ITEM 1. BUSINESS
We are the leading designer, manufacturer and branded marketer of premium scented candles, based on sales, in the growing giftware industry. We have a 34-year history of offering our distinctive products and marketing them as affordable luxuries and consumable gifts. Our candle products are available in approximately 180 fragrances and include a wide variety of jar candles, Samplers ® votive candles, Tarts ® wax potpourri, pillars and other candle products, all marketed under the Yankee Candle® brand. We also sell a wide range of coordinated candle and home décor accessories and branded fragranced non-candle products including Yankee Candle Car Jars® air fresheners and Yankee Candle™ Bath personal care products. We have also extended our brand into the growing premium home fragrance market segment with products such as our Housewarmer® electric home fragrancers, and Yankee Candle® branded potpourri, sachets, room sprays and linen sprays. We have a vertically integrated business model that enables us to manufacture and distribute high quality products, provide excellent customer service and achieve cost efficiencies.
Our multi-channel distribution strategy enables us to offer Yankee Candle® products through a wide variety of locations and sources. We sell our products through an extensive and growing wholesale customer network of approximately 15,000 stores in North America, primarily in non-mall locations, and through our rapidly expanding retail store base located primarily in malls. As of January 3, 2004, we had 286 Company-owned and operated stores in 42 states. We have grown our retail store count 36% annually over the past five years and opened 49 new retail stores and closed two underperforming retail stores in 2003. In addition, we own and operate a 90,000 square foot flagship store in South Deerfield, Massachusetts which has been ranked as the second most popular tourist attraction in Massachusetts. We also sell our products directly to consumers through our catalogs and our Internet web site at www.yankeecandle.com. Outside North America, we sell our products primarily through 23 distributors in 26 countries and through our distribution center located in the United Kingdom.
Since 1998, we have experienced compound annual revenue growth of 22%. Since 1999, we have experienced compound annual pretax income growth of 21%. Each of our distribution channels has contributed to this growth. Retail, which includes our catalog and Internet business, has achieved 27% compound annual revenue growth since 1998 and accounted for 52% of our $508.6 million total sales in 2003. Wholesale, which includes international operations and earns higher segment margins than our retail channel, has achieved an 18% compound annual revenue growth since 1998 and accounted for 48% of total sales in 2003. In 2003, our revenue increased 14% over 2002, and was comprised of an 11% increase in retail sales and an 18% increase in wholesale sales. In 2003, net income increased 17% over 2002. We believe our growth is primarily based on the strength of the Yankee Candle® brand, our commitment to product quality and innovation, the efficiency of our vertically integrated manufacturing and logistics operations and the success of our multi-channel distribution strategy.
INDUSTRY OVERVIEW
Yankee Candle operates in the domestic giftware industry. The domestic giftware industry has grown at an approximately 2% compound annual growth rate from approximately $50.9 billion in 1998 to reach approximately $54.3 billion in 2002 according to Unity Marketing, an independent market research firm. According to Unity Marketing’s most recent candle industry report issued in 2003, the domestic market for candles has grown at an approximately 2% compound annual growth rate from 1998 to 2002 to reach approximately $2.8 billion in 2002. According to Kline & Company, Inc., an international consulting firm, the premium scented candle segment, in which we compete, grew at an approximately 8% compound annual
growth rate from 1998 to 2002. Kline has projected that the premium scented candle segment will continue to grow at a compound annual growth rate of approximately 3% from 2002 to 2007.
We expect the premium scented candle market to continue to grow more quickly than the total candle market based upon favorable industry factors, including the continued interest of consumers in home décor and branded gifting, and the year-round usage of branded scented candles as an affordable luxury.
PRODUCTS
We develop and introduce new products and fragrances throughout the year. We currently offer approximately 2,000 stock-keeping units (SKUs) of Yankee Candle manufactured products. Virtually all of our candle products are marketed as Yankee Candle® branded products primarily under the trade names Housewarmer®, Home Classics™, YC™, Stripes™, Chandler’s Reserve™, A La Mode™, Country Kitchen® and Aroma Formula™ and include the following product styles:
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Housewarmer® Jar Candles - scented candles in decorative glass jars; available in 22 oz., 14.5 oz., and 3.7 oz. sizes.
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Samplers® - votive candles for sampling different fragrances.
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Tapers - the oldest candle style.
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Pillars - both smooth-sided standard pillars and textured designer pillars.
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Tarts ® Wax Potpourri - scented wax without wicks that releases its fragrance when melted and warmed in a potpourri pot.
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Scented Tea Lights - small, colored and scented candles in clear cups made for home fragrancing.
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Tart® Warmers - unscented candles in aluminum cups made to heat potpourri burners.
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Kindle Candles® - unscented wax in a paper cup for use in a fireplace or campfire as a firestarter.
In the fourth quarter of 2003 we introduced two new candle lines: our Stripes™ candle line and our YC™ collection. Stripes™ candles feature three of our popular fragrances layered on top of one another in a colorful combination, all in a clear glass tumbler, and are currently available in six different combinations. Our new YC™ collection is a premium natural wax blend candle line featuring unique and distinctive scents such as Apricot & Honey™ in clean, fashionable rectangular glass holders. YC™ candles are currently available in four different sizes and feature seven different fragrances.
Our candle products are generally available in a wide range of fragrances and colors. We currently have available approximately 180 fragrances for our retail stores. In addition, approximately 90 of our best-selling Housewarmer® fragrances are available nationwide to our wholesale customers, together with numerous special editions and seasonal fragrances. In addition to distinctive fragrances, we promote our brand through consistent product packaging and labeling and the use of a distinctive trade dress. The Yankee Candle name is typically embossed on the top of our glass containers and is clearly displayed on every product label. We also package our products in attractive gift baskets and other containers for sale in our retail stores. We offer glassware accessories and other coordinated candle-related and home décor accessories in dozens of exclusive patterns, colors and styles, including jar toppers, taper holders, pillar and jar bases, jar shades, tea light holders, potpourri burners and Samplers® votive candleholders.
Building on prior successful brand extensions such as our Yankee Candle® Car Jars® air fresheners and our Yankee Candle™ Bath line of personal care products, we have continued to extend our brand into other fragrance-based product categories. In 2003 we continued to expand our product portfolio in the home fragrance market segment by successfully launching our Housewarmer® electric home fragrancer. Designed to resemble a small night light and based on the shape of our Housewarmer® jar, our electric home fragrancers plug into any standard 120 volt outlet and the refillable unit diffuses scented oil versions of some of our most popular candle fragrances. The electric home fragrancers are currently available as a base package, consisting of the heating unit and scented oil jars, in eight different fragrances. Separate refills are available in ten fragrances. In 2004 we plan to increase the fragrance offerings for this product. In addition to our introduction of electric home fragrancers, we also continued to broaden our product offerings in the home fragrance segment by increasing our Yankee Candle® branded line of
potpourri, sachets, room sprays and linen sprays. We plan to continue to leverage our brand in the important home fragrancing category in 2004 by introducing new products and offerings.
We seek to maintain a moderate price for almost all of our products in order to reinforce our customers’ perception of our products as affordable. As a result, our retail prices for our core candle products generally range from $1.20 for a Tarts® wax potpourri to $19.99 for a 22 oz. Housewarmer® jar candle.
RETAIL OPERATIONS
Retail Stores
Our retail operations include retail stores, none of which are franchised, catalog and Internet operations and Chandler’s restaurant. From 1998 to 2003, sales from our retail division have grown at a compound annual growth rate of 27% from $81.2 million in 1998 to $266.6 million in 2003 and increased from 43% of our total sales in 1998 to 52% in 2003. Moreover, in 2003 our retail stores that were open for the full year, excluding the South Deerfield flagship store, achieved average sales per selling square foot of $614.
We opened 49 new retail stores during 2003, closed two underperforming retail stores and ended the year with 286 retail stores in 42 states. In addition, we are also testing certain outlet locations on a temporary basis to determine long-term viability. In opening new stores, we target high traffic retail locations in malls, tourist destinations and selected non-mall locations, including lifestyle centers. Of our 286 retail stores, 221 are located in malls. We plan to open approximately 45 additional stores during 2004.
The non-mall store count includes our flagship South Deerfield, MA store, which is a unique store. We believe that our flagship store is the world’s largest candle and Christmas store with approximately 90,000 square feet of retail and entertainment space. This store promotes Yankee Candle’s brand image and culture and is an important testing ground for our new product introductions. The store carries approximately 15,000 SKUs of gift items and generates approximately 53% of its revenues from the sale of Yankee Candle manufactured products. The store is a major tourist destination and provides visitors with a total shopping and entertainment experience including the Yankee Candlemaking Museum and a 240-seat restaurant. The flagship store also includes two “store within a store” concepts: our Yankee Candle™ Home store, which showcases home goods, accessories, furnishings and decorative accents in sophisticated country décor settings, and an Old Farmers Almanac General Store which features an assortment of products with a nostalgic country general store theme, including an exclusive line of candles, decorative home items, specialty foods, clothing and holiday ideas. We believe that each of these concepts are important contributors to our flagship store and will enable us to continue to test market new products and merchandising concepts.
Excluding the South Deerfield flagship store, the average store size for our 285 retail stores at the end of 2003 was 1,677 square feet. Our retail stores other than the South Deerfield store typically offer Yankee Candle products in approximately 160 fragrances and carry approximately 800 SKUs of candles and approximately 500 SKUs of candle accessories.
Superior customer service and a knowledgeable employee base are key elements of our retail strategy. We emphasize formal employee training, particularly with respect to product quality, candle manufacturing and the heritage of Yankee Candle. We also have a well-developed, nine day training program for managers and assistant managers and an eight hour training program for sales associates. Our high customer service standards are an integral part of our ongoing success. Each store is responsible for implementing and maintaining these customer service standards.
Catalog and Internet
As part of our retail division we market our products through our catalogs and Internet web site. We expect both businesses to grow over the next several years as a result of demographic and lifestyle changes in the consumer population, including the aging of baby boomers, decreased shopping time and a need for shopping convenience. Our catalogs feature a wide selection of our most popular products, together with additional products and offerings exclusive to our catalog channel. We believe there are continuing opportunities to grow the catalog business by adding additional products and accessories, new catalog concepts and expanding our mailing list. During 2003 we entered into an agreement with a third party logistics provider to manage the fulfillment of all catalog and Internet orders.
Our web site, www.yankeecandle.com, provides our on-line customers with an easy and convenient way to purchase a wide variety of our most popular products. This web site also offers features designed to promote sales and provide enhanced customer service and convenience, including personalized guest registration, gift cards and other gift giving programs, a store locator, decorating ideas, sites dedicated to corporate gifts, weddings and other customized purchasing opportunities and a personalized candle configuring capability that enables users to design and purchase their own custom-labeled Samplers® votive candles to commemorate special events such as weddings. In addition to our consumer-oriented web site, we have a separate business-to-business web site dedicated to our wholesale customers that offers such features as on-line ordering, order status information, purchase history and an enhanced dealer locator program. We continually upgrade our web site in order to better serve our retail and wholesale customers.
Our catalog and Internet business generated $18.4 million of sales in 2003, an increase of approximately 2.0% over 2002.
