10-Q 1 b39492tge10-q.txt THE HOLMES GROUP, INC. 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2001 COMMISSION FILE NUMBERS: 333-44473 333-77905 THE HOLMES GROUP, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) MASSACHUSETTS 04-2768914 (STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) ONE HOLMES WAY, MILFORD MASSACHUSETTS 01757 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) (508) 634-8050 (REGISTRANT'S TELEPHONE NUMBER) INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES [X] NO [ ] -------------------------------------------------------------------------------- Page 1 2 THE HOLMES GROUP, INC. FORM 10-Q QUARTER ENDED MARCH 31, 2001 TABLE OF CONTENTS PAGE PART I. FINANCIAL INFORMATION 3 ITEM 1. FINANCIAL STATEMENTS 3 CONSOLIDATED BALANCE SHEET AT DECEMBER 31, 2000 AND MARCH 31, 2001 (UNAUDITED) 3 CONSOLIDATED STATEMENT OF INCOME FOR THE THREE MONTHS ENDED MARCH 31, 2000 AND MARCH 31, 2001 (UNAUDITED) 4 CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 2000 AND MARCH 31, 2001 (UNAUDITED) 5 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 18 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 21 PART II. OTHER INFORMATION 22 SIGNATURES 23 -------------------------------------------------------------------------------- Page 2 3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS THE HOLMES GROUP, INC. CONSOLIDATED BALANCE SHEET (IN THOUSANDS)

The accompanying notes are an integral part of these consolidated financial statements -------------------------------------------------------------------------------- Page 3 4 THE HOLMES GROUP, INC. CONSOLIDATED STATEMENT OF INCOME (UNAUDITED) (IN THOUSANDS)

The accompanying notes are an integral part of these consolidated financial statements. -------------------------------------------------------------------------------- Page 5 6 THE HOLMES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2001 1. NATURE OF BUSINESS The Holmes Group, Inc. ("THG"), formerly known as Holmes Products Corp., along with its wholly-owned subsidiary, The Rival Company ("Rival") and its subsidiaries, acquired on February 5, 1999, designs, develops, imports and sells consumer durable goods, including fans, heaters, humidifiers, air purifiers, small kitchen electric appliances, personal care appliances, filters and accessories and lighting products, to retailers throughout the United States and Canada, and to a lesser extent, Europe, Latin America and Asia. Holmes Products (Far East) Limited ("HPFEL") and its subsidiaries manufacture, source and sell consumer durable goods, including fans, heaters and humidifiers and kitchen electrics, mainly to THG. HPFEL operates facilities in Hong Kong, Taiwan and The People's Republic of China. HPFEL is a wholly-owned subsidiary of THG. Prior to the recapitalization transaction described in Note 4, THG and HPFEL were both directly or indirectly 80%-owned subsidiaries of Asco Investments Ltd., a subsidiary of Pentland Group plc ("Pentland"). 2. BASIS OF CONSOLIDATION The accompanying unaudited financial statements include the accounts of THG and its wholly-owned subsidiaries, Rival, HPFEL, Holmes Manufacturing Corp., Holmes Air (Taiwan) Corp. and Holmes Motor Corp. The accompanying unaudited financial statements also include the accounts of Rival's direct and indirect wholly-owned subsidiaries, Bionaire International B.V., Patton Building Products, Inc. (which has subsequently been merged into Rival), Patton Electric Company, Inc. (which has subsequently been merged into Rival), Patton Electric (Hong Kong) Limited, Rival Consumer Sales Corporation, The Holmes Group Canada, Ltd., Rival de Mexico S.A. de C.V. and Waverly Products Company, Ltd. and HPFEL's wholly-owned subsidiaries, Esteem Industries Ltd., Raider Motor Corp., Dongguan Huixin Electrical Products Company, Ltd., Holmes Products (Europe) Ltd., Dongguan Holmes Products Ltd. and Dongguan Raider Motor Corp. Ltd. All significant inter-company balances and transactions have been eliminated. THG and its consolidated subsidiaries, including Rival, HPFEL and their respective subsidiaries, are referred to herein as the "Company." 3. ACQUISITION On February 5, 1999, THG completed its acquisition of Rival for an aggregate of $279.6 million, including $129.4 million cash paid in connection with a tender offer for all of the outstanding shares of Common Stock of Rival (including payments to optionees), $142.9 million to refinance Rival's outstanding debt and $7.3 million in acquisition costs. The acquisition was made utilizing cash on hand, borrowings under an amended and restated Credit Facility entered into in connection with the acquisition, the issuance of $31.3 million of senior subordinated notes and proceeds of $50.0 million from the sale of THG's common stock to investment funds affiliated with THG's majority shareholder, certain members of Holmes' management and to certain other co-investors. This acquisition has been accounted for as a purchase, and the results of operations of Rival have been included in the consolidated financial statements since the date of acquisition. The excess of the purchase price over the fair value of the net assets acquired was approximately $88.5 million and $88.7 million, before $5.6 million and $4.9 million of accumulated amortization at March 31, 2001 and December 31, 2000, respectively and is being amortized on a straight-line basis over 35 years. -------------------------------------------------------------------------------- Page 6 7 THE HOLMES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) In connection with the acquisition, THG recorded a restructuring reserve of $6.4 million as an assumed liability in accordance with EITF 95-3, "Recognition of Liabilities in Connection with a Purchase Business Combination." Management determined that certain restructuring actions would be required to effectively integrate the Rival operations into THG. These restructuring actions were comprised primarily of the elimination of certain overlapping positions within the management and support staff layers of the combined company, relocation of key home environment personnel from Kansas City, MO to Milford, MA, consolidation of the Rival Hong Kong and Canadian offices into other existing local offices, and closure of the Warrensburg, MO manufacturing facility. These actions resulted in the elimination of 216 Rival employees from a combination of the Rival Warrensburg facility and the Kansas City, Canada and Hong Kong offices. Severance for some of these employees will be paid during the remainder of fiscal 2001. Exit costs related to these restructuring plans are comprised primarily of lease exit costs for Canada and Hong Kong and facility closure and exit costs related to the Warrensburg facility. At December 31, 1999, the Hong Kong consolidation was completed resulting in exit costs of $0.1 million. The Montreal, Canada and the Warrensburg, Missouri facility closures were completed during fiscal 2000. The Warrensburg facility was sold during the first quarter of 2001 which resulted in a gain of approximately $559,000. Proceeds from the sale were approximately $1,965,000. The proceeds were received subsequent to March 31, 2001, and therefore are shown on the March 31, 2001 consolidated balance sheet as a current asset. The reserve activity for fiscal 2000 is as follows (in thousands):

