity $465,114 $423,224 ======== ========
The accompanying notes are an integral part of the consolidated financial statements. ICON Health & Fitness, Inc. CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (In Thousands)
For the Year Ended May 31, 2003 2002 2001 ---------- --------- --------- Net sales $1,011,544 $ 871,399 $ 796,994 Cost of sales 713,415 635,046 580,484 ---------- --------- --------- Gross profit 298,129 236,353 216,510 ---------- --------- --------- Operating expenses: Selling 134,047 101,355 86,279 Research and development 11,648 10,405 10,851 General and administrative 81,766 68,089 64,631 --------- --------- --------- Total operating expenses 227,461 179,849 161,761 --------- --------- --------- Income from operations 70,668 56,504 54,749 Interest expense (25,105) (26,149) (34,771) Amortization of deferred financing fees (1,267) (3,146) (3,189) Loss on extinguishment of debt - (7,435) - --------- --------- --------- Income before income taxes 44,296 19,774 16,789 Provision for income taxes 17,607 380 3,483 --------- --------- --------- Net income 26,689 19,394 13,306 Other comprehensive income (loss), comprised of foreign currency translation adjustment, net of income tax expense of $883 in 2003 and $129 in 2002 and net of a tax benefit of $325 in 2001. 1,440 210 (532) --------- --------- --------- Comprehensive income $ 28,129 $ 19,604 $ 12,774 ========= ========= =========
The accompanying notes are an integral part of the consolidated financial statements. ICON Health & Fitness, Inc. CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY (DEFICIT) (In Thousands, except share amounts)
Common Stock and additional paid-in capital Accumulated Total ---------------- Receivable other stockholder's from Accumulated comprehensive equity Shares Amount Parent deficit Income (loss) (deficit) ------------------------------------------------------------------------- Balance at May 31, 2000 1,000 $204,155 $ (2,200) $ (216,641) $(1,483) $(16,169) Other comprehensive loss - - - - (532) (532) Net income - - - 13,306 - 13,306 ------------------------------------------------------------------------- Balance at May 31, 2001 1,000 204,155 (2,200) (203,335) (2,015) (3,395) Other comprehensive income - - - - 210 210 Net income - - - 19,394 - 19,394 ------------------------------------------------------------------------- Balance at May 31, 2002 1,000 204,155 (2,200) (183,941) (1,805) 16,209 Other comprehensive income - - - - 1,440 1,440 Net income - - - 26,689 - 26,689 ------------------------------------------------------------------------- Balance at May 31, 2003 1,000 $204,155 $ (2,200) $ (157,252) $ (365) $ 44,338 ======================================================================
The accompanying notes are an integral part of the consolidated financial statements. ICON Health & Fitness, Inc. CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands)
For the Year Ended May 31, 2003 2002 2001 --------- --------- --------- OPERATING ACTIVITIES: Net income $ 26,689 $ 19,394 $ 13,306 Adjustments to reconcile net income to net cash provided by operating activities: Benefit for deferred taxes 306 (10,138) (588) Gain on sale of property and equipment (5) - - Amortization of gain on extinguishment of debt - (1,191) (1,300) Amortization of deferred financing fees 1,267 3,146 3,189 Amortization of debt discount 73 18 - Depreciation and amortization 19,170 19,162 17,372 Loss on extinguishment of debt - 7,435 - Changes in operating assets and liabilities, net of acquisitions: Accounts receivable, net (21,986) (19,968) (14,097) Inventories, net (27,955) 12,231 (14,784) Other assets, net 10,327 (4,162) (3,098) Accounts payable and accrued expenses 18,526 (671) 10,040 Income taxes payable (1,193) 5,076 345 Interest payable 4,439 2,272 2,022 Other liabilities 1,980 4,934 - --------- --------- --------- Net cash provided by operating activities 31,638 37,538 12,407 --------- --------- --------- INVESTING ACTIVITIES: Purchase of property and equipment (16,952) (11,624) (16,095) Purchase of intangible assets (4,892) (5,200) (2,693) Acquisitions, net of cash acquired - (306) (3,997) Proceeds from sale of property and equipment 19 - - --------- --------- --------- Net cash used in investing activities (21,825) (17,130) (22,785) --------- --------- --------- FINANCING ACTIVITIES: Borrowings (payments) on revolving credit facility, net (6,749) 32,831 19,497 Payments on other long-term debt (29) (48) (376) Proceeds from April 2002 term notes - 25,000 - Payments on April 2002 term notes (5,000) (1,250) - Payments on September 1999 term notes - (172,834) (9,273) Proceeds from 11.25% notes - 152,813 - Payments to 12% noteholders - (46,053) - Payment of fees-debt portion (481) (9,757) (1,153) --------- --------- --------- Net cash provided by (used in) financing activities (12,259) (19,298) 8,695 --------- --------- --------- Effect of exchange rates on cash 2,323 339 (857) --------- --------- --------- Net increase (decrease) in cash (123) 1,449 (2,540) Cash, beginning of period 4,773 3,324 5,864 --------- --------- --------- Cash, end of period $ 4,650 $ 4,773 $ 3,324 ========= ========= =========
The accompanying notes are an integral part of the consolidated financial statements. ICON Health & Fitness, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Basis of Presentation and Description of Business Basis of Presentation - The consolidated financial statements include the accounts of ICON Health & Fitness, Inc., and its wholly owned subsidiaries ("the Company"). At May 31, 2003 and 2002, the Company was a wholly owned subsidiary of HF Holdings, Inc. ("HF Holdings" or the "Parent"). Description of Business - The Company is principally involved in the development, manufacturing and distribution of home fitness equipment. The Company's revenues are derived from the sale of various aerobic and anaerobic fitness product lines in domestic and foreign markets. Because product life cycles can be short in the fitness industry, the Company emphasizes new product innovation and product repositioning. The Company primarily sells its products to retailers and, to a limited extent, to end-users through direct response advertising efforts and retail outlets. 2. Restatement The credit agreement, which includes the Company's $210 million revolving credit line and the term loan ("Credit Agreement"), requires the Company to maintain a lockbox arrangement whereby remittances from the Company's customers reduce the borrowings outstanding under the Credit Agreement. The Company has determined that the Credit Agreement also contains a Material Adverse Effect ("MAE") clause which grants the agent and lenders having more than 66 and 2/3% of the commitment or borrowings the right to block the Company's requests for future advances. EITF Issue 95-22 "Balance Sheet Classification of Borrowings Outstanding Under Revolving Credit Agreements That Include Both a Subjective Acceleration Clause and a Lockbox Arrangement" requires borrowings under credit agreements with these two provisions to be classified as current obligations. Accordingly, the Company has restated its balance sheets as of May 31, 2003 and 2002 to reclassify the borrowings of $86.3 million and $98.1 million from long-term debt to current as of May 31, 2003 and 2002, respectively. The disclosures in footnotes 9 and 17 have been restated for this reclassification. This restatement had no impact on the Company's compliance with its debt covenants under the Credit Agreement, its ability to draw on existing facilities, its previously reported total assets and stockholder's equity as of May 31, 2003 and 2002 or its previously reported net income for the years ended May 31, 2003, 2002 and 2001. 3. Significant Accounting Policies Principles of Consolidation - All significant intercompany accounts and transactions have been eliminated in the consolidated financial statements. Cash - At May 31, 2003, substantially all of the Company's cash is held by two banks located in Illinois and Massachusetts. The Company does not believe that as a result of this concentration it is subject to any unusual financial risk beyond the normal risk associated with commercial banking relationships. Inventories - Inventories consist primarily of raw materials (principally parts and supplies) and finished goods, and are valued at the lower of cost or market. Cost is determined using standard costs which approximate the first-in, first-out (FIFO) method. Property and Equipment - Property and equipment is stated at cost and depreciated using the straight-line method over the estimated useful lives of the respective assets. Expenditures for renewals and improvements are capitalized, and maintenance and repairs are charged to expense as incurred. Intangible Assets - In July 2001, the Financial Accounting Standards Board ("FASB") issued Statements of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations", and Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141 specifies criteria that must be met in order for intangible assets acquired in a purchase method business combination to be recognized and reported apart from goodwill. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized; but instead be tested for impairment at least annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets with definite lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". The Company adopted the provisions of SFAS No. 141 immediately and SFAS No. 142 effective June 1, 2002. The Company completed an impairment evaluation of its goodwill as of June 1, 2002 and May 31, 2003. No impairment was identified. At June 1, 2002, goodwill totaled $5,624,000, net of accumulated amortization of $1,919,000. The following table presents what reported net income would have been for the years ended May 31, 2002 and 2001 under SFAS No. 142:
Year Ended May 31, 2002 2001 -------------------------- Reported net income $ 19,394 $ 13,306 Add back: Goodwill amortization, net of income tax of $143 and $143 respectively, for the years ended May 31, 2002 and 2001 234 234 -------------------------- Adjusted net income $ 19,628 $ 13,540 ==========================
Intangible assets other than goodwill are recorded at cost and are amortized on a straight-line basis over the following estimated useful lives: Trademarks 20 years Other 5 years Long-Lived Assets - Long-lived assets are reviewed for impairment whenever events or circumstances indicate that the carrying amount of long-lived assets may not be recoverable. The carrying value of a long-lived asset is considered impaired when the anticipated cumulative undiscounted cash flows from that asset are less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair market value of the long-lived asset, which is generally based on discounted cash flows. As a result of its review, the Company does not believe that as of May 31, 2003 and 2002, any impairment exists related to its long-lived assets. Deferred Financing Costs - The Company deferred certain debt issuance costs relating to the establishment of the New 2002 Credit Facilities and the issuance of the 11.25% Notes as part of the April 2002 Refinancing (see Note 9). These costs are capitalized in other long-term assets and are being amortized using the effective interest method. Deferred costs relating to the 12% Notes and existing bank credit agreement were written off as part of the April 2002 Refinancing. Advertising Costs - The Company expenses the costs of advertising as incurred, except for the cost of direct response advertising, which is capitalized and amortized over its expected period of future benefit, generally twelve months. Direct response advertising costs consist primarily of costs to produce infomercials for the Company's products. At May 31, 2003 and 2002, $1,792,000 and $1,586,000, respectively, of capitalized advertising costs were included in other current assets. For the fiscal years ended May 31, 2003, 2002 and 2001, total advertising expense was approximately $30,743,000, $17,169,000 and $13,011,000, respectively. Revenue Recognition - The Company recognizes revenue upon the shipment of product to the customer. Allowances are recognized for estimated returns, discounts, advertising programs and warranty costs associated with these sales. Concentration of Credit Risk - The primary financial instruments which potentially expose the Company to concentration of credit risk include trade accounts receivable. To minimize this risk, ongoing credit evaluations of customers' financial condition are performed and reserves are maintained; however, collateral is not required. A significant portion of the Company's sales are made to Sears Roebuck ("Sears"). Sears accounted for approximately 39%, 44% and 44% of the total net sales for the fiscal years ended May 31, 2003, 2002 and 2001, respectively. Accounts receivable from Sears accounted for approximately 31% and 35% of gross accounts receivable at May 31, 2003 and 2002, respectively. The Company is not the exclusive supplier of home fitness equipment to any of its major customers. The loss of, or a substantial decrease in the amount of purchases by, or a write-off of any significant receivable due from, any of its major customers would have a material adverse effect on the Company's business. Research and Development Costs - Research and product development costs are expensed as incurred. Research and development activities include the design of new products and product enhancements, and are performed by both internal and external sources. Income Taxes - The Company accounts for income taxes utilizing the asset and liability method as prescribed by SFAS No. 109, "Accounting for Income Taxes". Deferred tax assets and liabilities are recorded based on the differences between the financial statement and tax bases of assets and liabilities at currently enacted tax rates. If appropriate, deferred tax assets are reduced by a valuation allowance which reflects expectations of the extent to which such assets will be realized. As of May 31, 2003 and 2002, the Company was included as part of the consolidated tax return filed by HF Holdings, Inc. The income tax provision for the Company has been prepared on a separate company basis. Foreign Operations - Assets and liabilities of the Company's European and Canadian subsidiaries are translated into U.S. dollars at the applicable rates of exchange at each period end. The Company's foreign transactions are primarily denominated in Canadian dollars and the Euro and transactions with foreign entities that result in income and expense for the Company are translated at the weighted average rate of exchange during the period. Translation gains and losses are reflected as a separate component of other comprehensive income (loss). Transaction gains and losses are recorded in the consolidated statements of operations and comprehensive income (loss) and were not material in the fiscal years ended May 31, 2003, 2002 and 2001. For the fiscal years ended May 31, 2003, 2002 and 2001, the Company's foreign operations represented less than 10% of the Company's net sales and effects of exchange rate changes did not have a material impact on the Company's earnings. Warranty Reserves - The Company maintains a warranty accrual for estimated future warranty obligations based upon the relationship between historical and anticipated costs and sales volumes. If actual warranty expenses are greater than those projected, additional reserves and other charges against earnings may be required. If actual warranty expenses are less than projected, prior reserves could be reduced providing a positive impact on the Company's reported results. The following table provides a reconciliation of the changes in the Company's product warranty reserve (table in thousands):
Year Ended May 31, ---------------------------------- 2003 2002 2001 ---------------------------------- Warranty Reserve: Balance at beginning of year $ 1,290 $ 2,557 $ 2,570 Additions: Charged to costs and expenses 1,349 - 30 Deductions: Reduction in reserve - (1,267) (43) ---------------------------------- Balance at end of year $ 2,639 $ 1,290 $ 2,557 ==================================
The reduction in the warranty reserve in the fiscal year ended May 31, 2002 resulted primarily from the reclassification of the accrued warranty reserve on long-term maintenance contracts to deferred revenue. Revenue from these contracts is recognized ratably over the term of the contract. Fair Value of Financial Instruments - The following methods and assumptions were used to estimate the fair value disclosures for financial instruments: 11.25% Notes - fair value equals quoted market price. Other long-term debt - fair value approximates carrying value since such debt is primarily variable rate debt. The carrying amounts and fair values of long-term debt at May 31, 2003 and 2002 were as follows (table in thousands):
2003 2003 2002 2002 ------------------------------------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value ------------------------------------------------- 11.25% Notes $152,903 $162,750 $152,831 $152,831 Other long-term debt 91,329 91,329 103,106 103,106
Stock-Based Compensation Plans - The Company accounts for employee stock-based compensation arrangements in accordance with provisions of Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees." Accordingly, no compensation cost has been recognized for options granted to employees under its fixed stock option plan. On December 31, 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation Transition and Disclosure," which amends SFAS No. 123, "Accounting for Stock-Based Compensation". SFAS No. 148 requires more prominent and frequent disclosures about the effects of stock-based compensation, which the Company has adopted for the period ending May 31, 2003. As permitted by SFAS No. 148, the Company will continue to account for its stock based compensation according to the provisions of APB No. 25. Had compensation cost for the Company's stock options been recognized based upon the estimated fair value on the grant date under the fair value methodology prescribed by SFAS No. 123, the Company's net earnings would have been as follows (table in thousands):
Year Ended May 31, 2003 2002 2001 ------ ------- ------- Net income, as reported $26,689 $19,394 $13,306 Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects 28 133 133 ------- ------- ------- Pro forma net income $26,661 $19,261 $13,173 ======= ======= =======