WHOLESALE OPERATIONS
Our wholesale strategy focuses on gift, home décor and other image appropriate retailers. The wholesale business is a critical part of our growth strategy and, together with our other distribution channels, helps to further build our brand awareness. From 1998 to 2003, sales from our wholesale accounts have grown at a compound annual growth rate of 18% from $107.5 million in 1998 to $242.0 million in 2003 and changed from 57% to 48% of our total sales. Our wholesale customers currently have approximately 15,000 locations in North America, approximately 90% of which are non-mall. We believe that as a result of our strong brand name, the popularity and profitability of our products and our emphasis on customer service, our wholesale customers are extremely loyal, with approximately 70% of them having been customers for over five years. No customer accounted for more than 6% of our total company sales in 2003.
The strength of our brand, the profitability and quality of our products, and our successful in-store merchandising and display system have made us the top selling brand for many of our wholesale customers. Since 1993, we have been continuously ranked first in gift store sales in the domestic candle category and have consistently been ranked either first or second in product reorders across all giftware categories by Giftbeat, a giftware industry publication. In addition, we have consistently been ranked as the most profitable product line across all giftware categories since Giftbeat introduced that survey category several years ago.
We actively seek to increase wholesale sales through our innovative product display systems, promotional programs, new products and telemarketing initiatives. We promote a “Shop Within A Shop” display system to our wholesale customers which presents our products in a distinctive wood hutch. We recommend that dealers invest in a minimum of an 8- to 12-foot display system which holds $6,000 to $9,000 of Yankee Candle products at suggested retail prices. This display system enhances Yankee Candle’s brand recognition in the marketplace and we believe positively impacts our wholesale sales. We have also introduced new products and implemented a number of promotional programs to increase the square footage dedicated to Yankee Candle products as well as the breadth of Yankee Candle products offered by our wholesale customers. For example, we promote a Fragrance of the Month program, with featured fragrance suggestions for each month. This program encourages dealers to increase their re-order schedules and implement a proven customer promotion. The promotion encourages consumers to try different fragrances and return to the stores more frequently in order to buy the Fragrance of the Month. In addition to specific promotions, we advise our wholesale customers on an ongoing basis regarding product knowledge, display suggestions, promotional ideas and geographical consumer preferences. As one example, we have introduced Yankee Candle University, a training program with in-depth courses on Yankee Candle product information, sales tactics and marketing techniques. We have also established a Wholesale Advisory Council made up of wholesale customers from across the country, which provides us with a forum for receiving invaluable feedback from our wholesale customers while also allowing us to work jointly with them to develop “best practices” and innovative ideas.
We have a selective dealer approval process, designed to apply consistent nationwide standards for all Yankee Candle dealers. As a result of these high credit standards for dealers, we had bad debt expense of only 0.5% of wholesale sales in 2003.
We use a dedicated in-house direct telemarketing sales force to service our wholesale customers. In addition, we have several account managers located in field offices across the United States to help us service our national accounts. This provides us with greater control over the sales process, and allows us to provide customers with better and more accurate information, faster order turn-around and improved customer service, to create more consistent merchandising nationwide and to reduce costs.
International Operations
We currently sell our products in Europe and the Middle East through our distribution center in the United Kingdom. As of January 3, 2004, this distribution center was selling our products to approximately 1,900 direct accounts and 23 distributors covering 26 countries. Revenues from our international operations outside of North America have accounted for less than 2.5% of our total revenues in each of the last three years. Our international operations also include our Canadian wholesale operations. In 2003 we terminated our relationship with our former Canadian distributor and have since entered into a relationship with a new distribution partner. We are pleased with the transition to our new distributor and do not expect any significant negative impact on our Canadian business in 2004 as a result of this change. During 2003 we also established a relationship with a new distributor to develop business in Japan and the Far East.
NEW PRODUCT DEVELOPMENT
We have a long history as a product innovator in the premium candle segment of the giftware industry. We have a strong and experienced in-house product design and development team comprised of artists, fragrance specialists, designers, packagers and buyers who work collaboratively to design new products that are attractive to customers and can be manufactured cost-effectively. New products are typically developed in less than a year.
Our innovation team focuses on several different areas of new product development. Each year we introduce a number of in-line extensions of our core candle lines, such as new Housewarmer® fragrances and the development of exclusive fragrances and special products for one or both of our retail and wholesale channels. In addition to new fragrances in our core Housewarmer® line, our new product development efforts focus on the addition of new candle lines and offerings. In 2003 these efforts included the introduction of our Stripes™ and YC™ product lines, the re-launch of our fashion pillar lines and other new candle introductions.
Beyond candles, our innovation team continually works to broaden our product portfolio and continue to extend our brand into the home fragrancing market segment and other fragrance-related categories. In 2003 these efforts led to the introduction of our electric home fragrancer products and the continued expansion of other branded home fragrance offerings such as potpourri, room sprays and linen sprays. These introductions followed prior brand extensions such as Car Jars® air fresheners and Yankee Candle™ Bath personal care products.
In 2004, we plan to continue to focus on broadening our product portfolio in both the candle and home fragrancing segments.
Our expenditures on research and development during the last three fiscal years have not been material because we have historically drawn on a broad group of our existing workforce to participate in research and development initiatives.
MANUFACTURING
Approximately 74% of our sales in 2003 were generated by products manufactured at our 294,000 square foot facility in Whately, Massachusetts. As a vertically integrated manufacturer, we are able to closely monitor the quality of our products, more effectively manage inventory and control our production costs. We believe this is an important competitive advantage that enables us to ensure high quality products, maintain affordable pricing and provide reliable customer service.
Our products are manufactured using filled, molded, extruded, compressed and dipped manufacturing methods. The majority of our products are filled products which are produced by pouring colored, scented liquid wax into a glass container with a wick. Pillars are made by extrusion, in which wax is pressed around a wick through a die. Tapers are produced through a dipping process and Tarts® wax potpourri and Samplers® votive candles are made by compression.
Yankee Candle uses high quality fragrances, premium grade, highly refined paraffin waxes, and superior wicks and dyes to create premium products. Our manufacturing processes are designed to ensure the highest quality and quantity of candle fragrance, wick quality and placement, color, fill level, shelf life and burn rate. We are continuously engaged in efforts to further improve our quality and lower our costs by using efficient production and distribution methods and technological advancements.
SUPPLIERS
We maintain strong relationships with our principal fragrance and petroleum based wax suppliers. We believe we use the highest-quality suppliers in our industry and maintain back-up suppliers who are able to provide services and materials of similar quality. We have been in the business of manufacturing premium scented candles for many years and are therefore knowledgeable about the different levels of quality of raw materials used in manufacturing candles. We have developed, jointly with our suppliers, proprietary fragrances which are exclusive to Yankee Candle. Other raw materials used in the manufacturing process, including wax, glassware, wick and packaging materials, are readily available from alternative sources at comparable prices. In 2003, no single supplier represented 7% or more of our total cost of goods sold, except for our primary glassware vendor who represented approximately 11% of our total cost of goods sold.
ORDER PROCESSING AND DISTRIBUTION
Our systems allow us to maintain efficient order processing from the time an order enters the system through shipping and ultimate payment collection from customers. We operate uniform computer and communication software systems allowing for online information access between our headquarters and retail stores. We use a software package that allows us to forecast demand for our products and efficiently plan our production schedules. We also utilize a pick-to-light system which allows Yankee Candle employees at our distribution center to receive information directly from the order collection center and quickly identify, by way of blinking lights, the products and quantity necessary for a particular order. To accurately track shipments and provide better service to customers we also use handheld optical scanners and bar coded labels. Our “best of breed” platform of manufacturing and distribution software enables us to further enhance our inventory management and customer service capabilities and also support a significantly larger infrastructure. We believe that our systems for the processing and shipment of orders from the distribution center have enabled us to improve our overall customer service through enhanced order accuracy and reduced turnaround time.
In 2003 we continued to expand and enhance our electronic data interchange (EDI) capabilities. We plan to further expand these capabilities in 2004 to additional customers and suppliers.
The products we sell in the United States are generally shipped by various national small-parcel carriers or other freight carriers. Our products are shipped to our retail stores on a fluctuating schedule, with the frequency of deliveries based upon a store’s sales volume and seasonal variances in demand. We ship to wholesale customers as orders are received. We believe that our timely and accurate distribution is an important differentiating factor for our wholesale customers. This belief is based on numerous conversations between our management and sales force, on the one hand, and our wholesale customers, on the other hand.
INTELLECTUAL PROPERTY
Yankee Candle has obtained 38 U.S. trademark registrations, including Yankee® (for candles), Yankee Candle®, Housewarmer®, Country Kitchen®, Samplers®, Tarts®, Country Classics®, Kindle Candles® and Car Jars® and has pending several additional trademark applications with respect to its products. We also register certain of our trademarks in various foreign countries. Trademark registrations allow us to use those trademarks on an exclusive basis in connection with our products. If we continue to use our trademarks and make all required filings and payments these trademarks can continue in perpetuity. These registrations are in addition to various copyright registrations and patents held by us, and all trademark, copyright and other intellectual property rights of Yankee Candle under statutory and common law, including those rights relating to our distinctive “trade dress” and our manufacturing and design “know how.”
We believe that our trademarks and intellectual property rights are valuable assets and we intend to maintain and renew our trademarks and their registrations and to vigorously defend them and all of our intellectual property rights against infringement.
ENVIRONMENTAL MATTERS
We are subject to various federal, state, local and foreign laws and regulations governing the generation, storage, use, emission, discharge, transportation and disposal of hazardous materials and the health and safety of our employees. In addition, we are subject to environmental laws which may require investigation and cleanup of any contamination at facilities we own or operate or at third party waste disposal sites we use. These laws could impose liability even if we did not know of, or were not responsible for, the contamination.
We have in the past and will in the future incur costs to comply with environmental laws. We are not, however, currently aware of any costs or liabilities relating to environmental matters, including any claims or actions under environmental laws or obligations to perform any cleanups at any of our facilities or any third party waste disposal sites, that are expected to have a material adverse effect on our operations, cash flow or financial condition. It is possible, however, that material environmental costs or liabilities may arise in the future.
COMPETITION
We compete generally for the disposable income of consumers with other manufacturers and retailers in the giftware industry. The giftware industry is highly competitive with a large number of both large and small participants. Our products compete with other scented and unscented candle and personal care products and with other gifts within a comparable price range, like boxes of candy, flowers, wine, fine soap and related merchandise. Our competitors distribute their products through independent gift retailers, department stores, mass market stores and mail order houses and some of our competitors are part of large, diversified companies having greater financial resources and a wider range of product offerings than us.
The candle market overall is highly fragmented. According to a recent Unity Marketing study released in 2003, approximately 90% of all candle companies had less than $5.0 million in total sales in 2002. In the premium scented candle segment of the market, in which we primarily compete, our manufacturing competitors include Blyth Industries, Inc., as well as many smaller branded manufacturers and private label manufacturers. We are not aware of any significant recent consolidation in the manufacturing segment of the candle market, nor do we anticipate that there will be any material consolidation based on our current knowledge and understanding of the market.
Our retail stores compete primarily with specialty candle retailers and a variety of other retailers including department stores, gift stores and national specialty retailers that carry candles along with personal care items, giftware and houseware. In addition, while we focus primarily on the premium scented candle segment, candles are also sold outside of that segment by a variety of retailers including mass merchandisers.
EMPLOYEES
At January 3, 2004, we employed approximately 2,000 full-time employees and 1,800 part-time employees. We are not subject to any collective bargaining agreements, and we believe that our relations with our employees are good. We also use seasonal and temporary workers, as necessary, to supplement our labor force during the peak selling season.
