UNITED STATESSECURITIES AND EXCHANGE COMMISSION
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIESEXCHANGE ACT OF 1934
For the quarterly period ended August 31, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIESEXCHANGE ACT OF 1934
For the transition period from to
Commission file number 001-14669
HELEN OF TROY LIMITED
Clarendon HouseChurch StreetHamilton, Bermuda(Address of Principal Executive Offices)
Registrant’s telephone number, including area code: (915) 225-8000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).Yes [X] No [ ]
As of October 6, 2004 there were 29,815,775 shares of Common Stock, $.10 Par Value, outstanding.
HELEN OF TROY LIMITED AND SUBSIDIARIES
INDEX
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PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Condensed Balance Sheets
See accompanying notes to consolidated condensed financial statements.
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Consolidated Condensed Statements of Income
4
Consolidated Condensed Statements of Cash Flows
5
6
7
THREE MONTHS ENDED AUGUST 31, 2004 AND 2003(in thousands)
SIX MONTHS ENDED AUGUST 31, 2004 AND 2003(in thousands)
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IDENTIFIABLE SEGMENT ASSETS, NET AT AUGUST 31, 2004 AND FEBRUARY 29, 2004 (in thousands)
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10
11
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ACCRUAL FOR WARRANTY RETURNS(in thousands)
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PAYMENTS DUE BY PERIOD(in thousands)
PROFORMA STOCK-BASED EMPLOYEE COMPENSATION(in thousands, except per share data)
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15
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Assets Received in Noncash Exchange for Ownership Interest in Tactica at April 29, 2004 (in thousands)
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OXO — Net Assets Acquired on June 1, 2004(in thousands)
Results of Operations if OXO Acquisition Had Been Completed at the Beginning of Each Period(in thousands, except per share data)
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This discussion contains a number of forward-looking statements, all of which are based on current expectations. Actual results may differ materially due to a number of factors, including those discussed in the section entitled “Forward-Looking Information and Factors That May Affect Future Results”, Item 3. “Quantitative and Qualitative Disclosures About Market Risk”, and in the Company’s most recent report on Form 10-K.
OVERVIEW OF THE QUARTER’S ACTIVITIES:
Our first fiscal quarter of each year is our seasonal low point in terms of overall activity, with sales tending to run approximately 20 percent of the year’s total on a historical basis. Our second fiscal quarter is characterized by stable sales in the June through first half of July timeframe with increasing sales in the second half of the July through August timeframe as we build towards a peak shipping season in the third quarter. The second fiscal quarter of 2005 also includes the first three full months of operations of our housewares segment (the operations of OXO acquired on June 1, 2004), offering home product tools in several categories, including: kitchen, cleaning, barbecue, barware, garden, automotive, storage, and organization. Overall, revenues were up 34.1 and 26.3 percent for the second fiscal quarter of 2005 and year-to-date, respectively, over the same periods in the prior year. Profitability followed revenue growth with fiscal second quarter and year-to-date increases of 40.6 and 30.7 percent, respectively, for operating income and 28.1 and 14.4 percent, respectively, for income from continuing operations.
Personal Care Segment
Housewares Segment
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In addition to the above activities, we continued to invest in our business, with a view toward potential future growth, through the following activities:
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RESULTS OF OPERATIONS
Comparison of fiscal quarter and six-month periods ended August 31, 2004 to the same periods ended August 31, 2003
The following table sets forth, for the periods indicated, our selected operating data, in dollars, as a percentage of net sales, and as a year-over-year percentage change.
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As more fully discussed in Note 5 to the accompanying consolidated condensed financial statements, in the first fiscal quarter of 2005, we reported a single operating segment, Personal Care and a discontinued segment. The Personal Care Segment includes the hair care appliances, hair brushes, combs, hair accessories, hair and skin care liquids and powders and other personal care products business. The Discontinued Segment includes the operations of Tactica International, Inc. (See Note 14 to the consolidated condensed financial statements for a further discussion of the sale of Tactica). Beginning with the second fiscal quarter of 2005, we are presenting an additional operating segment: housewares, to report the operations of OXO (“OXO”), which offers home product tools in several categories, including: kitchen, cleaning, barbecue, barware, garden, automotive, storage, and organization (See Note 15 to the consolidated condensed financial statements for a further discussion of the OXO acquisition). The accompanying discussion and analysis reflects this new change in operating segments.
Consolidated Sales and Gross Profit Margins
Our net sales for the three- and six-months ended August 31, 2004 increased 34.1 and 26.3 percent, or $35,894,000 and $51,679,000, respectively, versus the same periods a year earlier. In September 2003, we acquired the rights to produce and distribute the Brut® men’s grooming product line throughout the Western Hemisphere. In June 2004, we acquired OXO product lines from WKI Holding Company to form our new housewares operating segment. These new product acquisitions accounted for 30.8 and 21.2 percent, respectively, or $32,446,000 and $41,610,000, respectively, of the percentage sales growth for the three- and six-months ended August 31, 2004 versus the same periods a year earlier. Core growth (growth without acquisitions) accounted for 3.3 and 5.1 percent, respectively, or $3,448,000 and $10,069,000, respectively, of the sales growth over the same three-and six-month periods last year. The core growth for the first six months came from strong sales volume performance from our appliance business and growth in grooming, skin care and hair products, offset somewhat by sales volume declines in our brushes, combs and accessories business.