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 contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the period presented. Actual results could differ from those estimates. New Accounting Standards - In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations," which establishes accounting standards for the recognition and measurement of an asset retirement obligation and its associated asset retirement cost. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The adoption of SFAS No. 143 effective June 1, 2003 did not have a material effect on the Company's financial position or results of operations. In August 2001, the FASB issued SFAS No. 144, "Accounting for Impairment of Disposal of Long-Lived Assets" which supercedes SFAS No. 121 and requires that one accounting model be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired. SFAS No. 144 also broadens the presentation of discontinued operations to include more disposal transactions. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The adoption of SFAS No. 144 did not have a material effect on the Company's financial position or results of operations. In April 2002, the FASB issued SFAS No. 145, "Rescission of FAS Nos. 4, 44 and 64, Amendment of FAS 13 and Technical Corrections as of April 2002", which rescinds FAS Nos. 4, 44 and 64 and amends other existing authoritative pronouncements to make various technical corrections, clarify meaning or describe their applicability under changed conditions. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002 and resulted in the 2002 loss on debt extinguishment being reclassified from an extraordinary item to income from continuing operations. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities", which addresses significant issues relating to the recognition, measurement and report of costs associated with exit or disposal activities initiated after December 31, 2002 and is not expected to have a material effect on the Company's financial position or results of operations. In November 2001, the Emerging Issues Task Force issued EITF 01-09, "Accounting for Consideration Given by a Vendor to a Customer". EITF 01-09 provides guidance on the accounting treatment of various types of consideration given by a vendor to a customer. The Company has adopted EITF 01-09 effective June 1, 2002, which reduced net sales for the fiscal year ended May 31, 2003 by approximately $31.5 million with a corresponding reduction of selling, general and administrative expenses. This change has no effect on income from operations or net income. For comparative purposes, net sales for fiscal years ended May 31, 2002 and 2001 have been reduced by approximately $24.7 million and $23.5 million respectively, with a corresponding reduction of selling, general and administrative expenses. In November 2002, the FASB issued FASB Interpretation No. ("FIN") 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others". FIN 45 elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. It also clarifies that at the time a company issues a guarantee, the Company must recognize an initial liability for the fair value, or market value, of the obligations it assumes under that guarantee and must disclose that information in its interim and annual financial statements. FIN 45 is effective on a prospective basis for guarantees issued or modified after December 31, 2002. The disclosure requirements of FIN 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. The Company does not expect FIN 45 to have a material effect on its consolidated financial statements. In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest Entities", which clarifies the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements" to certain entities in which equity investors 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. FIN 46 is applicable immediately for variable interest entities created after January 31, 2003. For variable interest entities created prior to January 31, 2003, the provisions of FIN 46 are applicable no later than July 1, 2003. The Company does not expect FIN 46 to have a material effect on its consolidated financial statements. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity". SFAS No. 150 establishes standards on the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. The provisions of SFAS No. 150 are effective for financial instruments entered into or modified after May 31, 2003 and to all other instruments that exist as of the beginning of the first interim financial reporting period beginning after June 15, 2003. The Company does not expect SFAS No. 150 to have a material effect on its consolidated financial statements. Reclassifications - Certain balances of the prior years have been reclassified to conform to the current year's presentation. These reclassifications had no effect on net income or total assets. 4. Accounts Receivable Accounts receivable, net, consist of the following (table in thousands):
May 31, 2003 2002 --------------------- Trade accounts receivable $183,558 $161,117 Less allowance for doubtful accounts, advertising discounts and credit memos (8,394) (7,939) --------------------- $175,164 $153,178 =====================
5. Inventories Inventories, net, consist of the following (table in thousands):
May 31, 2003 2002 --------------------- Raw materials, principally parts and supplies $ 53,748 $ 60,136 Finished goods 107,960 73,617 --------------------- $161,708 $133,753 =====================
Inventories are net of allowances (primarily for finished goods) of $3,900,000 and $3,275,000 at May 31, 2003 and 2002, respectively. These allowances are established based on management's estimates of inventory held at fiscal year end that is potentially obsolete or for which its market value is below cost. 6. Property and Equipment Property and equipment, net, consist of the following (table in thousands):
Estimated May 31, Useful lives 2003 2002 ---------------------------------- (Years) Land - $ 2,160 $ 1,472 Building and improvements up to 31 21,053 21,174 Equipment and tooling 3-7 75,053 73,304 -------------------- 98,266 95,950 Less accumulated depreciation (49,489) (50,965) -------------------- $ 48,777 $ 44,985 ====================
For the fiscal years ended May 31, 2003, 2002 and 2001, the Company recorded depreciation expense of $13,166,000, $13,398,000 and $13,619,000, respectively. 7. Intangible Assets Intangible assets, net, consist of the following (table in thousands):
May 31, 2003 May 31, 2002 -------------------------------- ------------------------------ Accumulated Accumulated Cost Amortization Net Cost Amortization Net -------------------------------- ------------------------------- Goodwill $ 7,543 $ (1,919) $ 5,624 $ 7,543 $ (1,919) $ 5,624 Trademarks 27,607 (10,247) 17,360 27,963 (8,495) 19,468 Other 13,944 (7,859) 6,085 10,813 (5,704) 5,109 -------------------------------- ------------------------------- $49,094 $(20,025) $29,069 $46,319 $(16,118) $30,201 ================================ ===============================
Amortization expense related to intangible assets for the fiscal years ended May 31, 2003, 2002 and 2001 was $6,004,000, $5,764,000 and $3,753,000, respectively. Approximately $5,624,000 of the net goodwill at May 31, 2003 is tax deductible in future periods. Estimated amortization expense for years ending after May 31, 2003 is as follows (table in thousands):
Year Ending May 31, --------------------------- 2004 $ 4,428 2005 3,813 2006 2,930 2007 1,930 2008 1,171 Thereafter 9,173 -------- $ 23,445 ========
8. Other Assets Other assets, net, consist of the following (table in thousands):
May 31, 2003 2002 --------------------- Deferred financing costs, net $ 8,356 $ 9,142 Long-term receivables, net 556 10,362 Long-term portion of trade receivables 7,255 - Other 4,047 1,264 --------------------- $ 20,214 $ 20,768 =====================
At May 31, 2003 and 2002, deferred financing costs are net of accumulated amortization of $1,438,000 and $171,000, respectively. Long-term receivables consist of receivables whose collection is not considered to be current because the customer is in bankruptcy and whose carrying values have been written down to net realizable value. At May 31, 2003 and 2002, long-term receivables are net of an allowance for doubtful accounts of $70,000 and $2,434,000, respectively. As of May 31, 2003, long-term portion of trade receivables consists of the long-term portion of receivables from direct response sales. The allowance for doubtful accounts related to the long-term portion of these receivables is not significant. 9. Long-Term Debt Long-term debt consists of the following (table in thousands):
May 31, 2003 2002 -------------------- (as restated) (as restated) 2002 Revolver $ 72,563 $ 79,312 2002 Term Loan 18,750 23,750 11.25% Senior Subordinated Notes, face amount $155,000, net of unamortized discount of $2,096 and $2,169 at May 31, 2003 and 2002, respectively. 152,903 152,831 Other 16 44 -------------------- 244,232 255,937 Less current portion (91,313) (103,106) -------------------- $152,919 $152,831 ====================
