UNITED STATESSECURITIES AND EXCHANGE COMMISSION
Form 10-Q
For the quarterly period ended May 31, 2005
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 þ No o
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 þ No o
As of July 6, 2005 there were 29,887,651 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(in thousands, except shares and par value)
See accompanying notes to consolidated condensed financial statements.
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Consolidated Condensed Statements of Income(unaudited)(in thousands, except per share data)
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Consolidated Condensed Statements of Cash Flows(unaudited, in thousands)
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THREE MONTHS ENDED MAY 31, 2005 AND 2004(in thousands)
IDENTIFIABLE NET ASSETS AT MAY 31, 2005 AND FEBRUARY 28, 2005(in thousands)
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INTANGIBLE ASSETS(in thousands)
On June 1, 2004, we entered into a five year $75,000,000 Revolving Line of Credit Agreement and a one year $200,000,000 Term Loan Credit Agreement. The Term Loan Credit Agreement was a temporary financing to fund the balance of OXO’s purchase price (see Note 13). We entered into this Term Loan Credit Agreement until more permanent long-term financing could be put into place. The purchase price
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of the OXO International acquisition was funded by borrowings of $73,173,000 under the new Revolving Line of Credit Agreement and $200,000,000 under the Term Loan Credit Agreement. Borrowings under the 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 below). For the period outstanding, borrowings under the Term Loan Credit Agreement accrued interest at LIBOR plus a margin of 1.125%.
Borrowings under the Revolving Line of Credit Agreement accrue interest equal to the higher of the Federal Funds Rate plus 0.50% or Bank of America’s 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 percent. The margin rate on LIBOR based borrowings was reduced to 1.0 percent from 1.125 percent, effective May 27, 2005. The rates paid on various draws for the current fiscal quarter ranged from 4.090 percent to 4.215 percent. 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. As of May 31, 2005, there were $12,000,000 of revolving loans and $333,427 of open letters of credit outstanding against this facility.
The Revolving Line of Credit Agreement requires the maintenance of certain Debt/EBITDA, fixed charge coverage ratios, and other customary covenants. The agreements were guaranteed, on a joint and several basis, by the parent company, Helen of Troy Limited, and certain U.S. subsidiaries.
On January 5, 1996, one of our U.S. subsidiaries issued guaranteed Senior Notes at face value of $40,000,000. Interest is paid quarterly at an annual rate of 7.01 percent. The Senior Notes are unsecured, and are guaranteed by Helen of Troy Limited and certain of our subsidiaries. Annual principal payments of $10,000,000 each begin January 5, 2005, with the final payment due January 5, 2008. These notes had an outstanding current balance of $10,000,000 and a long-term balance of $20,000,000 at February 28, 2005 and May 31, 2005.
On July 18, 1997, one of our U.S. subsidiaries issued a $15,000,000 Senior Note. Interest is paid quarterly at an annual rate of 7.24 percent. The $15,000,000 Senior Note is unsecured, is guaranteed by Helen of Troy Limited and certain of our subsidiaries and is due July 18, 2012. Annual principal payments of $3,000,000 each begin July 18, 2008, with the final payment due July 18, 2012.
Both the $40,000,000 and $15,000,000 Senior Notes contain covenants that require that we meet certain net worth and other financial requirements. Additionally, the notes restrict us from incurring liens on any of our properties, except under certain conditions as defined in the Senior Note agreements. Under the terms of the Senior Notes, one of our U.S. subsidiaries is the borrower. Our consolidated group’s parent company, located in Bermuda, one of our subsidiaries located in Barbados, and three of our U.S. subsidiaries fully guarantee the Senior Notes on a joint and several basis.
On June 29, 2004, we closed on a $225,000,000 Floating Rate Senior Note (“Senior Notes”) financing consisting 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 February 28, 2005 the interest rates on these notes were 3.410 percent for the five and seven year notes and 3.460 percent for the ten year notes. At May 31, 2005,
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the interest rates on these notes were 3.940 percent for the five and seven year notes and 3.990 percent for the ten year notes. On June 29, 2005, the interest rates on these notes were reset for the next three months at 4.330 percent for the five and seven year notes and 4.380 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 Floating Rate 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.
Through May 31, 2005 we were in compliance with all the terms of all outstanding debt agreements.