Also contributing to growth has been the strengthening of the British Pound and the Euro versus the U.S. Dollar, offset somewhat by the impact of the weakening Mexican Peso vs. the U.S. Dollar. With the growth in our Latin American operations, the Mexican Peso exposure is growing and will be included in our foreign currency impact analysis. The overall net impact of foreign currency changes was to provide approximately $522,000 and $1,242,000 of additional sales dollars for the three- and six-month periods ended August 31, 2004, respectively, versus the same periods a year earlier.
Consolidated gross profit, as a percentage of sales for the three- and six-month periods ended August 31, 2004, increased 2.7 and 1.1 percentage points, respectively, to 47.4 and 47.2 percent compared to the same periods in the prior year. The increase is primarily due to a combination of sales mix changes to higher margin items resulting from Brut and OXO acquisitions and margin improvement due to selected product purchase cost decreases.
Selling, general, and administrative expenses
Selling, general, and administrative expenses, expressed as a percentage of net sales, increased from 27.7 to 29.5 percent for the three-months, and from 28.9 to 29.4 percent for the six-months ended August 31, 2004 compared to the same periods in the prior year. These increases were primarily due to higher media advertising and trade show costs. We have increased spending on advertising to help grow our grooming, skin care and hair products business. Additionally, we incurred foreign currency exchange losses of $214,000 and $624,000, respectively, for the three- and six-month periods ended August 31, 2004 versus exchange losses of $653,000 and $87,000 for the same periods a year earlier.
Interest expense and other income / expense
Interest expense for the three- and six-month periods ended August 31, 2004 increased compared with the three- and six-month periods ended August 31, 2003, to $2,681,000 and $3,675,000 from $956,000 and $1,965,000. The overall increase in interest expense is the result of the use of both short-term and long-term debt to fund the $273,173,000 acquisition of OXO (See Notes 8 and 15 for related discussions of new debt financings and the OXO acquisition).
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Other income, net for the three- and six-month periods ended August 31, 2004 was $15,000 and $119,000, respectively, compared with other income, net of $819,000 and $3,738,000, respectively, for the same periods in the prior year. The following schedule shows key components of other income and expense:
Interest income is lower for the three- and six-month periods ended August 31, 2004 compared to the same periods last year due to lower levels of temporarily investable cash being held this year. In the fiscal quarter ended August 31, 2003 we recorded other income of $2,600,000 in connection with the settlement of litigation.
Income tax expense
Income tax expense for the three- and six-month periods ended August 31, 2004 was 16.6 and 17.4 percent of earnings before income taxes, respectively, versus 17.5 and 17.5 percent of earnings before income taxes, respectively, for the same periods in the prior year. The overall year-to-year decline in rates is due to more of our income in fiscal 2005 being taxed in lower tax rate jurisdictions.
DISCONTINUED OPERATIONS
On April 29, 2004, we completed the sale of our 55 percent interest in Tactica back to certain shareholder-operating managers. In exchange for our 55 percent ownership share of Tactica and the release of $16,936,000 of its secured debt and accrued interest owed to us, we received marketable securities, intellectual properties, and the right to certain tax refunds. The fair value of net assets received was equal to the book value of net assets transferred. Accordingly, no gain or loss was recorded as a result of this sale.
Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”) requires at least an annual impairment review of goodwill and other intangible assets, which we normally undertake on March 1 of each year. SFAS 142 also requires a review of goodwill for impairment upon the occurrence of certain events that would more likely than not reduce the fair value of a segment below its carrying amount. One of those events at the end of fiscal 2004 was the impending disposal of Tactica. After evaluating the facts and circumstances surrounding Tactica’s fiscal 2004 operations and its subsequent sale, against the guidelines established by SFAS 142, we recorded a loss of $5,699,000 as of February 29, 2004 for the impairment of 100 percent of the Tactica goodwill, net of $1,938,000 of related tax benefits.
Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”) provides accounting guidance for accounting segments to be disposed by sale and, in our circumstances, required us to report Tactica as a discontinued operation. In accordance with SFAS 144, we classified all assets and liabilities of Tactica as “Assets of discontinued segment held for sale” and “Liabilities of discontinued segment held for sale” in the accompanying consolidated condensed balance sheet as of February 29, 2004. SFAS 144 also requires us to report Tactica’s operating results, net of taxes, as a separate summarized component after income from continuing operations for each year presented. The accompanying consolidated condensed statements of income and consolidated condensed statements of cash flows contain all appropriate reclassifications for each period presented.
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FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES
Selected measures of our liquidity and capital resources as of August 31, 2004 and August 31, 2003 are shown below:
Operating Activities
Our cash balance was $11,771,000 at August 31, 2004 compared to $53,048,000 at February 29, 2004. Operating activities used $19,137,000 of cash during the first six months of fiscal 2005, compared to $11,414,000 used during the first six months of fiscal 2004. Inventories increased $42,878,000 during the first six months of fiscal 2005 compared to $34,229,000 during the first six months of fiscal 2004. The increased inventory spending in fiscal 2005 was primarily due to the acquisition and building of inventory for our new housewares segment, which accounted for $19,095,000 of our inventory balance at August 31, 2004.
The increase in accounts receivable of $30,131,000 for the first six months of fiscal 2005, compared to $22,265,000 for the first six months of fiscal 2004 was primarily due to the Company’s growth in sales, including receivables added by the new housewares segment. Sales increased $51,679,000, or 26.3 percent, for the six months ended August 31, 2004, compared to the six months ended August 31, 2003.
