10-Q 1 a2030862z10-q.txt 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 333-58233 DIAMOND BRANDS INCORPORATED (Exact name of registrant as specified in its charter) MINNESOTA 411565294 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 1800 CLOQUET AVENUE 55720 CLOQUET, MINNESOTA (Address of principal executive offices) (Zip Code) (218) 879-6700 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: None 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 to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [x] No [x] As of November 13, 2000, 1,481,258 shares of common stock of the Registrant were issued and outstanding. Of total outstanding shares of common stock on November 10, 2000, 330,266 were held of record by affiliates. There is no established public trading market for such stock. Documents incorporated by reference: None DIAMOND BRANDS INCORPORATED TABLE OF CONTENTS PART I - FINANCIAL INFORMATION ITEM - 1. Financial Statements (Unaudited) Consolidated Balance Sheets Consolidated Statements of Operations Consolidated Statements of Cash Flow Notes to Consolidated Financial Statements ITEM - 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ITEM - 3. Quantitative and Qualitative Disclosures about Market Risk PART II - OTHER INFORMATION ITEM - 6. Exhibits and Reports on Form 8-K SIGNATURE DIAMOND BRANDS INCORPORATED Consolidated Balance Sheets (Unaudited) (In Thousands, Except Share and Per Share Amounts)

The accompanying notes are an integral part of these consolidated balance sheets. DIAMOND BRANDS INCORPORATED Consolidated Statements of Operations (Unaudited) (In Thousands)

The accompanying notes are an integral part of these consolidated financial statements. DIAMOND BRANDS INCORPORATED Consolidated Statements of Cash Flows (Unaudited) (In Thousands)

The accompanying notes are an integral part of these consolidated financial statements. DIAMOND BRANDS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The accompanying consolidated financial statements include the accounts of Diamond Brands Incorporated ("Holdings") and its wholly owned subsidiary, Diamond Brands Operating Corp. ("Operating Corp") and Operating Corp.'s wholly owned subsidiaries, Forster Inc. and Empire Candle, Inc. (Empire) after elimination of all material intercompany balances and transactions. Holdings and Operating Corp. are collectively referred to as "the Company". The consolidated financial statements have been restated to reflect the candle operation as a discontinued operation as further discussed in Note 2. The Company is a leading manufacturer and marketer of a broad range of consumer products including wooden matches, toothpicks, clothespins and wooden crafts and plastic cutlery and straws. The Company's products are marketed primarily in the United States and Canada under the nationally recognized Diamond and Forster brand names. The interim consolidated financial statements of the Company are unaudited; however, in the opinion of management, all adjustments necessary for a fair presentation of such consolidated financial statements have been reflected in the interim periods presented. The significant accounting policies and certain financial information which are normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States, but which are not required for interim reporting purposes, have been condensed or omitted. The accompanying consolidated financial statements of the Company should be read in conjunction with the consolidated financial statements and related notes included in the Company's Annual Report on Form 10-K. 2. DISCONTINUED OPERATIONS Effective September 30, 1999, the board of directors of the Company approved the divestiture of the candle operations of the Company and recorded a total charge for the loss from discontinued operations of approximately $18,500,000, net of tax. For segment reporting purposes, the candle operations were previously reported as the candles reportable segment. On December 14, 1999, the Company entered into an agreement to sell the net assets of Empire, which was included in the candle operations. The agreement provided for the sale of certain assets and liabilities of Empire for a total consideration of approximately $2,900,000. The sale resulted in a decrease of the net loss on disposal of discontinued operations of $2,300,000, net of tax, during the fourth quarter of 1999. On November 1, 2000, the former owner of the candle operation was awarded a judgement against Empire Candle, Inc. stemming from legal action regarding certain inventory. For the period ended September 30, 2000, $795,000, net of tax, was charged to discontinued operations to reflect this judgement and additional deductions. Net sales from discontinued operations were $0 and approximately $14,400,000 for the nine months ended September 30, 2000 and 1999, respectively 3. LONG TERM DEBT The Company's existing senior credit agreement contains financial covenants. As of September 30, 2000, the Company was not in compliance with the financial covenants contained in the senior credit agreement. However, the Company obtained a temporary waiver for non-compliance with such financial covenants on October 13, 2000. The temporary waiver extends through March 31, 2001 and contains temporary financial covenants for the quarters ending September 30, 2000 and December 31, 2000. The Company will be allowed to continue to borrow under its senior credit agreement during the waiver period so long the Company remains in compliance with its temporary financial covenants and satisfies other customary conditions. As of September 30, 2000, the Company was in compliance with all of the temporary covenants contained in the waiver. In order to continue borrowing under the senior credit facility after March 31, 2001, the Company must obtain another waiver prior to March 31, 2001. Because another waiver is required in order to extend the existing waiver past March 31, 2001, the Company has classified the Company's obligations under the senior credit agreement as current liabilities on the accompanying September 30, 2000 Consolidated Balance Sheet. See further discussion in the Liquidity and Capital Resources section of Management's Discussion and Analysis. On April 26, 2000, certain shareholders made a $9.425 million 12 7/8% bridge loan to the Company. The proceeds were used to retire $45 million face value, $31.1 million accreted value, senior discount debentures on April 27, 2000. Effective June 2, 2000, the bridge loan plus accrued interest was exchanged for $9.549 million of 12-7/8% convertible debt (See Note 6). 4. INCOME TAXES Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The deferred tax assets arise primarily due to net operating loss carryforwards expiring in various years through 2019. The Company believes the deferred tax assets will be realizable through future profitable operations. 5. SEGMENT REPORTING In 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." The Company has one reportable segment, consumer products, after the sale of the Company's candle operations (see Note 2). The consumer product segment consists of plastic cutlery and straws, matches, toothpicks, clothespins, wooden crafts and various woodenware items sold primarily to grocery, mass and drug store channels. Detailed revenue by product sold was as follows for the nine months ended September 30 (in thousands):

