ITEM 1. DESCRIPTION OF BUSINESS.
INDUSTRY
The fitness equipment industry in the United States includes cardiovascular and other fitness equipment, and strength training equipment. Cardiovascular and other fitness equipment includes treadmills, ellipticals, exercise bikes and other equipment, such as trampolines and relaxation products such as spas. Strength training equipment includes multi-purpose home gyms, free weights and weight benches and cages. According to the National Sporting Goods Association (NSGA) 2004 annual report, total retail sales of exercise equipment on an industry-wide basis are estimated to be $4.9 billion in calendar year 2004.
OUR COMPANY
We market and distribute a broad line of products in the fitness equipment market, which include cardiovascular and other fitness 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 strength training products for the institutional fitness equipment market. Our brand names include ProForm, NordicTrack, Weslo, HealthRider, Image, JumpKing, Weider, Epic, Free Motion Fitness and, under license, Reebok and Gold's Gym.
OUR BRANDS AND DISTRIBUTION CHANNELS
We market a complete line of products using multiple brands through multiple distribution channels to reach a wide range of consumers at various price points. This approach is enabled by our strong portfolio of brands which are placed strategically to align consumer demographics with respective brand attributes. We market our products through each distribution channel in which home fitness equipment products are sold, including: department stores, mass retailers and warehouse clubs, sporting goods and specialty fitness retailers, home improvement stores, electronic retailers and direct-to-consumer sales through catalogs, infomercials, the Internet and our company-owned NordicTrack™ stores.
PRODUCTS
Cardiovascular and Other Fitness Equipment
Our cardiovascular and other fitness equipment covers a broad range of technological sophistication and a variety of price points which include the following:
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Treadmills
We are the leading producer of motorized treadmills. We design, innovate, manufacture, market and distribute motorized and manual treadmills, designed to promote cardiovascular fitness. Our treadmills include proprietary technologies in the electronics console and drive train systems and overall frame design. In the June 2003 issue of Consumer Reports, six of our treadmills ranked among the top fifteen treadmills worldwide, based on criteria such as quality, durability, features and ease of use. Certain features offered by our motorized treadmills that enhance the home user's experience include bio-feedback electronics such as heart rate control, pulse, certain programmable speeds and inclines, electronic feedback on speed, elapsed time, distance traveled, calories/fat calories burned, and cross-training upper body exercise functions. The SpaceSaver® feature for treadmills (introduced in 1996), for which we hold six United States patents, enables treadmills with this feature to fold vertically for easy storage. As of the fall of 2001, we have equipped all our brands of treadmills with a price point of $599 and above with iFIT® technology, for which we hold two United States patents and have seven patents pending. iFIT® technology allows us to control and program speed and incline of a treadmill from remote locations for virtual personal training or control the treadmill through CDs, VHS tapes, DVD, MP3 and the iFit.com website. Consumers can benefit from iFIT® technology using streaming workouts from the iFIT® website, music workouts on compact discs or MP3, or multi-media iFIT® videos and DVDs. In addition, we also offer live personal training services via the Internet for consumers who choose to subscribe to our service.
Other popular features on our treadmill line of products include: cushioning technologies such as PRO SHOX™ adjustable leaf springs and soft belts for a quiet, shock-absorbent workout and the CrossWalk™ line of treadmills, which provides users with upper body exercise for a total body workout.
Ellipticals
Ellipticals offer a low-impact, high-intensity aerobic workout which harnesses the momentum of a natural striding motion, and reduces the impact of typical running or walking. Our ellipticals typically provide an electronic display that provides heart rate control, programmed workouts and feedback on speed, time, distance and calories burned. Our iFIT® technology, which automatically adjusts resistance and pace on elliptical trainers, is included on many elliptical trainers priced at $399 and above.
Exercise Bikes
We offer exercise bikes featuring a variety of resistance mechanisms including electromagnetic, self-generating, flywheel and air; electronic monitors which display elapsed time, speed, distance and calories burned; and dual function design, which allows the user to exercise the upper body, lower body or both simultaneously. Certain units include heart rate control, motivational electronics and programmable resistance which allow users to design their own workouts. Our iFIT® technology, which automatically adjusts pace and resistance, is included on several recumbent and upright bikes.
Recreational Sports Products
Recreational Sports Products. Through our JumpKing subsidiary, we manufacture and market trampolines that include both mini-trampolines for indoor home exercise use and full-sized trampolines for outdoor home recreational use.
Relaxation Products
In the spring of 1996, we introduced a full line of hydrotherapy spas. These hydrotherapy spas are currently distributed through various channels including department stores, mass retailers and warehouse clubs, home improvement stores, specialty dealers and direct-to-consumers through our own direct response marketing efforts.
Strength Training Equipment
We offer a complete line of anaerobic strength training equipment designed to develop muscle tone and strength. Strength training equipment includes the following:
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Home Gyms
Our multi-purpose home gyms offer a range of resistance mechanisms, from selectorized weight stacks to plate-loaded gyms to our powerstroke leverage system and our CRS™ ("Compound Resistance System"™). New products include our Platinum CrossBar by Weider™ home gym which features an DCR™ Digital Control Resistance that allows a user to adjust resistance at the touch of a button, and our patented Free Motion™ equipment, which enables users to enjoy a full range of motion with "functional movement" versus the rigid "fixed path movement" of traditional equipment. Other products include our multi-purpose home gyms, which integrate aerobic functions for cross training. Selected units are designed to allow multiple users to use the equipment simultaneously, thereby allowing circuit training.
Weight Benches, Cages and Free Weights
We offer a range of weight benches and squat cages. We also offer a broad assortment of cast-iron weight plates, vinyl and neoprene dipped weights and dumbbells, in standard and Olympic size formats.
Exercise Accesories
We offer a line of back support belts, workout gloves and exercise accessories, including ankle and hand weights and grip devices.
PRODUCT AND DESIGN INNOVATION
Product and design innovation has contributed significantly to our growth. On an ongoing basis, we evaluate new product concepts and seek to respond to the desires and needs of consumers by frequently introducing new products and repositioning existing products. As of May 31, 2004, we had approximately 370 employees in our research and development group. We hold 178 United States patents, we have 79 United States and 494 foreign trademarks, we have 34 United States and 58 foreign patents pending and 21 United States and 78 foreign trademarks pending.
We conduct most of our research and development in 40,000 square feet of space in our Logan, Utah headquarters. This facility includes industrial design, mechanical and electrical engineering capabilities that are used in creating proprietary designs and features.
CUSTOMERS
Our largest customer since 1985 has been Sears. In fiscal 2004, Sears accounted for approximately 38.7% of net sales, a 0.3% decrease from fiscal 2003. Other important customers include Wal-Mart, Sam's Club, The Sports Authority, Dick's Sporting Goods, Costco, Target, Home Shopping Network, Gold's Gym and 24 Hour Fitness. Although Sears still accounts for a substantial portion of our sales, the percentage of net sales to Sears has decreased over the past decade from a high of approximately 68% in 1989. Nevertheless, the dollar amount of our net sales to Sears has increased during this time period. Several customers have distinguished us with vendor awards for our commitment in providing quality and value to the consumer, including, among others, Sears' Vendor of the Year in 2000, Category Source of the Year in 2002 and their Partner in Progress award thirteen times since 1985. Wal-Mart has named us Vendor of the Quarter once in each of fiscal 1999, 2000, 2001 and 2002. In 2003 we received the Vendor of the Year Award by both K’s Merchandise and ShopKo. The Sports Authority named us Vendor of the Year in 2002, and iFIT.com® received The Sports Authority Victor Award for the most innovative product. We have received the annual SPARC Award eight times including the last seven years, consecutively. This annual award is the only industry-wide vendor recognition program in mass-market retailing, and is awarded by Discount Store News, a magazine which employs a panel made up of key merchandising executives from the mass market retailing industry. This award honors those who excel in new product innovation, on-time delivery, advertising support and quality control.
We sell our products to customers representing over 7,600 consumer locations, excluding those consumers we sell to directly through our retail, direct response, television and Internet distribution channels. Consistent with industry practice, we generally do not have long-term purchase agreements or other commitments from our customers as to levels of future sales.
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The level of our sales to large customers depends in large part on our continuing commitment to home fitness products and the success of our efforts to market and promote our products, as well as our competitiveness in terms of price, quality, product innovation and customer service. We are not the exclusive supplier of home fitness equipment to any of our major customers. The loss of, or a substantial decrease in the amount of purchases by, or the uncollectibility of any significant receivable due from any of our major customers could have a material adverse effect on our business.
COMPETITION
The fitness equipment market is highly competitive. It is characterized by frequent introduction of new products, often accompanied by major advertising and promotional programs. We believe that the principal competitive factors affecting our business include price, quality, brand name recognition, product innovation and customer service.
We compete with several domestic manufacturers and distributors such as Cybex International, Inc., Fitness Quest, Life Fitness (a division of Brunswick), Nautilus Group, Inc. and Precor (owned by Amer Group, PLC). We also compete with a number of United States and foreign importers in both the United States and global markets including Impex and Stamina. In Europe, we principally compete with BH (Spain), CARE (France), Helmut Kettler, Horizon, Tunturi, York (Great Britain) and other domestic competitors. The following table shows who may be the five largest competitors in the United States:
United States Fitness Competitors
DISTRIBUTION
We believe our distribution capabilities and post-sales support place us in a good position to service major retailers. This has been accomplished through the successful implementation of our integrated distribution and inventory management system that is used to ensure that the necessary components are available for manufacturing. This system is also capable of tracking finished goods through all levels of the distribution chain. Through the effective use of electronic data interchange, we are able to run manufacturing jobs to fill specific customer orders, arrange for shipping from many of our manufacturing facilities and make timely deliveries to our customer locations.
MANUFACTURING AND PURCHASING
In fiscal 2004, we manufactured or assembled our products at our company facilities in Utah, Texas and Canada; or through third parties, principally in Asia. We have long-standing supply relationships with several offshore vendors, many of which have exclusive relationships in the fitness industry with us. The combination of internal manufacturing and assembly capacity and our access to third-party vendors has helped us meet customer demand on a competitive basis. In addition, the third party vendors provide greater flexibility in manufacturing capacity to satisfy seasonal demands.
We utilize more than 1.1 million square feet for manufacturing, including a 300,000 square foot facility in Logan, Utah. We constructed our Logan, Utah, plant in 1990 and equipped the facility with modern manufacturing and assembly features, including fully integrated metal fabrication, powdercoat painting, robotic welding and injection molding equipment. In 1990, we purchased a trampoline manufacturing operation in Dallas, Texas. In 1991, we began operating our plant in Smithfield,
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Utah. In 1994, we began operating our Clearfield, Utah, manufacturing facility. In 1995, we opened our Smithfield North Plant. In 1996, we expanded our manufacturing capacity by 233,671 square feet through the acquisition of our Canadian manufacturing facility in St. Jerome, Canada. In 2003, we announced our plan to establish a manufacturing facility in Xiamen, China. This facility is expected to be operationally ready during fiscal 2005.
We apply a management system to control and monitor freight, labor, overhead and material cost components of our finished goods. In fiscal 1994, we received ISO 9001 certification for all of our non-retail facilities in Utah. ISO is a nonprofit association that monitors industrial companies' manufacturing processes, quality assurance controls, personnel management and customer service in order to improve plant efficiency, product quality, customer satisfaction and company profitability. ISO 9001 is a certification process used for companies whose business includes a range of activities from design and development to production, installation and servicing. ICON has been recertified by the ISO 9001 standards every year since 1994.
From fiscal 1996 to fiscal 2004, we have invested over $124.9 million in tooling, molding, production and computer equipment to develop state-of-the-art production, research and development, distribution and reporting systems. We have a fully implemented Enterprise Resource Planning ("ERP") system that integrates all manufacturing, planning, inventory, purchasing, order entry and financial functions. Our inventory management and manufacturing productivity are enhanced by our just-in-time system for purchasing materials and components. We have also invested in Electronic Data Interchange ("EDI") capabilities, including Wal-Mart's Retail Link system, which provides us and a substantial number of our primary customers a seamless flow from initial retailer orders to parts purchasing to product manufacturing to shipping.
EMPLOYEES
As of May 31, 2004, we employed approximately 5,142 people. Factory employees are compensated through a targeted incentive system. Managerial employees receive bonuses tied to the achievement of performance targets. As of May 31, 2004, approximately 370 employees were engaged in research and development, 510 in sales and marketing, 4,019 in manufacturing and 243 in other areas, primarily administrative. We are also subject to three employment agreements with our senior executives.
ENVIRONMENTAL MATTERS
Our operations are subject to federal, state and local health and 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. The nature of our manufacturing and assembly operations exposes us to the risk of claims with respect to environmental matters, and although compliance with local, state and federal requirements relating to the protection of the environment has not had a material adverse effect on our financial condition or results of operations, there can be no assurance that material costs or liabilities will not be incurred in connection with such environmental matters. Future events, such as changes in existing laws and regulations or enforcement policies or the discovery of contamination on sites owned or operated by us may give rise to additional compliance costs or operational interruptions which could have a material adverse effect on our financial condition. In addition, many but not all of our properties have been the subject of either Phase I or Phase II Environmental Site Assessments. While we are not aware of any existing conditions that are likely to result in material costs or liabilities to us, there can be no assurance that all potential instances of soil or ground water contamination have been identified even where Environment Site Assessments have been conducted. Accordingly, there can be no assurance that previously unknown environmental conditions, or known conditions which have not been fully evaluated, will not be discovered at any of our properties, whether presently or formerly owned or leased, or that the cost of remediating such condition will not be material.