Our accounts receivable turnover days decreased to 64.4 days at August 31, 2004 from 66.3 days at August 31, 2003. This improvement is due to the addition of the accounts receivable of our housewares segment which has shorter receivable terms than some of our other businesses. Our inventory turnover improved to 2.3 times at August 31, 2004 compared to 2.1 times at August 31, 2003. The improvement is due to the fact that in fiscal 2004, we accelerated inventory purchases and receipts in advance of anticipated ocean freight rate increases, and built inventory levels of newly acquired skin and hair care brands.
Working capital decreased to $147,096,000 at August 31, 2004, which was a $46,347,000 decrease from August 31, 2003. Our current ratio decreased to 2.1:1 at August 31, 2004 from 3.9:1 at August 31, 2003. The decrease in working capital levels and in the current ratio was due to a change in the classification of a $10,000,000 note payment due in January 2005 to a current liability, $34,000,000 of revolving credit outstanding, and a reduction of our cash balances in
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order to reduce our short-term borrowings. The $10,000,000 note payment due in January 2005 is the first in a series of scheduled payments we will make against our $55,000,000 unsecured Senior Notes.
Investing Activities
Investing activities used $268,305,000 of cash during the six months ended August 31, 2004. Listed below are some significant highlights of our investing activities:
Financing Activities
Financing activities provided $246,165,000 of cash during the six months ended August 31, 2004.
During the three- and six-month periods ended August 31, 2004, 32,900 and 277,104 stock option grants, respectively, were exercised for shares of our common stock providing $391,000 and $2,675,000 of cash. Purchases through our employee stock purchase plan of 5,614 shares at an average price of $23.33 provided an additional $131,000 of cash during the same periods. An additional 1,000,000 stock options were exercised during the fiscal quarter ending August 31, 2004 in a non-cash transaction in which the key employee tendered company stock having a market value of $5,757,900 as payment of the options’ exercise price.
During the three- and six-month periods ended August 31, 2004, we also repurchased 732,710 and 757,710 shares of our common stock for $24,344,966 and $25,039,465, respectively for an average share price of $33.23 and $33.05. These repurchases were made pursuant to our August 31, 2003 Board of Directors resolution authorizing us to purchase, in open market or private transactions, up to 3,000,000 shares of our common stock. From September 1, 2003 through August 31, 2004, we have repurchased in total 1,563,836 shares at a total cost of $45,611,690 or $29.17 average share price under the aforementioned resolution.
Included in our stock repurchases for the current fiscal quarter were 381,650 shares tendered by a key employee-shareholder as payment of the $13,797,000 of stock purchase price and related federal income tax obligations arising from the exercise of 1,000,000 stock options by the key employee-shareholder. This transaction was valued at an average share price of $36.15 using the average of the high bid and low bid prices for Helen of Troy stock as reported on the NASDAQ National Market System on the day the stock was tendered.
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As mentioned in Note 8 to our consolidated condensed financial statements, and further discussed under “Forward-Looking Information and Factors that may affect Future Results”, during the quarter ended August 31, 2004 we entered into a series of financing transactions that established a new five-year, $75,000,000 revolving credit facility, cancelled our existing $50,000,000 revolving credit facility, borrowed and subsequently repaid a $200,000,000 Term Loan Credit Agreement, and placed $225,000,000 of floating rate senior debt with five, seven and ten year maturities.
On June 1, 2004, we acquired certain assets and liabilities of OXO International for a net cash purchase price of approximately $273,173,000 including the assumption of approximately $4,040,000 of certain liabilities.
To fund the acquisition, we entered into a five-year $75,000,000 Revolving Line of Credit Agreement, dated as of June 1, 2004, with Bank of America, N.A. and other lenders and a one year $200,000,000 Term Loan Credit Agreement, dated as of June 1, 2004, with Banc of America Mezzanine Capital, LLC. The purchase price of the OXO International acquisition was funded by borrowings of $73,173,000 under the Revolving Line of Credit Agreement and $200,000,000 under the Term Loan Credit Agreement.
Borrowings under the Revolving Line of Credit Agreement accrue interest equal to the higher of the Federal Funds Rate plus 0.50% or the prime rate. Alternatively, upon timely election by the Company, borrowings accrue interest based on the respective 1, 2, 3, or 6-month LIBOR rate plus a margin of 0.75% to 1.25% based upon the “Leverage Ratio” at the time of the borrowing. The “Leverage Ratio” is defined by the Revolving Line of Credit Agreement as the ratio of total consolidated indebtedness, including the subject funding on such date to consolidated EBITDA (“Earnings Before Interest, Taxes, Depreciation and Amortization”) for the period of the four consecutive fiscal quarters most recently ended, with EBITDA adjusted on a pro forma basis to reflect the acquisition of OXO and the disposition of Tactica. At the time of funding, we elected LIBOR based funding with an initial margin rate of 1.125%. The new credit line allows for the issuance of letters of credit up to $10,000,000. Outstanding letters of credit reduce the $75,000,000 borrowing limit dollar for dollar. Upon the execution of this new credit facility, our previous $50,000,000 unsecured revolving credit facility was cancelled.
Borrowings under the $200,000,000 Term Loan Credit Agreement were subsequently paid off with the proceeds of the funding of $225,000,000 Floating Rate Senior Notes on June 29, 2004 (see Note 15). For the period, outstanding borrowings under the Term Loan Credit Agreement accrued interest at LIBOR plus a margin of 1.125%.