April 2002 Refinancing In April 2002, the Company entered into new credit facilities and issued new 11.25% senior subordinated notes ("11.25% notes") (the "April 2002 Refinancing"). The Company used the net proceeds of the 11.25% Notes and the New 2002 Credit Facilities to repay all outstanding indebtedness under the existing credit agreement, to redeem in full all of the outstanding 12% subordinated notes due 2005, to pay accrued interest and premiums thereon, and pay certain transaction fees and expenses. New Credit Facilities In connection with the April 2002 Refinancing, the Company entered into new credit facilities (the "New 2002 Credit Facilities") of $235 million with a syndicate of banks and financial services companies. The New 2002 Credit Facilities include a $210 million revolving credit line (the "2002 Revolver"), which includes a letter of credit sub-facility of up to $10 million and a swing line sub-facility of up to $10 million. The term is five years. Borrowing availability is limited to certain percentages of qualified assets as specified in the agreement. The letter of credit margin of 2% and an unused facility fee of .50% per annum of the average unused daily balance of the 2002 Revolver are due monthly. In addition, the New 2002 Credit Facilities include a $25 million Term Loan ("2002 Term Loan") with a 58-month term. The 2002 Term Loan amortizes quarterly at a rate of $1,250,000. At the Company's option, the 2002 Revolver and 2002 Term Loan bear interest at either (a) a floating rate equal to the Index Rate plus the applicable margin of 1.25% and 1.75%, respectively, or (b) a floating rate equal to the LIBOR rate plus the applicable margin of 2.625% and 3.125%, respectively. If the 2002 Revolver is terminated or if the 2002 Term Loan is prepaid, certain prepayment premiums will apply. All loans under the New 2002 Credit Facilities are collateralized by a first priority security interest in all of the existing and subsequently acquired assets of the Company and its domestic and Canadian subsidiaries, subject to specified exceptions, and a pledge of 65% of the stock of the Company's first-tier foreign subsidiaries. All loans are cross-collateralized and contain cross default provisions. All of the outstanding common stock of the Company, owned by HF Holdings, has been pledged to the lenders under the New 2002 Credit Facilities. If the Company were to default under these New 2002 Credit Facilities, the lenders would foreclose on the pledge and take control of the Company. The new credit agreement contains a number of restrictive covenants that, among other things, limit or restrict the Company's and its subsidiaries' ability to dispose of assets, incur additional indebtedness, incur guarantee obligations, prepay other indebtedness, make restricted payments, create liens, make equity or debt investments, make certain acquisitions, modify terms of the indenture, engage in mergers or consolidations, enter into operating leases or engage in transactions with affiliates. In addition, the Company is expected to comply with various financial ratios and tests, including a maximum capital expenditures test, minimum debt service coverage ratio, minimum EBITDA, maximum senior leverage ratio and minimum revenue. At May 31, 2003, the Company was in compliance with all of its debt covenants. 11.25% Senior Subordinated Notes The new 11.25% Notes are due April 2012. The 11.25% Notes were issued with a face principal amount of $155 million at a price of 98.589%. Interest is due January 1 and July 1 of each year, beginning on July 1, 2003. The 11.25% Notes are redeemable for a premium of between 1% and 5.625% anytime after April 2007, as outlined in the indenture. Up to 35% of the 11.25% Notes can be redeemed prior to April 1, 2005 at an 11.25% premium. The 11.25% Notes are guaranteed on an unsecured, senior subordinated basis by the Company's existing and future domestic subsidiaries. The 11.25% Notes contain certain restrictive covenants that, among other things, limit the ability of the Company and its subsidiaries to incur additional debt, pay dividends or make other distributions, make investments, dispose of assets, issue capital stock of subsidiaries, enter into mergers or consolidations or sell all, or substantially all, of their assets. The table below reflects the scheduled principal payment terms of the Company's long-term debt (table in thousands):
Year ending May 31, (as restated) ------------------- 2004 $ 91,328 2005 - 2006 - 2007 - 2008 - Thereafter 155,000 -------- 246,328 Unamortized debt discount (2,096) -------- $244,232 ========
For the fiscal year ended May 31, 2002, a loss of approximately $7.4 million was recorded on the extinguishment of the Company's Old 1999 Credit Facilities and the 12% Notes. 10. Stockholder's Equity The Company has 3,000 shares of $.01 par value common stock authorized and 1,000 shares issued and outstanding. During the fiscal year ended May 31, 2000, the Company established a new Junior Management stock option plan (the "Plan") and issued 333,300 options to purchase common stock of HF Holdings with an exercise price of $5.83 to members of the Plan. These options have a ten-year life, 25% vested immediately and the balance vests in 25% increments on each anniversary of the grant date. The following table summarizes activity under the Plan for the fiscal years ended May 31, 2003, 2002 and 2001:
Year Ended May 31, 2003 2002 2001 -------------------------------------------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price -------------------------------------------------------- Outstanding at beginning of year 333,330 $ 5.83 333,300 $ 5.83 333,330 $ 5.83 Granted - - - - - Expired - - - - - Exercised - - - - - Forfeited - - - - - -------------------------------------------------------- Outstanding at end of year 333,330 $ 5.83 333,300 % 5.83 333,330 $ 5.83 ======================================================== Options exercisable at end of year 333,330 249,975 166,650 ======================================================== Weighted average fair market value of options granted during year - - - ========================================================
The following table summarizes information about stock options outstanding at May 31, 2003:
Options Outstanding Options Exercisable ----------------------------------------------------------------------------------------- Weighted Average Weighted Weighted Range of Remaining Average Average Exercise Number Contractual Exercise Number Exercise Prices Outstanding Life(in years) Price Exercisable Price ----------------------------------------------------------------------------------------- $5.83 333,300 6.3 $5.83 333,330 $5.83
The fair value of each option was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions: (1) risk-free interest rate of 6.00%; (2) expected life of five years; (3) dividend yield of zero; and (4) a volatility of zero. 11. Income Taxes The provision for income taxes consists of the following (table in thousands):
Year Ended May 31, --------------------------------------------------- 2003 2002 2001 --------------------------------------------------- Current: Federal $ 12,453 $ 10,178 $ 2,720 State 1,067 872 233 Foreign 3,781 2,293 1,118 --------------------------------------------------- Total current 17,301 13,343 4,071 --------------------------------------------------- Deferred: Federal 346 (12,323) (1,041) State 30 (1,055) (90) Foreign (70) 415 543 --------------------------------------------------- Total deferred 306 (12,963) (588) --------------------------------------------------- Total provision for income taxes $ 17,607 $ 380 $ 3,483 ===================================================
The components of the Company's income before income taxes are as follows (table in thousands):
Year Ended May 31, --------------------------------------------------- 2003 2002 2001 --------------------------------------------------- Domestic $ 39,944 $ 17,017 $ 14,964 Foreign 4,352 2,757 1,825 --------------------------------------------------- $ 44,296 $ 19,774 $ 16,789 ===================================================
The provision for income tax differs from the amount computed by applying the statutory federal income tax rate to income before taxes as follows:
Year Ended May 31, --------------------------------------------------- 2003 2002 2001 --------------------------------------------------- Statutory federal income tax rate 35% 35% 35% State tax provision 3 3 3 Benefit from net operating loss related to September 1999 Restructuring - - (17) Provision for (Benefit from) Internal Revenue Service adjustment 2 (59) - Foreign income taxes 3 25 9 Foreign tax credit (3) (9) (1) Other - 7 (8) --------------------------------------------------- Provision for Income taxes 40% 2% 21% ===================================================
At May 31, 2003 and 2002, the net deferred tax asset consists of the following (table in thousands):
May 31, ------------------- 2003 2002 ------------------- Deferred tax assets: Foreign net operating loss carryforwards $ 8,037 $ 8,244 Expenses capitalized for income tax purposes 11,208 12,276 Reserves and allowances 5,999 4,478 Deferred compensation plan 1,525 470 Uniform capitalization of inventory 1,069 728 Other 2,029 2,763 ------------------- Total deferred tax assets: $29,867 $28,959 =================== Deferred tax liabilities: Property and equipment $ 4,389 $ 2,044 Other 1,739 1,780 ------------------- Total deferred tax liabilities: $ 6,128 $ 3,824 =================== Valuation allowance (8,037) (8,244) ------------------- Net deferred tax asset $15,702 $16,891 ===================