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 our weakest periods in terms of sales. During these periods, we build product inventory to prepare for the heavy demand anticipated during the upcoming peak season. This operating strategy helps us realize the efficiencies of a steady pace of year-round production.
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ITEM 2.
ITEM 2. PROPERTIES.
Our headquarters are located in Logan, Utah, and we own the related land and buildings. Additionally, we own land and buildings in Canada. The total square footage of our owned buildings is approximately 485,000 square feet.
We lease additional facilities for manufacturing, warehouses and offices in the United States and various foreign countries including the United Kingdom, Italy, France, Germany and China. We sublease certain of these facilities where space is not fully utilized.
We believe that these facilities are well maintained, in good operating condition and are adequate for our current needs and that suitable additional or substitute space will be available as needed to accommodate any expansion of our operations.
In addition, as of May 31, 2004 we operated under lease 68 NordicTrack™ retail stores in various cities in the United States.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
We are party to a variety of non-product liability commercial lawsuits involving contract claims, arising in the ordinary course of our business. We believe that adverse resolution of these lawsuits would not have a material adverse effect on our results of operations or financial position.
We are party to a variety of product liability lawsuits, arising in the ordinary course of our business, as a result of injuries sustained by customers while using a variety of our products. These claims include injuries sustained by individuals using trampolines and treadmills. We vigorously defend any and all product liability claims brought against us and do not believe that any currently pending claim or series of claims will have a material adverse effect on our results of operations or financial position.
We are also involved in several intellectual property and patent infringement claims, arising in the ordinary course of our business. We believe that the ultimate outcome of these matters will not have a material adverse effect on our results of operations or financial position.
We are involved in litigation with Service Merchandise in connection with its filing for bankruptcy protection. Service Merchandise filed three separate adversarial proceedings against us in the United States Bankruptcy Court, Middle District of Tennessee, Nashville Division, alleging preferential transfer in Adversarial Proceedings Nos. 301-0738A and 301-0770A, and Breach of Contract in Adversarial Proceeding No. 301-0586A. The bankruptcy trustee has filed suit in connection with the foregoing seeking to recapture an aggregate amount of $1.7 million in payments made to us as a voidable preference. The summons was issued on April 16, 2001. The proposed claim is currently being vigorously defended by our counsel. At this time, we are unable to determine the likelihood of an unfavorable outcome or the amount or range of potential recovery or loss.
On December 3, 2002, the Nautilus Group, Inc. (“Nautilus”) filed suit against us in the United States District Court, Western District of Washington (the “Court”) alleging we infringed Nautilus’ Bowflex patents. Nautilus seeks injunctive relief and monetary damages. In May 2003, the Court denied Nautilus’ motion for a preliminary injunction and granted partial summary judgment to us on the issue of “literal infringement.” Nautilus appealed this motion denying the preliminary injunction on literal patent infringement, and a trial has been scheduled for sometime in April of 2005. This case is currently being vigorously defended by our legal counsel; however, it is not possible for us to quantify with any certainty the extent of any potential liability.
As part of the above suit, in July 2003, the Court ruled in favor of Nautilus on a motion for preliminary injunction on the issue of trademark infringement, and entered an order barring us from using the trademark "CrossBow" on any exercise equipment. In June of 2004, the United States Court of Appeals for the Federal Circuit affirmed the grant of a preliminary injunction as previously granted by the Federal District Court. Thus, we are barred from using the “CrossBow” trademark on
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any of our exercise equipment pending trial. We subsequently changed the name from “CrossBow” to “CrossBar” or “The Max” by Weider. In July of 2004, Nautilus filed an additional lawsuit in the United States District Court for the Western District of Washington alleging that we further infringed on the Bowflex trademark by using the “CrossBar” trademark. Nautilus seeks injunctive relief and monetary damages. We believe this additional lawsuit is without merit and will vigorously defend our right to use the “CrossBar” trademark.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
We did not submit any matters during the fourth quarter of the fiscal year covered by this report to a vote of security holders through the solicitation of proxies or otherwise.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
As of May 31, 2004, we had 1,000 shares of common stock outstanding all of which were held by HF Holdings, Inc. ("HF Holdings"). There is not an established trading market for the common stock of HF Holdings or us. Our ability to pay dividends is limited under an indenture dated as of April 9, 2002 between us and the Bank of New York, as trustee, and by our Credit Agreement.
ITEM 6.
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, 2004 and the balance sheet data for May 31, 2004 and May 31, 2003 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, 2001 and 2000, and our balance sheet data as of May 31, 2002, 2001 and 2000, 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.
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For the Year Ended May 31,
(In Millions)
Operating Data:
Net Sales(1) $ 1,095.7
$ 1,011.5
$ 871.4
$ 797.0
$ 712.8
Cost of sales
769.3
713.4
635.0
580.5
531.6
Gross profit
326.4
298.1
236.4
216.5
181.2
Operating expenses:
Selling
154.1
134.1
101.4
86.3
75.8
Research and development
14.0
11.6
10.4
10.9
8.3
General and administrative
93.0
81.8
68.1
64.5
61.3
Total operating expenses $ 261.1
$ 227.5
$ 179.9
$ 161.7
$ 145.4
Income from operations
65.3
70.6
56.5
54.8
35.8
Interest expense
25.1
25.1
26.2
34.8
33.9
Amortization of deferred financing fees
0.9
1.2
3.1
3.2
3.7
Net income (loss)
23.4
26.7
19.4
13.3
(6.6 )
Other Financial Data:
Depreciation and amortization
21.4
19.2
19.2
17.4
16.7
Purchase of property and equipment
24.7
17.0
11.6
16.1
12.9
Net cash provided by (used) in
operating activities
(6.1 )
31.6
37.5
12.4
0.5
Net cash used in investing activities
(40.9 )
(21.8 )
(17.1 )
(22.8 )
(19.9 )
Net cash provided by (used) in
financing activities
48.0
(12.3 )
(19.3 )
8.7
21.4
Supplemental Data:
EBITDA(3)
86.7
89.8
68.3
72.1
49.4
Balance Sheet Data:(end of period)
Cash
5.1
4.7
4.8
3.3
5.9
Working capital
109.8
100.5
65.9
(48.4 )
(61.3 )
Total assets
558.5
465.1
423.2
405.5
368.1
Long-term obligations
165.9
162.6
157.7
47.3
48.6
(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)
Includes $9.0 million of purchase of property and equipment related to the manufacturing facility in China for fiscal year 2004. Excludes purchases of intangibles and trademarks and acquisitions of $16.2 million for fiscal year 2004, $4.9 million for fiscal year 2003, $5.5 million for fiscal year 2002, $6.7 million for fiscal year 2001 and $4.4 million for fiscal year 2000.
(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 is a significant covenant used by our creditors to measure our operating results. 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.
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For The Year Ended May 31,
(In Millions)
2001
Loss On Extinguishment of Debt(a) - - 7.4 - -
Kmart Bankruptcy Bad Debt(b) - 9.1 2.4 - -
Excess Air Freight Charges(c) - - - - 6.0
Non-recurring Recapitalization Cost(d) - - - - 1.8
Equity grant to senior management(e) - - - - 3.1
(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.
ITEM 7.
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 2004 ended on May 31, 2004.
RECENT DEVELOPMENTS
In fiscal 2003, we formed a foreign subsidiary to build a manufacturing facility in Xiamen, China. The original project costs were anticipated to be approximately $12.0 million. Due to our decision to increase the size of the facility, we now anticipate the total project cost to be approximately $30.5 million, with $15.5 million to be funded in the form of capital contributions and approximately $15.0 million in the form of debt. Our share of the equity investment is expected to be approximately $10.0 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
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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 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 2 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.
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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 of May 31, 2004, 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, 2004, 2003 and 2002:
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For The Year Ended May 31,
(% of Net Sales)
Year Ended May 31, 2004 Compared to Year Ended May 31, 2003
Net sales for fiscal 2004 increased $84.2 million, or 8.3%, to $1,095.7 million from $1,011.5 million in the comparable period in 2003. Sales increased primarily due to increased customer demand. Sales of our cardiovascular and other equipment in fiscal 2004 increased $65.1 million, to $890.7 million. Sales of our strength training equipment in fiscal 2004 increased $19.1 million, to $205.0 million.
Gross profit for fiscal 2004 was $326.4 million, or 29.8% of net sales, compared to $298.1 million, or 29.5% of net sales, in fiscal 2003. This 9.5% increase was largely due to changes in product mix and manufacturing efficiencies. Gross profit in fiscal 2004 was offset by increases in commodity prices, i.e., steel, plastic and wood in the fourth quarter.
Selling expenses increased $20.0 million, or 14.9%, to $154.1 million in fiscal 2004. This increase reflected increased direct to consumer advertising, commissions and freight. Expressed as a percentage of net sales, selling expenses were 14.1% in fiscal 2004 and 13.3% in fiscal 2003.
Research and development expenses increased $2.4 million, or 20.7%, to $14.0 million in 2004. This increase resulted from increased salaries, materials used in product development and contract labor. Expressed as a percentage of net sales, research and development expenses were 1.3% in fiscal 2004 and 1.1% in fiscal 2003.
General and administrative expenses increased $11.2 million, or 13.7%, to $93.0 million in fiscal 2004. This increase is a factor of legal fees, rent and lease payments, normal salary increases, depreciation expense, planned additions to staff, increased insurance costs and increases attributable to performance based bonus and incentive programs. Expressed as a percentage of net sales, general and administrative expenses were 8.5% in fiscal 2004 compared with 8.1% in fiscal 2003.
As a result of the foregoing factors, operating income decreased $5.3 million, or 7.5%, to $65.3 million in fiscal 2004. Expressed as a percentage of net sales, operating income was 5.9% in 2004 compared with 7.0% in fiscal 2003.
As a result of the foregoing factors, EBITDA decreased $3.1 million, or 3.5%, to $86.7 million in fiscal 2004. Expressed as a percentage of net sales, EBITDA was 7.9% in fiscal 2004 compared with 8.9% in fiscal 2003.
Interest expense, including amortization of deferred financing fees, decreased $0.3 million, or 1.1%, to $26.0 million in fiscal 2004. This decrease reflects lower interest rates during fiscal 2004. Expressed as a percentage of net sales, interest expense including amortization of deferred financing fees was 2.4% in fiscal 2004 compared with 2.6% in fiscal 2003.
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The provision for income taxes decreased $1.7 million, or 9.7%, to $15.9 million in fiscal 2004. Our effective tax rate was 40.5% in 2004 compared to 39.7% in fiscal 2003. The higher effective tax rate in fiscal 2004 is the result of foreign tax credit adjustments. 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 $23.4 million in fiscal 2004 compared to net income in fiscal 2003 of $26.7 million.
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 4,300.0%, 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.
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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.
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 our weakest periods in terms of sales. During these periods, we build product inventory to prepare for the heavy demand anticipated during the upcoming peak season. This operating strategy helps us 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 2004, 2003 and 2002(in millions):
First
Second
Third
Fourth
Quarter(1)
Quarter(2)
Quarter(3)
Quarter(4)
The following is a reconciliation of net income (loss) to EBITDA (6) by quarter (in millions):
First
Second
Third
Fourth
Quarter
Quarter
Quarter
Quarter
Total
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The following is a reconciliation of net income (loss) to EBITDA for the fiscal years ended May 31, 2001 and 2000. (in millions)
(1)
Our first quarter ended August 30, August 31, and September 1 for fiscal years 2004, 2003 and 2002, respectively.
(2)
Our second quarter ended November 29, November 30, December 1 for fiscal years 2004, 2003 and 2002, respectively.
(3)
Our third quarter ended February 28, March 1, and March 2 for fiscal years 2004, 2003 and 2002, respectively.
(4)
Our fourth quarter ended May 31 for the fiscal years 2004, 2003 and 2002, 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.
(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. Pursuant to our credit agreement, EBITDA is a significant covenant used by our creditors to measure operating results. 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.
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LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities was $6.1 million in fiscal 2004, as compared to $31.6 million of cash provided by operating activities in fiscal 2003. In fiscal 2004, major sources of funds were net income of $23.4 million, non-cash provisions of $21.4 million for depreciation and amortization and an increase in accounts payable and accrued expenses of $22.6 million. These changes were offset by increases in accounts receivable of $35.3 million, due to sales growth and increased direct response receivables which are financed over a longer period of time due to our various financing programs, and inventories of $34.2 million, due primarily to building inventory levels to meet anticipated sales levels and our contemplated strategic move to source overseas, i.e., moving part of our manufacturing to China. In fiscal 2003, major sources of funds were net income of $26.7 million and non-cash provisions of $19.2 million for depreciation and amortization. These changes were offset by an increase in
accounts receivable of $22.0 million, and a increase in inventories of $28.0 million.
Net cash used in investing activities was $40.9 million in fiscal 2004, compared to $21.8 million of cash used in investing activities in fiscal 2003. Investing activities in fiscal 2004 consisted primarily of capital expenditures of $15.7 million related to upgrades in plant and tooling and purchases of additional manufacturing equipment and purchases of intangible assets of $16.2 million. Cash used in 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.
Net cash provided by financing activities was $48.0 million in fiscal 2004, compared to $12.3 million of cash used in financing activities in fiscal 2003. Cash provided by financing activities in fiscal 2004 resulted from contributions made by the minority interest holder, borrowings less 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 2003 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 $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.