6. EXTRAORDINARY ITEM As discussed in Note 3, certain shareholders made a $9.425 million 12 7/8% bridge loan to the Company with the proceeds used to retire $45 million face value, $31.1 million accreted value, senior discount debentures. The transaction was completed on April 27, 2000, and is presented as an extraordinary gain from extinguishment of debt, net of income taxes of $8.3 million, of $12.4 million in the related consolidated statements of operations. 7. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement requires the recognition of derivative instruments as assets and liabilities, based on their fair value, and specifies certain methods for the recognition of related gains and losses. In June 2000, the FASB issued SFAS No. 138, which amends and clarifies certain guidance in SFAS No. 133. Diamond is in the process of implementing the appropriate process to adopt these statements effective January 1, 2001. Currently, Diamond does not anticipate the adoption to materially impact its result of operations. DIAMOND BRANDS INCORPORATED ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. RESULTS OF CONTINUING OPERATIONS The Company manufactures and markets consumer products, consisting primarily of plastic cutlery/straws, wooden matches, toothpicks, clothespins and wooden crafts. The Company's products are marketed primarily under the nationally recognized Diamond and Forster brand names, which have been in existence since 1881 and 1887, respectively. The Company derives its revenue primarily from the sale of its products to substantially all major grocery stores, drug stores, mass merchandisers and warehouse clubs in the United States. During the nine months ended September 30, 2000, sales to the Company's top 10 customers accounted for approximately 49.5% of the Company's gross sales, with one customer accounting for approximately 20.5% of the Company's gross sales. The following table sets forth, for the period indicated, certain historical statements of operations data, as well as the Company's EBITDA and EBITDA margin, for the continuing operations of the Company, with 1999 comparable results of continuing operations restated to exclude discontinued operations. THREE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 1999