In February 2002, the Internal Revenue Service ("IRS") completed an examination of the Company's taxable years ended May 31, 1997, 1996 and 1995. In May 2003, the examination report was approved by the Congressional Joint Committee. As a result of this examination, approximately $35.0 million of previously deducted expenses for tax purposes were capitalized during the fiscal year ended May 31, 2002 and are currently being amortized over fifteen years. These adjustments created a long-term deferred tax asset of approximately $11.5 million. During the fiscal year ended May 31, 2002, the valuation allowance increased by $624,000 due to additional foreign net operating loss carryforwards that may not be utilized in future years. During the fiscal year ended May 31, 2001, the valuation allowance decreased by $16,466,000 due to the elimination of net operating loss carryforwards that would provide no future benefit to the Company. Management believes that it is more likely than not that the Company will generate sufficient future taxable income to realize the balance of the net deferred tax asset as of May 31, 2003. However, there can be no assurance that the Company will generate any specific level of taxable income or that it will be able to realize any of the remaining deferred tax assets in future periods. If the Company were unable to generate sufficient taxable income in the future, an additional valuation allowance against this deferred tax asset would result in a charge to earnings. During the fiscal year ended May 31, 2001, the Company utilized approximately $9.5 million in net operating loss carryforwards generated during the period from September 1999 to May 2000. At May 31, 2003, the Company had approximately $21.2 million of foreign net operating loss carryforwards which may be carried forward indefinitely. The Company has provided a full valuation allowance against the deferred tax asset related to these carryforwards. 12. Supplemental Disclosures of Cash Flow Information
Year Ended May 31, ------------------------------------------- 2003 2002 2001 ------------------------------------------- Cash paid during the period for (in thousands): Interest $20,665 $27,222 $34,063 Income taxes, net 9,813 8,221 6,131
Non-cash investing and financing activities: During the fiscal year ended May 31, 2001, the Company added interest of $2.9 million to long-term debt principal. 13. Commitments and Contingencies Leases - The Company has noncancellable operating leases, primarily for warehouse and production facilities and computer and production equipment, that expire over the next five years. These leases generally contain renewal options for periods ranging from three to five years and require the Company to pay all executory costs such as maintenance and insurance. Future minimum payments under noncancellable operating leases consist of the following (table in thousands): Year ending May 31: ------------------ 2004 $ 9,131 2005 10,917 2006 7,818 2007 4,715 2008 1,456 Thereafter 2,324 ------------------ $ 36,361 ================== Rental expense under noncancellable operating leases was approximately $14,650,000, $15,060,000 and $15,282,000 for the fiscal years ended May 31, 2003, 2002 and 2001, respectively. Environmental Issues - The Company's operations are subject to federal, state and local health, safety and environmental laws and regulations that impose workplace standards and limitations on the discharge of pollutants into the environment and establish standards for the handling, generation, emission, release, discharge, treatment, storage and disposal of materials, substances and wastes. As of July 17, 2003, the Company was unaware of any environmental, health or safety violations. Product Liability - Due to the nature of the Company's products, the Company is subject to product liability claims involving personal injuries allegedly related to the Company's products. These claims include injuries sustained by individuals using the Company's products. The Company currently carries an occurrence-based product liability insurance policy. The current policy provides coverage for the period from October 1, 2002 to October 1, 2003 of up to $5.0 million per occurrence and $5.0 million in the aggregate. The policy has a deductible on each claim of up to $1,000,000. For occurrences prior to October 1, 2002, the policy provides coverage of up to $5.0 million per occurrence and $5.0 million in the aggregate. The policy has a deductible on each claim of up to $500,000. For occurrences prior to October 1, 2001, the policy provides coverage of up to $5.0 million per occurrence and $25.0 million in the aggregate. The policy has a deductible on each claim ranging from $100,000 to $250,000. The Company believes that its insurance is generally adequate to cover product liability claims. Nevertheless, currently pending claims and any future claims are subject to the uncertainties related to litigation, and the ultimate outcome of any such proceedings or claims cannot be predicted. Due to uncertainty with respect to the nature and extent of manufacturers' and distributors' liability for personal injuries, the Company cannot guarantee that its product liability insurance is or will be adequate to cover such claims. The Company vigorously defends any and all product liability claims brought against it and does not believe that any currently pending claim or series of claims will have a material adverse effect on its results of operations, liquidity or financial position. Other Litigation - The Company is party to a variety of non-product liability commercial suits involving contract claims. The Company believes that adverse resolution of these lawsuits would not have a material adverse effect on its results of operations or financial position. In December 2001, a claim was made against the Company alleging the Company received $1.7 million of preferential transfers in connection with the 1999 Service Merchandise bankruptcy proceedings. The proposed claim is currently being vigorously defended by the Company's counsel. At this time, the Company and its counsel are unable to determine the likelihood of an unfavorable outcome or the amount or range of potential recovery or loss. The Company is involved in litigation with Vectra Fitness, Inc. ("Vectra"). Vectra filed a civil action in the United States District Court, for the Western District of Washington in Seattle, Washington. Vectra is alleging one claim of patent infringement by the Company on one of its patents. The complaint seeks monetary damages and other relief. This case is currently being vigorously defended by the Company's counsel; however, it is not possible for the Company to quantify with any certainty the extent of any potential liability. The Company is also involved in several intellectual property and patent infringement claims, arising in the ordinary course of its business. The Company believes that the ultimate outcome of these matters will not have a material adverse effect upon its results of operations or financial position. Retirement Plans - All employees who have met minimum age and service requirements are eligible to participate in the 401(k) savings plan. Company contributions to the plan for the fiscal years ended May 31, 2003, 2002 and 2001 were $630,000, $610,000 and $540,000, respectively. In September 2001, the Company established a nonqualified deferred compensation plan that permits certain employees to annually elect to defer a portion of their compensation for their retirement. The amount of compensation deferred and related investment earnings have been placed in an irrevocable rabbi trust and recorded within other assets in the Company's consolidated balance sheet, as this trust will be available to the Company's general creditors in the event of insolvency. An offsetting deferred compensation liability, which equals the total value of the trust at May 31, 2003 and 2002 of $4,015,000 and $1,238,000, respectively, and which is recorded within other liabilities in the Company's consolidated balance sheet, reflects amounts due to employees who contributed to the plan. The Company's contributions to the deferred compensation plan for the fiscal years ended May 31, 2003 and 2002 were $1,293,000 and $120,000, respectively. Employment Agreements - In May of 2003, the Company renegotiated the September 27, 1999 employment agreements ("second amendment") with each of the Chairman and Chief Executive Officer and the President and Chief Operating Officer. The second amendment extends these agreements to September 27, 2005. The employment agreements provide for the continued employment of Chairman and Chief Executive Officer with an increase in base salary from $525,000 to $625,000, and President and Chief Operating Officer with an increase in base salary from $475,000 to $575,000. Except as set forth below, in all other material respects the agreements are substantially identical to the September 1999 agreement. The second amendment provides for a one-time