We made capital expenditures of approximately $24.7 million during fiscal 2004, which include expenditures totaling $9.0 million for additions made in China. We expect to make capital expenditures of approximately $41.0 million in fiscal 2005, which include $21.0 million in additions to the facility in China. Capital expenditures are primarily for expansion of physical plant, purchases of additional or replacement manufacturing equipment and revisions and upgrades in plant tooling.
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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, 2004, we had $87.9 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.
The credit agreement, which includes our $210 million revolving credit line and our term loan, ("Credit Agreement" or Credit Facility") requires us to maintain a lockbox arrangement whereby remittances from our customers reduce the borrowings outstanding under the Credit Agreement. 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.
We do not believe that any of these MAEs have occurred or can reasonably be expected to occur based upon our history and our relationship with the Credit Facility lenders. We intend to manage the Credit Facility as long-term debt with a final maturity date in 2007, as provided for in the Credit Agreement.
As of May 31, 2004, the balance outstanding under the existing Credit Agreement consisted of (in millions):
Revolver $ 122.1
Term Loan
13.8
$ 135.9
As of May 31, 2004, our consolidated indebtedness was approximately $289.0 million, of which approximately $135.9 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 Agreement, will be adequate to meet future liquidity needs for 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.
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As of May 31, 2004, our contractual cash obligations and commercial commitments were as follows:
Payments Due by Period(in millions)
Total
Less Than
1-Year
2-3 Years
4-5 Years
After 5
Years
Credit Facilities $ 135.9
$ 135.9
$ -
$ -
$ -
Senior Subordinated Notes
153.1
-
-
-
153.1
Operating Leases
55.9
19.4
20.3
10.3
5.9
Total Contractual Cash Obligations $ 344.9
$ 155.3
$ 20.3
$ 10.3
$ 159.0
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 December 2003, the FASB issued Interpretation No. 46R, "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51." This accounting standard became effective in fiscal 2004. The adoption of FIN 46 did not have a material impact on our consolidated financial statements.
RISK FACTORS
We are exposed to the risks associated with the slowdown in the U.S. and worldwide economy.
Among other factors, concerns about inflation, decreased consumer confidence and spending and reduced corporate profits and capital spending resulted in a downturn in the U.S. economy generally. If the adverse economic conditions continue or worsen, our business, financial condition and results of operations may be seriously effected.
Our future operating results are likely to fluctuate and therefore may fail to meet expectations.
Our operating results have varied widely in the past and may continue to fluctuate in the future. In addition, our operating results may not follow any past trends. Our future operating results will depend on many factors and may fluctuate and fail to meet our expectations or those of others for a variety of reasons, including the following:
1. competitive pricing pressure and
2. the need for constant, rapid, new product introductions present an ongoing design and manufacturing challenge.
As a result of these or other factors, we could fail to achieve our expectations as to future revenues, gross profit and income from operations. Any downward fluctuation or failure to meet expectations will likely adversely affect our financial results.
Our financial results could be seriously harmed if the markets in which we sell our products do not grow.
Our continued success depends in large part on the continued growth of the exercise equipment market. Any reduction in the growth of, or decline in the demand for exercise equipment could seriously harm our business, financial condition and results of operations. In addition, certain of our products, may in the future, experience significant fluctuations in demand. We may also be seriously harmed by slower growth in the other markets in which we sell our products. Even in the absence of an
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industry downturn, the average selling prices of our products have historically decreased during the products’ lives and we expect this trend to continue. In order to offset selling price decreases, we attempt to decrease the manufacturing costs of our products and to introduce new, higher priced products that incorporate advanced features. If these efforts are not successful or do not occur in a timely manner, or if our newly introduced products do not gain market acceptance, our business, financial condition and results of operations could be seriously harmed.
In addition to following the general pattern of decreasing average selling prices, the selling prices for certain products fluctuate significantly with real and perceived changes in the balance of supply and demand for these products. In the event we are unable to decrease per unit manufacturing costs at a rate equal to or faster than the rate at which selling prices continue to decline, our business, financial condition and results of operations will be seriously harmed. Furthermore, we expect our competitors to invest in new manufacturing capacity and achieve significant manufacturing yield improvements in the future. These developments could dramatically increase the worldwide supply of competitive products and result in further downward pressure on prices.
We are Functioning under New Operating Management
On July 1, 2004, we announced the appointment of David Watterson as Chairman and Chief Executive Officer, replacing the then-current Chairman and Chief Executive Officer, Scott Watterson. Until that time, David Watterson was the President of North America Operations. Additionally, Matthew Allen, moved to the position of President and Chief Merchandising Officer, Joseph Brough became the Chief Operating Officer, replacing Gary Stevenson, and Jace Jergensen became the Senior Vice President. There can be no assurance that the transition to this new management, or the new structure itself, will be successful.
We may face product liability claims that are disproportionately higher than the value of the products involved.
Although all of our products sold are covered by our standard warranty, we could incur costs not covered by our warranties including, but not limited to, labor and other costs of replacing defective parts, lost profits and other damages. These costs could be disproportionately higher than the revenue and profits we receive from the products involved. If we are required to pay for damages resulting from quality or other, our business, financial condition and results of operations could be adversely affected.
We may be unable to protect our intellectual property rights adequately and may face significant expenses as a result of ongoing or future litigation.
Protection of our intellectual property rights is essential to keep others from copying the innovations that are central to our existing and future products. Consequently, we may become involved in litigation to enforce our patents or other intellectual property rights, to protect our trade secrets and know-how, to determine the validity or scope of the proprietary rights of others or to defend against claims of invalidity. This type of litigation can be expensive, regardless of whether we win or lose.
We are now and may again become involved in litigation relating to alleged infringement by us of others’ patents or other intellectual property rights. This type of litigation is frequently expensive to both the winning party and the losing party and could take up significant amounts of management’s time and attention. In addition, if we lose such a lawsuit, a court could require us to pay substantial damages and/or royalties or prohibit us from using essential technologies. For these and other reasons, this type of litigation could seriously harm our business, financial condition and results of operations. Also, although in certain instances we may seek to obtain a license under a third party’s intellectual property rights in order to bring an end to certain claims or actions asserted against us, we may not be able to obtain such a license on reasonable terms or at all.
For a variety of reasons, we have entered into license agreements with third parties that give those parties the right to use patents and other technology developed by us and that gives us the right to use patents and other technology developed by them. We anticipate that we will continue to enter into these kinds of licensing arrangements in the future. It is possible, however, that licenses we want will not be available to us on commercially reasonable terms or at all. If we lose existing licenses to key technology, or are unable to enter into new licenses that we deem important, our business, financial condition and results of operations could be seriously harmed.
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It is critical to our success that we are able to prevent competitors from copying our innovations. We, therefore intend to continue to seek patent, trade secret and mask work protection for our manufacturing technologies. The process of seeking patent protection can be long and expensive and we cannot be certain that any currently pending or future applications will actually result in issued patents, or that, even if patents are issued, they will be of sufficient scope or strength to provide meaningful protection or any commercial advantage to us. Furthermore, others may develop technologies that are similar or superior to our technology or design around the patents we own.
We also rely on trade secret protection for our technology, in part through confidentiality agreements with our employees, consultants and third parties. However, these parties may breach these agreements and we may not have adequate remedies for any breach. Also, others may come to know about or determine our trade secrets through a variety of methods. In addition, the laws of certain countries in which we develop, manufacture or sell our products may not protect our intellectual property rights to the same extent as the laws of the United States.
Our ability to meet our cash requirements depends on a number of factors, many of which are beyond our control.
Our ability to meet our cash requirements (including our debt service obligations) is dependent upon our future performance, which will be subject to financial, business and other factors affecting our operations, many of which are beyond our control. We cannot guarantee that our business will generate sufficient cash flows from operations to fund our cash requirements. If we were unable to meet our cash requirements from operations, we would be required to fund these cash requirements by alternative financing. The degree to which we may be leveraged could materially and adversely affect our ability to obtain financing for working capital, acquisitions or other purposes, could make us more vulnerable to industry downturns and competitive pressures or could limit our flexibility in planning for, or reacting to changes and opportunities in our industry, which may place us at a competitive disadvantage compared to our competitors. There can be no assurance that we will be able to obtain alternative financing, that any such financing would be on acceptable terms or that we will be permitted to do so under the terms of our existing financing arrangements. In the absence of such financing, our ability to respond to changing business and economic conditions, make future acquisitions, react to adverse operating results, meet our debt service obligations or fund required capital expenditures or increased working capital requirements may be adversely affected.
Interruptions in the availability of raw materials can harm our financial performance.
Our manufacturing operations require raw materials that must meet exacting standards. We generally have more than one source available for these materials, but for certain of our products there are only a limited number of suppliers capable of delivering the raw materials that meet our standards. If we need to use other companies as suppliers, they must go through a qualification process, which can be difficult and lengthy. In addition, the raw materials we need for certain of our products could become scarcer as worldwide demand for these materials increases. Interruption of our sources of raw materials could seriously harm our business, financial condition and results of operations.
We spend heavily on equipment to stay competitive and will be adversely impacted if we are unable to secure financing for such investments.
In order to remain competitive, exercise equipment manufacturers generally must spend heavily on equipment to maintain or increase technology and design development and manufacturing capacity and capability. We currently plan for approximately $41.0 million in capital expenditures in fiscal 2005, and anticipate significant continuing capital expenditures in subsequent years. In the past, we have reinvested a substantial portion of our cash flow from operations in tooling, design development and capacity expansion and improvement programs. If we are unable to decrease costs for our products at a rate at least as fast as the rate of the decline in selling prices for such products, we may not be able to generate enough cash flow from operations to maintain or increase manufacturing capability and capacity as necessary. In such a situation, we would need to seek financing from external sources to satisfy our needs for manufacturing equipment and, if cash flow from operations declines too much, for operational cash needs as well. Such financing, however, may not be available on terms that are satisfactory to us or at all, in which case our business, financial condition and results of operations would seriously be harmed.
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We depend on third parties to transport our products.
We rely on independent carriers and freight haulers to move our products between manufacturing plants and our customers. Any transport or delivery problems because of their errors or because of unforeseen interruptions in their activities due to factors such as strikes, political instability, terrorism, natural disasters and accidents could seriously harm our business, financial condition and results of operations and ultimately impact our relationship with our customers.
FORWARD-LOOKING STATEMENTS
Forward-looking statements in this Form 10-K, including, without limitation, statements relating to our plans, strategies, objectives, expectations, intentions and adequacy of resources, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. These factors include, but are not limited to, the competitive environment in our industry in general and in our specific market area; inflation; economic conditions in general and in our specific market areas; the number of store openings and closings; the profitability of certain product lines, capital expenditures and future liquidity; liability and other claims asserted against us; uncertainties related to the internet and our internet initiative. In addition, such forward-looking statements are necessarily dependent upon assumptions, estimates and dates that may be incorrect or imprecise and involve known and unknown risks, uncertainties and other factors. Accordingly, any forward-looking statements included herein do not purport to be predictions of future events or circumstances and may not be realized. Given these uncertainties, shareholders and prospective investors are cautioned not to place undue reliance on such forward-looking statements. We disclaim any obligations to update any such factors or to publicly announce the results of any revisions to any of the forward-looking statements contained herein to reflect future events or developments.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLODURES ABOUT MARKET RISK.
MARKET RISK
Fluctuations in the general level of interest rates on our current and future fixed and variable rate debt obligations expose us to market risk. We are vulnerable to significant fluctuations in interest rates on our variable rate debt and on any future repricing or refinancing of our fixed rate debt and on future debt.
We use long-term and medium-term debt as a source of capital. At May 31, 2004, we had approximately $153.1 million in outstanding fixed rate debt, consisting of 11.25% subordinated notes maturing in April 2012. When debt instruments of this type mature, we typically refinance such debt at the then-existing market interest rates, which may be more or less than the interest rates on the maturing debt.
Our Credit Agreement has variable interest rates and any fluctuation in interest rates could increase or decrease our interest expense. At May 31, 2004, we had approximately $135.9 million in outstanding variable rate debt. The weighted average rate of interest on the variable interest rate debt was approximately 3.9% for the fiscal year ended May 31, 2004. If the interest rate for our variable rate debt increased or decreased by 1% during fiscal year 2004, our interest expense on outstanding variable rate debt would increase or decrease by approximately $1.5 million.
Due to the uncertainty of fluctuations in interest rates and the specific actions that might be taken by us to mitigate the impact of such fluctuations and their possible effects, the foregoing sensitivity analysis assumes no changes in our financial structure.