WEB SITE
Our internet address is www.yankeecandle.com. We make available free of charge through our web site our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file such materials with the Securities and Exchange Commission. We are not including the information contained on our web site as a part of, or incorporating it by reference into, this Annual Report on Form 10-K. We also include on our web site the Corporate Governance Guidelines adopted by our Board of Directors, our Code of Business Conduct and Ethics and the charters for each of the major committees of our Board of Directors. In addition, we intend to disclose on our web site any amendments to, or waivers from, our Code of Business Conduct and Ethics that are required to be publicly disclosed pursuant to rules of the Securities and Exchange Commission and the New York Stock Exchange.
ITEM 2.
ITEM 2. PROPERTIES
We own or lease several facilities located in Deerfield and Whately, Massachusetts, including those described in the table below:
We also lease a 27,000 sq. ft. distribution facility in Bristol, England.
We believe these facilities are suitable and adequate and have sufficient capacity to meet our current needs. In addition to the foregoing facilities, and the retail satellite stores referenced below, we own various other properties in the Deerfield/Whately area, none of which are material to our operations.
Other than the South Deerfield flagship store and three smaller retail locations, we lease our retail stores. Initial store leases for mall locations typically range from eight to ten years. For non-mall locations, most leases are five years, with a five-year renewal option.
Our retail stores were located in the following 42 states as of January 3, 2004:
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are involved from time to time in ordinary routine legal proceedings relating to our business. We believe that none of these legal proceedings will have a material adverse impact on our results of operations, cash flow or financial condition.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our annual meeting of stockholders will be held on June 16, 2004. No matter was submitted to a vote of security holders in the fourth quarter of the fiscal year ended January 3, 2004.
Executive Officers of the Registrant
The following table sets forth the names, ages and positions of our executive officers as of March 12, 2004:
CRAIG W. RYDIN is the Chairman of the Board of Directors and the President and Chief Executive Officer. Prior to joining Yankee Candle in April 2001, Mr. Rydin was the President of the Away From Home food services division of Campbell Soup Company since 1998, and President of the Godiva Chocolatier division of Campbell from 1996 to 1998. Prior to Godiva, Mr. Rydin held a number of senior management positions at Pepperidge Farm, Inc., also a part of Campbell.
ROBERT R. SPELLMAN is a Director and the Senior Vice President, Finance and Chief Financial Officer. Prior to joining Yankee Candle in November 1998, Mr. Spellman was Senior Vice President of Finance of Staples, Inc. from 1988 through 1994, and Chief Financial Officer of Star Markets Company, Inc. from 1994 through 1998.
GAIL M. FLOOD is the Senior Vice President, Retail. Ms. Flood joined Yankee Candle in 1982 as Retail Store Manager. Since 1988, she has been in charge of the Company’s retail operations. She was appointed Vice President of Retail Operations in July 1996, and promoted to her current position in November 1998.
PAUL J. HILL is the Senior Vice President, Supply Chain. Prior to joining Yankee Candle in October 2000, Mr. Hill was employed by Kraft Foods, Inc. from 1987 to 2000. At Kraft, Mr. Hill held various supply chain
and strategy positions. His last assignment with Kraft, from 1997 to 2000, was as the Plant Manager at one of the largest plants in Kraft’s system.
HARLAN M. KENT is the Senior Vice President, Wholesale. Prior to joining Yankee Candle in June 2001, Mr. Kent was Senior Vice President and General Manager of the Wholesale Division of Totes Isotoner Corporation from 1997 to 2001, and Vice President of Global Sales and Marketing for the Winchester Division of Olin Corporation from 1995 to 1997. Mr. Kent has also held a number of senior marketing and strategic planning positions at both the Campbell Soup Company and its Pepperidge Farm Division.
MARTHA S. LACROIX is the Senior Vice President, Human Resources. Ms. LaCroix joined Yankee Candle in February 1993 as Director of Employee Relations and has since held various positions of increasing responsibility in the Company’s Human Resources Department. Ms. LaCroix was appointed Vice President, Human Resources in December 2000 and promoted to her current position in 2003.
JAMES A. PERLEY is the Vice President, General Counsel of the Company. Prior to joining Yankee Candle in September 1999, Mr. Perley was Vice President and General Counsel of Star Markets Company, Inc., where he served from 1997 to 1999. From 1987 to 1997, Mr. Perley was a member of the Boston-based law firm of Hale and Dorr LLP, where he served as an Associate from 1987-1992 and as a Junior Partner from 1992-1997.
There are no family relationships among any of the executive officers.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock has been traded on the New York Stock Exchange since July 1, 1999 under the symbol “YCC”. For the fiscal periods indicated, the high and low sales prices per share of the common stock as reported on the New York Stock Exchange - Composite Transaction Reporting System were as follows:
On March 12, 2004, the closing sale price as reported on the New York Stock Exchange-Composite Transaction Reporting System for our common stock was $27.97 per share. As of March 12, 2004, there were 593 holders of record of our common stock. This does not include the number of persons whose stock is in nominee or “street name” accounts through brokers.
Dividends
We have never paid a cash dividend on our common stock as a public company. Instead, we have retained earnings for the future operation of our business. While we have no current plan to pay any cash dividends in the foreseeable future, we intend to periodically evaluate the advisability of a dividend program. Any determination to pay dividends in the future will be at the discretion of the board of directors and will be dependent upon results of operations, financial condition, contractual and legal restrictions and other factors deemed relevant by our board of directors. Under the terms of our existing credit agreement (which is scheduled to expire on July 7, 2004), we may not declare or pay dividends on our common stock unless our ratio of consolidated total debt to consolidated EBITDA (as defined in our credit agreement) is less than or equal to 2:1 or our aggregate principal amount of loans and letters of credit outstanding is less than $100 million. Although we currently meet this requirement, we have no current plan to pay dividends.
Stock Repurchases
On May 9, 2003 we announced that our Board of Directors had approved a stock repurchase program authorizing us to repurchase up to $100 million of Yankee Candle common stock. During fiscal 2003, we repurchased a total of 4,084,200 shares of common stock for an aggregate purchase price of approximately $100 million at an average price per share of approximately $24.48.
On February 12, 2004, the Board of Directors authorized a new stock repurchase program for the repurchase of up to an additional $100 million of our common stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The selected historical consolidated financial and other data that follows should be read in conjunction with the “Consolidated Financial Statements”, the accompanying notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this Annual Report on Form 10-K. The historical financial data as of December 28, 2002 and January 3, 2004 and for the fifty-two weeks ended December 29, 2001 and December 28, 2002 and fifty-three weeks ended January 3, 2004 has been derived from the audited consolidated financial statements and the accompanying notes included in this document at Item 8.
The historical financial data as of January 1, 2000, December 30, 2000, and December 29, 2001 and for the fifty-two weeks ended January 1, 2000 and December 30, 2000 has been derived from audited financial statements for the corresponding period, which are not contained in this document.
The selected historical financial data may not be indicative of our future performance.
(1)
EBITDA represents earnings before extraordinary items, income taxes, interest, depreciation and amortization (which includes amortization of deferred financing costs) and amortization of non-cash compensation, pursuant to Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees.” Amortization of deferred financing costs is included in interest expense in the Consolidated Statements of Operations and in depreciation and amortization in the Consolidated Statements of Cash Flows. EBITDA is presented because management believes it is a widely accepted financial indicator used by certain investors and analysts to analyze and compare companies on the basis of operating performance. EBITDA as presented may not be comparable to similarly titled measures reported by other companies since not all companies necessarily calculate EBITDA in an identical manner and therefore is not necessarily an accurate means of comparison between companies. EBITDA is not intended to represent cash flows for the period or funds available for management’s discretionary use nor has it been represented as an alternative to operating income as an indicator of operating performance and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with generally accepted accounting principles. For each of the years shown above, EBITDA is calculated based upon our net income (as shown above) and adjusted as follows:
(2)
Adjusted EBITDA reflects EBITDA adjusted to eliminate the $8.0 million restructuring charge in 2001. For each of the years shown above, Adjusted EBITDA is calculated based upon EBITDA (as shown above) and adjusted as follows:
(3)
Adjusted EBITDA margin is adjusted EBITDA as a percentage of sales.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
“Management’s Discussion and Analysis of Financial Condition and Results of Operations” discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those related to inventories, restructuring costs, bad debts, intangible assets, income taxes, debt service and contingencies and litigation. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about operating results and the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Management believes the following critical accounting policies, among others, involve its more significant estimates and judgments and are therefore particularly important to an understanding of our results of operations and financial position.
REVENUE / RECEIVABLES
We sell our products both directly to retail customers and through wholesale channels. Revenue from the sale of merchandise to retail customers is recognized at the time of sale, while revenue from wholesale customers is recognized when risk of loss has passed to the customers. We believe that this is the time that persuasive evidence of an agreement exists, delivery has occurred, the price is fixed and determinable and collectability is reasonably assured. Revenue is recognized net of any applicable discounts and allowances. Customers, be they retail or wholesale, do have the right to return product to us in certain limited situations. Such rights of return have not precluded revenue recognition because we have a long history with such returns, which we use in constructing a reserve. This reserve, however, is subject to change. In addition to returns, we bear credit risk relative to our wholesale customers. We have provided a reserve for bad debts in our financial statements based on our estimates of the creditworthiness of our customers. However, this reserve is also subject to change. Changes in these reserves could affect our operating results.
INVENTORY
We write down our inventory for estimated obsolescence or unmarketable inventory in an amount equal to the difference between the cost of inventory and the estimated market value, based upon assumptions about future demand and market conditions. If actual future demand or market conditions are less favorable than those projected by management, additional inventory write-downs may be required. In addition, our inventory is stated at the lower of cost or market on a last-in first-out (“LIFO”) basis. Fluctuations in inventory levels along with the cost of raw materials could impact the carrying value of our inventory. Changes in the carrying value of inventory could affect our operating results.
TAXES
We have a significant deferred tax asset recorded on our financial statements. This asset arose at the time of our recapitalization in 1998 and is a future tax deduction for us. The recoverability of this future tax deduction is dependent upon our future profitability. We have made an assessment that this asset is likely to be recovered and is appropriately reflected on the balance sheet. Should we find that we are not able to utilize this deduction in the future we would have to record a reserve for all or a part of this asset, which would adversely affect our operating results and cash flows.
RESTRUCTURING RESERVE
In fiscal 2001 we closed our distribution facility in Utah, recorded a restructuring charge and established a reserve for future expenses related to the restructuring. Part of the restructuring charge related to the lease commitment that we have through 2005. In connection with the restructuring we did not record the entire lease commitment as a liability because we believed we would be able to sublet the facility. During the second quarter of fiscal 2002 we were successful in subletting the facility for the remaining lease term. If the facility were to be vacated by the current tenant in breach of its sublease this would negatively affect our results of operations and cash flows.
VALUE OF LONG-LIVED ASSETS, INCLUDING INTANGIBLES
Long-lived assets on our balance sheet consist primarily of property, plant and equipment and trademarks. We periodically review the carrying value of all of these assets based, in part, upon our projections of anticipated undiscounted future cash flows. We undertake this review when facts and circumstances suggest that cash flows emanating from those assets may be diminished. Any impairment charge that we record reduces our earnings. While we believe that our future estimates are reasonable, different assumptions regarding items such as future cash flows and the volatility inherent in markets which we serve could affect our evaluations and result in impairment charges against the carrying value of those assets.