(1) Excludes amortization of deferred financing costs. (2) EBITDA represents operating income plus depreciation and amortization (excluding amortization of deferred financing costs). The Company believes that EBITDA provides useful information regarding the Company's ability to service its debt; however, EBITDA does not represent cash flow from operations as defined by generally accepted accounting principles and should not be considered as a substitute for net income as an indicator of the Company's operating performance or cash flow as a measure of liquidity (3) EBITDA margin represents EBITDA as a percentage of net sales. Net sales were $73.0 million for the nine months ended September 30, 2000, a $3.1 million or 4.1% decrease from net sales of $76.1 million for the nine months ended September 30, 1999. Net sales of plastic cutlery/straws increased 7.2%, but were offset by 10.9% decreased net sales in all other product lines, including wooden lights and other woodenware products. Gross profit was $22.6 million or 31.0% of net sales for the nine months ended September 30, 2000, compared to $29.0 million or 38.1% for the comparable 1999 period. Lower sales volume and increased raw material costs cause the lower gross profit. Rising polystyrene costs, the primary plastic cutlery component, as well as increased packaging costs adversely impacted gross margins. Selling, general and administrative expenses were $9.2 million for the nine months ended September 30, 2000, compared to $9.2 million for the comparable 1999 period. Interest expense for the nine months ended September 30, 2000 was $18.0 million compared to $18.8 million for the comparable 1999 period. Interest expense decreased primarily due to lower interest expense associated with the retirement of $45 million face value discounted bonds with $9.5 million convertible debt. See Notes 3 and 5 in Notes to Consolidated Financial Statements. RESULTS FROM DISCONTINUED OPERATIONS On November 1, 2000, the former owner of the candle operation was awarded a judgement against Empire Candle, Inc. stemming from legal action regarding certain inventory. For the period ended September 30, 2000, $795,000, net of tax, was charged to discontinued operations to reflect this judgement and additional deductions. EXTRAORDINARY ITEM Certain shareholders made a $9.425 million 12 7/8% bridge loan to the Company with the proceeds used to retire $45 million face value, $31.1 million accreted value, senior discount debentures. The transaction was completed on April 27, 2000, and is presented as an extraordinary gain from extinguishment of debt, net of income taxes of $8.3 million, of $12.4 million in the related consolidated statements of operations. See Notes 3 and 5 in Notes to Consolidated Financial Statements. LIQUIDITY AND CAPITAL RESOURCES The Company's existing senior credit agreement contains financial covenants. As of September 30, 2000, the Company was not in compliance with the financial covenants contained in the senior credit agreement. However, the Company obtained a temporary waiver for non-compliance with such financial covenants on October 13, 2000. The temporary waiver extends through March 31, 2001 and contains temporary financial covenants for the quarters ending September 30, 2000 and December 31, 2000. The Company will be allowed to continue to borrow under its senior credit agreement during the waiver period so long as the Company remains in compliance with its temporary financial covenants and satisfies other customary conditions. As of September 30, 2000, the Company was in compliance with all of the temporary covenants contained in the waiver. In order to continue borrowing under the senior credit facility after March 31, 2001, we must obtain another waiver prior to March 31, 2001. Because another waiver is required in order to extend the existing waiver past March 31, 2001, we have classified the Company's obligations under the senior credit agreement as current liabilities on the accompanying September 30, 2000 Consolidated Balance Sheet. We cannot provide any assurances that we will be successful in negotiating additional waivers or amendments to our senior credit agreement. If we fail to obtain additional waivers or amendments, and cannot refinance the existing senior credit facility or secure an additional source of liquidity, the indebtedness under our senior credit facility may become due and our financial condition and results of operation may be materially adversely affected. The Company has been advised by its independent public accountants that unless additional waivers or amendments are obtained prior to December 31, 2000, the auditor's report on those financial statements may contain qualifications. The Company is highly leveraged. The Company's high degree of leverage may have important consequences for the Company, including that (i) the ability of the Company to obtain additional financing, if necessary, for working capital, capital expenditures, acquisitions or other purposes may be impaired, or such financing may not be available on terms favorable to the Company; (ii) a substantial portion of the Company's cash flow will be used to pay the Company's interest expense and, in the cases of indebtedness incurred in the future, possible principal repayments, which will reduce the funds that would otherwise be available to the Company for its operations and future business opportunities; (iii) a substantial decrease in net operating cash flows or an increase in expenses of the Company could make it difficult for the Company to meet its debt service requirements and force it to modify its operations; (iv) the Company may be more highly leveraged than its competitors, which may place it at a competitive disadvantage; and (v) the Company's high degree of leverage may make it more vulnerable to a downturn in its business, the general economy or interest rate increases. Any inability of the Company to service its indebtedness or to obtain additional financing, as needed, would have a material adverse effect on the Company's business. CASH FLOW - OPERATING ACTIVITIES. Cash provided by operating activities was $3.3 million for the nine months ended September 30, 2000. Cash provided by operating activities was $4.0 million for the comparable 1999 period. Cash used for inventory and accounts payable was $7.3 million higher while cash provided by accounts receivable and other accrued expenses was $8.1 million higher. CASH FLOW - INVESTMENT ACTIVITIES. Capital expenditures of $4.6 million for the nine months ended September 30, 2000, were primarily used to expand capacity at the cutlery plant. Planned capital expenditures for 2000 are $3.2 million. Capital expenditures for the comparable period in 1999 were $2.9 million. CASH FLOW - FINANCING ACTIVITIES. Cash provided by financing activities was $1.2 million for the nine months ended September 30, 2000, as compared to cash used for financing activities of $1.0 million for the same period in 1999. Line of credit net borrowings were $5.05 million for the nine months ended September 30, 2000, compared to 1999 nine months net borrowings of $1.25 million. CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 This document contains statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. When used in this document, the words "anticipates," "plans," "believes," "estimates," "expects," and similar expressions are intended to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, but are not limited to: the Company's highly leveraged capital structure, its substantial principal repayment obligations, price and product changes and promotional activity by competitors, the loss of a significant customer, the difficulties of integrating acquisitions, adverse publicity and product liability claims and dependence on key employees. The risk factors described herein could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements of the Company and investors, therefore, should not place undue reliance on any such forward-looking statements. Further, any forward-looking statement speaks only as of the date on which such statement is made, and the Company undertakes no obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for management to predict all such factors. Further, management cannot assess the impact of each such factor on the Company's business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There were no material changes in reported market risks since December 31, 1999. See discussion at Item 7a in the Company's annual report on Form 10-K. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a. Exhibits Exhibit No. 10.1 Amendment No. 2 to credit agreement dated April 21, 1998. 27 Financial data schedule worksheet b. Reports on Form 8-K No reports on Form 8-K were filed by the Company during the quarter ended September 30, 2000. SIGNATURE 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. DIAMOND BRANDS INCORPORATED (Registrant) By:/s/ William L. Olson ------------------------------------------------------- William L. Olson, Vice President of Finance (authorized officer, principal financial and accounting officer) Date: November 13, 2000 -----------------

DIAMOND BRANDS INC 10-Q