Product Warranties
The Company’s products are under warranty against defects in material and workmanship for a maximum of two years. We have established accruals to cover future warranty costs of approximately $5,108,000 and $5,767,000 as of May 31, 2005 and February 28, 2005, respectively. We estimate our warranty accrual using historical trends. We believe that these trends are the most reliable method by which we can estimate our warranty liability. The following table summarizes the activity in the Company’s accrual for the three-months ended May 31, 2005 and fiscal year ended February 28, 2005:
ACCRUAL FOR WARRANTY RETURNS(in thousands)
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Contractual Obligations
PAYMENTS DUE BY PERIOD(in thousands)
PROFORMA STOCK-BASED EMPLOYEE COMPENSATION(in thousands, except per share data)
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Assets Received in Noncash Exchange for Ownership Interest in Tacticaat April 29, 2004(in thousands)
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OXO — Net Assets Acquired on June 1, 2004(in thousands)
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Results of Operations if OXO Acquisition Had Been Completed at March 1, 2004(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. This discussion should be read in conjunction with our consolidated condensed financial statements included under Part I, Item 1 of this Quarterly Report on Form 10-Q for the fiscal quarter ended May 31, 2005.
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 first quarter of fiscal 2005 does not include the operations of our Housewares segment (the operations of OXO International (“OXO”) acquired on June 1, 2004), offering home product tools in several categories, including: kitchen, cleaning, barbecue, barware, garden, automotive, storage and organization.
Overall, net sales were up 19.0 percent or $20,371,000 for the first quarter of fiscal 2006 over the same period in the prior year. Overall operating income was 12.0 percent of net sales in the first quarter of fiscal 2006 compared to 17.7 percent of net sales for the same period in the prior year. Income from continuing operations was 8.3 percent of net sales in the first quarter of fiscal 2006 compared to 13.7 percent of net sales for the same period in the prior year.
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RESULTS OF OPERATIONS
Comparison of fiscal quarter ended May 31, 2005 to the same period ended May 31, 2004.
The following table sets forth, for the periods indicated, our selected operating data, in U.S. dollars, as a percentage of net sales, and as a year-over-year percentage change.
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 one 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 12 to the consolidated condensed financial statements for a further discussion of the sale of Tactica). Beginning with the second quarter of fiscal 2005, we presented an additional operating segment, Housewares, to report the operations of OXO. The Housewares Segment offers home product tools in several categories, including: kitchen, cleaning, barbecue, barware, garden, automotive, storage and organization (See Note 13 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-months ended May 31, 2005 increased 19.0 percent, or $20,371,000, versus the same period a year earlier. New product acquisitions accounted for 26.1 percent, or $27,920,000 of the net sales growth. This growth was offset by a 7.1 percent, or $ 7,549,000 decline in our core business (business that we operated over the same fiscal period last year) for the three-months ended May 31, 2005 when compared to the same period a year earlier. New product acquisitions included all OXO Housewares products acquired in June 2004, and Skin Milk® and TimeBlock® lines of skin care products, acquired in September 2004.
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As previously discussed, during the first quarter of fiscal 2006, we saw overall lower consumer demand at retail in many of our categories in our core business. Thus far, through innovation we have been successful in replacing low price point sales with higher price point items in key SKU categories. We experienced some erosion in our realized net selling prices due to market conditions. We have adjusted our product mix, pricing, and marketing programs in order to maintain, and in some cases, acquire more retail shelf space. Offsetting our core business sales declines has been the continued strength of the British Pound and the Euro versus the U.S. Dollar. With the growth in our International operations, other foreign currency exposures are growing and will be included in our foreign currency impact analysis as they become material. The overall net impact of foreign currency changes was to provide approximately $310,000 of additional sales dollars for the three-month period ended May 31, 2005, versus the same period a year earlier.
Consolidated gross profit, as a percentage of sales for the three-month period ended May 31, 2005, decreased 0.8 percentage points, to 46.1 percent compared to the same period in the prior year. The decrease in gross profit is primarily due to a combination of the higher costs of customer promotion programs which reduced our net sales and a reduction in sales prices on certain key items in order to maintain our competitive position.