STOCK BASED COMPENSATION
Effective in 2003, we adopted the fair value recognition provisions of SFAS No. 123 “Accounting for Stock Based Compensation.” Under the prospective transition method selected by us, as described in SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of SFAS No. 123,” all stock option grants beginning with grants made in fiscal 2003 are being expensed over the vesting period, based on the fair value at the date of the grant. Fair value is determined based on a variety of factors, all of which are estimates subject to judgment. Changes in estimated lives of options, risk free interest rates or exercise patterns could impact our results of operations. We recorded a charge of approximately $0.6 million for the fifty-three weeks ended January 3, 2004.
PERFORMANCE MEASURES
We measure the performance of our retail and wholesale segments through a segment margin calculation, which specifically identifies not only gross profit on the sales of products through the two channels but also costs and expenses specifically related to each segment.
FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
We have experienced, and may experience in the future, fluctuations in our quarterly operating results. There are numerous factors that can contribute to these fluctuations; however, the principal factors are seasonality and new store openings.
Seasonality. We have historically realized higher revenues and operating income in our fourth quarter, particularly in our retail business. We believe that this has been due primarily to the increase in the number of our retail stores and to increased sales in the giftware industry during the holiday season of the fourth quarter.
New Store Openings. The timing of our new store openings may also have an impact on our quarterly results. First, we incur certain one-time expenses related to opening each new store. These expenses, which consist primarily of salaries, supplies and marketing costs, are expensed as incurred. Second, most store expenses vary proportionately with sales, but there is a fixed cost component. This typically results in lower store profitability when a new store opens because new stores generally have lower sales than mature stores. Due to both of these factors, during periods when new store openings as a percentage of the base are higher, operating profit may decline in dollars and/or as a percentage of sales. As the overall store base matures, the fixed cost component of selling expenses is spread over an increased level of sales, assuming sales increase as stores age, resulting in a decrease in selling and other expenses as a percentage of sales.
FIFTY-THREE WEEKS ENDED JANUARY 3, 2004 (“2003”) COMPARED TO FIFTY-TWO WEEKS ENDED DECEMBER 28, 2002 (“2002”)
GENERAL
The fiscal year ended January 3, 2004 consisted of 53 weeks, while the fiscal years ended December 28, 2002 and December 29, 2001 consisted of 52 weeks.
SALES
Sales increased 14.3% to $508.6 million in 2003 from $444.8 million in 2002. The additional 53rd week in 2003 contributed $5.2 million and $1.1 million in retail and wholesale sales, respectively. Wholesale sales, including European operations, increased 18.1% to $242.0 million in 2003 from $204.9 million for 2002. This growth was achieved primarily by increasing sales to existing customers and to a lesser extent by increasing the number of wholesale locations.
Retail sales increased 11.1% to $266.6 million in 2003 from $239.9 million for 2002. There were 286 retail stores open as of January 3, 2004 compared to 239 stores open at December 28, 2002. The increase in retail sales was achieved primarily through the addition of 49 new stores in 2003 and to a lesser extent increased sales in the 47 stores opened in 2002 (which in 2002 were open for less than a full year), partially offset by a decrease in comparable store sales. Comparable store and catalog and Internet sales in 2003 decreased 4.0% compared to 2002. Retail comparable store sales in 2003 decreased 4.0% compared to 2002. We believe the primary factor contributing to the decrease in comparable store sales was a decline in store traffic, and mall traffic generally. Comparable store sales were also negatively impacted in 2003 due to the President’s Day (February 16-17) snowstorm which affected most of our store base in the Eastern half of the United States and successive weekend snowstorms in early December. Comparable store sales represent a comparison of the sales, during the corresponding fiscal periods of the two fiscal years compared, of the stores included in our comparable store sales base. A store first enters our comparable store sales base after completing 13 fiscal months of operation. There were 237 stores included in the comparable store base at the end of 2003, and 47 of these stores were included for less than a full year.
GROSS PROFIT
Gross profit increased 17.3% to $293.3 million in 2003 from $250.1 million in 2002. As a percentage of sales, gross profit increased to 57.7% in 2003 from 56.2% in 2002. The increase in gross profit dollars in 2003 compared to 2002 was primarily attributable to the increase in sales and more efficient supply chain operations. The improvement in gross profit rate in 2003 compared to 2002 was primarily due to continued productivity improvements in supply chain operations and more efficient sourcing of non-manufactured product.
SELLING EXPENSES
Selling expenses increased 19.7% to $115.8 million in 2003 from $96.7 million in 2002. These expenses are related to both wholesale and retail operations and consist of payroll, occupancy, advertising and other operating costs, as well as preopening costs, which are expensed as incurred. As a percentage of sales, selling expenses were 22.8% in 2003 and 21.7% in 2002. The increase in selling expenses in dollars and as a percentage of sales was primarily related to the continued growth in the number of retail stores, from 239 as of December 28, 2002 to 286 as of January 3, 2004, the effect of which is an increase in the weighting of immature stores. Immature stores are generally stores that are less than four years old. Immature stores typically generate higher selling expenses as a percentage of sales than stores that have been open for more than four years since fixed costs, as a percent of sales, are higher during the early sales maturation period. The increase in selling expense as a percentage of sales for 2003 is also explained by the decrease in retail comparable store sales since the fixed components of labor and occupancy do not decrease with negative comparable store sales. Selling expenses were also unfavorably impacted by the $1.0 million bad debt provision the Company recognized in the fourth quarter of 2003 related to the failure of our former Canadian distributor to pay to us amounts due and payable for product shipped.
SEGMENT PROFITABILITY
Segment profitability is sales less cost of sales and selling expenses. Segment profitability for our wholesale operations, including Europe, was $101.6 million or 42.0% of wholesale sales in 2003 compared to $87.2 million or 42.6% of wholesale sales in 2002. Segment profitability for our retail operations was $76.0 million or 28.4% of retail sales in 2003 compared to $66.2 million or 27.6% of retail sales in 2002. The increase in wholesale segment profitability in dollars was primarily attributable to increased wholesale sales. The decrease in wholesale segment profitability as a percentage of wholesale sales was primarily due to a $1.0 million bad debt provision the Company recognized in the fourth quarter of 2003 related to the failure of our former Canadian distributor to pay to us amounts due and payable for product shipped. The increase in retail segment profitability in dollars and as a percentage of retail sales was primarily attributable to increased retail sales and improved supply chain operations, offset in part by a decrease in retail comparable store sales and the impact of our most immature stores, the 2003 and 2002 store classes.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses, which consist primarily of personnel-related costs, increased 16.3% to $50.6 million in 2003 from $43.5 million in 2002. As a percentage of sales, general and administrative expenses increased to 9.9% from 9.8%. The increase in general and administrative expenses was primarily attributable to headcount additions in the latter part of 2002 and in 2003, consulting costs related to a strategic planning project that began in late February 2003, stock option expense, profit sharing expense and to a lesser extent increased insurance costs associated with the Company’s Directors and Officers insurance policy.
In 2003, we adopted the fair value recognition provisions of SFAS No. 123. Under the prospective transition method selected by us as described in SFAS No. 148, all stock option grants beginning with grants made in fiscal 2003 are being expensed over the vesting period, based on the fair value at the date of the grant. This resulted in $0.6 million of incremental stock compensation expense in 2003.
NET OTHER EXPENSE
Net other expense was $3.4 million in 2003 compared to $4.4 million in 2002. The primary component of this expense was interest expense, which was $3.8 million in 2003 compared to $4.9 million in 2002. The decrease in interest expense in 2003 compared to 2002 was primarily the result of the reduction in the average daily debt outstanding.
INCOME TAXES
The income tax provision for 2003 was $48.8 million compared to $41.4 million for 2002. The 2003 tax provision was based on an effective tax rate of 39.5%. The 2002 tax provision was based on an effective tax rate of 39.3%. We have provided and expect to provide in 2004 a valuation allowance against the deferred tax asset for our international operations. As a result, it is anticipated that our effective tax rate for 2004 will be approximately 39.5%. We re-evaluate our effective tax rate on a quarterly basis.
NET INCOME
Net income increased 16.9% to $74.8 million in 2003 from $64.0 million in 2002.
FIFTY-TWO WEEKS ENDED DECEMBER 28, 2002 (“2002”) COMPARED TO FIFTY-TWO WEEKS ENDED DECEMBER 29, 2001 (“2001”)
SALES
Sales increased 17.1% to $444.8 million in 2002 from $379.8 million in 2001. Wholesale sales, including European operations, increased 21.9% to $204.9 million in 2002 from $168.1 million for 2001. This growth was achieved primarily by increasing the number of wholesale locations and also by increasing sales to existing customers.
Retail sales increased 13.3% to $239.9 million in 2002 from $211.7 million for 2001. There were 239 retail stores open as of December 28, 2002 compared to 192 stores open at December 29, 2001. The increase in retail sales was achieved primarily through two factors, the addition of 47 new stores in 2002 and increased sales in the 45 stores opened in 2001 (which in 2001 were open for less than a full year), and, to a lesser extent, through increased sales in catalog and Internet operations, partially offset by a decrease in comparable store sales. Comparable store and catalog and Internet sales in 2002 decreased 4.4% compared to 2001. Retail comparable store sales in 2002 decreased 6.3% compared to 2001. The primary factors which drove the decrease in comparable store sales were a decline in store traffic, and mall traffic generally, and our decision not to repeat certain promotional activities undertaken in 2001. There were 192 stores included in the comparable store base at the end of 2002, and 45 of these stores were included for less than a full year.
GROSS PROFIT
Gross profit increased 21.6% to $250.1 million in 2002 from $205.7 million in 2001. As a percentage of sales, gross profit increased to 56.2% in 2002 from 54.2% in 2001. The increase in gross profit dollars in 2002 compared to 2001 was primarily attributable to the increase in sales and more efficient supply chain operations. The improvement in gross profit rate in 2002 compared to 2001 was primarily the result of improved productivity in supply chain operations, supply chain inefficiencies in early 2001 that were not experienced in 2002 and our decision not to engage in deep discounting activities.
SELLING EXPENSES
Selling expenses increased 25.1% to $96.7 million in 2002 from $77.3 million in 2001. These expenses are related to both wholesale and retail operations and consist of payroll, occupancy, advertising and other operating costs, as well as preopening costs, which are expensed as incurred. As a percentage of sales, selling expenses were 21.7% in 2002 and 20.4% in 2001. The increase in selling expenses in dollars and as a percentage of sales was primarily related to the continued growth in the number of retail stores, from 192 as of December 29, 2001 to 239 as of December 28, 2002, the effect of which is an increase in the weighting of immature stores. Immature stores are generally stores that are less than four years old. Immature stores typically generate higher selling expenses as a percentage of sales than stores that have been open for more than four years since fixed costs, as a percent of sales, are higher during the early sales maturation period. The increase in selling expense as a percentage of sales for 2002 is also explained by the decrease in retail comparable store sales since the fixed components of labor and occupancy do not decrease with negative comparable store sales.