The Revolving Line of Credit Agreement requires the maintenance of certain Debt/EBITDA, fixed charge coverage ratios, and other customary covenants. The agreement has been guaranteed, on a joint and several basis, by the parent company, Helen of Troy Limited, and certain U.S. subsidiaries.
On June 29, 2004, we closed on a $225,000,000 Floating Rate Senior Note (“Senior Notes”). The Senior Notes consist of $100,000,000 of five year notes, $50,000,000 of seven year notes, and $75,000,000 of ten year notes. Interest on the notes is payable quarterly. Interest rates are reset quarterly based on the 3 month LIBOR rate plus 85 basis points for the five and seven year notes, and the 3 month LIBOR rate plus 90 basis points for the ten year notes. At closing, the initial interest rates were 2.436 percent for the five and seven year notes, and 2.486 percent for the ten year notes. On September 29, 2004, the interest rates on these notes were reset for the next three months at 2.82 percent for the five and seven year notes and 2.87 percent for the ten year notes. The Senior Notes allow for prepayment subject to the following terms: five year notes can be prepaid in the first year with a 2 percent penalty, thereafter there is no penalty; seven and ten year notes can be prepaid after one year with a 1 percent penalty, and after two years with no penalty.
The proceeds of the Senior Notes financing were used to repay the $200,000,000 borrowings under the Term Loan Credit Agreement, and $25,000,000 of the outstanding borrowings on our $75,000,000 Revolving Line of Credit Agreement.
The Senior Notes are unsecured and require the maintenance of certain Debt/EBITDA, fixed charge coverage ratios, consolidated net worth levels, and other customary covenants. The Senior Notes have been guaranteed, on a joint and several basis, by the parent company, Helen of Troy Limited, and certain U.S. subsidiaries.
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In connection with these series of financing transactions, we incurred $4,398,000 of financing costs. These costs are being amortized over the related lives of the various notes financed, ranging from 5 to 10 years.
With the completion of these financings, the Company now operates under substantially more leverage and incurs higher interest costs. While at May 31, 2004 we had total indebtedness of $55,000,000, as of August 31, 2004 we had $314,000,000 in total indebtedness outstanding. This increase in debt has added new constraints on our ability to operate our business, including but not limited to:
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Our contractual obligations and commercial commitments as of August 31, 2004 were:
We have no existing activities involving special purpose entities or off-balance sheet financing.
Current and Future Capital Needs
Based on our current financial condition and current operations, we believe that cash flows from operations and available financing sources will continue to provide sufficient capital resources to fund the Company’s foreseeable short and long-term liquidity requirements. The Company’s cash used by operating activities of $19,137,000 over the first two fiscal quarters of 2005 resulted from the inventory and accounts receivable increases required as a result of the OXO acquisition, typical seasonal inventory increases in anticipation of third quarter sales activity, and normal seasonal receivable collection patterns. Typically, we can expect cash flow from operating activities in the second half of the fiscal year to recoup the cash used in the first half of the fiscal year and provide additional positive cash flow as third quarter seasonal peak accounts receivable are collected and seasonal peak inventory levels are lowered. We expect that our capital needs will stem primarily from the need to purchase sufficient levels of inventory and to carry normal levels of accounts receivable on our balance sheet. In addition, we will continue to evaluate acquisition opportunities on a regular basis and may augment our internal growth with acquisitions of complementary businesses or product lines. Subject to the limitations imposed by our new financing arrangements, we may finance acquisition activity with available cash, the issuance of stock, or with additional debt, depending upon the size and nature of any such transaction and the status of the capital markets at the time of such acquisition.
INCOME TAXES
Hong Kong Income Taxes - The Inland Revenue Department (“the IRD”) in Hong Kong has assessed a total of $32,086,000 (U.S.) in tax on certain profits of our foreign subsidiaries for the fiscal years 1995 through 2003. Hong Kong taxes income earned from certain activities conducted in Hong Kong. We are vigorously defending our position that we conducted the activities that produced the profits in question outside of Hong Kong. We also assert that we have complied with all applicable reporting and tax payment obligations. In connection with the IRD’s tax assessment for the fiscal years 1995 through 1997, we were required to purchase $3,282,000 (U.S.) in tax reserve certificates in Hong Kong, which represented approximately 49 percent of the liability assessed by the IRD. The Company purchased additional tax reserve certificates in the amount of $3,583,000 (U.S.) on April 26, 2004 as required by the IRD which represents 100 percent of the tax liability assessed for fiscal year 1998. Tax reserve certificates represent the prepayment by a taxpayer of potential tax liabilities. The amounts paid for tax reserve certificates are refundable in the event that the value of the tax reserve certificates exceeds the related tax liability. These certificates are denominated in Hong Kong dollars and are subject to the risks associated with foreign currency fluctuations.
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If the IRD’s position were to prevail and if it were to assert the same position for fiscal years after fiscal year 2003, the resulting assessment could total $15,215,000 (U.S.) in tax for fiscal year 2004 and the first two fiscal quarters of 2005. We vigorously disagree with the proposed adjustments and intend to aggressively contest this matter through applicable taxing authority and judicial procedures, as appropriate. Although the final resolution of the proposed adjustments is uncertain and involves unsettled areas of the law, based on currently available information, we have provided our best estimate of the probable tax liability for this matter. While the resolution of the issue may result in tax liabilities which are significantly higher or lower than the reserves established for this matter, management currently believes that the resolution will not have a material effect on our consolidated financial position or liquidity. However, an unfavorable resolution could have a material effect on our consolidated results of operations or cash flows in the quarter in which an adjustment is recorded or the tax is due or paid.