In addition to the United States, we have operations or transact business in Canada, the United Kingdom, France, Italy, Germany, and Asia. The operations in these foreign countries conduct business in their local currencies as well as other regional currencies. To mitigate our exposure to transactions denominated in currencies other than the functional currency of each entity, we enter into forward exchange contracts from time to time to manage foreign currency risk related to the procurement of merchandise from foreign sources. As of May 31, 2004, the Company had foreign currency contracts in the form of forward exchange contracts in the amount of approximately $1.3 million in Canadian dollars. The unrealized gain
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associated with these contracts is a $15,000 gain on Canadian dollars. This unrealized gain is included in the statement of operations. The market risk inherent in these instruments was not material to the Company’s consolidated financial condition, results of operations, or cash flow during fiscal 2004. Because of the variety of currencies in which purchases and sales are transacted, it is not possible to predict the impact of a movement in foreign currency exchange rates on future operating results. However, we intend to continue to mitigate our exposure to foreign exchange gains or losses.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH AUDITORS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
Not Applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
MANAGEMENT DIRECTORS AND OFFICERS
Our directors and executive officers, their ages and number of years of service are as follows:
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Name Age Years
with ICON
Position
Scott R. Watterson
-Chairman of the board
-Chief Executive Officer
Gary E. Stevenson
-President
-Chief Operating Officer
-Director
S. Fred Beck
-Chief Financial and Accounting Officer
-Vice President
-Treasurer
David J. Watterson
-President, North American Operations
Jon M. White
-Senior Vice President, Manufacturing
William T. Dalebout
-Vice President, Design
M. Joseph Brough
-Vice President, Operations and Information Technology
Matthew N. Allen
-Vice President, Product Development
Brad H. Bearnson
-General Counsel, Secretary
Richard Hebert
-President, ICON Canada
Robert C. Gay -
Vice Chairman of the Board
Ronald P. Mika -
Director
Gregory Benson -
Director
Stanley C. Tuttleman -
Director
Alan H. Freudenstein -
Director
W. Steve Albrecht -
Director
EXECUTIVE OFFICERS OF THE REGISTRANT
Scott R. Watterson
Mr. Watterson has served as Chairman of the Board of Directors and CEO since 1988. Prior to 1988, Mr. Watterson co-founded Weslo, Inc., a predecessor entity of the Company, in 1977. In addition, Mr. Watterson is a director of the Utah State University Foundation. He is also on the Board of Trustees for the Utah Foundation and the Make-A-Wish Foundation of Utah. Mr. Watterson graduated from Utah State University College of Business, Cum Laude, in 1979 with a B.S. in Business Marketing and a minor in Chinese.
Gary E. Stevenson
Mr. Stevenson has served as President, COO and as one of the Company's directors since 1988. Prior to 1988, Mr. Stevenson co-founded Weslo, Inc., the predecessor entity of the Company, in 1977. Mr. Stevenson's current and past affiliations include: Utah State University President's National Advisory Council, Utah State University College of Business and Engineering Advisory Board, Marriott School, Brigham Young University National Advisory Council, among others. Mr. Stevenson graduated from Utah State University College of Business in 1979 with a B.S. in Business Administration and a minor in Japanese.
S. Fred Beck
Mr. Beck has served as the Company's CFO and Accounting Officer, VP and Treasurer since 1989. Mr. Beck is a CPA and a member of the AICPA (national chapter of CPAs) and the UACPA (the Utah chapter of CPAs). Mr. Beck is also a member of the Board of Directors of Regence BlueCross BlueShield of Utah and a member of The Regence Group Board of Directors. Mr. Beck graduated from Utah State University with a B.S. in Accounting.
David J. Watterson
Mr. Watterson was recently named President of North America. Prior to his role as President of North America, Mr. Watterson served as SVP of Marketing and Research and Development since November 1992. Prior to 1992, Mr. Watterson served as ICON's Sales Manager and VP of Sales since joining the Company in 1980. Mr. Watterson is Scott R. Watterson's brother. Mr. Watterson graduated from Utah State University with a B.S. in Marketing.
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Jon M. White
Mr. White has served as SVP and VP of Manufacturing since 1988. Mr. White is responsible for all domestic manufacturing operations in the Logan, Clearfield and Smithfield plants in Utah and product distribution at the Clearfield distribution center. Prior to 1988, Mr. White served as Plant Manager of Weathershield Manufacturing Inc.'s, Nibley, Utah plant and production control manager for the Wurlitzer Co.'s, Logan, Utah, manufacturing plant.
William T. Dalebout
Mr. Dalebout has served as VP of Design since 1987. Prior to working for ICON, Mr. Dalebout was President and founder of Ziba Design Inc., an industrial design consultancy. Prior to founding and managing Ziba Design Inc., Mr. Dalebout worked for Hewlett-Packard, Tektronix Inc. and Smith Corona Marchant. Mr. Dalebout graduated with a B.A. in Industrial Design from Brigham Young University.
M. Joseph Brough
Mr. Brough joined the Company in 1989 and has served as VP of Operations and Information Technology since 1995. Prior to working for ICON, Mr. Brough worked for Andersen Consulting. Mr. Brough graduated with a M.B.A from the University of Utah in 1987 where he was ranked number one in his graduating class.
Matthew N. Allen
Mr. Allen joined the Company in 1984 and has served as VP of Product Development since 1999. He served as VP of Sales from 1996-1999. Between 1984 and 1996, Mr. Allen served in various roles in sales, quality control and production. Mr. Allen graduated with B.S. in Business Marketing from Utah State University.
Brad H. Bearnson
Mr. Bearnson joined the Company in 1995 and presently serves as General Counsel and Secretary. Mr. Bearnson is a CPA and was admitted to the Utah State Bar in 1982. Mr. Bearnson has also served as a Member of the Legislative Affairs Committee of the Utah State Bar from 1997-2000. Mr. Bearnson graduated with a B.S. from Utah State University and then earned his Juris Doctorate degree from the University of Utah.
Richard Hebert
Mr. Hebert has served as President of ICON Canada since 1994. Mr. Hebert founded his first manufacturing company in 1967 named Athletimonde, Inc. In 1980, Mr. Hebert established his second manufacturing company named Rickbend Industries, Inc. In 1990, Mr. Hebert began a third company called Fitquip, Inc. These three companies were consolidated into one entity in an acquisition by ICON Health & Fitness, Inc. in 1994.
DIRECTORS OF THE COMPANY
Robert C. Gay
Mr. Gay became Vice Chairman of our Board of Directors in November 1994. Mr. Gay has been a Managing Director of Bain Capital, a private investment firm, since April 1993 and has been a General Partner of Bain Venture Capital, the venture capital arm of Bain Capital, which focuses on first and second institutional round investing in software, technology-driven business services, hardware and information companies, since February 1989. In addition, Mr. Gay serves as a director of Nutraceutical, GS Technologies Corporation, Anthony Crane and Alliance Laundry and Buhrmann.
Ronald P. Mika
Mr. Mika became one of our directors in November 1994. Mr. Mika is a principal at Sorenson Capital Partners. Prior to joining Sorenson Capital, Mr. Mika was a managing director at Bain Capital. In addition, Mr. Mika serves as a director of Professional Services Industries.
Gregory Benson
Mr. Benson became one of our directors in September 1999. Mr. Benson was an executive vice president of Bain Capital from 1996 until 2004. Prior to joining Bain Capital, Mr. Benson was an executive vice president of American Pad and Paper Company.
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Stanley C. Tuttleman
Mr. Tuttleman became one of our directors in September 1999. Mr. Tuttleman has been the Chief Executive Officer and President of Tuttson Capital Corp., a financial services corporation, since 1983. Mr. Tuttleman also serves as the Chief Executive Officer of Telepartners International, a wireless program company. In addition, Mr. Tuttleman is a director of Mothers Work, Inc., and a trustee of the Franklin Institute, the Philadelphia Orchestra, the Philadelphia Museum of Art, Graduate Hospital, Gratz College and the Harrison Foundation.
Alan H. Freudenstein
Mr. Freudenstein became one of our directors in November 2002. Mr. Freudenstein is a Managing Director in the Private Equity Group of Credit Suisse First Boston, LLC. He is also a Vice President of Credit Suisse First Boston Management Corporation and Special Situations Holdings, Inc. - Westbridge. From 1992 through July 2000, Mr. Freudenstein was a Managing Director at Bankers Trust Company, where he was responsible for incubation and venture investments within the New World Ventures Group. Mr. Freudenstein is also on the board of directors of Ascent Assurance, Inc. (OTCBB:AASR).
Dr. W. Steve Albrecht
Dr. Albrecht became one of our directors in November 2002. Dr. Albrecht serves as the Associate Dean of the Marriott School of Management and Arthur Andersen Professor at Brigham Young University. Prior to becoming Associate Dean, Dr. Albrecht served as director of the School of Accountancy and Information Systems at Brigham Young University for eight years. Dr. Albrecht is a certified public accountant, a certified internal auditor and a certified fraud examiner. Dr. Albrecht is also on the board of directors of Cypress Semiconductor Corp. (NYSE:CY), SkyWest, Inc. (NASDAQ:SKYW) and Red Hat, Inc. (NASDAQ:RHAT).
BOARD COMMITTEES
Compensation Committee
We maintained a compensation committee during fiscal 2004. The Compensation Committee consists of the following non-employee directors: Messrs. Gay, Benson and Tuttleman. The Compensation Committee of the Board of Directors, composed of Messrs. Gay, Benson and Tuttleman, has the authority to administer the executive compensation for Scott R. Watterson, our Chief Executive Officer, and Gary E. Stevenson, our Chief Operating Officer. Messrs. Watterson and Stevenson participated in the deliberations concerning the compensation of other officers other than their own, and Mr. Beck participated in the deliberations concerning the compensation of officers other than himself and Messrs. Watterson and Stevenson.
Audit Committee
The Audit Committee includes Messrs. Albrecht, Tuttleman, and Mika. This committee reviews the professional services provided by the Company's independent registered public accounting firm and the independence of such firm from the management of the Company. This committee also reviews the scope of the audit by the Company's independent auditors, the annual and interim financial statements of the Company, the Company's systems of internal accounting controls, and such other matters with respect to the accounting, auditing, and financial reporting practice and procedures of the Company as it may find appropriate.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The following table sets forth information concerning the compensation for fiscal 2004, 2003, and 2002 for Mr. Scott Watterson and our other four most highly compensated executive officers (collectively, the "Named Executive Officers"):
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SUMMARY COMPENSATION TABLE
Name Position Fiscal
Year Salary
($) Bonus
($) Other
Annual
Compensation
($) Long-Term
Compensation
Options
(#)(2) All
Other
Compensation
($)(3)
Scott R. Watterson Chairman of the Board and Chief Executive Officer
703,250
677,250
604,813 1,369,330
1,879,640
995,000 90,847(1)(5)
102,473(1)(5)
103,679(1)(5) -
-
- 76,208(4)
71,539(4)
580,527(4)
Gary E. Stevenson President and Chief Operating Officer
624,000
624,000
524,000 1,205,010
1,656,320
875,600 75,635(1)(5)
71,967(1)(5)
62,213(1)(5) -
-
- 81,096(4)
68,534(4)
368,969(4)
S. Fred Beck Chief Financial and Accounting Officer, Vice President and Treasurer
285,000
270,000
249,000 200,480
334,390
165,910 17,998(1)(5)
10,815(1)
- -
-
- 134,597
9,433
188,500
David J. Watterson President, North America Operations
341,000
323,000
300,000 200,480
340,390
520,910 22,064(1)
25,302(1)(5)
- -
-
- 17,643
10,972
85,165
Richard Hebert General Manager, ICON Du Canada, Inc.
335,143
294,914
262,000 167,330
157,549
145,850 11,939(1)
10,165(1)
8,700(1) -
-
- -
-
-
Footnotes To Compensation Table
(1)
Includes the annual cost of providing the named person with the use of an automobile during the year.
(2)
Options to purchase shares of HF Holdings' common stock.
(3)
Includes amounts contributed by the Company for the benefit of the Named Executive Officers under the Company's 401 (K) Plan and the Company's deferred compensation plan.
(4)
Includes a management fee of $33,500 paid by the company.
(5)
Includes amounts for personal use of the Company jet.
The following table sets forth information as of May 31, 2004, concerning options of HF Holdings, Inc. exercised by each of the named executive officers in 2004 and year-end option values:
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR END OPTION VALUES
Name Shares Aquired
On Exercise (#) Other
Value
Realized ($) Number of Unexercised
Options at
May 31, 2004 (#)
Exercisable/Unexercisable Value of
Unexercised In-the-
Money Options at
May 31, 2004 ($)(1)
Exercisable/Unexercisable
Common Stock Common Stock Common Stock Common Stock
Scott R. Watterson - - -/- -/-
Gary E. Stevenson - - -/- -/-
S. Fred Beck - - 49,995 / 49,995 -/-
David J. Watterson - - 59,979 / 59,979 -/-
Richard Hebert - - -/- -/-
(1)
As of May 31, 2004, there was no market for the common stock of HF Holdings, Inc.; no value has been attributed to the equity underlying these options. There have been no arm's length sales of HF Holding's common stock since the closing of the recapitalization in September of 1999.
1999 JUNIOR MANAGEMENT STOCK OPTION PLAN
In September 1999, HF Holdings adopted its 1999 Junior Management Stock Option Plan (the "1999 Stock Option Plan")
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which provides for the grant of nonstatutory options to eligible employees. A total of 333,300 shares of common stock of HF Holdings were reserved and issued under the 1999 Stock Option Plan, which is administered by the Board of Directors or a committee thereof.
COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
We maintained a compensation committee during fiscal 2004. The Compensation Committee consists of the following non-employee directors: Messrs. Gay, Benson and Tuttleman.
REPORT OF THE COMPENSATION COMMITTEE
The Compensation Committee of the Board of Directors, composed of Messrs. Gay, Benson and Tuttleman, has the authority to administer the executive compensation for Scott R. Watterson, our Chief Executive Officer. Messrs. Watterson and Stevenson participated in the deliberations concerning the compensation of other officers other than their own, and Mr. Beck participated in the deliberations concerning the compensation of officers other than himself and Messrs. Watterson and Stevenson.