SEGMENT PROFITABILITY
Segment profitability is sales less cost of sales and selling expenses. Segment profitability for our wholesale operations, including Europe, was $87.2 million or 42.6% of wholesale sales in 2002 compared to $65.5 million or 38.9% of wholesale sales in 2001. Segment profitability for our retail operations was $66.2 million or 27.6% of retail sales in 2002 compared to $62.9 million or 29.7% of retail sales in 2001. The increase in wholesale segment profitability was primarily attributable to increased wholesale sales and improved productivity in supply chain operations. The increase in retail segment profitability in dollars was primarily attributable to increased retail sales and improved supply chain operations. The decrease in retail segment profitability as a percentage of retail sales was primarily attributable to a decline in retail comparable store sales and a decline in operating profit in catalog and Internet operations, partially offset by improved productivity in supply chain operations.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses, which consist primarily of personnel-related costs, increased 13.1% to $43.5 million in 2002 from $38.5 million in 2001. As a percentage of sales, general and administrative expenses decreased to 9.8% from 10.1%. The increase in general and administrative expenses in dollars was primarily attributable to headcount additions in the latter part of 2001 and in 2002, higher bonus program accruals for fiscal 2002 as compared to 2001 and occupancy expenses associated with our new headquarters opened in May 2001 (i.e. we incurred 12 months of such expenses in 2002 compared to approximately eight months in 2001). The decrease in general and administrative expenses as a percentage of sales for fiscal 2002 was primarily attributable to our ability to leverage these expenses over a larger sales base and our continued focus on expense control.
NET OTHER EXPENSE
Net other expense was $4.4 million in 2002 compared to $10.9 million in 2001. The primary component of this expense was interest expense, which was $4.9 million in 2002 compared to $10.6 million in 2001. The decrease in interest expense was the result of the reduction in total debt outstanding from $115.0 million at December 29, 2001 to $60.5 million at December 28, 2002, and a reduction in borrowing rates resulting from decreases in the federal funds and eurodollar rates.
INCOME TAXES
The income tax provision for 2002 was $41.4 million compared to $27.7 million for 2001. The 2002 tax provision reflects an effective tax rate of 39.3%. The 2001 tax provision reflects an effective tax rate of 39.0%. We are currently providing a valuation allowance against the deferred tax asset for our international operations. As a result, it is anticipated that our effective tax rate for 2003 will be approximately 39.5%. We re-evaluate our effective tax rate on a quarterly basis.
NET INCOME
Net income increased 48% to $64.0 million in 2002 from $43.3 million in 2001.
RESTRUCTURING CHARGE
A restructuring charge for $8.0 million was recorded in fiscal 2001 to record costs associated with our decision to consolidate and restructure our distribution and manufacturing operations. We closed our Utah distribution facility and restructured our distribution and manufacturing work-force during 2001. Included in the restructuring charge are severance and other employee related costs, $2,124 of a non-cash write-down of non-recoverable leasehold improvements, fixture and equipment investments and estimated continuing occupancy expenses for abandoned facilities, net of anticipated sub-lease income. As a result of this consolidation and restructuring, the Company terminated approximately 450 manufacturing and logistics employees. An analysis of the activity within the restructuring reserve since its inception is as follows:
During the second quarter of fiscal 2002, the Company was successful in subletting the facility covered under the “Occupancy” heading for the remaining lease term. Management believes that the remaining reserve at January 3, 2004 appropriately reflects the Company’s remaining lease commitment exposure.
LIQUIDITY AND CAPITAL RESOURCES
We have consistently generated positive cash flow from operations. Specifically, over the last three fiscal years we have generated a total cash flow of approximately $292 million, including approximately $113 million in 2003. These amounts have exceeded net income in all the fiscal years presented due to two factors. First, we have incurred non-cash charges for depreciation and amortization. Second, income tax expense has significantly exceeded taxes actually paid owing to the tax deduction that we continue to utilize that arose from the 1998 recapitalization. This tax deduction is expected to continue to provide an annual cash benefit for the next ten years. On an annual basis, this results in tax savings of approximately $11.7 million per year through 2013 assuming sufficient income to realize the full benefit of this deduction.
These internally generated cash flows have been sufficient to fund necessary capital expenditures for our expansion plans. Capital expenditures in 2003 were $22.0 million and were primarily related to the capital requirements to open 49 new stores and investments in manufacturing and logistics operations. Capital expenditures were approximately $25.9 million in 2002 and primarily related to similar expenditures. We anticipate that capital expenditures in 2004 will total approximately $24 million and will be spent in a similar manner as in 2003. We plan to open approximately 45 new stores in 2004.
Despite significant capital expenditures, and our repurchase of $100 million of our common stock pursuant to our stock repurchase program discussed below, operating cash flows have also provided sufficient cash to fund both repayments of our term loan and borrowings under our credit facility. We currently have a credit agreement with a consortium of banks that was established at the time of our initial public offering. This credit agreement provides for an initial maximum borrowing of $300 million and consists of a revolving credit facility for $150 million and a term loan for $150 million. We can elect to set the interest rates on all or a portion of the borrowings outstanding under the credit agreement at a rate per annum equal to (a) the greatest of (1) the prime rate, (2) the base CD rate plus 1.00% or (3) the federal funds effective rate plus 1/2%, plus a margin ranging from 0.00% to 0.75%, or (b) the eurodollar rate plus a margin ranging from 1.00% to 1.75%. The weighted-average interest rate on outstanding borrowings at January 3, 2004 was 2.9%.
Our credit agreement requires that we comply with several financial and other covenants, including requirements that we maintain at the end of each fiscal quarter the following financial ratios as set forth in our credit agreement:
Our credit agreement defines EBITDA as our consolidated net income (excluding extraordinary gains, and gains and losses from material dispositions), plus the amount of net interest expense, depreciation and amortization, income taxes, certain non-cash compensation expenses, and certain rental expenses. EBITDA as defined in our credit agreement differs from the definition of EBITDA used elsewhere herein, in that it excludes gains and losses from dispositions of material assets and non-cash compensation expense. We have included the amount of these expenses in our more conservative calculation of EBITDA used elsewhere, which calculation is therefore lower than EBITDA as used in our credit agreement.
This credit arrangement matures in July 2004 and we have accordingly classified all our debt as current on our balance sheet. No payments of principal are due on the revolving credit facility until this maturity date. The term loan is payable in quarterly installments. In 2004, the remaining two term loan payments of $9.5 million
each will be made in March and June. As of January 3, 2004, $46.0 million was outstanding under the revolving credit facility, leaving $104.0 million in availability. As of January 3, 2004, we were in compliance with all covenants under our credit facility.
We are currently engaged in negotiations with various commercial banks to replace our existing Credit Agreement with a new credit facility. We are optimistic that a new credit facility will be finalized and in place prior to the expiration of our existing Credit Agreement in July 2004.
In addition to obligations to repay our debt obligations, we lease the majority of our retail stores under long-term operating leases. The following table summarizes our commitments under both our debt and lease obligations:
On May 9, 2003 we announced that our Board of Directors had approved a stock repurchase program authorizing us to repurchase up to $100 million of Yankee Candle common stock. During fiscal 2003, we repurchased a total of 4,084,200 shares of common stock for an aggregate purchase price of approximately $100 million. Our repurchase activities were funded from cash flow from operations and borrowings under our existing Credit Agreement. On February 12, 2004, the Board of Directors authorized a new stock repurchase program for the repurchase of up to an additional $100 million of our common stock.
We expect that the principal sources of funding for our planned store openings and other working capital needs, capital expenditures, debt service obligations and stock repurchase program will be a combination of our available cash and cash equivalents, funds generated from operations, and borrowings under our credit facility. We believe that our current funds and sources of funds will be sufficient to fund our liquidity needs for at least the next 12 months. However, there are a number of factors that may negatively impact our available sources of funds. The amount of cash generated from operations will be dependent upon factors such as the successful execution of our business plan and worldwide economic conditions. In addition, borrowings under our credit facility are dependent upon our continued compliance with the financial and other covenants contained therein and will cease as of July 2004.
ACCOUNTING CHANGE
The Company currently sponsors stock option plans. Prior to the third quarter of 2003, the Company accounted for employee options or share awards under the intrinsic-value method prescribed by Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees.” Compensation expense, if any, was recognized based on the difference between the fair value of the common stock and the exercise price of the option on the measurement date, as defined by Opinion No. 25. Pro forma disclosures of net earnings and earnings per share had been provided supplementally, as if the fair value method of accounting defined in SFAS No. 123 “Accounting for Stock Based Compensation” had been applied. Effective September 27, 2003, the Company adopted the fair value recognition provisions of SFAS No. 123 using the prospective transition method provided by SFAS No. 148 “Accounting for Stock Based Compensation-Transition and Disclosure, an amendment of SFAS No. 123.” Under the prospective transition method, the Company has valued all stock option grants beginning with grants made in fiscal 2003. These are being expensed over the vesting period based on the fair value at the date of the grant. The adoption of the fair value method of accounting for stock-based compensation resulted in a charge of $0.6 million for the fiscal year ended January 3, 2004.
IMPACT OF INFLATION
We do not believe inflation has a significant impact on our operations. The prices of our products have not varied based on the movement of the consumer price index. The majority of our material and labor costs have not been materially affected by inflation.
FUTURE OPERATING RESULTS
As referenced above, there are a number of factors that might cause our actual results to differ significantly from the results reflected by the forward-looking statements contained herein. In addition to factors generally affecting the political, economic and competitive conditions in the United States and abroad, such factors include those set forth below.
If we fail to grow our business as planned, our business could suffer and financial results could decline. As we grow it will be difficult to maintain our historical growth rates.
We intend to continue to pursue a business strategy of increasing sales and earnings by expanding our retail and wholesale operations both in the United States and internationally. Our current plans are to grow internally and not by acquisition, although from time to time we do consider possible acquisition candidates. In particular, our retail growth strategy depends in large part on our ability to open new stores in both existing and new geographic markets. Since our ability to implement our growth strategy successfully will be dependent in part on factors beyond our control, including consumer preferences and the competitive environment, we may not be able to achieve our planned growth or sustain our financial performance. Our ability to anticipate changes in the candle and giftware industries, and identify industry trends, will be critical factors in our ability to remain competitive.
We expect that, as we grow, it will become more difficult to maintain our historical growth rate, which could negatively impact our operating margins and results of operations. New stores typically generate lower operating margin contributions than mature stores because fixed costs, as a percentage of sales, are higher and because pre-opening costs are fully expensed in the year of opening. In addition, our retail sales generate lower margins than our wholesale sales. Our wholesale business has grown by increasing sales to existing customers and by adding new customers. If we are not able to continue this, our sales growth and profitability
could be adversely affected. We cannot assure you that we will continue to grow at a rate comparable to our historic growth rate or that our historic financial performance will continue as we grow.
We face significant competition in the giftware industry. This competition could cause our revenues or margins to fall short of expectations which could adversely affect our future operating results, financial condition and liquidity and our ability to continue to grow our business.
We compete generally for the disposable income of consumers with other producers in the giftware industry. The giftware industry is highly competitive with a large number of both large and small participants. Our products compete with other scented and unscented candle and personal care products and with other gifts within a comparable price range, like boxes of candy, flowers, wine, fine soap and related merchandise. Our retail stores compete with franchised candle store chains, specialty candle stores and gift and houseware retailers. Some of our competitors are part of large, diversified companies which have greater financial resources and a wider range of product offerings than we do. This competitive environment could adversely affect our future revenues and profits, financial condition and liquidity and our ability to continue to grow our business.
A material decline in consumers’ discretionary income could cause our sales and income to decline.
Our results depend on consumer spending, which is influenced by general economic conditions and the availability of discretionary income. Accordingly, we may experience declines in sales during economic downturns or during periods of uncertainty like that which followed the September 11, 2001 terrorist attacks on the United States or which result from the threat of war or the possibility of further terrorist attacks. Any material decline in the amount of discretionary spending could have a material adverse effect on our sales and income.