United States Income Taxes - The Internal Revenue Service (“the IRS”) is currently auditing the U.S. federal tax returns of our largest U.S. subsidiary for fiscal years 2000, 2001, and 2002. The IRS has provided notice of proposed adjustments to taxable income in the amount of $39,483,000 for the three years under audit. We vigorously disagree with the proposed adjustments and intend to aggressively contest this matter through applicable IRS and judicial procedures, as appropriate. Although the final resolution of the proposed adjustments is uncertain and involves areas of law subject to varying interpretation, based on currently available information, we have provided for our best estimate of the probable tax liability for these matters. This estimate includes additional tax liabilities related to U.S. taxable income for all periods subsequent to fiscal year 2002, as well as the years currently under audit. While the resolution of the issue may result in tax liabilities which are significantly higher or lower than the reserves established for this matter, management currently believes that the resolution will not have a material effect on our consolidated financial position or liquidity. However, an unfavorable resolution could have a material effect on our consolidated results of operations or cash flows in the quarter in which an adjustment is recorded or the tax is due or paid.
We plan to permanently reinvest all of the undistributed earnings of the non-U.S. subsidiaries of the U.S. subsidiaries. We have made no provision for U.S. federal income taxes on these undistributed earnings. At August 31, 2004, undistributed earnings for which we had not provided deferred U.S. federal income taxes totaled $37,748,000.
Income Tax Provisions - We must make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes. We must assess the likelihood that we will be able to recover our deferred tax assets. If recovery is not likely, we must increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable. As changes occur in our assessments regarding our ability to recover our deferred tax assets, our tax provision is increased in any period in which we determine that the recovery is not probable.
In 1994, we engaged in a corporate restructuring that, among other things, resulted in a greater portion of our income not being subject to taxation in the United States. If such income were subject to U.S. federal income taxes, our effective income tax rate would increase materially. On October 11, 2004, the U.S. Senate passed the "Jumpstart our Business Strength (JOBS) Act" (H.R. 4520) that was previously approved by the U.S. House of Representatives. The President has publicly indicated he will sign the new legislation. Although the bill contains provisions applicable to companies that have engaged in inversion transactions, these provisions only apply to transactions that occurred after March 4, 2003. Our restructuring occurred in 1994 and consequently we are not subject to the anti-inversion provisions of the bill. There can be no assurance, however, that the I.R.S. will not claim that additional income is subject to U.S. taxation or that future legislation might increase our U.S. tax liability. In addition to potential changes in tax laws, our position on various tax matters may be challenged. Our ability to maintain our position that the parent company is not a Controlled Foreign Corporation (as defined under the U.S. Internal Revenue Code) is critical to the tax treatment of our non-U.S. earnings. A Controlled Foreign Corporation is a non-U.S. corporation whose largest U.S. shareholders (i.e., those owning 10 percent or more of its stock) together own more than 50 percent of the stock in such corporation. If a change of ownership were to occur such that the parent company became a Controlled Foreign Corporation, such a change could have a material negative effect on the largest U.S. shareholders and, in turn, on our business.
In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of other complex tax regulations. We recognize liabilities for anticipated tax audit issues in the United States and other tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes will be due. If we ultimately determine that payment of these amounts are not probable, we reverse the liability and recognize a tax benefit during the period in which we determine that the liability is no longer probable. We record an additional charge in our provision for taxes in the period in which we determine that the recorded tax liability is less than we expect the ultimate assessment to be.
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CRITICAL ACCOUNTING POLICIES
The U.S. Securities and Exchange Commission defines critical accounting policies as “those that are both most important to the portrayal of a company’s financial condition and results, and require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.” Preparation of our financial statements involves the application of several such policies. These policies include: estimates of our exposure to liability for income taxes, estimates of credits to be issued to customers for sales that have already been recorded, the valuation of inventory on a lower-of-cost-or-market basis, the carrying value of long-lived assets, and the economic useful life of intangible assets.
Income Taxes - We must make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes.
We must assess the likelihood that we will be able to recover our deferred tax assets. If recovery is not likely, we must increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable. As changes occur in our assessments regarding our ability to recover our deferred tax assets, our tax provision is increased in any period in which we determine that the recovery is not probable.
In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of other complex tax regulations. We recognize liabilities for anticipated tax audit issues in the United States and other tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes will be due. If we ultimately determine that payment of these amounts are unnecessary, we reverse the liability and recognize a tax benefit during the period in which we determine that the liability is no longer necessary. We record an additional charge in our provision for taxes in the period in which we determine that the recorded tax liability is less than we expect the ultimate assessment to be.
Estimates of credits to be issued to customers - We regularly receive requests for credits from retailers for returned products or in connection with sales incentives, such as cooperative advertising and volume rebate agreements, as well as general returns due to product quality issues. We reduce sales or increase selling, general, and administrative expenses, depending on the nature of the credits, for estimated future credits to customers. Our estimates of these amounts are based either on historical information about credits issued, relative to total sales, or on specific knowledge of incentives offered to retailers. With respect to credits for product quality issues, we also estimate our warranty accrual using historical trends and believe these trends are the most reliable method by which we can estimate our warranty liability.