retention bonus for each of Chairman and Chief Executive Officer and President and Chief Operating Officer of $300,000. Each executive is also entitled to participate in a bonus program providing for a bonus equal to a percentage of the Company's consolidated EBITDA (as defined in the Company's credit facility) and the Company's subsidiaries (the Company's "EBITDA") which percentage shall equal 1.50% for Chairman and Chief Executive Officer and 1.32% for President and Chief Operating Officer. The executives will not be entitled to a bonus, however, unless the Company's Profits exceed 5.5% of net sales. The Company may terminate each executive's employment (1) for cause as provided in each agreement, (2) upon six months' disability, or (3) without cause. Each executive may similarly terminate his employment immediately for cause as provided in his employment agreement, upon three months notice to perform full-time church service or for any reason upon six months' notice. The employment agreements prohibit the executives from engaging in outside business activity during the term, subject to certain exceptions. The employment agreements provide for customary confidentiality obligations and, in addition, a non-competition obligation for a period of four years following termination (two years if the executive quits with cause or without cause or is terminated without cause, except that the Company may, at the Company's option, extend such period for up to two additional years by paying the executive his salary and bonus during the extended period). In fiscal 2003, the Company formed a foreign subsidiary to build a manufacturing facility in Xiamen, China. The total project cost is anticipated to be approximately $12.0 million, with $7.0 million to be funded in the form of equity by the subsidiary, and approximately $5.0 million in the form of debt. The Company's share of the equity investment is expected to be approximately $5.0 million. The Company is in the process of arranging for the debt portion of the financing, which is expected to be provided by the Bank of China. 14. Related Party Transactions Management Fees The Company has an agreement with major stockholders of HF Holdings who provide management and advisory services to the Company. Total annual fees due under this agreement are $800,000, for the fiscal years ended May 31, 2003, 2002 and 2001. The Company recorded management fee expense of $800,000 each year. If the Company enters into any acquisition transaction involving at least $10 million, the Company must pay a fee of approximately 1% of the gross purchase price, including liabilities assumed, of the transaction to these stockholders. In addition, in the event of a Liquidity Event (as defined in the Stockholder's Agreement), the Company will pay a fee in an amount which will approximate 1% of the purchase price of the transaction to another major stockholder. Airplane Lease In June 1996, the Company entered into an agreement with FG Aviation, Inc. ("FG"), a company which is jointly owned by officers of the Company, whereby the Company committed to lease an airplane from FG. Minimum rentals under the lease, which expires in May 2005, are $56,610 per month. In February 2002, the Company entered into a new agreement with FG whereby the Company terminated the original airplane lease and committed to lease a new airplane from FG. Minimum lease rentals under the lease, which expires February 2009, are $120,000 per month. The Company is responsible for scheduled maintenance and fuel costs; however, these costs reduce the monthly rental. In addition, the Company is responsible for payment of the aircraft crew and any unscheduled maintenance of the aircraft. In connection with its airplane lease commitments, the Company recorded $809,000, $695,000 and $903,000 of rental expense for the fiscal years ended May 31, 2003, 2002 and 2001, respectively. In addition, in February 2002, the Company advanced $280,000 to FG as a security deposit on the aircraft lease. Receivable from Parent As part of the September 1999 Restructuring, HF Holdings loaned to senior management an aggregate of $2.2 million against non-recourse notes with a maturity of 10 years. HF Holdings used funds advanced from the Company to make the loans. The notes bear interest at a rate equal to that of the New Credit Facilities, payable in cash until the first date as of which the cumulative net taxable income of the Company arising on or after the date of consummation of the September 1999 Restructuring exceeds zero. As of May 31, 2003 and 2002, these notes are non-interest bearing. The notes may be accelerated upon specified defaults and liquidity events, and are collateralized by shares of HF Holdings common stock. 15. Acquisition of Business On December 20, 2000, the Company acquired certain assets of a corporation. The aggregate purchase price was $3,997,000, net of cash acquired of $3,438. The acquisition was accounted for under the purchase method of accounting. The costs of the acquisition have been allocated on the basis of the estimated fair market value of the assets acquired and the liabilities assumed as reflected in the following table (in thousands). The results of the operations of the acquired business have been included in the accompanying consolidated financial statements since the date of acquisition. The acquired corporation's historical revenue and net income for the period preceding the acquisition date was not significant to the Company.
Fair value of assets acquired: Trade accounts receivable $ 756 Inventories 835 Property and equipment 429 Goodwill 4,430 Other 32 ------- Total assets acquired 6,482 Liabilities assumed: Accounts payable (2,320) Other (100) Note payable (65) ------- Total liabilities assumed (2,485) ------- Cash paid for acquisition $ 3,997 =======
As a result of a contingent purchase price agreement, the Company paid $306,000 of additional consideration during the fiscal year ended May 31, 2002, which was classified as goodwill. 16. Geographic Segment Information Based on the Company's method of internal reporting, the Company operates and reports as a single industry segment, which is, development, manufacturing and distribution of home fitness equipment. Revenue and long-lived asset information by geographic area as of and for the fiscal years ended May 31 is as follows (table in thousands):
Revenues Long-lived for the years ended May 31 assets (net) as of May 31, ----------------------------- ---------------------------- 2003 2002 2001 2003 2002 ----------------------------- ---------------------------- United States $924,047 $794,319 $728,221 $44,961 $41,650 Foreign 87,497 77,080 68,773 3,816 3,335 ----------------------------- ---------------------------- Total $1,011,544 $871,399 $796,994 $48,777 $44,985 ============================= ============================
Foreign revenue is based on the country in which the sales originate (i.e. where the legal subsidiary is domiciled). Revenue from no single foreign country was material to the consolidated revenues of the Company. 17. Condensed Consolidating Financial Statements The Company's subsidiaries JumpKing, Inc., 510152 N.B. Ltd., Universal Technical Services, Inc., ICON International Holdings, Inc., NordicTrack, Inc. and Free Motion Fitness, Inc. ("Subsidiary Guarantors") have fully and unconditionally guaranteed on a joint and several basis, the obligation to pay principal and interest with respect to the 11.25% Notes. A significant portion of the Company's operating income and cash flow is generated by its subsidiaries. As a result, funds necessary to meet the Company's debt service obligations are provided in part by distributions or advances from its subsidiaries. Under certain circumstances, contractual and legal restrictions, as well as the financial condition and operating requirements of the Company's subsidiaries, could limit the Company's ability to obtain cash from its subsidiaries for the purpose of meeting its debt service obligations, including the payment of principal and interest on the 11.25% Notes. Although holders of the 11.25% Notes will be direct creditors of the Company's principal direct subsidiaries by virtue of the guarantees, the Company has indirect subsidiaries located primarily in Europe ("Non-Guarantor Subsidiaries") that are not included among the Guarantor Subsidiaries, and such subsidiaries will not be obligated with respect to the 11.25% Notes. As a result, the claims of creditors of the Non-Guarantor Subsidiaries will effectively have priority with respect to the assets and earnings of such companies over the claims of creditors of the Company, including the holders of the 11.25% Notes. The following supplemental condensed consolidating financial statements are presented (in thousands): 1. Condensed consolidating balance sheets as of May 31, 2003 and 2002 and condensed consolidating statements of operations and cash flows for each of the years in the three year period ended May 31, 2003. 2. The Company's combined Subsidiary Guarantors and combined Non- Guarantor Subsidiaries with their investments in subsidiaries accounted for using the equity method. 3. Elimination entries necessary to consolidate the Company and all of its subsidiaries.