Selling, general, and administrative expenses
Selling, general, and administrative expenses, expressed as a percentage of net sales, increased from 29.3 to 34.1 percent for the three-months ended May 31, 2005 compared to the same period in the prior year. The increase for the quarter ending May 31, 2005 is primarily due to increased personnel costs, increased consulting fees and depreciation associated with our new information system (which was placed into service early in our third fiscal quarter of fiscal 2005), increased advertising, and higher warehousing costs due to the use of outside third party warehouses to manage and distribute certain inventories until our new 1,200,000 square foot warehouse (as more fully discussed in Note 14 to our consolidated condensed financial statements) is completed and occupied, and higher outbound freight costs (primarily from a sharp rise in fuel surcharges).
Interest expense and other income / expense
Interest expense for the three-month period ended May 31, 2005 increased compared with the three-month period ended May 31, 2005, to $3,263,000 from $986,000. 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 and the $12,001,000 acquisition of Timeblock® and Skin Milk® (See Notes 8, 13 and 14 to our consolidated condensed financial statements for related discussions of new debt financings and the OXO, Timeblock® and Skin Milk® acquisitions).
Other income (expense), net for the three-month period ended May 31, 2005 was $58,000 net expense, compared with other income, net of $96,000 for the same period in the prior year. The following schedule shows key components of other income and expense:
Interest income is lower for the three-month period ended May 31, 2005 when compared to the same period last year due to lower levels of temporarily invested cash being held this year.
Realized and unrealized losses on securities for the three-month period ended May 31, 2005 includes a $60,000 loss on marketable securities acquired in connection with the sale of Tactica (see Note 12) and a $121,000 loss on trading
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securities. The marketable securities acquired from Tactica carry a restriction that prevents us from disposing of the stock prior to July 31, 2005, and are accordingly classified as stock available for sale. On the acquisition date, the securities had a market value of $3,030,000. At May 31, 2005 and February 28, 2005 the market value of these securities was $60,000 and $120,000, respectively. During the quarter ended May 31, 2004, a $780,000 decline in market value was then considered temporary and recorded in other comprehensive income. In the third fiscal quarter of 2005, management determined the decline in market value on these securities to be other-than-temporary and accordingly began recording losses on the securities in other income (expense), net. Through the end of fiscal 2005, the total loss on the stock available for sale was $2,910,000. During the quarter ended May 31, 2005, a $60,000 loss on the stock available for sale was recorded in other income (expense), net.
Income tax expense
Income tax expense for the three-month period ended May 31, 2005 was 11.9 percent of earnings before income taxes, versus 18.4 percent of earnings before income taxes for the same period in the prior year. The overall year-to-year decline in rates is due to more of our income in fiscal 2006 being taxed in lower tax rate jurisdictions and the elimination of a Hong Kong tax accrual after fiscal 2005. Effective March 2005, the Company no longer conducts operating activities in Hong Kong for which the IRD has previously assessed taxes. As such, no additional accruals for contingent tax liabilities beyond February 2005 will be provided. We now expect our future tax rates to range in the 10 to 14 percent range on a go forward basis.
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. 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 for the months held in fiscal 2005. Under this accounting treatment, Tactica’s operating results, net of taxes, are recorded as a separate summarized component after income from continuing operations for each year presented.
FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES
Selected measures of our liquidity and capital resources as of May 31, 2005 and May 31, 2004 are shown below:
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Operating Activities
Our cash balance was $6,781,000 at May 31, 2005 compared to $21,752,000 at February 28, 2005. Operating activities consumed $23,705,000 of cash during the first three months of fiscal 2006, compared to $140,000 of cash provided during the first three months of fiscal 2005. Inventories increased $36,364,000 during the first three months of fiscal 2006 compared to $1,784,000 during the first three months of fiscal 2005. Inventory levels increase in the first quarter of fiscal 2006. Inventory increases are part of a normal seasonal build to service the increased demand for product anticipated in the coming second and third fiscal quarters, to build up certain inventories due to new product introductions. In addition, in some product categories we increased our purchases to take advantage of favorable current prices, which we expect may increase as a result of recent increases in the prices of raw materials such as copper, steel and plastics.