The cash payments/adjustments made in fiscal 2001 primarily include the cash payments made for severance in the first quarter of 2001. Following the Rival acquisition, the Company divested two of Rival's non-core business units. On October 8, 1999, the Company sold the assets of Rival's sump and utility pump division for $11.4 million. The proceeds received for the assets exceeded the net asset values recorded by $0.7 million. On December 21, 1999, the Company sold the net assets of Rival's -------------------------------------------------------------------------------- Page 7 8 THE HOLMES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) industrial and building supply products businesses for proceeds of $9.7 million, net of contingent consideration of $2.7 million. The contingent consideration was based on certain performance metrics and actual final inventory counts. Excluding the contingent consideration, the book value of the assets sold exceeded the proceeds by $5.5 million. Due to the proximity of the transactions to the original Rival acquisition date, the net loss on these transactions of $4.7 million was recorded as an increase to goodwill. 4. RECAPITALIZATION On November 26, 1997, the Company and its stockholders consummated an agreement to perform the following: (i) the stockholders of HPFEL contributed their shares of common stock to THG in exchange for 2,750,741 shares of THG's common stock (ii) THG issued 4,718,579 shares of its common stock to outside investors and certain executive officers of the Company for approximately $15.5 million, net of related issuance costs, (iii) the Company repaid all amounts outstanding to Pentland affiliates and repaid all amounts outstanding on the Company's trade acceptances, including accrued interest, and (iv) THG redeemed 18,620,450 shares of its common stock held by Pentland for approximately $62.1 million. In connection with these transactions, THG issued $105.0 million of 9 7/8% Senior Subordinated Notes due in November 2007 and borrowed $27.5 million under a new line of credit facility. The transactions described above have been accounted for as a leveraged recapitalization of the Company. The Company has retained its historical cost basis of accounting, due to the significant minority shareholders which remained. The shares redeemed from Pentland have been recorded as treasury stock, at cost. 5. UNAUDITED INTERIM FINANCIAL STATEMENTS In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation of the Company's financial position as of March 31, 2001 and the Company's results of operations and cash flows for the three months ended March 31, 2000 and 2001. This interim financial information and notes thereto should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2000. Due to the seasonality of the Company's business, the Company's consolidated results of operations for the three month period ended March 31, 2001 are not necessarily indicative of the results to be expected for any other interim period or the entire fiscal year. 6. INVENTORIES All inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out (FIFO) method on approximately 80% of the inventories and the last-in, first-out method (LIFO) for the remaining 20% of the inventory. Inventories are as follows:

-------------------------------------------------------------------------------- Page 8 9 THE HOLMES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) 7. LONG-TERM DEBT Senior Subordinated Notes In connection with the recapitalization transactions described in Note 4 and the Rival acquisition described in Note 3, THG issued $105.0 million and $31.3 million, respectively, in senior subordinated notes, maturing on November 15, 2007 (the "Notes"). The Notes bear interest at 9 7/8%, payable semi-annually on May 15 and November 15. No principal is due until the maturity date. The Notes are subordinated to the Company's other debt, including the Credit Facility (as described below) and capital leases. The Notes are guaranteed by THG's current and future domestic subsidiaries (see Note 12) on a full, unconditional and joint and several basis, but are otherwise unsecured. THG can, at its option, redeem the Notes at any time after November 15, 2002, subject to a fixed schedule of redemption prices which declines from 104.9% to 100% of the face value. However, THG may redeem up to $43.3 million of the Notes prior to such date at a price of 109.875% of face value upon issuance of equity securities. Additionally, upon certain sales of stock or assets or a change of control of THG, THG must offer to repurchase all or a portion of the Notes at a redemption price of 101% of face value. The Notes contain certain restrictions and covenants, including limitations (based on certain financial ratios) on THG's ability to pay dividends, repurchase stock or incur additional debt (other than borrowings under the Credit Facility and other enumerated exceptions). The Notes are cross-defaulted to payment defaults under the Credit Facility. Credit Facility The Company entered into an amended and restated Credit Facility agreement in February, 1999 in connection with the Rival acquisition. The Credit Facility consisted of a tranche A term loan of $40.0 million that matures February 5, 2005, a tranche B term loan of $85.0 million that matures February 5, 2007 and a $140.0 million revolving credit facility that matures February 5,2005. Availability under the Credit Facility is reduced by outstanding letters of credit. As of March 31, 2001, the Company's availability was $31.5 million, net of outstanding letters of credit totaling $3.7 million. The Credit Facility bears interest at variable rates based on either the prime rate or eurodollar, at the Company's option, plus a margin which, in the case of the tranche A term loan and the revolving credit facility, varies depending upon certain financial ratios. The Credit Facility, and the guarantees thereof by the Company's domestic subsidiaries, are secured by substantially all of the Company's domestic and certain foreign assets. The Credit Facility is cross-defaulted to the Notes Indentures. The Company's financial performance in the fourth quarter of 2000 resulted in a default, as of December 31, 2000, of certain financial ratio covenants in the Credit Facility as previously amended. The lending group agreed to a Forbearance Agreement with respect to such defaults on April 13, 2001. On May 7, 2001, the Credit Facility was further amended to waive the defaults and to revise certain of the financial ratio covenants through June 30, 2002. In addition, the maximum revolving credit availability under the Credit Facility has been increased from $140.0 million to an aggregate of $180.0 million through January 31, 2002, decreasing to an aggregate of $155.0 million through July 1, 2002 and $115.0 million thereafter, subject to a borrowing base formula. As partial consideration for the amendments, the Company issued warrants to the lenders to acquire up to 5% of THG's common stock on a fully-diluted basis. The warrants are exercisable at a price of $5.04 per share, and expire May 7, 2006. Additionally, the majority stockholder agreed to provide a $43.5 million guarantee in support of the increased revolving credit commitment. -------------------------------------------------------------------------------- Page 9 10 THE HOLMES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) The Credit Facility as amended, and the Notes Indentures include certain financial and operating covenants, which, among other things, restrict the ability of the Company to incur additional indebtedness, grant liens, make investments and take certain other actions. The ability of the Company to meet its debt service obligations will be dependent upon the future performance of the Company, which will be impacted by general economic conditions and other factors. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Forward-Looking Statements." Long term debt consists of the following:

Effective May 7, 1999 the Company entered into an interest rate collar transaction agreement with its lending bank. The interest rate collar consists of a cap rate of 6.5% and a floor rate of 4.62%. The one-time premium payment for the collar was $225,000 and the agreement terminates March 31, 2002. Quarterly on the last business day of March, June, September and December beginning September 30, 1999 if the LIBOR interest rate at the lending bank is greater than the cap rate, the lending bank agrees to pay the Company a notional amount as described in the agreement multiplied by the number of days in that quarter over 365 days times the difference between the LIBOR rate and the cap rate. If on the other hand the LIBOR rate is less than the floor rate, the Company would have to pay the lending bank based on the same calculation. If the LIBOR rate is between the cap and floor rate, no payments would be necessary by either party. The LIBOR interest rate at March 31, 2001 was 6.44%. 8. COMPREHENSIVE INCOME The Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income." This Statement establishes standards for reporting comprehensive income and its components in financial statements. Comprehensive income consists of net earnings and foreign currency translation adjustments as presented in the following table.

-------------------------------------------------------------------------------- Page 10 11 THE HOLMES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) 9. BUSINESS SEGMENTS The Company adopted SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information" ("SFAS 131"), during 1998. SFAS 131 established standards for reporting information about business segments in annual financial statements. It also established standards for related disclosures about products and services, major customers and geographic areas. Business segments are defined as components of a business about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. The business segments are managed separately because each segment represents a strategic business unit whose main business is entirely different. The adoption of SFAS 131 did not affect the Company's results of operations or financial position. The Company currently manages its operations through three business segments: consumer durables, international and Far East. The consumer durables segment sells products including fans, heaters, humidifiers, air purifiers, Crock-Pot (R) slow cookers, toasters, ice cream freezers, can openers, showerheads, massagers, electric space heaters and lighting products to retailers throughout the U.S. The consumer durables segment is made up of home environment products and kitchen electric products, which are considered one business segment due to the similar customer base and distribution channels. The international segment sells the Company's products outside the U.S. The Far East segment is the manufacturing and sourcing operation located primarily at HPFEL. The International and Other category in 2001 represents the International segment. For 2000, the other category represented the International segment and the divested industrial and building supply segment combined as neither accounted for over 10% of net sales individually. Summary financial information for each reportable segment for the three-month periods ended March 31, 2001 and 2000 is as follows (in thousands):

The following information is summarized by geographic area (in thousands):

Net sales are grouped based on the geographic origin of the transaction. The "Other International" area is comprised of sales of products that originated in Europe, Mexico, Latin America and Canada. The Company's manufacturing entities in the Far East sell completed products to THG in the United States at intercompany transfer prices which reflect management's estimate of amounts which would be charged by an unrelated third party. These sales are eliminated in consolidation. The remaining Far East sales are to unrelated third parties. -------------------------------------------------------------------------------- Page 11 12 THE HOLMES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) 10. CONTINGENCIES The Company is involved in litigation and is the subject of claims arising in the normal course of its business. In the opinion of management, based upon discussions with legal counsel, no existing litigation or claims will have a materially adverse effect on the Company's financial position or results of operations and cash flows. 11. RECLASSIFICATIONS Certain amounts in the prior period financial statements have been reclassified to conform to the current period presentation. 12. CONDENSED CONSOLIDATING INFORMATION The senior subordinated notes described in Note 7 were issued by THG and are guaranteed by Rival and its three domestic subsidiaries and Holmes Manufacturing Corp. ("Manufacturing"), Holmes Motor Corp. ("Motor") and Holmes Air (Taiwan) Corp. ("Taiwan"), but are not guaranteed by THG's other subsidiaries, HPFEL and Holmes Air (Canada) Corp. ("Canada"), or Rival's five foreign subsidiaries. The guarantor subsidiaries are directly or indirectly wholly-owned by THG, and the guarantees are full, unconditional and joint and several. The following condensed consolidating financial information presents the financial position, results of operations and cash flows of (i) THG, as parent, as if it accounted for its subsidiaries on the equity method, (ii) Rival (on a consolidated basis following its acquisition by THG, Manufacturing, Motor and Taiwan, the guarantor subsidiaries, and (iii) HPFEL and Canada, Bionaire International B.V., The Holmes Group Canada, Ltd., Waverly Products Company, Ltd., and Rival de Mexico S.A. de C.V. the non-guarantor subsidiaries. There were no transactions between Rival, Manufacturing, Motor and Taiwan, or between HPFEL and Canada, during any of the periods presented. Taiwan had no revenues or operations during the periods presented, and Manufacturing ceased operations in March 1997. As further described in Note 15 of the Company's audited financial statements for the year ended December 31, 2000, included in the Company's Form 10-K, as amended, as filed with the Securities and Exchange Commission, certain of HPFEL's subsidiaries in China have restrictions on distributions to their parent companies. -------------------------------------------------------------------------------- Page 12 13 CONSOLIDATING BALANCE SHEET DECEMBER 31, 2000 (IN THOUSANDS)