COMPENSATION OF DIRECTORS
Our directors do not receive any compensation for serving on the Board of Directors except for Mr. Tuttleman and Mr. Albrecht. Mr. Tuttleman is paid $35,000 annually for his services as a director. Mr. Albrecht is paid $40,000 annually plus $1,000 for each meeting attended for his services as a director. Directors are reimbursed for their out-of-pocket expenses incurred in connection with their service as directors. We also maintain liability insurance policies for our directors.
PERFORMANCE BONUS
In fiscal 2003 and 2002, the Board of Directors approved the establishment of a performance bonus pool in addition to the regular bonus program of $1.0 million and $1.5 million, respectively. The Board gave discretion to Gary Stevenson and Scott Watterson to determine eligible employees and the amounts payable to each employee. These bonuses were paid in August of each year and accrued in our May 31, 2003 and May 31, 2002 financial statements. No additional performance bonus pool was awarded in fiscal 2004.
EMPLOYMENT AGREEMENTS
On January 6, 2004, we filed on Form 8-K a press release outlining a pending management transition based on news that Scott Watterson, Chief Executive Officer and Gary Stevenson, Chief Operating Officer intend to take a leave of absence from their respective positions sometime in the second or third quarter of calendar 2004. The Company and Mr. Watterson and Mr. Stevenson are currently in discussions regarding the modification of their existing employment contracts to take into account the anticipated leave of absence. The modifications have not been completed or agreed to as of the date of this filing.
On August 11, 2004, we announced by press release that effective July 1, 2004, Scott Watterson and Gary Stevenson began their leave of absence to accept assignments from the Church of Jesus Christ of Latter Day Saints as Mission Presidents. In their absence, the daily operations of the Company are being managed by David J. Watterson, a 23-year ICON veteran who was recently elected Chairman and Chief Executive Officer.
In May of 2003, we renegotiated the September 27, 1999 employment agreements ("second amendment") with each of Mr. Watterson and Mr. Stevenson. The second amendment extends these agreements to September 27, 2005. The employment agreements provide for the continued employment of Mr. Watterson as Chairman and Chief Executive Officer with an increase in base salary from $525,000 to $625,000, and Mr. Stevenson as 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.
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The second amendment provides for a one-time retention bonus for each of Mr. Watterson and Mr. Stevenson of $300,000. Each executive is also entitled to participate in a bonus program providing for a bonus equal to a percentage of our consolidated EBITDA (as defined in our Credit Facility) and our subsidiaries (our "EBITDA") which percentage shall equal 1.50% for Mr. Watterson and 1.32% for Mr. Stevenson. The executives will not be entitled to a bonus, however, unless our Profits exceed 5.5% of net sales.
We 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. In the event we terminate either executive's employment for cause, or such employment terminates as a result of the death of the executive, as the case may be, the executive will not be entitled to further salary, benefits or bonus. If we terminate the executive's employment without cause, or the executive terminates his employment with or without cause, we will be obligated to pay the executive his salary and bonus for a period of three years from the date of termination. If we terminate the executive's employment upon the executive's disability, we are obligated to pay as severance an amount equal to one month's base salary then in effect for each calendar year or part thereof elapsed since January 1, 1988, provided that such severance pay is reduced by payments under applicable disability insurance.
The employment agreements prohibit the executives from engaging in outside business activity during the term, subject to 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 we may, at our option, extend such period for up to two additional years by paying the executive his salary and bonus during the extended period).
Under the employment agreements, the executives (and their affiliates) shall be entitled to indemnification to the fullest extent allowed by Delaware law with respect to all losses, costs, expenses and other damages in connection with any lawsuits or other claims brought against them in their capacity as officers or directors or shareholders (or affiliates thereof) of HF Holdings or any of its past or present parent or subsidiary or other affiliated companies.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
HF Holdings owns all of our outstanding common stock. The following table and related notes set forth information with respect to the beneficial ownership of HF Holdings' 7,771,613 outstanding shares of common stock as of May 31, 2004 by (i) each person known to HF Holdings to beneficially own more than 5.0% of the outstanding shares of common stock of HF Holdings, and (ii) each director and executive officer of HF Holdings individually and (iii) all directors and executive officers of HF Holdings as a group.
Common Stock
Beneficially Owned (1)
Name Number
Of Shares Percent of
Outstanding
Shares
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Common Stock
Beneficially Owned (1)
Name Number
Of Shares Percent of
Outstanding
Shares
Footnotes To Common Stock Beneficially Owned Table
(1)
Except as otherwise indicated, (a) each owner has sole voting and investment power with respect to the shares set forth and (b) the figures in this table are calculated in accordance with Rule 13d-3, under the Exchange Act of 1934, as amended. The table includes the HF Holdings Warrants (which have an exercise price, subject to adjustment, of $.01 per share) which are presently exercisable. The shares reported in this table as owned by a stockholder do not include the shares over which such stockholder has the right to direct the vote pursuant to the Stockholders Agreement.
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(2)
Includes 1,000 shares of common stock owned by HF Investment Holdings, of which Mr. Watterson is deemed the beneficial owner by virtue of being a director. Mr. Watterson disclaims beneficial ownership of any such shares in which he does not have a pecuniary interest.
(3)
Includes 1,000 shares of common stock owned by HF Investment Holdings, of which Mr. Stevenson is deemed the beneficial owner by virtue of being a director. Mr. Stevenson disclaims beneficial ownership of any such shares in which he does not have a pecuniary interest.
(4)
Includes 5,160,035 shares of common stock beneficially owned by HF Investment Holdings, of which the Bain Funds may be deemed the beneficial owners by virtue of their control of HF Investment Holdings pursuant to its operating agreement. Also includes 1,000 shares of common stock owned by HF Investment Holdings, of which the Bain Funds may be deemed the beneficial owners by virtue of the fact that one or more of their general partners or principals, or one or more general partners or principals of one of their general partners, is a director of HF Investment Holdings. The Bain Funds disclaim beneficial ownership of any shares in which they do not have a pecuniary interest.
(5)
Includes the shares beneficially owned by each of the Bain Funds, of which each of Mr. Gay and Mr. Mika may be deemed the beneficial owner by virtue of being a general partner or principal, or a general partner or a principal of the general partner, of such Bain Fund. Also includes 1,000 shares owned by HF Investment Holdings, of which each of Mr. Gay or Mr. Mika may be deemed the beneficial owner by virtue of each being a director. Each of Mr. Gay and Mr. Mika disclaims the beneficial ownership of any such shares in which he does not have a pecuniary interest.
(6)
Includes 669,179 shares of common stock subject to purchase upon exercise of warrants that are presently exercisable.
(7)
Includes 1,312,934 shares beneficially owned by Credit Suisse First Boston Corporation, of which Mr. Freudenstein may be deemed the beneficial owner by virtue of being an officer of Credit Suisse First Boston Corporation. Mr. Freudenstein disclaims beneficial ownership of any such shares in which he does not have a pecuniary interest.
(8)
Represents shares of common stock issuable upon exercise of the vested portion of options awarded pursuant to the 1999 HF Holdings Junior Management Stock Option Plan.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED-PARTY TRANSACTIONS
MANAGEMENT EQUITY GRANT
On September 27, 1999, HF Holdings issued to Scott Watterson and Gary Stevenson, without cost, an aggregate of 666,700 shares of the common stock of HF Holdings (or approximately 6.7% of its common stock outstanding on a fully diluted basis upon the consummation of the September recapitalization). Mr. Watterson received 375,000 of these shares, while Mr. Stevenson received 291,700 shares.
STOCKHOLDERS AGREEMENT
On September 27, 1999, we entered into a stockholders agreement (the "Stockholders Agreement") with HF Holdings, HF Investment Holdings, Bain Capital, Credit Suisse First Boston Corporation ("CFSB") and Scott Watterson and Gary Stevenson.
Under the Stockholders Agreement, holders of HF Holdings' common stock, who received such common stock in the exchange offer, are subject to transfer restrictions with respect to their common stock. In addition, these holders received customary tag along and drag along rights with respect to sales of common stock of HF Holdings (including sales by any Bain Capital Holder) and pre-emptive rights with respect to any issuances of common stock by HF Holdings to HF Investment Holdings. The tag along, drag along and registration rights of our management are subject to the condition that our senior management own at least 25% of the common stock held by all management holders and the junior management own at least 15% of the common stock of HF Holdings held by all management holders, provided such person is still employed by us or has been employed within the 12 preceding months and the purchaser of the common stock is a financial buyer.
Holders of warrants to purchase common stock of HF Holdings issued in the exchange offer received registration rights with respect to the common stock issuable upon exercise of such warrants.
Pursuant to the Stockholders Agreement, HF Investment Holdings granted to CSFB an option to purchase a certain percentage (based on the date of exercise of such option) of the common stock of HF Holdings held by HF Investment Holdings. HF Investment Holdings also granted to members of our junior management an option to purchase 216,700 shares of common stock of HF Holdings held by HF Investment Holdings. Each of these options is exercisable only upon the occurrence of a Liquidity Event (as defined in the Stockholders Agreement).
In addition, HF Investment Holdings is entitled to appoint seven directors and CSFB is entitled to appoint two directors to our Board of Directors. Upon a liquidation of HF Investment Holdings, Bain Capital will be entitled to appoint five directors and Scott Watterson and Gary Stevenson shall have the right to be directors, provided they remain employed by us.
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MANAGEMENT AGREEMENTS
On September 27, 1999, our Company and HF Holdings also entered into a new management agreement with Bain Capital which provides an annual management fee not to exceed $366,500 in exchange for management consulting services including providing advice on strategic planning, development and acquisitions. In addition, if we enter into any acquisition transactions involving a gross purchase price of at least $10.0 million, Bain Capital will receive a fee in an amount which will approximate 1% of the gross purchase price of the transaction (including assumed debt). In the event of a Liquidity Event (as defined in the Stockholders Agreement), Bain Capital will also receive a fee in an amount which will approximate 1% of the gross purchase price of the transaction.
Additionally, HF Holdings entered into a management arrangement with CSFB which provides for an annual management fee of $366,500 in exchange for consulting services. In addition, if we enter into transactions which will constitute a Liquidity Event (as defined in the Stockholders Agreement), CSFB will receive a fee in an amount which will approximate 50% of the fee payable under the management agreement with Bain Capital in connection with such transaction.
On September 27, 1999, our Company and HF Holdings also entered into management agreements with each of Mr. Watterson and Mr. Stevenson which provide, so long as Bain Capital is receiving a management fee under its management agreement, an annual management fee of $67,000 in the aggregate shall be paid to Mr. Watterson and Mr. Stevenson.
The respective management agreements include full indemnification and expense reimbursement provisions in favor of Bain Capital, CSFB, Mr. Watterson and Mr. Stevenson, respectively.
CHINA BUSINESS VENTURE
In fiscal 2003, our Company formed a foreign subsidiary to build a manufacturing facility in Xiamen, China. Our equity interest in the foreign subsidiary is 70%, which will be funded in the form of equity and debt. 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. As of May 31, 2004, we have made contributions of $5.0 million and the minority interest contributions were $3.5 million. The minority interest shareholder is also a long-time vendor our Company. We have recorded purchases from this vendor of approximately $93.0 million and $75.3 million during the fiscal years ended May 31, 2004 and 2003, respectively. He also holds an equity interest in our Company. As a result of our controlling interest in the foreign subsidiary, the investment has been reported on a consolidated basis beginning in the first quarter of fiscal 2004.
LOANS TO SENIOR MANAGEMENT
On September 27, 1999 we made non-recourse loans to Scott Watterson and Gary Stevenson in the principal amounts of $1,209,340 and $990,660 respectively. The loans were made in connection with stock grants made to Messrs. Watterson and Stevenson at the time of our September 1999 recapitalization. The notes bear interest only to the extent that we have taxable net income less than zero in any given fiscal year. The notes are secured by shares of ICON and shares of HF Investment Holdings LCC held by Messrs. Watterson and Stevenson. The notes have a maturity of 10 years and may be accelerated upon specified events of default and liquidity events.
AIRCRAFT LEASE
In June 1996, we entered into an agreement with FG Aviation, Inc. ("FG"), a company which is jointly owned by our officers, whereby we 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, we entered into a new agreement with FG whereby we 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. We are responsible for scheduled maintenance and fuel costs; however, these costs reduce the monthly rental. In addition, we are responsible for payment of the aircraft crew and any unscheduled maintenance of the aircraft. In connection with its airplane lease commitments, we recorded $644,000, $809,000 and $695,000 of rental expense for the
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fiscal years ended May 31, 2004, 2003 and 2002, respectively. In addition, in February of 2002, we advanced $280,000 to FG as a security deposit on the aircraft lease.
ITEM 14.
ITEM 14. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Our Chief Executive Officer, Chief Operating Officer and Chief Financial Officer have evaluated the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of May 31, 2004 (the "Evaluation Date"). Based on such evaluation, such officers have concluded that, as of the Evaluation Date, our disclosure controls and procedures are effective in alerting them, on a timely basis, to material information relating to our Company (including our consolidated subsidiaries) required to be included in our periodic filings under the Exchange Act.