Accounts receivable remained relatively flat over the first quarter of fiscal 2006. Net sales in the first quarter of fiscal 2006 were $127,392,000 compared to $127,617,000 for the preceding quarter ended February 28, 2005. Accounts receivable at the end of the first quarter of fiscal 2006 were $111,742,000 compared to $111,739,000 at the end of the preceding quarter. This pattern reflects relatively stable timing of customer payments.
Our accounts receivable turnover increased to 72.3 days at May 31, 2005 from 62.8 days at May 31, 2004. We have seen an increase in domestic and international receivable turnover days due to retail shipping requirements and marketing, promotional, and incentive programs we offer to remain competitive. This has required more follow-through and collections management on each account in order to help our customers resolve billing issues and properly issue and apply any credits due customers. This process has extended our collection cycle, but has not had a negative impact on our overall credit quality or ultimate collection rates. Our international business (primarily from European and Latin American countries) has longer credit terms than our domestic business. Due to the recent growth in our international business, overall receivable turnover days are increasing.
Working capital decreased $14,950,000 from $177,165,000 at May 31, 2004 to $162,215,000 at May 31, 2005. Our current ratio decreased to 2.1:1 at May 31, 2005 from 3.3:1 at May 31, 2004. Our working capital and current ratio continue to drop as a result of the acquisition of OXO which reduced our cash levels, and increased our current liabilities.
Investing Activities
Investing activities used $3,756,000 of cash during the three months ended May 31, 2005. Listed below are some significant highlights of our investing activities:
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Financing Activities
Financing activities provided $12,490,000 of cash during the three months ended May 31, 2005.
During the three-month period ended May 31, 2005, 48,875 stock option grants were exercised for shares of our common stock providing $490,000 of cash. No shares of common stock were repurchased during this same period.
For the three-month period ended May 31, 2005, borrowings against the Company’s Revolving line of credit provided net cash of $12,000,000.
Our contractual obligations and commercial commitments as of May 31, 2005 were:
We have no existing activities involving special purpose entities or off-balance sheet financing.
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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 (see Note 8 of our consolidated condensed financial statements) will continue to provide sufficient capital resources to fund the Company’s foreseeable short and long-term liquidity requirements. Our cash used by operating activities of $23,705,000 over the first quarter of 2005 resulted from seasonal inventory increases to build our stocks for our peak selling season (which starts midway through the second quarter and runs through the end of the third quarter), the build-up of certain inventories to service new product introductions, and normal seasonal receivable collection patterns. In addition, in some product categories we increased our purchases to take advantage of favorable current prices, which may increase as a result of recent increases in the prices of raw materials.
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 continue to fund our new warehouse acquisition, 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.
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 used to compute our allowance for doubtful accounts, 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.
Allowance for accounts receivable - We maintain an allowance for doubtful accounts for estimated losses that may result from the inability of our customers to make required payments. That estimate is based on historical collection experience, current economic and market conditions, and a review of the current status of each customer’s trade accounts receivable. If the financial condition of our customers were to deteriorate or our judgment regarding their financial condition was to change negatively, additional allowances may be required resulting in a charge to income in the period such determination was made. Conversely, if the financial condition of our customers were to improve or our judgment regarding their financial condition was to change positively, a reduction in the allowances may be required resulting in an increase in income in the period such determination was made.
Income Taxes - We must make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments must be used in the calculation of certain tax assets and liabilities because of 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
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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. 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. This process entails a significant amount of inherent subjectivity and uncertainty.
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 average cost or its net realizable value. Determination of net realizable value requires us 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 we 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 market 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 analysis of the carrying value of our goodwill and other intangible assets during the first quarter of fiscal 2006, and accordingly, recorded no impairment.
Economic useful life of intangible assets - We apply Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“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 we 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 analysis of the remaining useful economic lives of our intangible assets during the first quarter of fiscal 2006 and determined that the useful lives currently being used to determine amortization of each asset are appropriate.
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.
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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. 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
We rely on key senior management to operate our business; the loss of any of these senior managers could have an adverse impact on our business.
We do not have a large group of senior executives in our business. Accordingly, we depend on a small number of key senior executives to run our business. We do not maintain “key man” life insurance on any of our key senior executives. The loss of any of these persons could have a material adverse effect on our business, financial condition and results of operations, particularly if we are unable to find, relocate and integrate adequate replacements for any of these persons. Further, in order to continue to grow our business, we will need to expand our key senior management team. We may be unable to attract or retain these persons. This could hinder our ability to grow our business and could disrupt our operations or materially adversely affect the success of our business.