Supplemental Condensed Consolidating Balance Sheet Year ended May 31, 2003 --------------------------------------------------------------------- ICON Combined Combined Health & Guarantor Non-Guarantor Fitness,Inc. Subsidiaries Subsidiaries Eliminations Consolidated ------------ ------------ ------------ ------------ ------------ ASSETS Current assets: Cash $ 941 $ 2,385 $ 1,324 $ - $ 4,650 Accounts receivable, net 103,461 74,425 12,376 (15,098) 175,164 Inventories, net 101,297 51,142 9,825 (556) 161,708 Deferred income taxes 6,838 241 244 - 7,323 Other current assets 1,611 4,397 3,822 - 9,830 -------- -------- ------- --------- -------- Total current assets 214,148 132,590 27,591 (15,654) 358,675 -------- -------- ------- --------- -------- Property and equipment, net 37,813 9,581 1,383 - 48,777 Receivable from affiliates 116,479 25,889 - (142,368) - Intangible assets, net 20,295 7,556 1,218 - 29,069 Deferred income taxes 8,154 225 - - 8,379 Investment in subsidiaries 57,793 - - (57,793) - Other assets, net 12,936 7,255 23 - 20,214 -------- -------- ------- --------- -------- Total Assets $467,618 $183,096 $30,215 $(215,815) $465,114 ======== ======== ======= ========== ======== LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT) Current liabilities: Current portion of long-term debt (as restated) $ 91,313 $ - $ - $ - $ 91,313 Accounts payable 86,192 25,876 24,207 (15,098) 121,177 Accrued expenses 21,772 6,802 5,390 - 33,964 Income taxes payable 3,969 (856) 1,115 - 4,228 Interest payable 7,484 - - - 7,484 -------- --------- ------- --------- -------- Total current liabilities 210,730 31,822 30,712 (15,098) 258,166 -------- --------- ------- --------- -------- Long-term debt (as restated) 152,904 15 - - 152,919 Other liabilities 4,015 5,676 - - 9,691 Payable to affiliates 25,889 95,128 21,351 (142,368) - Stockholder's equity (deficit): Common stock and additional paid-in capital 206,324 37,259 5,481 (44,909) 204,155 Receivable from Parent (2,200) - - - (2,200) Retained earnings (accumulated deficit) (130,525) 11,191 (24,478) (13,440) (157,252) Accumulated other comprehensive income (loss) 481 2,005 (2,851) - (365) -------- --------- ------- --------- -------- Total stockholder's equity (deficit) 74,080 50,455 (21,848) (58,349) 44,338 -------- --------- ------- --------- -------- Total Liabilities and Stockholder's Equity $467,618 $183,096 $30,215 $(215,815) $465,114 ======== ======== ======= ========== ========
Supplemental Condensed Consolidating Balance Sheet Year Ended May 31, 2002 --------------------------------------------------------------------- ICON Combined Combined Health & Guarantor Non-Guarantor Fitness,Inc. Subsidiaries Subsidiaries Eliminations Consolidated ------------ ------------ ------------ ------------ ------------ ASSETS Current assets: Cash $ 327 $ 1,448 $ 2,998 $ - $ 4,773 Accounts receivable, net 104,553 54,071 11,249 (16,695) 153,178 Inventories, net 82,558 45,657 5,847 (309) 133,753 Deferred income taxes 4,591 214 2 - 4,807 Other current assets 8,472 8,457 1,746 - 18,675 -------- -------- ------- --------- -------- Total current assets 200,501 109,847 21,842 (17,004) 315,186 -------- -------- ------- --------- -------- Property and equipment, net 34,031 10,101 853 - 44,985 Receivable from affiliates 81,636 16,361 - (97,997) - Intangible assets, net 20,466 8,517 1,218 - 30,201 Deferred income taxes 11,402 377 305 - 12,084 Investment in subsidiaries 31,104 - - (31,104) - Other assets, net 20,756 - 12 - 20,768 -------- -------- ------- --------- -------- Total Assets $399,896 $145,203 $24,230 $(146,105) $423,224 ======== ======== ======= ========== ======== LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT) Current liabilities: Current portion of long-term debt (as restated) $103,062 $ 44 $ - $ - $103,106 Accounts payable 81,909 28,586 20,127 (16,695) 113,927 Accrued expenses 16,280 4,998 2,473 - 23,751 Income taxes payable - 5,069 352 - 5,421 Interest payable 3,045 - - - 3,045 -------- -------- ------- --------- -------- Total current liabilities 204,296 38,697 22,952 (16,695) 249,250 -------- -------- ------- --------- -------- Long-term debt (as restated) 149,135 3,696 - - 152,831 Other liabilities 4,934 - - - 4,934 Payable to affiliates 16,361 60,784 20,852 (97,997) - Stockholder's equity (deficit): Common stock and additional paid-in capital 206,324 37,259 5,481 (44,909) 204,155 Receivable from Parent (2,200) - - - (2,200) Retained earnings (accumulated deficit) (178,954) 5,632 (24,115) 13,496 (183,941) Accumulated other comprehensive loss - (865) (940) - (1,805) -------- -------- ------- --------- -------- Total stockholder's equity (deficit) 25,170 42,026 (19,574) (31,413) 16,209 -------- -------- ------- --------- -------- Total Liabilities and Stockholder's Equity $399,896 $145,203 $24,230 $(146,105) $423,224 ======== ======== ======= ========== ========
Supplemental Condensed Consolidating Statement of Operations Year ended May 31, 2003 --------------------------------------------------------------------- ICON Combined Combined Health & Guarantor Non-Guarantor Fitness,Inc. Subsidiaries Subsidiaries Eliminations Consolidated ------------ ------------ ------------ ------------ ------------ Net sales $659,357 $300,539 $51,648 $ - $1,011,544 Cost of sales 499,796 183,755 29,617 247 713,415 -------- -------- ------- ------- ---------- Gross profit 159,561 116,784 22,031 (247) 298,129 Total operating expenses 103,988 103,883 19,590 - 227,461 -------- -------- ------- ------- ---------- Income (loss) from operations 55,573 12,901 2,441 (247) 70,668 Interest expense (23,299) (32) (1,774) - (25,105) Amortization of deferred financing fees (1,267) - - - (1,267) Equity in earnings of subsidiaries 4,949 - - (4,949) - -------- -------- ------- ------- ---------- Income (loss) before income taxes 35,956 12,869 667 (5,196) 44,296 Provision for income taxes 9,267 7,310 1,030 - 17,607 -------- -------- ------- ------- ---------- Net income (loss) $ 26,689 $ 5,559 $ (363) $(5,196) $ 26,689 ======== ======== ======= ======= ==========
Supplemental Condensed Consolidating Statement of Operations Year ended May 31, 2002 --------------------------------------------------------------------- ICON Combined Combined Health & Guarantor Non-Guarantor Fitness,Inc. Subsidiaries Subsidiaries Eliminations Consolidated ------------ ------------ ------------ ------------ ------------ Net sales $623,012 $206,193 $42,194 $ - $871,399 Cost of sales 464,431 141,733 29,025 (143) 635,046 -------- -------- ------- ------ -------- Gross profit 158,581 64,460 13,169 143 236,353 Total operating expenses 98,244 68,127 13,478 - 179,849 -------- -------- ------- ------ -------- Income (loss) from operations 60,337 (3,667) (309) 143 56,504 Interest expense (23,200) (1,177) (1,772) - (26,149) Amortization of deferred financing fees (3,146) - - - (3,146) Loss on extinguishment of debt (7,435) - - - (7,435) Equity in earnings of subsidiaries (6,629) - - 6,629 - -------- -------- ------- ------ -------- Income (loss) before income taxes 19,927 (4,844) (2,081) 6,772 19,774 Provision (benefit) for income taxes 533 (404) 251 - 380 -------- -------- ------- ------ -------- Net income (loss) $ 19,394 $ (4,440) $(2,332) $6,772 $ 19,394 ======== ======== ======= ====== ========
Supplemental Condensed Consolidating Statement of Operations Year Ended May 31, 2001 --------------------------------------------------------------------- ICON Combined Combined Health & Guarantor Non-Guarantor Fitness,Inc. Subsidiaries Subsidiaries Eliminations Consolidated ------------ ------------ ------------ ------------ ------------ Net sales $652,445 $106,685 $37,864 $ - $796,994 Cost of sales 474,343 81,163 25,055 (77) 580,484 -------- -------- ------- ------ -------- Gross profit 178,102 25,522 12,809 77 216,510 Total operating expenses 122,140 25,870 13,751 - 161,761 -------- -------- ------- ------ -------- Income (loss) from operations 55,962 (348) (942) 77 54,749 Interest expense (31,875) (1,408) (1,488) - (34,771) Amortization of deferred financing fees (3,189) - - - (3,189) Equity in earnings of subsidiaries (4,503) - - 4,503 - -------- -------- ------- ------ -------- Income (loss) before income taxes 16,395 (1,756) (2,430) 4,580 16,789 Provision for income taxes 3,089 60 334 - 3,483 -------- -------- ------- ------ -------- Net income (loss) $ 13,306 $ (1,816) $(2,764) $4,580 $ 13,306 ======== ========= ======== ====== ========