CHANGES IN INTERNAL CONTROLS
Since the Evaluation Date, there have not been any significant changes in our internal controls or in other factors that could significantly affect such controls.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
The following documents are filed as part of this report:
Consolidated Financial Statements (See Item 8)
Consolidated Balance Sheets at May 31, 2004 and 2003
Consolidated Statements of Operations and Comprehensive Income for the Years Ended May 31, 2004, 2003, and 2002
Consolidated Statement of Stockholder's Equity for the Years Ended May 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows for the Years Ended May 31, 2004, 2003 and 2002
Notes to Consolidated Financial Statements
FINANCIAL STATEMENT SCHEDULE (See Item 8)
Schedule II
- Valuation and Qualifying Accounts for the three Years Ended May 31, 2004
All other schedules are omitted as the required information is not applicable or is included in the financial statements or related notes, or can be derived from information contained in the consolidated financial statements and related notes.
EXHIBITS
The following designated exhibits have heretofore been filed with the Securities and Exchange Commission under the Securities Act of 1933 and are referred to and incorporated herein by reference to the correspondingly numbered exhibit filed as part of the Registrants' Registration Statement on Form S-1 of IHF Capital, as amended (No.33-87930/87930-1) and on Form S-4 of ICON Fitness, as amended (No.333-18475).
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Exhibit Number
Description of Exhibit
1.1
Purchase Agreement dated November 15, 1996 regarding the issuance and sale of the Senior Discount Notes between ICON Fitness and Donaldson, Lufkin & Jenrette Securities Corporation.
3.1
Certificate of Incorporation.
3.1A
Amendment to Certificate of Incorporation.
3.2
By-laws.
4.2
Indenture dated as of November 20, 1996 between ICON Fitness as Issuer, and Fleet National Bank as Trustee, with respect to the $162,000,000 in aggregate principal amount at maturity of Senior Discount Notes due 2006, including the form of the Senior Discount Note.
4.2A
Supplemental Indenture dated as of March 20, 1995 between IHF Holdings, as Issuer, and Fleet Bank of Massachusetts, N.A., as Trustee, with respect to the $123,700,000 in aggregate principal amount at maturity of Discount Notes due 2004.
4.3
Registration Rights Agreement dated as of November 20, 1996 by and between ICON Fitness and Donaldson, Lufkin & Jenrette Securities Corporation.
4.4
Registration rights Agreement dated November 14, 1994 between ICON Health and Weider Health and Fitness with respect to the Senior Subordinated Notes due 2004.
10.1
Amended and Restated Credit Agreement dated as of November 14, 1994 among ICON Health, the lenders named therein, and General Electric Capital Corporation.
10.1A
Agreement of IHF Holdings, Inc. and IHF Capital, dated November 14, 1994 in favor of General Electric Capital Corporation, as agent.
10.1B
Amended and Restated Credit Agreement dated as of July 15, 1998 among ICON Health & Fitness, Inc., the lenders named therein, and General Electric Capital Corporation.
10.1C
Amended and Restated Credit Agreement dated as of April 15, 1999 among ICON Health & Fitness, Inc., the lenders named therein, and General Electric Capital Corporation.
10.1D
Amended and Restated Credit Agreement dated as of April 16, 1999 among ICON Health & Fitness, Inc., the lenders named therein, and General Electric Capital Corporation.
10.2
First Amended and Restated Master Transaction Agreement dated as of October 12, 1994 among ICON Health and each of Weider Health and Fitness and Weider Sporting Goods, Inc. and each of Hornchurch Investments Limited, Bayonne Settlement, The Joe Weider Foundation, Ronald Corey, Jon White, William Dalebout, David Watterson, S. Fred Beck, Gary Stevenson and Scott Watterson.
10.3
Adjustment Agreement dated as of November 14, 1994 between Weider Health and Fitness and Health & Fitness.
10.4
10.4 Stockholder Agreement dated as of November 14, 1994 by and among ICON Health, IHF Holdings each of the Bain Funds named therein and certain other persons named therein.
10.4A
Registration Rights Agreement dated November 14, 1994 among ICON Health and IHF Holdings and Donaldson, Lufkin & Jenrette Securities Corporation and Bear, Stearns & Co.
10.5
Non-Competition Agreement dated as of November 14, 1994 among ICON Health, Weider Health and Fitness, Gary E. Stevenson and Scott R. Watterson.
10.6
Management and Advisory Agreement dated as of November 14, 1994 among ICON Health, IHF Holdings, the Company, and Bain Capital Partners IV, L.P.
10.7
Distribution Agreement dated as of September 26, 1994, as amended by letter of Ben Weider dated October 12,1994 between ICON Health and Weider Sports Equipment Co., Ltd.
10.8
Exclusive License Agreement dated as of November 14, 1994 among Weider Health and Fitness, Weider Sporting Goods, Inc., Weider Europe B.V., and Health & Fitness.
10.9
Canada Exclusive License Agreement dated as of November 14, 1994 between Weider Sports Equipment Co., Ltd. and Health & Fitness.
10.10
Employment Agreement dated as of November 14, 1994 among the Company, ICON Health, IHF Holdings and Gary E. Stevenson.
10.10B
Second Amendment to Employment Agreement dated as of May 17, 2003 among the Company, ICON Health, and HF Holdings and Gary E. Stevenson.
10.11
Employment Agreement dated as of November 14, 1994 among the Company, ICON Health, IHF Holdings and Scott R. Watterson.
10.11B
Second Amendment to Employment Agreement dated as of May 17, 2003 among the Company, ICON Health, and HF Holdings and Scott R. Watterson.
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Exhibit Number
Description of Exhibit
10.12
Asset Option Agreement dated as of November 14, 1994 among Health & Fitness, Weider Sporting Goods, Inc. and Weider Europe B.V., including ICON Health's assignment of its rights thereunder.
10.13
Asset Option Agreement dated as of November 14, 1994 between ICON Health and each of Athletimonde Inc., Les Industries Rickbend Inc. and Fitquip International Inc., including ICON Health's assignment of its rights thereunder.
10.14
CanCo Management and Advisory Agreement dated as of November 14, by and among ICON Health, Scott Watterson, Gary E. Stevenson and Les Industries Rickbend Inc., Althletimonde Inc., and Fitquip International Inc., including Health & Fitness' assignment of rights thereunder.
10.15
Weider Europe Management Agreement dated as of November 14, 1994 among ICON Health and Weider Europe B.V., including Health & Fitness' assignment of its rights thereunder.
10.16
Amended and Restated WSG Management Agreement dated as of June 1, 1994 among ICON Health, Weider Health and Fitness and Weider Sporting Goods, Inc.
10.17
Advertising Space Contract dated as of November 14, 1994 between ICON Health and Weider Publications, Inc.
10.18
Trade Payables Agreement dated as of November 14, 1994 between ICON Health and IHF Holdings.
10.19
Tax Agreement dated as of November 14, 1994 among the Company and its subsidiaries.
10.20
The Company's Stock Subscription and Exchange Agreement dated as of November 14, 1994 among the Company and each of the Existing Stockholders named therein.
10.21
Warrant Agreement dated as of November 14, 1994 among IHF Capital, Weider Health and Fitness, Scott Watterson and Gary Stevenson.
10.22
Bain Stock Subscription Agreement dated as of November 14, 1994 among the Company and each of the Bain Funds and other subscribers named therein.
10.23
IHF Capital's Stock Subscription and Purchase Agreement dated as of November 14, 1994 among IHF Capital and the Subscribers named therein.
10.24
IHF Holdings Stock Subscription and Exchange Agreement dated as of November 14, 1994 among IHF Holdings and each of the persons named therein.
10.25
IHF Capital's Option Exchange Agreement dated as of November 14, 1994, among the Company, Scott Watterson and Gary Stevenson.
10.26
IHF Holdings Option Exchange Agreement dated as of November 14, 1994, among IHF Holdings, Scott Watterson and Gary Stevenson.
10.27
IHF Capital's Employee Stock Option Plan dated as of November 14, 1994.
10.27.1
Form of Option Certificate for Management Options.
10.27.2
Form of Option Certificate for Performance Options.
10.28
Agreement and Plan of Merger dated as of November 14, 1994 among ICON Health, American Physical Therapy, Inc., Weslo, Inc. and ProForm Fitness Products, Inc.
10.29
Promissory Note dated December 30, 1993 and a loan made by David Watterson in favor of ProForm Fitness Products, Inc. in the amount of $60,000.
10.30
Promissory Note dated December 30, 1993 and a loan, made by William Dalebout in favor of ProForm Fitness Products, Inc. in the amount of $57,000.
10.31
Promissory Note dated December 30, 1993 and a loan, made by Fred Beck in favor of ProForm Fitness Products, Inc. in the amount of $60,000.
10.32
Promissory Note dated December 30, 1993 and a loan, made by Jon White in favor of ProForm Fitness Products, Inc. in the amount of $57,000.
10.33
Sublease dated as of June 1, 1994 between Weider Health and Fitness and ProForm Fitness Products, Inc.
10.34
Indenture dated as of November 14, 1994 between ICON Health, as Issuer, and Fleet Bank of Massachusetts, N.A., as Trustee, with respect to the $101,250,000 in aggregate principal amount of Senior Subordinated Notes due 2002, including the form of Senior Subordinated Note.
10.34A
Supplemental Indenture dated as of March 20, 1995 between ICON Health, as Issuer, and Fleet Bank of Massachusetts, N.A., as Trustee, with respect to the $101,250,000 in aggregate principal amount of Senior Subordinated Notes due 2002.
10.35
Indenture dated as of November 14, 1994 between IHF Holdings, as Issuer, and Fleet Bank of Massachusetts, N.A., as Trustee, with respect to the $123,700,000 in aggregate principal amount at maturity of Discount Notes due 2004, including the form of Discount Note.
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Exhibit Number
Description of Exhibit
10.35A
Supplemental Indenture dated as of March 20, 1995 between IHF Holdings, as Issuer, and Fleet Bank of Massachusetts, N.A., as Trustee, with respect to the $123,700,000 in aggregate principal amount at maturity of Discount Notes due 2004.
10.36
Registration Rights Agreement dated November 14, 1994 between ICON Health and Weider Health and Fitness with respect to the Senior Subordinated Notes due 2002.
10.37
Asset Purchase Agreement dated as of July 3, 1996 by and among IHF Capital, Inc. HealthRider Acquisition Corp. and HealthRider, Inc.
10.38
Asset Purchase Agreement for the purchase of certain assets of Parkway Manufacturing, Inc. dated July 3, 1996.
10.39
Buy-Out Agreement between HealthRider Acquisition Corp. and Parkway Manufacturing, Inc. dated August 26, 1996.
10.40
IHF Capital's 1996 Stock Option Plan.
10.41
WSE Asset Purchase Agreement dated September 6, 1996 between Weider Sports Equipment Co. Ltd. and ICON Health.
10.42
CanCo Asset Purchase Agreement, dated September 6, 1996 among ICON of Canada Inc., ICON Health, ALLFITNESS, Inc., Scott Watterson and Gary Stevenson.
10.43
Stock and Warrants Purchase Agreement, dated September 6, 1996 among IHF Capital, Inc., IHF Holdings, Inc., Weider Health & Fitness, Greyfriars Limited, Bayonne Settlement, Hornchurch Investments Limited, Ronald Corey, Bernard Cartoon, Ronald Novak, Eric Weider, Richard Bizarro, Robert Reynolds, Michael Carr, Thomas Deters, Barbara Harries and Zbigniew Kindella.
10.44
Amendment No. 1 to Stockholders Agreement, dated September 6, 1996 among IHF Holdings, Inc., Weider Health & Fitness, Greyfriars Limited, Bayonne Settlement, Hornchurch Investments Limited, the Fund Investors, DLJ Capital Corporation, General Electric Capital Corporation, and certain other signatories named therein.
10.45
Amendment and Restatement of Stockholders Agreement, dated as of September 6, 1996 among IHF Holdings, Inc., Weider Health & Fitness, Greyfriars Limited, Bayonne Settlement, Hornchurch Investments Limited, the Fund Investors, DLJ Capital Corporation, General Electric Capital Corporation, and certain other signatories named therein.
10.46
Key Executive Preferred Stock Option Purchase Agreement, dated September 6, 1996 among IHF Capital, Inc., Gary Stevenson and Scott Watterson.
10.47
First Amendment to Stevenson Employment Agreement, dated September 6, 1996 to the Employment Agreement dated November 14, 1994 among ICON Health & Fitness, Inc., IHF Capital, Inc., IHF Holdings, Inc. and Gary Stevenson.
10.48
First Amendment to Watterson Employment Agreement, dated September 6, 1996 to the Employment Agreement dated November 14, 1994 among ICON Health & Fitness, Inc., IHF Capital, Inc., IHF Holdings, Inc. and Scott Watterson.
10.49
Weider Release, dated September 6, 1996 by Weider Health & Fitness, Weider Sports Equipment Co., Ltd., Weider Sporting Goods, Inc., Weider Europe, B.V., CANCO, Ben Weider, Eric Weider, Richard Renaud and the Weider Releasors.
10.50
ICON Release, dated September 6, 1996 made by ICON Health, IHF Capital, Inc., IHF Holdings, Inc., Scott Watterson, Gary Stevenson and the ICON Releasors.
10.51
Settlement Agreement, dated September 6, 1996 among ICON Health, IHF Capital, Inc., the Fund Investors, IHF Holdings, Inc., Weider Health & Fitness, Weider Sports Equipment, CANCO, Weider Sporting Goods, Inc., Weider Europe, B.V., and each of Ben Weider, Eric Weider, Richard Renaud, Gary Stevenson and Scott Watterson.
10.52
Escrow Agreement, dated September 6, 1996 among ICON Health, ICON of Canada, Inc., CANCO, Lapointe Rosenstein and Goodman Phillips of Vineberg.