We rely on our new Global Enterprise Resource Planning System; the failure of which could have an adverse impact on our profitability.
On September 7, 2004, we implemented our new Global Enterprise Resource Planning System, along with other new technologies. With the implementation of this new system, most of our businesses with the significant exception of the newly acquired Housewares segment run under one integrated information system. We continue with the process of closely monitoring the new system and making normal and expected adjustments to improve its effectiveness. Complications resulting from the continuing process adjustments could potentially cause considerable disruptions to our business. The change from the old system to the new system continues to involve risk. Application program bugs, system conflict crashes, user error, data integrity issues, customer data conflicts and integration issues with certain remaining legacy systems all pose potential risks. Implementing new data standards and converting existing data to accommodate the new system’s requirements have required a significant effort across our entire organization. During the third fiscal quarter of 2005, we began the implementation and transition of our Housewares segment to the new system. We continue to implement several significant functionality enhancements. These additional implementations will continue to strain our internal resources, could impact our ability to do business, and may result in higher implementation costs and concurrent reallocation of human resources.
To support these new technologies, we are building and supporting a much larger and more complex information technology infrastructure. Increased computing capacity, power requirements, back-up capacities, broadband network infrastructure and increased security needs are all potential areas for failure and risk. We continue to rely substantially on outside vendors to assist us with implementation and enhancements and will continue to rely on certain vendors to assist us in maintaining some of our new infrastructure. Should they fail to perform due to events outside our control, it could affect our service levels and threaten our ability to conduct business. Over time, we plan to transition many of these third party services to our in-house staff and continue with significant training efforts in order to do so. The transition from third party services to in-house staffing of such services poses risks that could cause additional business disruptions. Finally, natural disasters may disrupt our infrastructure and our disaster recovery process may not be sufficient to protect against loss.
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Our business operations are dependent on our logistical systems, which include our order management system and our computerized warehouse network. These logistical systems depend on our new Global Enterprise Resource Planning System. Any interruption in our logistical systems would impact our ability to procure our products from our factories and suppliers, transport them to our distribution facilities, and store and deliver them to our customers on time and in the correct amounts.
Acquisitions and partnerships may be more costly or less profitable than anticipated and may adversely affect the price of our company stock.
As previously mentioned, we acquired certain assets and liabilities of OXO International on June 1, 2004. On September 29, 2004, we acquired certain assets related to the worldwide production and distribution of TimeBlock® and Skin Milk® body and skin care products lines from Naterra International, Inc. TimeBlock® is a line of clinically tested anti-aging skin care products. Skin Milk® is a line of body, bath and skin care products enriched with real milk proteins, vitamins and botanical extracts. To the extent that these acquisitions are not favorably received by consumers, 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:
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.
Our sales are dependent on sales from several large customers and the loss of, or substantial decline in sales to, a top customer could have a material adverse effect on our revenues and profitability.
A few customers account for a substantial percentage of our sales. Our financial condition and results of operations could suffer if we lost all or a portion of the sales to these customers. In particular, sales to Wal-Mart Stores, Inc., and its affiliate, SAM’S Club, accounted for approximately 25 percent of our net sales in fiscal 2005. While no other customer accounted for ten percent or more of net sales, our top 5 customers accounted for approximately 44 percent of fiscal 2005 net sales. Although we have long-standing relationships with our major customers, no contracts require these customers to buy from us, or to purchase a minimum amount of our products. A substantial decrease in sales to any of our major customers could have a material adverse effect on our financial condition and results of operations.
Our projections of sales and earnings are highly subjective and our future sales and earnings could vary in a material amount from our projections.
Most of our major customers purchase our products electronically through electronic data interchange and expect us to promptly deliver products from our existing inventories to the customers’ retail stores or distribution centers. This method of ordering products allows our customers to immediately respond to changes in demands of their retail customers. From time to time, we provide projections to our shareholders and the investment community of our future sales and earnings. Since we do not have long-term purchase commitments from our major customers and the customer order and ship process is short, it is difficult for us to accurately predict the amount of our sales and related earnings. Our projections are based on management’s best estimate of sales using historical sales data and other information deemed
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relevant. These projections are highly subjective since sales to our customers can fluctuate substantially based on the demands of their retail customers. Additionally, changes in retailer inventory management strategies could make inventory management more difficult. Because our ability to forecast sales is highly subjective, there is a risk that our future sales and earnings could vary materially from our projections.