-------------------------------------------------------------------------------- Page 13 14 CONSOLIDATING BALANCE SHEET MARCH 31, 2001 (IN THOUSANDS) (UNAUDITED)

-------------------------------------------------------------------------------- Page 14 15 CONSOLIDATING INCOME STATEMENT THREE MONTHS ENDED MARCH 31, 2000 (IN THOUSANDS) (UNAUDITED)

-------------------------------------------------------------------------------- Page 15 16 CONSOLIDATING INCOME STATEMENT THREE MONTHS ENDED MARCH 31, 2001 (IN THOUSANDS) (UNAUDITED)

-------------------------------------------------------------------------------- Page 16 17 CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS THREE MONTHS ENDED MARCH 31, 2000 AND 2001 (IN THOUSANDS) (UNAUDITED)

-------------------------------------------------------------------------------- Page 17 18 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Holmes Group, Inc. formerly known as Holmes Products Corp., is a leading developer, manufacturer and marketer of quality, branded home appliances, including home environment, small kitchen and personal care appliances. Our home environment products include fans, heaters, humidifiers and air purifiers. We believe that we have the leading U.S. market share in each of these product categories. Our kitchen appliances include Crock-Pot(R) slow cookers, can openers, ice cream freezers and other similar small kitchen electric appliances where we hold a leading market share. Our personal care products include massagers and showerheads. We believe that our strong market position and success are attributable to our continuous product innovation, engineering and manufacturing expertise, close customer partnerships, breadth of product offerings, reputation for quality, and presence and experience in the Far East. Our products are sold under the Holmes(R), Rival(R), Crock-Pot(R), White Mountain(R), Pollenex(R), Bionaire(R), Patton(R), Family Care(R) and Titan(R) brand names. These products are sold to consumers through major retail chains, including mass merchants, do-it-yourself home centers, warehouse clubs, hardware, department and specialty stores and national drug store chains. We believe that the strength, scope and visibility of our retail account base provide a competitive advantage with respect to brand recognition, access to shelf space and penetration of the consumer market. Sales of our products are highly seasonal, and counter-seasonal weather can adversely affect our results of operations. Within the home environment product line, sales of fans occur predominantly from January through June, and sales of heaters and humidifiers occur predominantly from July through December. Although kitchen appliances, personal care products and certain home environment products such as air purifiers and lighting products are used year-round, the nature of these products tend to draw increased sales during the winter months when people are indoors and, as a result, sales of these products tend to be greatest in advance of the winter months from July through December. Additionally, because many of the kitchen and personal care products we sell are given as gifts, we sell more of these products in anticipation of the holiday season. When holiday shipments are combined with seasonal products such as heaters and humidifiers, our sales during the months of August through November are generally at a higher level than during the other months of the year. In addition to the seasonal fluctuations in sales, we experience seasonality in gross profit, as margins realized on fan products tend to be lower than those realized on heater, humidifier and air purifier products. On February 5, 1999 Holmes completed its acquisition of Rival. In connection with the acquisition, as described in Note 3 of the Company's Notes to Consolidated Financial Statements included herein, we issued an additional $31.3 million of senior subordinated notes due in November 2007, bearing interest at 9 7/8%, and amended and restated our existing $100 million credit facility to have a total availability of $325 million. We also sold $50 million of common stock in a private placement to investment funds affiliated with Berkshire Partners LLC (Holmes' majority shareholder), and to members of management and certain other co-investors. The initial borrowings under the credit facility, together with the net proceeds of the equity investment and the offering of the Notes, were used to consummate the Rival acquisition, refinance Rival's then existing indebtedness, and pay the fees and expenses of the transaction. Holmes had completed a recapitalization transaction in November 1997, in which it issued $105 million of senior subordinated notes due in November 2007, bearing interest at 9 7/8%, and entered into a $100 million line of credit facility, of which approximately $27.5 million was initially drawn. The proceeds of these borrowings were used to repay all existing indebtedness (primarily a line of credit and other current debt facilities) and redeem a significant portion of the previous majority shareholder's common stock. -------------------------------------------------------------------------------- Page 18 19 