Because we are not a diversified company and are effectively dependent upon one industry, we have less flexibility in reacting to unfavorable consumer trends, adverse economic conditions or business cycles.
We rely primarily on the sale of premium scented candles and related products in the giftware industry. In the event that sales of these products decline or do not meet our expectations, we cannot rely on the sales of other products to offset such a shortfall. As a significant portion of our expenses is comprised of fixed costs, such as lease payments, our ability to decrease expenses in response to adverse business conditions is limited in the short term. As a result, unfavorable consumer trends, adverse economic conditions or changes in the business cycle could have a material and adverse impact on our earnings.
If we lose our senior executive officers, our business could be disrupted and our financial performance could suffer.
Our success is substantially dependent upon the retention of our senior executive officers. If our senior executive officers become unable or unwilling to participate in our business, our future business and financial performance could be materially affected.
Many aspects of our manufacturing and distribution facilities are customized for our business; as a result, the loss of one of these facilities would disrupt our operations.
Approximately 74% of our sales in 2003 were generated by products we manufacture at our manufacturing facility in Whately, Massachusetts and we rely primarily on our distribution facilities in South Deerfield, Massachusetts to distribute our products. Because most of our machinery is designed or customized by us to manufacture our products, and because we have strict quality control standards for our products, the loss of
our manufacturing facility, due to natural disaster or otherwise, would materially affect our operations. Similarly, our distribution facilities rely upon customized machinery, systems and operations, the loss of which would materially affect our operations. Although our manufacturing and distribution facilities are adequately insured, we believe it would take up to twelve months to resume operations at a level equivalent to current operations.
Seasonal, quarterly and other fluctuations in our business, and general industry and market conditions, could affect the market for our common stock.
Our sales and operating results vary from quarter to quarter. We have historically realized higher sales and operating income in our fourth quarter, particularly in our retail business, which accounts for a larger portion of our sales. We believe that this has been due primarily to an increase in giftware industry sales during the holiday season of the fourth quarter. As a result of this seasonality, we believe that quarter to quarter comparisons of our operating results are not necessarily meaningful and that these comparisons cannot be relied upon as indicators of future performance. In addition, we may also experience quarterly fluctuations in our sales and income depending on various factors, including, among other things, the number of new retail stores we open in a particular quarter, changes in the ordering patterns of our wholesale customers during a particular quarter, and the mix of products sold. Most of our operating expenses, such as rent expense, advertising and promotional expense and employee wages and salaries, do not vary directly with sales and are difficult to adjust in the short term. As a result, if sales for a particular quarter are below our expectations, we might not be able to proportionately reduce operating expenses for that quarter, and therefore a sales shortfall could have a disproportionate effect on our operating results for that quarter. Further, our comparable store sales from our retail business in a particular quarter could be adversely affected by competition, economic or other general conditions or our inability to execute a particular business strategy. As a result of these factors, we may report in the future sales, operating results or comparable store sales that do not match the expectations of market analysts and investors. This could cause the trading price of our common stock to decline. In addition, broad market and industry fluctuations may adversely affect the price of our common stock, regardless of our operating performance.
Public health epidemics such as Severe Acute Respiratory Syndrome may affect our operating results.
Approximately 11% of our sales in 2003 were generated by products, primarily accessories, that we purchased overseas. Substantially all of these products were purchased from East Asia. A sustained interruption of the operations of our suppliers, as a result of the impact of Severe Acute Respiratory Syndrome or other similar health epidemics, could have an adverse effect on our ability to receive timely shipments of certain of our products and could result in scrutiny or embargoing of goods produced in infected areas.
Provisions in our corporate documents and Massachusetts law could delay or prevent a change in control of Yankee Candle.
Our Articles of Organization and By-Laws may discourage, delay or prevent a merger or acquisition involving Yankee Candle that our stockholders may consider favorable, by:
•
authorizing the issuance of preferred stock, the terms of which may be determined at the sole discretion of the board of directors,
•
providing for a classified board of directors, with staggered three-year terms, and
•
establishing advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted on by stockholders at meetings.
Massachusetts law may also discourage, delay or prevent someone from acquiring or merging with us.
We do not currently intend to pay dividends on our capital stock.
We have never paid a cash dividend on our common stock as a public company. Instead, we have retained earnings for the future operation of our business. While we have no current plan to pay any cash dividends in the foreseeable future, we intend to periodically evaluate the advisability of a dividend program. Any determination to pay dividends in the future will be at the discretion of our board of directors and will be dependent upon our results of operations, our financial condition, contractual and legal restrictions, and other factors deemed relevant by our board of directors. Under the terms of our existing credit agreement (which is scheduled to expire on July 7, 2004), we may not declare or pay dividends on our common stock unless our ratio of consolidated total debt to consolidated EBITDA (as defined in our credit agreement) is less than or equal to 2:1 or our aggregate principal amount of loans and letters of credit outstanding is less than $100 million. Although we currently meet this requirement, we have to current plan to pay dividends.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
Our market risks relate primarily to changes in interest rates. We bear this risk in two specific ways. First, we have debt outstanding. At January 3, 2004, we had $65.0 million outstanding under our credit agreement, which bears interest at variable rates. At January 3, 2004, the weighted-average interest rate on outstanding borrowings was 2.9%. This facility is intended to fund operating needs if necessary. Because this facility carries a variable interest rate pegged to market indices, our results of operations and cash flows will be exposed to changes in interest rates. Based on January 3, 2004 borrowing levels, a 1.00% increase or decrease in current market interest rates would have the effect of causing an approximately $0.7 million additional annual pre-tax charge or credit to the statement of operations.
The second component of interest rate risk involves the short-term investment of excess cash. This risk impacts fair values, earnings and cash flows. Excess cash is primarily invested in interest bearing accounts that fluctuate with market interest rates. Based on January 3, 2004 cash equivalents, a 1.00% increase or decrease in current market interest rates would have the effect of causing an approximately $0.4 million additional pre-tax credit or charge to the annual statements of operations.
We buy a variety of raw materials for inclusion in our products. The only raw material that is considered to be of a commodity nature is wax. Wax is a petroleum-based product. However, its market price has not historically fluctuated with the movement of oil prices. Rather, over the past five years wax prices have generally moved with inflation.
At this point in time, operations outside of the United States are immaterial. Accordingly, we are not exposed to substantial risks arising from foreign currency exchange rates.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEPENDENT AUDITORS’ REPORT
Board of Directors
The Yankee Candle Company, Inc.
South Deerfield, Massachusetts 01373
We have audited the accompanying consolidated balance sheets of The Yankee Candle Company, Inc. and subsidiaries (the “Company”) as of December 28, 2002 and January 3, 2004, and the related consolidated statements of operations, stockholders’ equity and cash flows for the fifty-two weeks ended December 29, 2001 and December 28, 2002 and the fifty-three weeks ended January 3, 2004. The financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of The Yankee Candle Company, Inc. and subsidiaries as of December 28, 2002 and January 3, 2004 and the results of their operations and their cash flows for the fifty-two weeks ended December 29, 2001 and December 28, 2002 and the fifty-three weeks ended January 3, 2004 in conformity with accounting principles generally accepted in the United States of America.
As described in Note 2 to the financial statements, the Company changed its method of accounting for stock-based compensation to conform to the provisions of Statement of Financial Accounting Standard No. 123 “Accounting for Stock-Based Compensation and No. 148 “Accounting for Stock-Based Compensation-Transition and Disclosure” during the year ended January 3, 2004.
/s/ Deloitte & Touche, LLP
Boston, Massachusetts
February 25, 2004
THE YANKEE CANDLE COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
See notes to consolidated financial statements.
THE YANKEE CANDLE COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
See notes to consolidated financial statements.
THE YANKEE CANDLE COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FIFTY-TWO WEEKS ENDED DECEMBER 29, 2001, DECEMBER 28, 2002
AND FIFTY-THREE WEEKS ENDED JANUARY 3, 2004
(in thousands)
See notes to consolidated financial statements.
THE YANKEE CANDLE COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
See notes to consolidated financial statements.
THE YANKEE CANDLE COMPANY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE FIFTY-TWO WEEKS ENDED DECEMBER 29, 2001 AND DECEMBER 28, 2002 AND FIFTY-THREE WEEKS ENDED JANUARY 3, 2004 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
1. NATURE OF BUSINESS
The Yankee Candle Company, Inc. and subsidiaries (“Yankee Candle” or “the Company”) is the leading designer, manufacturer and branded marketer of premium scented candles in the giftware industry. The Company has a 34-year history of offering its distinctive products and marketing them as affordable luxuries and consumable gifts. Yankee Candle products are available in approximately 180 fragrances and include a wide variety of jar candles, Samplers ® votive candles, Tarts ® wax potpourri, pillars and other candle products, all marketed under the Yankee Candle® brand. The Company also sells a wide range of coordinated candle and home décor accessories and branded fragranced non-candle products including, Yankee Candle Car Jars® air fresheners and Yankee Candle™ Bath personal care products. The Company has also extended its brand into the growing premium home fragrance market segment with products such as Housewarmer® electric home fragrancers and Yankee Candle® branded potpourri, sachets, room sprays and linen sprays. The Company sells its products through several channels including wholesale customers who operate approximately 15,000 stores in North America, 286 Company-owned and operated retail stores in 42 states as of January 3, 2004, direct mail catalogs, its Internet web site (www.yankeecandle.com), international distributors and its distribution center located in the United Kingdom.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION - The fiscal year is the 52 or 53 weeks ending the Saturday closest to December 31. In some instances, the fifty-two weeks ended December 29, 2001 and December 28, 2002 and fifty-three weeks ended January 3, 2004 are referred to as fiscal 2001, fiscal 2002, and fiscal 2003, respectively.
PRINCIPLES OF CONSOLIDATION - The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated.
ACCOUNTING 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 during the reporting period. Actual results could differ from those estimates.
REVENUE RECOGNITION - The Company sells its products directly to retail customers and through wholesale channels. Revenue from the sale of merchandise to retail customers is recognized at the time of sale while revenue from wholesale customers is recognized when risk of loss has passed to the customers. The Company believes that these are the times when persuasive evidence of an arrangement exists, delivery has occurred, the Company’s price is fixed and collectibility is reasonably assured. Revenue is recognized net of any applicable discounts and allowances. Customers, be they retail or wholesale, do have the right to return product in certain limited situations. Such right of returns have not precluded revenue recognition because the Company has a long history with such returns on which it constructs a reserve.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Company has sold gift certificates in prior years and currently sells gift cards. At the point of sale of a gift certificate or gift card, the Company records a deferred liability. Revenue is recorded upon the redemption of the gift certificate or gift card.
CASH AND CASH EQUIVALENTS - The Company considers all short-term interest-bearing investments with original maturities of three months or less to be cash equivalents. Such investments are classified by the Company as “held to maturity” securities under the provisions of Statement of Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” These securities are stated at cost, adjusted for amortization of discounts and premiums to maturity.
MARKETABLE SECURITIES - The Company classifies the marketable securities held in its deferred compensation plan as “trading” securities under SFAS No. 115. In accordance with the provisions of this statement, the investment balance is stated at fair market value, based on quoted market prices. Unrealized gains and losses are reflected in earnings; realized gains and losses are also reflected in earnings and are computed using the specific-identification method. As the assets held in the deferred compensation plan reflect amounts due to employees, but available for general creditors of the Company in the event the Company becomes insolvent, the Company has recorded the investment balance as a noncurrent asset and has established a corresponding other long-term liability entitled “deferred compensation obligation” on the balance sheet.