We are dependent on third party manufacturers, most of which are located in the Far East and any inability to obtain products from such manufacturers could have a material adverse effect on our business, financial condition and results of operations.
All of our products are manufactured by unaffiliated companies, most of which are in the Far East. Risks associated with such foreign manufacturing include: changing international political relations; changes in laws, including tax laws, regulations and treaties; changes in labor laws, regulations, and policies; changes in customs duties and other trade barriers; changes in shipping costs; currency exchange fluctuations; local political unrest; an extended and complex transportation cycle; and the availability and cost of raw materials and merchandise. To date, these factors have not significantly affected our production in the Far East. However, any change that impairs our ability to obtain products from such manufacturers, or to obtain products at marketable rates, could have a material adverse effect on our business, financial condition and results of operations.
With most of our manufacturers located in the Far East, our production lead times are relatively long. Therefore, we must commit to production in advance of customer orders. If we fail to forecast customer or consumer demand accurately, we may encounter difficulties in filling customer orders or in liquidating excess inventories. We may also find that customers are canceling orders or returning products. Distribution difficulties may have an adverse effect on our business by increasing the amount of inventory and the cost of storing inventory. Any of these results could have a material adverse effect on our business, financial condition and results of operations.
We have incurred substantial debt to fund acquisitions which could have an adverse impact on our business and profitability.
During the second quarter of fiscal 2005, we incurred substantial debt as more fully described in Note 8 to the consolidated condensed financial statements. We are now operating under substantially more leverage and have begun to incur higher interest costs. This substantial increase in debt has added new constraints on our ability to operate our business, including but not limited to:
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Our disagreements with taxing authorities, tax compliance and the impact of changes in tax law could have an adverse impact on our business.
Hong Kong Income Taxes - The Inland Revenue Department (“the IRD”) in Hong Kong has assessed taxes of $32,086,000 (U.S.) 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 assessments for the fiscal years 1995 through 2003, we have purchased tax reserve certificates totaling $28,425,000. 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.
If the IRD’s position were to prevail and if it were to assert the same position for fiscal years 2004 and 2005, the resulting assessment could total $18,340,000 (U.S.) in taxes. We would vigorously disagree with the proposed adjustments and would 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 for 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.
Effective March 2005, the Company no longer conducts operating activities in Hong Kong for which the IRD has previously assessed taxes. As such, no additional accruals for contingent tax liabilities beyond February 2005 will be provided.
United States Income Taxes - The Internal Revenue Service (“the IRS”) has completed its audits of the U.S. consolidated federal tax returns for fiscal years 2000, 2001 and 2002. We previously disclosed that the IRS provided notice of proposed adjustments to taxes of approximately $13,424,000 for the three years under audit. We have resolved the various tax issues and agreed to an additional assessment of $3,568,000 in taxes. The resulting tax liability had already been provided for in our tax reserves and we have decreased our tax accruals related to the IRS audits for fiscal years 2000, 2001 and 2002 during the last quarter of the 2005 fiscal year, accordingly. We believe this additional tax liability will be settled with funds already on deposit with the IRS.
The American Jobs Creation Act (“AJCA”) was signed into law by the President on October 22, 2004. The AJCA creates a temporary incentive for U.S. multinational corporations to repatriate accumulated income earned outside the United States by providing an 85 percent dividend received deduction for certain dividends from controlled foreign corporations. According to the AJCA, the amount of eligible repatriation is limited to $500 million or the amount described as permanently reinvested earnings outside the United States in the Company’s most recent audited financial
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statements filed with the Securities and Exchange Commission on or before June 30, 2003. Whether the Company will ultimately take advantage of the provision depends on a number of factors including potential forthcoming Congressional actions, Treasury regulations and development of a qualified reinvestment plan.