Supplemental Condensed Consolidating Statement of Cash Flows Year Ended May 31, 2003 --------------------------------------------------------------------- ICON Combined Combined Health & Guarantor Non-Guarantor Fitness,Inc. Subsidiaries Subsidiaries Eliminations Consolidated ------------ ------------ ------------ ------------ ------------ Operating activities: Net cash provided by (used in) operating activities: $ 55,844 $(24,595) $ 389 $ - $ 31,638 -------- -------- ------- ------ -------- Investing activities: Net cash used in investing activities: (18,568) (2,301) (956) - (21,825) -------- -------- ------- ------ -------- Financing activities: Borrowings on revolving credit facility, net (6,749) - - - (6,749) Payments on other long-term debt - (29) - - (29) Payments on April 2002 term notes (5,000) - - - (5,000) Payment of fees-debt (481) - - - (481) Other (25,315) 24,816 499 - - -------- -------- ------- ------ -------- Net cash provided by (used in) financing activities: (37,545) 24,787 499 - (12,259) -------- -------- ------- ------ -------- Effect of exchange rates on cash 883 3,046 (1,606) - 2,323 -------- -------- ------- ------ -------- Net increase (decrease) in cash 614 937 (1,674) - (123) Cash, beginning of period 327 1,448 2,998 - 4,773 -------- -------- ------- ------ -------- Cash, end of period $ 941 $ 2,385 $ 1,324 $ - $ 4,650 ======== ======== ======= ====== ========
Supplemental Condensed Consolidating Statement of Cash Flows Year Ended May 31, 2002 --------------------------------------------------------------------- ICON Combined Combined Health & Guarantor Non-Guarantor Fitness,Inc. Subsidiaries Subsidiaries Eliminations Consolidated ------------ ------------ ------------ ------------ ------------ Operating activities: Net cash provided by operating activities: $ 30,169 $ 6,133 $ 1,236 $ - $ 37,538 -------- -------- ------- ------ -------- Investing activities: Net cash used in investing activities: (13,747) (2,834) (549) - (17,130) -------- -------- ------- ------ -------- Financing activities: Borrowings on revolving credit facility, net 32,831 - - - 32,831 Payments on other long-term debt, net - (48) - - (48) Proceeds from April 2002 term notes 25,000 - - - 25,000 Payments on April 2002 term notes (1,250) - - - (1,250) Payments on September 1999 term notes (172,834) - - - (172,834) Proceeds from 11.25% notes 152,813 - - - 152,813 Payments to 12% noteholders (46,053) - - - (46,053) Payment of fees-debt (9,757) - - - (9,757) Other 1,540 (2,689) 1,149 - - -------- -------- ------- ------ -------- Net cash provided by (used in) financing activities: (17,710) (2,737) 1,149 - (19,298) -------- -------- ------- ------ -------- Effect of exchange rates on cash - 273 66 - 339 -------- -------- ------- ------ -------- Net increase (decrease) in cash (1,288) 835 1,902 - 1,449 Cash, beginning of period 1,615 613 1,096 - 3,324 -------- -------- ------- ------ -------- Cash, end of period $ 327 $ 1,448 $ 2,998 $ - $ 4,773 ======== ======== ======= ====== ========
Supplemental Condensed Consolidating Statement of Cash Flows Year Ended May 31, 2001 --------------------------------------------------------------------- ICON Combined Combined Health & Guarantor Non-Guarantor Fitness,Inc. Subsidiaries Subsidiaries Eliminations Consolidated ------------ ------------ ------------ ------------ ------------ Operating activities: Net cash provided by (used in) operating activities: $ 28,025 $(14,425) $ (330) $ (863) $ 12,407 -------- -------- ------- ------ -------- Investing activities: Net cash provided by (used in) investing activities: (16,526) (7,271) 149 863 (22,785) -------- -------- ------- ------ -------- Financing activities: Borrowings on revolving credit facility, net 19,497 - - - 19,497 Payments on other long-term debt, net (393) 17 - - (376) Payments on September 1999 term notes (9,273) - - - (9,273) Payment of fees-debt (1,153) - - - (1,153) Other (22,195) 22,381 (186) - - -------- -------- ------- ------ -------- Net cash provided by (used in) financing activities: (13,517) 22,398 (186) - 8,695 -------- -------- ------- ------ -------- Effect of exchange rates on cash - (622) (235) - (857) -------- -------- ------- ------ -------- Net increase (decrease) in cash (2,018) 80 (602) - (2,540) Cash, beginning of period 3,633 533 1,698 - 5,864 -------- -------- ------- ------ -------- Cash, end of period $ 1,615 $ 613 $ 1,096 $ - $ 3,324 ======== ======== ======= ====== ========
Valuation and Qualifying Accounts Financial Statement Schedule II (in thousands)
Year Ended May 31, ---------------------------------- 2003 2002 2001 ---------------------------------- Trade accounts receivable-allowance for doubtful accounts, advertising discounts and and credit memos: Balance at beginning of year $ 7,939 $ 6,752 $ 7,004 Additions: Charged to costs and expenses (allowance for doubtful accounts and credit memos) 14,528 4,658 3,582 Charged to costs and expenses (discounts and advertising) 52,461 45,998 41,668 Deductions: Accounts charged off (allowance for doubtful accounts and credit memos) (12,460) (3,906) (5,044) Accounts charged off (advertising) (54,074) (45,563) (40,458) ---------------------------------- Balance at end of year $ 8,394 $ 7,939 $ 6,752 ==================================
Year Ended May 31, ---------------------------------- 2003 2002 2001 ---------------------------------- Inventory reserve: Balance at beginning of year $ 3,275 $ 3,185 $ 2,829 Additions: Charged to costs and expenses 625 679 506 Deductions: Reduction in reserve - (589) (150) ---------------------------------- Balance at end of year $ 3,900 $ 3,275 $ 3,185 ==================================
CERTIFICATION -------------- I, David J. Watterson, certify that: 1. I have reviewed this annual report of ICON Health & Fitness, Inc.; 2. Based on my knowledge, this annual 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(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and 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) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) 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 d) 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(s) 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 function): a) all significant deficiencies and material weaknesses in the design or operation of internal control 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. Date: August 27, 2004 /s/ David J. Watterson ---------------------- David J. Watterson Chief Executive Officer CERTIFICATION -------------- I, S. Fred Beck, certify that: 1. I have reviewed this annual report of ICON Health & Fitness, Inc.; 2. Based on my knowledge, this annual 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(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and 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) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) 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 d) 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(s) 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 function): a) all significant deficiencies and material weaknesses in the design or operation of internal control 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. Date: August 27, 2004 /s/ S. Fred Beck ---------------- S. Fred Beck Chief Financial Officer