The marketable securities held in this plan consist of investments in mutual funds at December 28, 2002 and January 3, 2004. Unrealized gains (losses) included in earnings during the fifty-two weeks ended December 29, 2001 and December 28, 2002 and fifty-three weeks ended January 3, 2004 were $(58), $(171) and $364, respectively. Gains of $11 and $36 were realized during the fifty-two weeks ended December 29, 2001 and December 28, 2002, respectively. There were no realized gains for the fifty-three weeks ended January 3, 2004.
INVENTORIES - Inventories are stated at the lower of cost or market on a last-in, first-out (“LIFO”) basis. In fiscal 2001, the liquidation of certain LIFO layers decreased cost of sales by $171. There were no such liquidations in either fiscal years 2002 or 2003. Inventory quantities on hand are regularly reviewed, and where necessary provisions for excess and obsolete inventory are recorded based primarily on the Company’s forecast of product demand and production requirements.
PROPERTY, PLANT AND EQUIPMENT - Property, plant and equipment are stated at cost and are depreciated on the straight-line method based on the estimated useful lives of the various assets. The estimated useful lives are as follows:
Buildings and improvements
5 to 40 years
Computer equipment
2 to 5 years
Furniture and fixtures
5 to 10 years
Equipment
10 years
Vehicles
5 years
Leasehold improvements are amortized using the straight-line method over the lesser of the estimated life of the improvement or the remaining life of the lease. Expenditures for normal maintenance and repairs are charged to expense as incurred.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
DEFERRED FINANCING COSTS - The Company amortizes deferred financing costs using the effective-interest method over the life of the related debt. Accumulated amortization was $4,367 and $5,480 at December 28, 2002 and January 3, 2004, respectively.
TRADEMARKS - Trademarks are recorded at cost and amortized over 15 years. Cost of trademarks, included in other assets at December 28, 2002 and January 3, 2004, was $231. Accumulated amortization was $132 and $147, at December 28, 2002 and January 3, 2004, respectively.
ADVERTISING - The Company expenses the costs of advertising, including cooperative funds provided to customers, as they are incurred. Advertising expense was $4,869, $7,745 and $8,712 for the fifty-two weeks ended December 29, 2001 and December 28, 2002 and fifty-three weeks ended January 3, 2004, respectively.
IMPAIRMENT OF LONG-LIVED ASSETS - The Company reviews the recoverability of its long-lived assets (property, plant and equipment and trademarks) when events or changes in circumstances occur that indicate that the carrying value of the assets may not be recoverable. This review is based on the Company’s ability to recover the carrying value of the assets from expected undiscounted future cash flows. If an impairment is indicated, the Company measures the loss based on the fair value of the asset using various valuation techniques. If an impairment loss exists, the amount of the loss will be recorded in the consolidated statements of operations. It is possible that future events or circumstances could cause these estimates to change.
INCOME TAXES - The Company accounts for income taxes under the provisions of SFAS No. 109, “Accounting for Income Taxes.” SFAS No. 109 requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities using expected tax rates in effect in the years in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amount that is more likely than not to be realized. The provision for income taxes in the consolidated statements of operations is the actual computed tax obligation or receivable for the period, plus or minus the change during the period in deferred income tax assets and liabilities.
FAIR VALUE OF FINANCIAL INSTRUMENTS - At January 3, 2004, the estimated fair values of all financial instruments approximate their carrying amounts in the consolidated balance sheets due to (i) the short-term maturity of certain instruments or (ii) the variable interest rate associated with certain instruments which have the effect of repricing such instruments regularly.
EARNINGS PER SHARE - SFAS No. 128, “Earnings Per Share,” requires two presentations of earnings per share, “basic” and “diluted”. Basic earnings per share is computed by dividing income available to common stockholders (the numerator) by the weighted-average number of common shares (the denominator) for the period. The computation of diluted earnings per share is similar to basic earnings per share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potentially dilutive common shares had been issued. The denominator in the calculation is based on the following weighted-average number of common shares:
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
At December 29, 2001, December 28, 2002 and January 3, 2004, approximately 79,000, 554,000 and 13,000 shares issuable pursuant to option grants were excluded from the computation of diluted earnings per share due to the anti-dilutive effect, respectively.
FOREIGN OPERATIONS - Assets and liabilities of foreign operations are translated into U.S. dollars at the exchange rate on the balance sheet date. The results of foreign subsidiary operations are translated using average rates of exchange during each reporting period. Gains and losses upon translation are deferred and reported as a component of other comprehensive income. Foreign currency transaction gains or losses, whether realized or unrealized, are recorded directly in the statements of operations.
COMPREHENSIVE INCOME - Comprehensive income includes all changes in equity during the period except those resulting from transactions with owners of the Company. It has two components: net income and other comprehensive income. Accumulated other comprehensive income reported on the Company’s consolidated balance sheets consists of foreign currency translation adjustments. Comprehensive income, net of related tax effects (where applicable), is detailed in the consolidated statements of stockholders’ equity.
ACCOUNTING CHANGE -The Company currently sponsors stock option plans. Prior to the third quarter of 2003, the Company accounted for employee options or share awards under the intrinsic-value method prescribed by Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees.” Compensation expense, if any, was recognized based on the difference between the fair value of the common stock and the exercise price of the option on the measurement date, as defined by Opinion No. 25. Pro forma disclosures of net earnings and earnings per share had been provided supplementally, as if the fair value method of accounting defined in SFAS No. 123 “Accounting for Stock Based Compensation” had been applied. Effective September 27, 2003, the Company adopted the fair value recognition provisions of SFAS No. 123 using the prospective transition method provided by SFAS No. 148 “Accounting for Stock Based Compensation-Transition and Disclosure, an amendment of SFAS No. 123.” Under the prospective transition method, the Company has valued all stock option grants beginning with grants made in fiscal 2003. These are being expensed over the vesting period based on the fair value at the date of the grant. The adoption of the fair value method of accounting for stock-based compensation resulted in a charge of $633 for the fiscal year ended January 3, 2004.
Awards under the Company’s option plan vest, in general, over a four year period. Therefore, the cost related to stock-based employee compensation included in the determination of net income for all periods presented in the Company’s historical consolidated statements of operations is less than that which would have been recognized if the fair value based method had been applied to all awards since the original effective date of SFAS No. 123.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following table illustrates the effect on net income and earnings per share if the fair value based method had been applied to all outstanding and unvested awards in each period.
The following weighted-average assumptions were used to compute the pro forma results of operations for fiscal 2001 and 2002 and the stock option expense that was recorded in the Statement of Operations in fiscal 2003:
PRIOR-YEAR RECLASSIFICATIONS - Certain prior year amounts have been reclassified to conform to the current year presentation.
3. INVENTORIES
The components of inventory were as follows:
4. PROPERTY, PLANT AND EQUIPMENT
The components of property, plant and equipment were as follows:
Depreciation and amortization expense related to property, plant and equipment was $13,061, $16,045 and $18,118 for the fifty-two weeks ended December 29, 2001 and December 28, 2002 and fifty-three weeks ended January 3, 2004, respectively. $464, $119 and $68 of interest was capitalized in the fifty-two weeks ended December 29, 2001 and December 28, 2002 and fifty-three weeks ended January 3, 2004, respectively.
5. CONCENTRATION OF CREDIT RISK
The Company maintains cash balances at several financial institutions. Accounts at each institution are insured by the Federal Deposit Insurance Corporation up to $100. Uninsured balances aggregated $38,117 and $38,670 at December 28, 2002 and January 3, 2004, respectively. The Company extends credit to its wholesale customers. For the fifty-two weeks ended December 29, 2001 and December 28, 2002 and fifty-three weeks ended January 3, 2004, no single customer accounted for more than 2.0%, 4.0% and 6.0% of total sales, respectively.
6. LONG-TERM DEBT
Long term debt is summarized as follows:
The Company has a credit agreement with a consortium of banks (the “Credit Agreement”). The Credit Agreement provides for a maximum borrowing of $300,000 and consists of a revolving credit facility for $150,000 and a term loan for $150,000. The term loan is payable in quarterly installments ranging from $7,500 to $9,500 in March, June, September and December. As of December 28, 2002 and January 3, 2004, the unused portion of the revolving credit facility was $140,500 and $104,000, respectively. The Credit Agreement matures on July 7, 2004, with any outstanding amounts due on that date; no payments of principal are due on the revolving credit facility until this maturity date. The Company is currently engaged in negotiations with various commercial banks to replace the existing Credit Agreement with a new credit facility. The Company is optimistic that a new credit facility will be finalized and in place prior to the expiration of our existing Credit Agreement in July 2004.
The Company is required to pay a commitment fee on the average daily unutilized portion of the revolving credit facility at a rate ranging from 1/4% to 3/8% per annum. The Company may elect to set the interest rate on all or a portion of the borrowings outstanding under the Credit Agreement at a rate per annum equal to (a) the greatest of (1) the prime rate, (2) the base CD rate plus 1.00% or (3) the federal funds effective rate plus 1/2% plus a margin ranging from 0.00% to 0.75%, or (b) the eurodollar rate plus a margin ranging from 1.00% to 1.75%. The weighted-average interest rate on outstanding borrowings at January 3, 2004 was 2.90%.
The Credit Agreement includes restrictions as to, among other things, the amount of additional indebtedness, contingent obligations, liens, investments, asset sales and capital expenditures and requires the maintenance of minimum levels of interest coverage. It also includes a restriction for the payment of dividends. None of the restrictions contained in the Credit Agreement are expected to have a significant effect on the ability of the Company to operate.
7. RESTRUCTURING CHARGE
A restructuring charge for $8.0 million was recorded in fiscal 2001 to record costs associated with our decision to consolidate and restructure our distribution and manufacturing operations. We closed our Utah distribution facility and restructured our distribution and manufacturing work-force during 2001. Included in the restructuring charge are severance and other employee related costs, $2,124 of a non-cash write-down of non-recoverable leasehold improvements, fixture and equipment investments and estimated continuing occupancy expenses for abandoned facilities, net of anticipated sub-lease income. As a result of this consolidation and restructuring, the Company terminated approximately 450 manufacturing and logistics employees. An analysis of the activity within the restructuring reserve since its inception is as follows:
During the second quarter of fiscal 2002, the Company was successful in subletting the facility covered under the “Occupancy” heading for the remaining lease term.
8. PROVISION FOR INCOME TAXES
Income tax expense, exclusive of that relating to extraordinary items, consists of the following:
In connection with the recapitalization of the Company in 1998, an election was made for federal and state income tax purposes to value the assets and liabilities of the Company at fair value. As a result of such election, there is a difference between the financial reporting and tax bases of the Company’s assets and liabilities. This difference was accounted for by recording a deferred tax asset of approximately $175,700 with a corresponding credit to additional paid-in capital. The deferred tax asset is being realized as these differences, including tax goodwill, are deducted, principally over a period of 15 years. In the opinion of management, the Company will have sufficient profits in the future to realize the deferred tax asset.
The tax effect of significant items comprising the Company’s net deferred tax assets (liabilities) are as follows:
8. PROVISION FOR INCOME TAXES (CONTINUED)
A reconciliation of the statutory federal income tax rate and the effective rate of the provision for income taxes consists of the following:
At January 3, 2004, the Company has foreign net operating loss carryforwards totaling approximately $8,500. A valuation allowance has been established for these net operating losses which have been fully reserved.