At this time, we have not made any changes to our existing position on reinvestment of foreign earnings subject to the AJCA. We currently intend to permanently reinvest all of the undistributed earnings of the non-U.S. subsidiaries of certain U.S. subsidiaries and accordingly we have made no provision for U.S. federal income taxes on these undistributed earnings. At May 31, 2006, undistributed earnings for which we had not provided deferred U.S. federal income taxes totaled $37,748,000.
Compliance with and Changes in Tax Law – The future impact of tax legislation, regulations or treaties, including any future legislation in the United States or abroad that would affect the companies or subsidiaries that comprise our consolidated group is always uncertain. Our ability to respond to such changes so that we maintain favorable tax treatment, the cost and complexity of such compliance, and its impact on our ability to operate in jurisdictions flexibly always poses a risk.
In addition, because our Parent Company is a foreign corporation, we incur risks associated with our ability to avoid classification of our parent company as a Controlled Foreign Corporation. In order for us to preserve our current tax treatment of our non-U.S. earnings, it is critical we avoid Controlled Foreign Corporation status. 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 of the Company 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 the Company’s business.
We materially rely on licensed trademarks, the loss of which could have a material adverse effect on our revenues and profitability.
We are materially dependent on our licensed trademarks as a substantial portion of our sales revenue comes from selling products under licensed trademarks. As a result, we are materially dependent upon the continued use of such trademarks, particularly the Vidal Sassoon® and Revlon® trademarks. Actions taken by licensors and other third parties could diminish greatly the value of any of our licensed trademarks. If we were unable to sell products under these licensed trademarks or the value of the trademarks were diminished by the licensor due to their continuing long-term financial capability to perform under the terms of the agreements or other reasons, or due to the actions of third parties, the effect on our business, financial condition and results of operations could be both negative and material.
In our Housewares segment, we rely on a third party to provide certain warehousing, order fulfillment and shipment services. Any inability of the third party to continue to provide us these services until such time as we can effectively transfer these operations to our own warehouse facilities, or problems encountered during the transition to our own warehouse facilities, could have an adverse affect on the Company’s revenues and profitability and impair this segment’s business.
On June 1, 2004, we acquired indirectly through our subsidiary Helen of Troy Limited (Barbados), certain assets and liabilities of OXO from World Kitchen (GHC), LLC, WKI Holding Company, Inc. and World Kitchen, Inc. (collectively, “Seller”) for approximately $273.2 million plus the assumption of certain liabilities. In connection with this acquisition, Seller agreed to perform certain transitional services for the Company until March 31, 2005, including, the warehousing, order fulfillment and shipment of OXO products. Seller and the Company agreed to extend the period of these services until February 28, 2006. The Company is in the process of planning the transition of the warehousing, order fulfillment and shipment services from Seller to Company on or before February 28, 2006. This transition includes, the:
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Any delays in construction of the new warehouse facility or problems encountered in connection with any of the foregoing requirements for transitioning the warehousing, order fulfillment and shipment services could have an adverse effect on the Company’s ability to fill orders for OXO products which could adversely affect the Company’s revenues and profitability and impair the OXO business.
NEW ACCOUNTING GUIDANCE
In November 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4” (FAS 151). FAS 151 clarifies that abnormal inventory costs such as costs of idle facilities, excess freight and handling costs, and wasted materials (spoilage) are required to be recognized as current period charges. The provisions of FAS 151 are effective for fiscal years beginning June 15, 2005 or later. Management is currently evaluating the provisions of FAS 151 and does not expect that the adoption will have a material impact on the Company’s consolidated financial position or results of operations.
In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets—an amendment of APB Opinion No. 29.” The guidance in APB Opinion No. 29, “Accounting for Nonmonetary Transactions”, is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The guidance in that Opinion, however, included certain exceptions to that principle. This Statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The provisions of this Statement will be effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The adoption of SFAS 153 is not expected to have a material impact on our consolidated financial condition, results of operations, or cash flows.
In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123R “Share-Based Payment” which revises SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” The statement 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 other rights to receive future compensation that are based on the fair value of the company’s equity securities. The statement eliminates the use of APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and generally requires such transactions be accounted for using a fair-value-based method and recording compensation expense rather than an optional pro forma disclosure of what expense amounts might be. The provisions of SFAS 123R are effective for public companies at the beginning of their first annual period beginning after June 15, 2005.
We expect to adopt SFAS No. 123R on March 1, 2006.