10.53
Representation Agreement, dated September 6, 1996 between ICON Health and Ben Weider.
10.54
Letter Agreement regarding advertising space, dated September 6, 1996 between Weider Publications, Inc., and ICON Health.
10.55
Letters of Credit issued by Royal Bank of Canada to ICON Health dated September 5, 1996.
10.56
Letters of Credit issued by Royal Bank of Canada to ICON Health and ICON of Canada, Inc., dated September 5, 1996.
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Exhibit Number
Description of Exhibit
10.57
Letter from Royal Bank of Canada to ICON of Canada, Inc., dated September 5, 1996, outlining terms of financing by Royal Bank of Canada in favor of ICON of Canada, Inc.
10.58
Letter Agreement dated September 6, 1996 among ICON Health, Ben Weider and Eric Weider regarding charitable contributions.
10.59
Deed of Sale.
Subsidiaries of the Company.
Powers of Attorney (included on signature page).
Statement of Eligibility of Fleet National Bank, Trustee.
Financial Data Schedules.
99.1
Form of Letter of Transmittal used in connection with the Exchange Offer.
99.2
Form of Notice of Guaranteed Delivery used in connection with the Exchange Offer.
REPORTS ON FORM 8-K
Report on Form 8-K dated April 13, 2004 containing ICON's press release dated April 13, 2004 announcing earnings for the third quarter of fiscal 2004 which ended February 28, 2004. (press release)
Supplemental Information to be Furnished with Reports Filed Pursuant to Section 15(d) of the Act by Registrants Which Have Not Registered Pursuant to Section 12 of the Act:
No annual report covering the Registrants' last fiscal year or any proxy material with respect to a meeting of security holders has been sent to any of the Registrants' security holders.
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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 30, 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.
By: /s/ David J. Watterson
David J. Watterson, Chairman of the Board of Directors
and Chief Executive Officer (Principal Executive Officer)
Date: August 30, 2004
By: /s/ S. Fred Beck
S. Fred Beck, Vice President, Chief Financial
and Accounting Officer, and Treasurer
Date: August 30, 2004
By: /s/ Ronald P. Mika
Ronald P. Mika, Director
Date: August 30, 2004
By: /s/ W. Steve Albrecht
W. Steve Albrecht, Director
Date: August 30, 2004
By: /s/ Stan Tuttleman
Stan Tuttleman, Director
Date: August 30, 2004
By: /s/ Gregory Benson
Gregory Benson, Director
Date: August 30, 2004
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ICON Health & Fitness, Inc.
Consolidated Financial Statements
May 31, 2004
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholder of
ICON Health & Fitness, Inc.:
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of ICON Health & Fitness, Inc. and its subsidiaries at May 31, 2004 and 2003, 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. In addition, in our opinion, the financial statement schedule listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Salt Lake City , Utah
August 23, 2004
ICON Health & Fitness, Inc.
Consolidated Balance Sheet
(expressed in thousands)
The accompanying notes are an integral part of the consolidated financial statements
ICON Health & Fitness, Inc.
Consolidated Statement of Operations and Comprehensive Income
(expressed in thousands)
For the Year Ended May 31,
Net income
23,389
26,689
19,394
Other comprehensive income (loss), comprised of
foreign currency translation adjustment, net of
tax benefit of $240 in 2004 and net of income tax
expense of $883 in 2003 and $129 in 2002
(392 )
1,440
Comprehensive income $ 22,997
$ 28,129
$ 19,604
The accompanying notes are an integral part of the consolidated financial statements.
ICON Health & Fitness, Inc.
Consolidated Statement of Stockholder's Equity
(expressed in thousands, except share amounts)
Common Stock
and
Additional Paid in Capital
Shares
Amount
Receivable
From
Parent
Accumulated
Deficit
Accumulated Other
Comprehensive Income (loss)
Total
Stockholders's
Equity
The accompanying notes are an integral part of the consolidated financial statements.
ICON Health & Fitness, Inc.
Consolidated Statement of Cash Flows
(expressed in thousands)
For the Year Ended May 31,
Effect of exchange rates on cash
(632 )
2,323
The accompanying notes are an integral part of these financial statements
ICON Health & Fitness, Inc.
Notes to the Consolidated Financial Statements
May 31, 2004
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, 2004 and 2003, 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. SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
All significant intercompany accounts and transactions have been eliminated in the consolidated financial statements.
Cash
At May 31, 2004, 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 May 31, 2004 and 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 year ended May 31, 2002 under SFAS No. 142 (table in thousands):
May 31,
Intangible assets other than goodwill are recorded at cost and are amortized on a straight-line basis over the following estimated useful lives:
Patents, license agreements
and trademarks 5-20 years
Other 2-3 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, 2004 and 2003, 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 8). 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, 2004 and 2003, $1,511,000 and $1,792,000, respectively, of capitalized advertising costs were included in other current assets. For the fiscal years ended May 31, 2004, 2003 and 2002, total advertising expense was approximately $41,083,000, $30,743,000 and $17,169,000 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. Receivables from direct response sales are reported at outstanding principal adjusted for any chargeoffs and allowance for doubtful accounts, and are held until maturity or payoff. Revenue from extended warranty contracts is deferred and is recognized ratably over the term of the contract.
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%, 39% and 44% of the total net sales for the fiscal years ended May 31, 2004, 2003 and 2002, respectively. Accounts receivable from Sears accounted for approximately 37% and 31% of gross accounts receivable at May 31, 2004 and 2003, 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, 2004 and 2003, 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, 2004, 2003 and 2002. For the fiscal years ended May 31, 2004, 2003 and 2002, 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):
Years Ended May 31,
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 extended warranty contracts to deferred revenue.
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.
The carrying amounts and fair values of long-term debt at May 31, 2004 and 2003 were as follows (table in thousands):
Carrying
Amount
Estimated
Fair Value
Carrying
Amount
Estimated
Fair Value
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, 2004. 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):
Years Ended May 31,
Pro forma net income $ 23,389
$ 26,661
$ 19,261
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 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, 2004 by approximately $25.8 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, 2003 and 2002 have been reduced by approximately $31.5 million and $24.7 million respectively, with a corresponding reduction of selling, general and administrative expenses.
In December 2003, the FASB issued Interpretation No. 46R, "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51." This accounting standard became effective in fiscal 2004. The adoption of FIN 46 did not have a material impact on our 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.
3. ACCOUNTS RECEIVABLE
Accounts receivable, net, consist of the following (table in thousands):
May 31,
Accounts receivable, net $ 210,498
$ 175,164
4. INVENTORIES
Inventories, net, consist of the following (table in thousands):
May 31,
Total inventories $ 195,928
$ 161,708
Inventory allowances are primarily for finished goods. 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.
5. PROPERTY AND EQUIPMENT
Property and equipment, net, consist of the following (table in thousands):
Estimated
Useful Lives
May 31,
(Years)
For the fiscal years ended May 31, 2004, 2003 and 2002, the Company recorded depreciation expense of $14,880,000, $13,166,000, and $13,398,000, respectively.
6. INTANGIBLE ASSETS
Intangible assets, net, consist of the following (table in thousands):
May 31, 2004
May 31, 2003
Cost
Accumulated
Amortization
Net
Cost
Accumulated
Amortization
Net
Total $ 63,467
$ (24,786 ) $ 38,681
$ 49,094
$ (20,025 ) $ 29,069
Amortization expense related to intangible assets for the fiscal years ended May 31, 2004, 2003 and 2002 was $ 6,601,000, $6,004,000 and $5,764,000, respectively. Approximately $5,624,000 of the net goodwill at May 31, 2004 is tax deductible in future periods. Estimated amortization expense for years ending after May 31, 2004 is as follows (table in thousands):
Year Ending May 31,
7. OTHER ASSETS
Other assets, net, consist of the following (table in thousands):
May 31,
Other assets, net $ 23,388
$ 20,214
At May 31, 2004 and 2003, deferred financing costs are net of accumulated amortization of $1,108,000 and $1,438,000 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, 2004 and 2003, long-term receivables are net of an allowance for doubtful accounts of $0 and $70,000 respectively.
As of May 31, 2004, 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.
8. LONG-TERM DEBT
Long-term debt consists of the following (table in thousands):
May 31,
Long-Term Debt $ 153,111
$ 152,919
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 Facility 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.
The 2002 Credit Agreement
In connection with the April 2002 Refinancing, the Company entered into a new credit agreement ("2002 Credit Agreement") of $235 million with a syndicate of banks and financial services companies.
The 2002 Credit Agreement includes 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 2002 Credit Agreement includes 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 2002 Credit Agreement 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 2002 Credit Agreement. If the Company were to default under the 2002 Credit Agreement, the lenders would foreclose on the pledge and take control of the Company.
The 2002 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, 2004, the Company was in compliance with all of its debt covenants.
The 2002 Credit Agreement requires the Company to maintain a lockbox arrangement whereby remittances from the Company's customers reduce the borrowings outstanding under the 2002 Credit Agreement. The 2002 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 classified the outstanding borrowings under the 2002 Credit Agreement, which totaled $135.9 million as of May 31, 2004, as a long-term liability.
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,
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.
9. 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, 2004, 2003 and 2002:
Year Ended May 31,
Shares
Weighted
Average
Exercise
Price
Shares
Weighted
Average
Exercise
Price
Shares
Weighted
Average
Exercise
Price
Outstanding at End of year
333,333
$ 5.83
333,333
$ 5.83
333,333
$ 5.83
Exercisable options at end of year
333,333
333,333
333,333
Weighted average fair market value of options granted during year
-
-
-
The following table summarizes information about stock options outstanding at May 31, 2004:
Options Outstanding
Options Exercisable
Range of
Exercise
Prices
Numbers
Outstanding
Weighted Average
Remaining
Contractual
Life (in years)
Weighted
Average
Exercise
Price
Number
Exercisable
Weighted
Average
Exercise
Price
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.
10. INCOME TAXES
The provision for income taxes consists of the following (table in thousands):
Year Ended May 31,
Total deferred
2,659
(12,963 )
The components of the Company's income before income taxes are as follows (table in thousands):
Year Ended May 31,
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,
At May 31, 2004 and 2003, the net deferred tax asset consists of the following (table in thousands):
May 31,
Total deferred tax assets: $ 31,554
$ 29,867
Net deferred tax asset $ 13,283
$ 15,702
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, 2004, the valuation allowance increased by $1.3 million due to additional foreign net operating loss carryforwards that may not be utilized in future years. During the fiscal year ended May 31, 2003 the valuation allowance decreased $207,000 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, 2004. 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.
At May 31, 2004, the Company had approximately $26.5 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, with the exception of $739,000, which relates to foreign net loss carryforwards that are expected to be utilized.
11. SUPPLEMENTAL DISCLOSURES OF CASH FLOW
The following table illustrates the cash paid during the period for listed items (in thousands):
Year Ended May 31,
12. 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,
$ 55,861
Rental expense under noncancellable operating leases was approximately $15,424,000, $14,650,000 and $15,060,000 for the fiscal years ended May 31, 2004, 2003 and 2002, 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 August 23, 2004, 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, 2003 to October 1, 2004 with limits of $10.0 million per occurrence and $10.0 million in the aggregate. The policy has a deductible on each claim of $1.0 million. For occurrences prior to October 1, 2003, the policy provided coverage of $5.0 million per occurrence and $5.0 million in the aggregate. The policy had a deductible on each claim of $1.0 million. For occurrences prior to October 1, 2002, the policy provided coverage of $5.0 million per occurrence and $5.0 million in the aggregate. The policy had a deductible on each claim of $0.5 million. 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 current pending claims or series of claims will have a material adverse effect on its results of operations, liquidity or financial position. At May 31, 2004 and 2003, the Company has accrued $5,064,000 and $5,075,000; respectively, for known product liability claims and for claims incurred but not reported.
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.
On December 3, 2002, the Nautilus Group, Inc. (“Nautilus”) filed suit against the Company in the United States District Court, Western District of Washington (the “Court”) alleging the Company infringed Nautilus’ Bowflex patents. Nautilus seeks injunctive relief and monetary damages. In May 2003, the Court denied Nautilus’ motion for a preliminary injunction and granted partial summary judgment to the Company on the issue of “literal infringement.” Nautilus appealed this motion denying the preliminary injunction on literal patent infringement, and a trial has been scheduled for sometime in April of 2005. 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.
As part of the above suit, in July 2003, the Court ruled in favor of Nautilus on a motion for preliminary injunction on the issue of trademark infringement, and entered an order barring the Company from using the trademark "CrossBow" on any exercise equipment. In June of 2004, the United States Court of Appeals for the Federal Circuit affirmed the grant of a preliminary injunction as previously granted by the Federal District Court. Thus, the Company is barred from using the “CrossBow” trademark on any of its exercise equipment pending trial. The Company subsequently changed the name from “CrossBow” to “CrossBar” or “The Max” by Weider. In July of 2004, Nautilus filed an additional lawsuit in the United States District Court for the Western District of Washington alleging that the Company further infringed on the Bowflex trademark by using the “CrossBar” trademark. Nautilus seeks injunctive relief and monetary damages. The Company believes this additional lawsuit is without merit and will vigorously defend its right to use the “CrossBar” trademark.