Accordingly, commencing in November 1997, we had a significantly higher level of borrowing and a corresponding higher level of interest expense than in the past. The Rival acquisition and the related financing transactions consummated on February 5, 1999 further increased our indebtedness and interest expense substantially. COMPARISON OF THREE MONTH PERIODS ENDED MARCH 31, 2001 AND MARCH 31, 2000 Net Sales. Net sales for the first quarter of fiscal 2001, which ended March 31, 2001, were $127.2 million compared to $118.6 million for the first quarter of fiscal 2000, which ended March 31, 1999, an increase of $8.6 million or 7.3%. Excluding the sales related to the residual sourcing agreements for the pump and industrial businesses, which were divested in the fourth quarter of 1999, net sales increased approximately 10.2% versus the first quarter of 2000. This increase was primarily due to increased shipments of kitchen electric products over the corresponding period of 2000. International shipments also increased in the first quarter of 2001 versus the first quarter of 2000, driven by shipments in Mexico and Latin America and in the Far East. The Far East increase was due to increased sales by our motor joint venture with General Electric. Returns in the first quarter of 2001 also decreased and contributed to the net sales increase during the quarter. Sales for the divested businesses in the first quarter of 2000 were $3.2 million pursuant to supply agreements with the buyers. Gross Profit. Gross profit for the first quarter of 2001 was $33.4 million compared to $35.4 million for the first quarter of 2000, a decrease of $2.0 million or 5.7%. This was due to a higher proportion of third-party sourced items (particularly kitchen electrics), which have a lower margin, and lower in-house manufacturing of fans due to the higher carryover inventory from the cooler than anticipated 2000 summer season. Also, the retail fan shipments during the first quarter of 2001 were at lower overall margins due to the carryover inventory at higher 2000 season costs. Distribution and warehousing costs were also higher, again due to the carryover fan inventory from the 2000 summer season. We also had sales of low margin closeouts which increased sales with no gross profit impact. Lastly, discounts and allowances were slightly higher during the first quarter of 2001 versus 2000, which also negatively impacted gross margin. Selling Expenses. Selling expenses for the first quarter of 2001 were $16.2 million compared to $17.3 million for the first quarter of 2000, a decrease of $1.1 million or 6.4%. As a percentage of net sales, selling expenses decreased to 12.7% for the first quarter of 2001 from 14.6% for the first quarter of 2000. The selling expense decrease was due to a reduction in several sales and marketing expense line items such as sales samples, print and trade advertising and sales travel expenses. These reductions resulted from our continued effort to lower discretionary spending throughout the Company. General and Administrative Expenses. General and administrative expenses for the first quarter of 2001 were $8.3 million compared to $7.8 million for the first quarter of 2000, an increase of $0.5 million or 6.4%. As a percentage of net sales, general and administrative expenses decreased to 6.5% for the first quarter of 2001 from 6.6% for the first quarter of 2000. The increase in general and administrative expense was attributable to a number of factors including MIS infrastructure and legal and professional costs. Product Development Expenses. Product development expenses for the first quarter of 2001 were $2.6 million compared to $2.8 million for the first quarter of 2000, a decrease of $0.2 million or 7.1%. The expenditures in 2001, which are in line with expenditures in 2000, relate to the development of a number of new products in the home environment and kitchen product lines. Plant Closing Costs. There were no plant closing costs in the first quarter of 2001. The closing costs in 2000 were associated with the closing of the Fayetteville, North Carolina plant. Interest and Other Expense, Net. Interest and other expense, net for the first quarter of 2001 was $9.4 million compared to $9.2 million for the first quarter of 2000, an increase of $0.2 million or 2.2%. The increase in interest expense was primarily due to higher debt levels during the first quarter of 2001 versus 2000. -------------------------------------------------------------------------------- Page 19 20 Income Tax Expense (Benefit). The income tax expense for the first quarter of 2001 was $1.3 million compared to a benefit of $0.1 million in 2000. The income tax expense in 2001 was largely due to the establishment of a valuation reserve primarily against losses experienced in the U.S. and a tax expense on income taxed in foreign jurisdictions. Equity in Earnings from Joint Venture. We recorded $0.6 million in equity in earnings from our joint venture with General Electric for the shipment of motors from the Joint Venture in 2001 versus $0.1 million in 2000. Net Income. As a result of the foregoing factors, our net loss for the first quarter of 2001 was $4.4 million, compared to a net loss of $2.3 