Valuation of inventory - We account for our inventory using a first-in-first-out system in which we record inventory on our balance sheet at the lower of its cost or its net realizable value. Determination of net realizable value requires management to estimate the point in time at which an item’s net realizable value drops below its cost. We regularly review our inventory for slow-moving items and for items that we are unable to sell at prices above their original cost. When we identify such an item, we reduce its book value to the net amount that we expect to realize upon its sale. This process entails a significant amount of inherent subjectivity and uncertainty.
Carrying value of long-lived assets - We apply the provisions of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”) and Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”) in assessing the carrying values of our long-lived assets. SFAS 142 and SFAS 144 both require that a company consider whether circumstances or conditions exist that suggest that the carrying value of a long-lived asset might be impaired. If such circumstances or conditions exist, further steps are required in order to determine whether the carrying value of the asset exceeds its fair value. If analyses indicate that the asset’s carrying value does exceed its fair market value, the next step is to record a loss equal to the excess of the asset’s carrying value over its fair value. The steps required by SFAS 142 and SFAS 144 entail significant amounts of judgment and subjectivity. We completed our annual analysis of the carrying value of our goodwill during the first quarter of fiscal 2005 and, accordingly, recorded no impairment.
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Economic useful life of intangible assets - We apply SFAS 142 in determining the useful economic lives of intangible assets that we acquire and that we report on our consolidated balance sheets. SFAS 142 requires that companies amortize intangible assets, such as licenses and trademarks, over their economic useful lives, unless those assets’ economic useful lives are indefinite. If an intangible asset’s economic useful life is deemed to be indefinite, that asset is not amortized. When we acquire an intangible asset, we consider factors such as the asset’s history, our plans for that asset, and the market for products associated with the asset. We consider these same factors when reviewing the economic useful lives of our previously acquired intangible assets as well. We review the economic useful lives of our intangible assets at least annually. The determination of the economic useful life of an intangible asset requires a significant amount of judgment and entails significant subjectivity and uncertainty. We have completed our annual analysis of the remaining useful economic lives of our intangible assets during the first quarter of fiscal 2005 and determined that the useful lives currently being used to determine amortization of each asset are appropriate.
With respect to the June 1, 2004 acquisition of intangible assets of OXO International, we have completed our analysis of the economic lives of the assets acquired and have made an allocation of the initial purchase price based upon independent appraisals.
For a more comprehensive list of our accounting policies, we encourage you to read Note 1 — Summary of Significant Accounting Policies, included in the consolidated financial statements included in our latest annual report on Form 10-K. Note 1 in the consolidated financial statements included with Form 10-K contains several other policies, including policies governing the timing of revenue recognition, that are important to the preparation of our consolidated financial statements, but do not meet the SEC’s definition of critical accounting policies because they do not involve subjective or complex judgments.
FORWARD-LOOKING INFORMATION AND FACTORS THAT MAY AFFECT FUTURE RESULTS
Certain written and oral statements made by our Company and subsidiaries or with the approval of an authorized executive officer of our Company may constitute “forward-looking statements” as defined under the Private Securities Litigation Reform Act of 1995. This includes statements made in this report, in other filings with the Securities and Exchange Commission, in press releases, and in certain other oral and written presentations. Generally, the words “anticipates”, “believes”, “expects”, “plans”, “may”, “will”, “should”, “seeks”, “estimates”, “predict”, “potential”, “continue”, “intends”, and other similar words identify forward-looking statements. All statements that address operating results, events or developments that we expect or anticipate will occur in the future, including statements related to sales, earnings per share results, and statements expressing general expectations about future operating results, are forward-looking statements. In this report, we have provided among other items, projected sales information in connection with our OXO acquisition and the acquisition of TimeBlock® and Skin Milk® body and skin care product lines. These projections are “forward-looking statements” and were based upon management’s analysis of the underlying acquired products distribution along with subjective assessments of the additional opportunities for sales growth within our existing and target customer bases. The Company cautions readers not to place undue reliance on forward-looking statements. Forward-looking statements are subject to risks that could cause such statements to differ materially from actual results. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.
Risk Factors
Factors that could cause actual results to differ from those anticipated include:
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As previously mentioned, we acquired certain assets and liabilities of OXO International on June 1, 2004. To the extent that the OXO acquisition is not favorably received by shareholders, analysts, and others in the investment community, the price of our common stock could be adversely affected. In addition, acquisitions involve numerous risks, including:
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If we are unable to successfully integrate the operations, technologies, products or personnel that we have acquired, our business, results of operations, and financial condition could be materially adversely affected.
NEW ACCOUNTING GUIDANCE
In May 2003, the FASB issued FASB Statement No. 150 “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity” (“SFAS 150”). This statement establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. It requires that issuers classify as liabilities a financial instrument that is within its scope as a liability because that financial instrument embodies an obligation of the issuer. This statement does not affect the timing of recognition of financial instruments as contingent consideration nor does it apply to obligations under stock-based compensation arrangements if those obligations are accounted for under APB Opinion No. 25. Application of this statement is effective for applicable financial instruments entered into or modified after August 31, 2003, and otherwise is effective at the beginning of the first interim fiscal period beginning after June 15, 2003. We currently do not have any financial instruments that are covered under this statement.