The Company is also involved in several intellectual property and patent infingement 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, 2004, 2003 and 2002 were $731,878, $630,000 and $610,000, 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, 2004, 2003 and 2002 of $6,723,000, $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, 2004, 2003 and 2002 were $2,355,000, $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 Agreement) 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). The Company and Mr. Watterson and Mr. Stevenson are currently in discussions regarding the modification of their existing employment contracts to take into account the anticipated resignations. The modifications have not been completed or agreed to as of the date of this filing.
In May of 2004, the Company negotiated a employment agreement with David J. Watterson. The employment agreement provides for the continued employment of Mr. Watterson at a base salrary of $500,000. Mr. Watterson is 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 Agreement) and the Company's subsidiaries (the Company's "EBITDA") which percentage shall equal 0.63%. The Company may terminate Mr. Watterson's employment (1) for cause as provided in each agreement, (2) upon six months' disability, or (3) without cause. Mr. Watterson may similarly terminate his employment immediately for cause as provided in his employment agreement at any time.
China Business Venture
In fiscal 2003, the Company formed a foreign subsidiary to build a manufacturing facility in Xiamen, China. The original project costs were anticipated to be approximately $12.0 million. Due to our decision to increase the size of the facility, we now anticipate the total project cost to be approximately $30.5 million, with $15.5 million to be funded in the form of equity by the subsidiary, and approximately $15.0 million in the form of debt. The Company's share of the equity investment is expected to be approximately $10.0 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. The Company's equity interest in the foreign subsidiary is 70%, which will be funded in the form of equity and debt. As of May 31, 2004, the Company has made contributions of $5.0 million and the minority interest contributions were $3.5 million. The minority interest shareholder is also a long-time vendor of the Company. The Company has recorded purchases from this vendor of approximately $93.0 million and $75.3 million during the fiscal years ended May 31, 2004 and 2003, respectively. He also holds an equity interest in the Company. As a result of the Company's controlling interest in the foreign subsidiary, the investment has been reported on a consolidated basis beginning in the first quarter of fiscal 2004.
13. 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, 2004, 2003 and 2002. 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 $644,000, $809,000 and $695,000 of rental expense for the fiscal years ended May 31, 2004, 2003 and 2002, respectively. In addition, in February of 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, 2004 and 2003, 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.
14. 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):
Revenue
for the year ended May 31,
Long-lived
assets (net) of May 31,
United States $ 988,897
$ 924,047
$ 794,319
$ 46,149
$ 44,961
Foreign
106,847
87,497
77,080
12,379
3,816
Total $ 1,095,744
$ 1,011,544
$ 871,399
$ 58,528
$ 48,777
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.
15. 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% Not
es 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, 2004 and 2003 and condensed consolidating statements of operations and cash flows for each of the years in the three year period ended May 31, 2004.
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, 2004
ICON
Health &
Fitness, Inc.
Combined
Guarantor
Subsidiaries
Combined
Non-Guarantor
Subsidiaries
Eliminations
Consolidated
ASSETS
Current assets:
Cash $ 1,246
$ 2,450
$ 1,426
$ -
$ 5,122
Accounts receivable, net
132,027
85,132
15,045
(21,706 )
210,498
Inventories, net
118,310
67,227
11,096
(705 )
195,928
Deferred income taxes
6,469
-
-
6,974
Other current assets
4,716
4,156
4,195
-
13,067
Total current assets
262,768
158,965
32,267
(22,411 )
431,589
Property & equipment, net
38,302
19,058
1,168
-
58,528
Receivable from affiliates
141,561
55,579
-
(197,140 )
-
Intangible assets, net
30,868
6,595
1,218
-
38,681
Deferred income taxes
5,570
-
-
6,309
Investment in subsidiaries
39,130
-
-
(39,130 )
-
Other assets, net
15,071
7,452
-
23,388
Total assets $ 533,270
$ 247,649
$ 36,257
$ (258,681 ) $ 558,495
LIABILITIES & STOCKHOLDER'S EQUITY
Current liabilities:
Current portion of long-term debt $ 135,879
$ -
$ -
$ -
$ 135,879
Accounts payable
97,860
36,676
34,114
(21,706 )
146,944
Accrued liabilities
18,800
8,340
3,671
-
30,811
Accrued Income Taxes
2,509
(2,299 )
-
Interest payable
7,544
-
-
-
7,544
Total current liabilities
262,592
42,717
38,149
(21,706 )
321,752
Long-term debt
153,102
-
-
153,111
Other long-term liabilities
6,723
6,074
-
-
12,797
Payable to affiliates
43,518
130,942
22,680
(197,140 )
-
Minority interest
-
-
-
3,500
3,500
Stockholder's equity:
Common stock & additional
paid in capital
204,155
45,759
5,481
(51,240 )
204,155
Receivable from Parent
(2,200 )
-
-
-
(2,200 )
Retained earnings
(accumulated deficit)
(133,863 )
20,295
(26,961 )
6,666
(133,863 )
Accumulated other comprehensive
income (loss)
(757 )
1,853
(3,092 )
1,239
(757 )
Total stockholder's equity
67,335
67,907
(24,572 )
(43,335 )
67,335
Total liabilities &
stockholder's equity $ 533,270
$ 247,649
$ 36,257
$ (258,681 ) $ 558,495
Supplemental Condensed Consolidating Balance Sheet
Year ended May 31, 2003
ICON
Health &
Fitness, Inc.
Combined
Guarantor
Subsidiaries
Combined
Non-Guarantor
Subsidiaries
Eliminations
Consolidated
ASSETS
Current assets:
Cash $
$ 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
-
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 & 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
-
-
8,379
Investment in subsidiaries
28,051
-
-
(28,051 )
-
Other assets, net
12,936
7,255
-
20,214
Total assets $ 437,876
$ 183,096
$ 30,215
$ (186,073 ) $ 465,114
LIABILITIES & STOCKHOLDER'S EQUITY
Current liabilities:
Current portion of long-term debt $ 91,313
$ -
$ -
$ -
$ 91,313
Accounts payable
86,192
25,876
24,207
(15,098 )
121,177
Accrued liabilities
21,772
6,802
5,390
-
33,964
Accrued Income Taxes
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
152,904
-
-
152,919
Other long-term liabilities
4,015
5,676
-
-
9,691
Payable to affiliates
25,889
95,128
21,351
(142,368 )
-
Minority interest
-
-
-
-
-
Stockholder's equity:
Common stock & additional
paid in capital
204,155
37,259
5,481
(42,740 )
204,155
Receivable from Parent
(2,200 )
-
-
-
(2,200 )
Retained earnings
(accumulated deficit)
(157,252 )
11,191
(24,478 )
13,287
(157,252 )
Accumulated other comprehensive
income (loss)
(365 )
2,005
(2,851 )
(365 )
Total stockholder's equity
44,338
50,455
(21,848 )
(28,607 )
44,338
Total liabilities &
stockholder's equity $ 437,876
$ 183,096
$ 30,215
$ (186,073 ) $ 465,114
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
Year ended May 31,
ICON
Health &
Fitness, Inc.
Combined
Guarantor
Subsidiaries
Combined
Non-Guarantor
Subsidiaries
Eliminations
Consolidated
Net sales $ 683,680
$ 342,458
$ 69,606
$ -
$ 1,095,744
Cost of sales
518,230
206,463
44,536
769,378
Gross profit
165,450
135,995
25,070
(149 )
326,366
Total operating expenses
114,592
121,593
24,928
-
261,113
Income (loss) from operations
50,858
14,402
(149 )
65,253
Interest expense
(22,950 )
(88 )
(2,012 )
-
(25,050 )
Amortization of deferred
financing fees
(872 )
-
-
-
(872 )
Equity in earnings
of subsidiaries
6,472
-
-
(6,472 )
-
Income before income taxes
33,508
14,314
(1,870 )
(6,621 )
39,331
Provision for income tax
10,119
5,211
-
15,942
Net income $ 23,389
$ 9,103
$ (2,482 ) $ (6,621 ) $ 23,389
Net sales $ 659,357
$ 300,539
$ 51,648
$ -
$ 1,011,544
Cost of sales
499,796
183,755
29,617
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 before income taxes
35,956
12,869
(5,196 )
44,296
Provision for income tax
9,267
7,310
1,030
-
17,607
Net income $ 26,689
$ 5,559
$ (363 ) $ (5,196 ) $ 26,689
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
236,353
Total operating expenses
98,244
68,127
13,478
-
179,849
Income (loss) from operations
60,337
(3,667 )
(309 )
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 before income taxes
19,927
(4,844 )
(2,081 )
6,772
19,774
Provision for income tax
(404 )
-
Net income $ 19,394
$ (4,440 ) $ (2,332 ) $ 6,772
$ 19,394
Supplemental Condensed Consolidating Statement of Cash Flows
Year ended May 31, 2004
ICON
Health &
Fitness, Inc.
Combined
Guarantor
Subsidiaries
Combined
Non-Guarantor
Subsidiaries
Eliminations
Consolidated
Operating Activities:
Net cash provided by (used in)
operating activities $ (3,507 ) $ (1,877 ) $ (667 ) $ -
$ (6,051 )
Investing Activities:
Net cash provided by (used in)
investing activities
(28,023 )
(12,527 )
(320 )
-
(40,870 )
Financing Activities:
Borrowings (payments) on revolving
credit facility, net
49,566
-
-
-
49,566
Payments on other long-term debt
-
(7 )
-
-
(7 )
Payments on April 2002 term notes
(5,000 )
-
-
-
(5,000 )
Payment of fees-debt
(34 )
-
-
-
(34 )
Minority interest
(5,000 )
8,500
-
-
3,500
Other
(7,455 )
6,126
1,329
-
-
Net cash provided by (used in)
financing activities
32,077
14,619
1,329
-
48,025
Effect of exchange rates on cash
(240 )
(152 )
(240 )
-
(632 )
Net increase (decrease) in cash
-
Cash, beginning of period
2,385
1,324
-
4,650
Cash, end of period $ 1,248
$ 2,448
$ 1,426
$ -
$ 5,122
Supplemental Condensed Consolidating Statement of Cash Flows
Year ended May 31, 2003
ICON
Health &
Fitness, Inc.
Combined
Guarantor
Subsidiaries
Combined
Non-Guarantor
Subsidiaries
Eliminations
Consolidated
Operating Activities:
Net cash provided by (used in)
operating activities $ 55,844
$ (24,595 ) $
$ -
$ 31,638
Investing Activities:
Net cash provided by (used in)
investing activities
(18,568 )
(2,301 )
(956 )
-
(21,825 )
Financing Activities:
Borrowings (payments) 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
-
-
Net cash provided by (used in)
financing activities
(37,545 )
24,787
-
(12,259 )
Effect of exchange rates on cash
3,046
(1,606 )
-
2,323
Net increase (decrease) in cash
(1,674 )
-
(123 )
Cash, beginning of period
1,448
2,998
-
4,773
Cash, end of period $
$ 2,385
$ 1,324
$ -
$ 4,650
Supplemental Condensed Consolidating Statement of Cash Flows
Year ended May 31, 2002
ICON
Health &
Fitness, Inc.
Combined
Guarantor
Subsidiaries
Combined
Non-Guarantor
Subsidiaries
Eliminations
Consolidated
Operating Activities:
Net cash provided by (used in)
operating activities $ 30,169
$ 6,133
$ 1,236
$ -
$ 37,538
Investing Activities:
Net cash provided by (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
-
(48 )
-
-
(48 )
Proceeds on April 2002 term notes
25,000
-
-
-
25,000
Payments on April 2002 term notes
(1,250 )
-
-
-
(1,250 )
Payments on Sept. 1999 term notes
(172,834 )
-
-
-
(172,834 )
Proceeds from 11.25% notes
152,813
-
-
-
152,813
Payments to 12% note holders
(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
-
-
Net increase (decrease) in cash
(1,288 )
1,902
-
1,449
Cash, beginning of period
1,615
1,096
-
3,324
Cash, end of period $
$ 1,448
$ 2,998
$ -
$ 4,773
SCHEDULE II
Valuation and qualifying accounts for the three years ended May 31, (in thousands):
Year Ended May 31,
Trade accounts receivable-allowance
for doubtful accounts, advertising
discounts and credit memos:
Balance at beginning of year $ 8,394
$ 7,939
$ 6,752
Additions:
Charged to costs and expenses
Allowance for doubtful accounts
6,462
13,962
4,308
Credit memos
Discounts and advertising
49,258
52,461
45,998
Deductions:
Accounts charged off
Allowance for doubtful accounts
(6,932 )
(12,169 )
(3,906 )
Credit memos
(55 )
(291 )
-
Advertising
(47,944 )
(54,074 )
(45,563 )
Balance at end of year $ 9,299
$ 8,394
$ 7,939
Year Ended May 31,
Inventory reserve:
Balance at beginning of year $ 3,900
$ 3,275
$ 3,185
Additions:
Charged to costs and expenses
-
Deductions:
Reduction in reserve
(858 )
-
(589 )
Balance at end of year $ 3,042
$ 3,900
$ 3,275
Year Ended May 31,
Product liability reserve:
Balance at beginning of year $ 5,075
$ 3,675
$ 3,500
Additions:
Additions to reserve
3,414
5,200
3,507
Deductions:
Paid claims
(3,425 )
(3,800 )
(3,332 )
Balance at end of year $ 5,064
$ 5,075
$ 3,675
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 30, 2004 /s/ David J. Watterson
(Signature)
Chief Executive Officer
(Title)
Page 40 of 41
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 30, 2004 /s/ S. Fred Beck
(Signature)
Chief Financial Officer
(Title)
Page 41 of 41