9. PROFIT SHARING PLAN
The Company maintains a profit sharing plan (the “Plan”) under section 401(k) of the Internal Revenue Code. Under the terms of the Plan the Company may make discretionary matching contributions in an amount, if any, to be determined annually based on a percentage of the employee’s pretax contributions. Matching contributions, if made, are subject to a maximum of 4% of the employee’s eligible compensation contributed to the Plan during the applicable plan year. Employer matching contributions amounted to $632, $731 and $815 for the fifty-two weeks ended December 29, 2001 and December 28, 2002 and fifty-three weeks ended January 3, 2004, respectively. The Company, at its discretion, may also make annual profit sharing contributions to the Plan. For the fifty-three weeks ended January 3, 2004, the Company incurred $500 for profit sharing contributions. There were no profit sharing contributions in fiscal 2001 and 2002.
10. DEFERRED COMPENSATION
The Company has a deferred compensation agreement with certain key employees. Under this agreement, the Company at its election may match certain elective salary deferrals of eligible employees’ compensation up to a maximum of $20 per employee per year. Employer contributions amounted to $89, $94 and $135 for fiscal 2001, 2002 and 2003, respectively. Benefits under the plan will be paid in a lump sum upon termination of the plan or termination of employment. Benefits paid to retired employees during fiscal 2001 and 2002 were $255 and $263, respectively. There were no benefits paid in 2003.
11. CONTINGENCIES
The Company is engaged in various lawsuits, either as plaintiff or defendant. In the opinion of management, the ultimate outcome of these lawsuits will not have a material adverse effect on the Company’s financial condition, results of operations or cash flows.
12. STOCKHOLDERS’ EQUITY
CAPITAL STOCK - As of December 28, 2002 and January 3, 2004, the Company had 104,188,000 and 104,397,000 shares of common stock (par value $.01) issued, respectively. In connection with the recapitalization of the Company in 1998, the Company repurchased for treasury approximately 49,560,000 shares of common stock. Subsequently, pursuant to a stock repurchase program adopted May 9, 2003, the Company repurchased a total of 4,084,200 shares for an aggregate purchase price of approximately $100,000,000. These shares are also held in treasury. On February 12, 2004, the Board of Directors authorized a new stock repurchase program for the repurchase of up to $100,000,000 of currently outstanding shares.
Options to purchase common stock were granted to key employees and directors of the Company in 1998 (the “1998 Plan”). The options granted under the 1998 Plan were “nonqualified” for tax purposes. For financial reporting purposes, the award of the right to purchase stock and the grant of options, in certain cases, were considered to be below the fair value of the stock at the time of grant. The fair value was determined based on an appraisal conducted by an independent appraisal firm as of the relevant dates. The differences between fair value and the purchase price or the exercise price was being charged to compensation expense over the relevant vesting period - generally between three and five years. In the fifty-two weeks ended December 29, 2001 and December 28, 2002 and fifty-three weeks ended January 3, 2004, such expense aggregated $570, $434 and $88, respectively.
In addition to the options granted above, the Company adopted the 1999 Employee Stock Option and Award Plan in June 1999 (the “1999 Plan”). The 1999 Plan provides for the grant of both incentive stock options intended to qualify under Section 422 of the Internal Revenue Code and nonqualified options. Options, granted to date under the 1999 Plan generally have an exercise price equal to the fair market value of the stock on the date of grant, are non-qualified and expire after 10 years. Options granted under the 1999 Plan vest ratably over four years.
12. STOCKHOLDERS’ EQUITY (CONTINUED)
A summary of the status of option grants and changes during the period ending on that date are presented below:
Under the existing stock option plans, there are 858,626 shares available for future grants at January 3, 2004. At January 3, 2004, options were exercisable for 716,118 shares of common stock at a weighted average exercise price of $13.88 per share.
The following table summarizes information about the Company’s stock options outstanding at January 3, 2004:
13. COMMITMENTS
The Company leases most store locations, its corporate office building, a distribution facility and a number of vehicles. The operating leases, which expire in various years through 2016, contain renewal options ranging from six months to five years and provide for base rentals plus contingent rentals thereafter, which are a function of sales volume. In addition, the Company is required to pay real estate taxes, maintenance and other operating expenses applicable to the leased premises. Furthermore, several facility leases contain rent escalation clauses.
The aggregate annual future minimum lease commitments under operating leases as of January 3, 2004 are as follows:
Rent expense, including contingent rentals, for the fifty-two weeks ended December 29, 2001 and December 28, 2002 and fifty-three weeks ended January 3, 2004 was approximately $13,583, $17,975 and $20,851, respectively. Included in rent expense were contingent rental payments of approximately $1,368, $996 and $802, for the fifty-two weeks ended December 29, 2001 and December 28, 2002 and fifty-three weeks ended January 3, 2004, respectively.
14. SEGMENTS OF ENTERPRISE AND RELATED INFORMATION
The Company has segmented its operations in a manner that reflects how its chief operating decision-maker (the “CEO”) currently reviews the results of the Company and its subsidiaries’ businesses. The Company has two reportable segments - retail and wholesale. The identification of these segments results from management’s recognition that while the product produced is similar, the type of customer for the product and services and the methods used to distribute the product are different.
The CEO evaluates both its retail and wholesale operations based on an “operating earnings” measure. Such measure gives recognition to specifically identifiable operating costs such as cost of sales and selling expenses. Administrative charges are generally not allocated to specific operating segments and are accordingly reflected in the unallocated/corporate/other category. Other components of the statement of operations, which are classified below operating income, are also not allocated by segments. The Company does not account for or report assets, capital expenditures or depreciation and amortization by segment to the CEO.
14. SEGMENTS OF ENTERPRISE AND RELATED INFORMATION (CONTINUED)
The following are the relevant data for the fifty-two weeks ended December 29, 2001 and December 28, 2002 and fifty-three weeks ended January 3, 2004:
15. Valuation and Qualifying Accounts
Amounts charged to deductions from reserves represent the write-off of uncollectible balances.
16. QUARTERLY FINANCIAL DATA (UNAUDITED)
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. Our management, with the participation of our Chief Executive Officer, or CEO, and Chief Financial Officer, or CFO, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act) as of January 3, 2004. Based on this evaluation, our CEO and CFO concluded that, as of January 3, 2004, our disclosure controls and procedures were (1) designed to ensure that material information relating to us, including our consolidated subsidiaries, is made known to our CEO and CFO by others within those entities, particularly during the period in which this report was being prepared and (2) effective, in that they provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
(b) Changes in Internal Controls. No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act) occurred during the fiscal quarter ended January 3, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Except as set forth below, the information required by this item is incorporated by reference from the information under the captions “Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” contained in the Proxy Statement relating to the 2004 Annual Meeting of Stockholders to be held on June 16, 2004 (the “Proxy Statement”) and the caption “Executive Officers of the Registrant” in Part I of this Annual Report on Form 10-K.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from the information under the captions “Compensation of Directors,” “Compensation of Executive Officers” and “Employment Contracts, Termination of Employment and Change-in-Control Arrangements” contained in the Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item is incorporated by reference from the information under the captions “Equity Compensation Plans” and “Stock Ownership of Certain Beneficial Owners and Management” contained in the Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference from the information under the caption “Certain Relationships and Related Transactions” contained in the Proxy Statement.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is incorporated by reference from the information under the caption “Principal Accountant Fees and Services” contained in the Proxy Statement.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Consolidated Financial Statements
The consolidated financial statements listed below are included in this document under Item 8.
Independent Auditors’ Report
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
2. Consolidated Financial Statement Schedule
All schedules for which provision is made in the applicable regulations of the Securities and Exchange Commission have been omitted because the information is disclosed in the Consolidated Financial Statements or because such schedules are not required or not applicable.
3. Exhibits
The exhibits are listed below under Part IV, Item 15(c) of this Annual Report on Form 10-K.
(b) Reports on Form 8-K
We furnished a current report on form 8-K dated October 22, 2003 pursuant to which we furnished, under Items 7 and 9, our earnings release for the period ended September 27, 2003.
(c) Exhibits
See the exhibit index accompanying this filing.
EXHIBIT INDEX
2.1
Recapitalization Agreement, dated as of March 25, 1998, as amended by and among Yankee Candle Holdings Corp., The Yankee Candle Company, Inc., Forstmann Little & Co. Subordinated Debt and Equity Management Buyout Partnership-VI, L.P. and Michael J. Kittredge.*
2.2
Asset Purchase Agreement, dated as of April 1, 1998, by and among The Yankee Candle Company, Inc., Chandler’s Tavern, Inc. and Michael J. Kittredge.*
2.3
Form of Agreement and Plan or Reorganization between The Yankee Candle Company, Inc. and Yankee Candle Holdings Corp.*
2.4
Form of Share Exchange between The Yankee Candle Company, Inc. and Michael J. Kittredge.*
3.1
Form of Restated Articles of Organization of The Yankee Candle Company, Inc.*
3.2
Form of Amended and Restated By-Laws of The Yankee Candle Company, Inc.*
4.1
Form of Common Stock Certificate.*
10.1
Form of outside director Stock Option Agreement.*+
10.2
Form of outside director Stockholder’s Agreement.*+
10.3
Form of Employee Stockholder’s Agreement.*+
10.4
The Yankee Candle Company Inc. Employee Stock Option Plan and form of Stock Option Agreement.*+
10.5
The Yankee Candle Company, Inc. 1999 Stock Option and Award Plan.*+
10.6
Stockholder’s Agreement, dated April 27, 1998, by and between The Yankee Candle Company, Inc. and Michael J. Kittredge.*
10.7
Form of Stockholder’s Agreement between The Yankee Candle Company, Inc. and employees.*+
10.8
Form of Indemnification Agreement between The Yankee Candle Company, Inc. and its directors and executive officers.*
10.9
Form of Credit Agreement among The Yankee Candle Company, Inc., The Chase Manhattan Bank, as sole administrative agent, and the banks and other financial institutions party thereto.*
10.10
Employment Agreement, dated as of October 22, 1998, as amended on February 9, 1999, between The Yankee Candle Company, Inc. and Robert R. Spellman.*+
10.11
Employment Letter Agreement dated March 31, 2001 between The Yankee Candle Company, Inc. and Craig W. Rydin.**+
10.12
Employment Letter Agreement dated August 31, 2000 between The Yankee Candle Company, Inc. and Paul J. Hill.***+
10.13
Employment Letter Agreement dated May 2, 2001 between The Yankee Candle Company, Inc. and Harlan Kent.***+
23.1
Consent of Deloitte and Touche LLP****
31.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.****
31.2
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. ****
32.1
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. ****
32.2
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. ****
*
Incorporated by reference from the Company’s Registration Statements on Form S-1 (File No. 333-76397).
**
Incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the first quarter of fiscal 2001.
***
Incorporated by reference from the Company’s Annual Report on Form 10-K for fiscal 2001.
****
Filed herewith.
+
Management compensation contract/plan.
SIGNATURES
Pursuant to the requirements of Section 13 of 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 12, 2004.
/s/ MICHAEL B. POLK
Director
Michael B. Polk
/s/ RONALD L. SARGENT
Director
Ronald L. Sargent
/s/ DOREEN A. WRIGHT
Director
Doreen A. Wright