On March 31, 2004, the Financial Accounting Standards Board (FASB) issued a proposed statement, Share-Based Payment, that addresses the accounting for share-based payment transactions (for example, stock options and awards of restricted stock) in which an employer receives employee-services in exchange for equity securities of the company or liabilities that are based on the fair value of the company’s equity securities. This proposal, if finalized as proposed, would eliminate use of APB Opinion No. 25, Accounting for Stock Issued to Employees, and generally would require such transactions be accounted for using a fair-value-based method and recording compensation expense rather than optional pro forma disclosure of what expense amounts might be. The proposal, if approved, would substantially amend FASB Statement No. 123, Accounting for Stock-Based Compensation. The comment period for the exposure draft ended on June 30, 2004 and final rules are expected to be issued late in 2004. Because of the timing of the proposal and the uncertainty of whether it will be adopted substantially as proposed, management will evaluate the impact of such a change in the accounting standards on the Company’s financial position and results of operations when final rules are issued.
A variety of proposed or otherwise potential accounting standards are currently under study by standard-setting organizations and various regulatory agencies. Because of the tentative and preliminary nature of these proposed standards, management has not determined whether implementation of such proposed standards would be material to our consolidated financial statements.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Changes in interest rates and currency exchange rates represent our primary financial market risks. Fluctuation in interest rates causes variation in the amount of interest that we can earn on our available cash and the amount of interest expense we incur on our short-term borrowings. Interest on our long-term debt outstanding as of August 31, 2004 is both floating and fixed. Fixed rates are in place on $55,000,000 senior notes at rates ranging from 7.01 percent to 7.24 percent. Floating rates are in place on $225,000,000 of senior notes. Interest rates on these notes are reset quarterly based on the 3 month LIBOR rate plus 85 basis points for the five and seven year notes, and the 3 month LIBOR rate plus 90 basis points for the ten year notes. At closing on June 29, 2004, the initial interest rates were 2.436 percent for the five and seven year notes, and 2.486 percent for the ten year notes. On September 29, 2004, the interest rates on these notes were reset for the next three months at 2.82 percent for the five and seven year notes and 2.87 percent for the ten year notes. Increases in interest rates expose us to risk on this debt. Also, with respect to our $55,000,000 senior notes, as interest rates drop below the rates on this debt, our interest cost can exceed the cost of capital of companies who borrow at lower rates of interest.
As mentioned in “Financial Condition, Liquidity, and Capital Resources”, interest rates on our revolving credit agreement vary based on the LIBOR rate and the applicable period for the LIBOR rate. Therefore, the potential for interest rate increases exposes us to interest rate risk on our revolving credit agreement. Our revolving credit agreement allows for maximum revolving borrowings of $75,000,000. At August 31, 2004, there were $34,000,000 of outstanding borrowings and open letters of credit of $3,340,000 under this credit line. The need to continue to borrow under this and similar successor agreements could ultimately subject us to higher interest rates, thus increasing the future cost of such debt. We do not currently hedge against interest rate risk.
As mentioned under Note 8 to our consolidated condensed financial statements, “Financial Condition, Liquidity, and Capital Resources”, and “Forward-Looking Information and Factors that may affect Future Results”, on June 29, 2004, we established a new five year, $75,000,000 revolving credit facility, cancelled our existing $50,000,000 revolving credit facility, and placed $225,000,000 of floating rate senior debt with five, seven, and ten year maturities. Both the new revolving credit facility and the senior debt bear floating rates of interest. For example, a 1 percent increase in our base interest rates could impact us by adding up to $3,000,000 of additional interest cost annually. The addition of this level of debt exposure to our consolidated operations, and the uncertainty regarding the level of our future interest rates, substantially increases our risk profile.
Because we purchase a majority of our inventory using U.S. Dollars, we are subject to minimal short-term foreign exchange rate risk in purchasing inventory. However long-term declines in the value of the U.S. Dollar could subject us to higher inventory costs. Such an increase in inventory costs could occur if foreign vendors were to react to such a decline by raising prices. Sales in the United States are transacted in U.S. Dollars. The majority of our sales in the United Kingdom are transacted in British Pounds, in France and Germany are transacted in Euros, in Mexico are transacted in Pesos, and in Canada are transacted in Canadian Dollars. When the U.S. Dollar strengthens against other currencies in which we transact sales, we are exposed to foreign exchange losses on those sales because our foreign currency sales prices are not adjusted for currency fluctuations. When the U.S. Dollar weakens against those currencies, we could realize foreign currency gains.
During the three- and six-month periods ended August 31, 2004, we transacted 15 and 15 percent, respectively, of our sales from continuing operations in foreign currencies. For the three- and six-month periods ended August 31, 2003, we transacted 12 and 12 percent respectively, of our sales from continuing operations in foreign currencies. For the three- and six-month periods ended August 31, 2004 we incurred foreign currency exchange losses of $214,000 and $624,000. For the same periods in fiscal 2004, we incurred foreign exchange losses of $653,000 and $87,000.
We hedge against foreign currency exchange rate-risk by entering into a series of forward contracts designated as cash flow hedges to protect against the foreign currency exchange risk inherent in our forecasted transactions denominated in currencies other than the U.S. Dollar. For transactions designated as cash flow hedges, the effective portion of the change in the fair value (arising from the change in the spot rates from period to period) is deferred in Other Comprehensive Income. These amounts are subsequently recognized in “Other income, net” in the Consolidated Statements of Income in the same period as the forecasted transactions close out over the remaining balance of their
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terms. The ineffective portion of the change in fair value (arising from the change in the difference between the spot rate and the forward rate) is recognized in the period it occurred. These amounts are also recognized in “Other income, net” in the Consolidated Statements of Income. We do not enter into any forward exchange contracts or similar instruments for trading or other speculative purposes.