SFAS No. 123R permits public companies to adopt its requirements using one of two methods:
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The adoption of SFAS No. 123R’s fair value method will have an impact on our results of operations, although it will have an insignificant impact on our overall financial position. At May 31, 2005, we had 22,486 options available for issue under our employee stock option plan, and 308,000 options available for issue under our non-employee director’s stock option plan. The director’s stock option plan expired by its own terms in June 2005. Based upon our analysis of our current stock option plans in place, and assuming no further modifications to these plans, the estimated impact of adopting SFAS No. 123R for fiscal 2007 (fiscal year of adoption) will be to add approximately $856,000 net of tax benefits, to our annual operating expense. SFAS No. 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. We cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options).
In December 2004, the FASB issued FASB Staff Position (FSP) No. 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Job Creation Act of 2004.” FSP No. 109-2 amends the existing accounting literature that requires companies to record deferred taxes on foreign earnings, unless they intend to indefinitely reinvest those earnings outside the U.S. This pronouncement temporarily allows companies that are evaluating whether to repatriate foreign earnings under the American Jobs Creation Act of 2004 to delay recognizing any related taxes until that decision is made. This pronouncement also requires companies that are considering repatriating earnings to disclose the status of their evaluation and the potential amounts being considered for repatriation. The U.S. Treasury Department has not issued final guidelines for applying the repatriation provisions of the American Jobs Creation Act. We continue to evaluate this legislation and FSP No. 109-2 to determine whether we will repatriate any foreign earnings and the impact, if any, that this pronouncement will have on our consolidated financial statements.
In May 2005, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 154, “Accounting Changes and Error Corrections — a replacement of APB Opinion No. 20 and FASB Statement No. 3”. SFAS No. 154 requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS No. 154 also requires that retrospective application of a change in accounting principle be limited to the direct effects of the change. Indirect effects of a change in accounting principle, such as a change in contractual bonus payments resulting from an accounting change, should be recognized in the period of the accounting change. SFAS No. 154 also requires that a change in depreciation, amortization, or depletion method for long-lived, nonfinancial assets be accounted for as a change in accounting estimate affected by a change in accounting principle. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Early adoption is permitted for accounting changes and corrections of errors made in fiscal years beginning after the date this Statement is issued. The Company will adopt the provisions of SFAS No. 154, if applicable, beginning in fiscal 2007.
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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 borrowings. Interest on our long-term debt outstanding as of May 31, 2005 is both floating and fixed. Fixed rates are in place on $45,000,000 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 May 31, 2005, the interest rates on these notes were 3.940 percent for the five and seven year notes and 3.990 percent for the ten year notes. On June 29, 2005, the interest rates on these notes were reset for the next three months at 4.330 percent for the five and seven year notes and 4.380 percent for the ten year notes. Increases in interest rates expose us to risk on this debt. Also, with respect to our $45,000,000 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 Note 8 to our consolidated condensed financial statements, 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 May 31, 2005, there were $12,000,000 of outstanding borrowings and open letters of credit of $481,866 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, in June 2004, we established a new five year, $75,000,000 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-month period ended May 31, 2005, we transacted 12 percent of our sales from continuing operations in foreign currencies. For the three-month period ended May 31, 2004, we transacted 15 percent of our sales from continuing operations in foreign currencies. For the three-month period ended May 31, 2005 we incurred foreign currency exchange losses of $698,000. For the same period in fiscal 2005, we incurred foreign exchange losses of $410,000.
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 “Selling, general and administrative expense” in the consolidated condensed statements of income in the same period as the forecasted transactions close out over the remaining balance of their 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 occurs. These amounts are also
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recognized in “Selling, general and administrative expense” in the consolidated condensed 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 May 31, 2005 and February 28, 2005:
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
EVALUATION OF DISCLOSURE CONTROLS
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, as amended) 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 May 31, 2005 that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.
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PART II. OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the quarter ended August 31, 2003, our Board of Directors authorized us 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. During the quarter ended May 31, 2005, we did not purchase any shares. From September 1, 2003 through May 31, 2005, we have repurchased 1,563,836 shares at a total cost of $45,611,690 or an average share price of $29.17. An additional 1,436,164 shares are authorized for purchase under this plan.
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ITEM 6. EXHIBITS
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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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