The following table summarizes the various forward contracts we designated as cash flow hedges that were open at August 31, 2004 and February 29, 2004:
We expect that as currency market conditions warrant, and our foreign denominated transaction exposure grows, we will continue to execute additional contracts in order to hedge against potential foreign exchange losses.
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ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this Form 10-Q, we conducted an evaluation of the effectiveness of the design and operation of our “disclosure controls and procedures” (Disclosure Controls). The controls evaluation was done under the supervision and with the participation of management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO).
Disclosure Controls are controls and procedures designed to reasonably assure that information required to be disclosed in our reports filed under the Exchange Act, such as this Quarterly Report, is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure Controls are also designed to reasonably assure that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. Our Disclosure Controls include components of our internal control over financial reporting, which consists of control processes designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles in the United States.
Our management, including the CEO and CFO, does not expect that our Disclosure Controls or our internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
In the process of our evaluation, among other matters, we considered the existence of any “significant deficiencies” or “material weaknesses” in our internal control over financial reporting, and whether we had identified any acts of fraud involving personnel with a significant role in our internal control over financial reporting. In the professional auditing literature, “significant deficiencies” are referred to as “reportable conditions,” which are deficiencies in the design or operation of controls that could adversely affect our ability to record, process, summarize and report financial data in the financial statements. Auditing literature defines “material weakness” as a particularly serious reportable condition in which the internal control does not reduce to a relatively low level the risk that misstatements caused by error or fraud may occur in amounts that would be material in relation to the financial statements and the risk that such misstatements would not be detected within a timely period by employees in the normal course of performing their assigned functions.
Through the date of this report, no corrective actions were required to be taken with regard to either significant deficiencies or material weaknesses in our controls. Based on their evaluation, as of the end of the period covered by this Form 10-Q, our CEO and CFO have concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934) are effective.
In connection with the evaluation described above, we identified no change in our internal control over financial reporting that occurred during our fiscal quarter ended August 31, 2004, and that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
In conjunction with our efforts to convert to a new global information system which was placed into service on September 7, 2004, we have committed substantial internal and external resources to revise and document operational processes and related internal controls. Our objective is to promote greater uniformity and consistency of transaction
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processing across all aspects of our operations. Our conversion to the new information system included a project phase specifically focused on revising our formal understanding of our system of internal control over financial reporting with the objective of meeting the formalized requirements of Section 404 of the Sarbanes-Oxley Act.
Our intent is to maintain the Disclosure Controls and more pervasive Internal Controls over Financial Reporting as dynamic systems that can undergo appropriately authorized change as conditions warrant. Due to the complexities of the conversion to the new global information system, and the resulting human resource diversions, we now expect completion of the re-documentation process early in the fourth fiscal quarter of 2005. For the next three to six months, we expect to experience a period of significant change and refinement of our procedures. While nothing has come to our attention that would lead us to believe that we may experience errors or misstatements of our financial results during this time-frame, we recognize that this continues to be a challenging transition for us. We believe we have the process and appropriate management in place to effectively manage this transition.
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PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES
The following is a summary of all repurchases by the Company of its common stock during the fiscal quarter ended August 31, 2004:
During the quarter ended August 31, 2003, our Board of Directors approved a resolution authorizing the Company to purchase, in open market or through private transactions, up to 3,000,000 shares of our common stock over a period extending to May 31, 2006.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company’s Annual Meeting of Shareholders was held August 31, 2004 in El Paso, Texas. At that meeting, the shareholders voted on the following proposals:
A description of the foregoing matters is contained in the Company’s Proxy Statement dated July 26, 2004, relating to the 2004 Annual Meeting of Shareholders.
With respect to Proposal 1, the Shareholders elected each of the following directors to the Company’s Board of Directors by the votes indicated below, to serve for the ensuing year:
Proposal 2, to amend the Helen of Troy Limited 1998 Stock Option Plan and Restricted Stock plan received the following votes:
Proposal 3, to appoint KPMG LLP as independent auditors received the following votes:
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ITEM 5. OTHER INFORMATION
On April 29, 2004, we completed the sale of our 55 percent interest in Tactica International, Inc. (“Tactica”) back to certain shareholder-managers. Statement of Financial Accounting Standards No.144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”), provides accounting guidance for these circumstances and requires us to present any operating results for Tactica in the accompanying consolidated condensed financial statements as a discontinued operation. Under discontinued operations accounting treatment, we must report Tactica’s operating results, net of taxes, as a separate summarized component after income from continuing operations for each period presented. Accordingly, the accompanying consolidated condensed statements of income contain all appropriate reclassifications for each prior period presented. In order to facilitate investors’ trend analysis, we believe it appropriate to provide the following supplementary schedule of restated quarterly operating results for fiscal 2004. The schedule shows all four quarter’s operating results presented in accordance with SFAS 144. We anticipate also including this same information with our Form 10-Q filing for the third fiscal quarter of 2005.
Consolidated Quarterly Statements of Income Restated For Tactica Discontinued Operations for Fiscal 2004(Unaudited)(in thousands, except per share data)
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
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* This furnished Form 8-K is not to be deemed filed or incorporated by reference into any filing.
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SIGNATURES
Pursuant to the requirements 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.
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Index to Exhibits
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