million in the first quarter of 2000. LIQUIDITY AND CAPITAL RESOURCES Analysis of Cash Flows. Following the recapitalization transaction in November 1997 and the Rival acquisition in February 1999, we have funded our liquidity requirements with cash flows from operations and borrowings under the Credit Facility. Our primary liquidity requirements are for working capital and to service our indebtedness. While there can be no assurance, we believe that existing cash resources, cash flows from operations and borrowings under the recently amended Credit Facility will be sufficient to meet our liquidity needs for the next twelve months, during which time we will continue to carefully evaluate our financing requirements. Cash provided by operations for the three months ended March 31, 2000 and 2001 was $23.1 million and $18.7 million, respectively. Cash provided by operations in the first quarter of 2001 primarily reflected a $14.4 million decrease in accounts receivable levels, as heavy cash collection activity typically follows the seasonally higher sales activity during the fourth quarter of the fiscal year. Cash used for investing for the three months ended March 31, 2000 and 2001 was $1.8 million and $4.8 million, respectively. Cash used for investing in the first quarter of 2001 reflected capital expenditures of approximately $5.3 million offset by additional cash received from our joint venture partner as part of their contribution towards joint venture capital equipment. Cash used for financing activities for the three months ended March 31, 2000 and 2001 was $25.0 million and $14.1 million, respectively. Cash used for financing in the first quarter of 2001 reflected repayments of the credit facility using cash flows from operations. Financing Arrangements. We issued $105.0 million of 9 7/8% Senior Subordinated Notes due November 2007 (the "Notes") in November 1997, and an additional $31.3 million of Notes in February, 1999. While we may repurchase Notes from time to time in open market or privately negotiated transactions, the Notes are not redeemable at our option prior to November 15, 2002. Thereafter, the Notes are subject to redemption at any time at our option, in whole or in part, at stated redemption prices. Annual interest payments on the Notes are approximately $13.5 million. The payment of principal and interest on the Notes is subordinated to the prior payment in full of all our senior debt, including borrowings under the Credit Facility. The Notes are guaranteed by our domestic subsidiaries but are otherwise unsecured. We entered into an amended and restated Credit Facility with a syndicate of banks in February, 1999 in connection with the Rival acquisition. The Credit Facility consisted of a tranche A term loan of $40.0 million that matures February 5, 2005, a tranche B term loan of $85.0 million that matures February 5, 2007 and a $140.0 million revolving credit facility that matures February 5, 2005. -------------------------------------------------------------------------------- Page 20 21 Availability under the Credit Facility is reduced by outstanding letters of credit. As of March 31, 2001, our availability was $31.5 million, net of outstanding letters of credit totaling $3.7 million. The Credit Facility bears interest at variable rates based on either the prime rate or eurodollar rate, at our option, plus a margin which, in the case of the tranche A term loan and the revolving credit facility, varies depending upon certain financial ratios. The Credit Facility, and the guarantees thereof by our domestic subsidiaries, are secured by substantially all of our domestic and certain foreign assets. The Credit Facility is cross-defaulted to the Notes Indentures. Our financial performance in the fourth quarter of 2000 resulted in a default, as of December 31, 2000, of certain financial ratio covenants in the Credit Facility as previously amended. The lending group agreed to a Forbearance Agreement with respect to such defaults on April 13, 2001. On May 7, 2001, the Credit Facility was further amended to waive the defaults and to revise certain of the financial ratio covenants through June 30, 2002. In addition, the maximum revolving credit availability under the Credit Facility has been increased from $140.0 million to an aggregate of $180.0 million through January 31, 2002, decreasing to an aggregate of $155.0 million through July 1, 2002 and $115.0 million thereafter, subject to a borrowing base formula. As partial consideration for the amendments, we issued warrants to the lenders to acquire up to 5% of Holmes' common stock on a fully-diluted basis. The warrants are exercisable at a price of $5.04 per share, and expire May 7, 2006. Additionally, Berkshire Partners LLC, our equity partners, agreed to provide a $43.5 million guarantee in support of the increased revolving credit commitment. The Credit Facility, as amended, and the Notes Indentures include certain financial and operating covenants which, among other things, restrict our ability to incur additional indebtedness, make investments and take certain other actions. Our ability to meet our debt service obligations will be dependent upon the future performance, which will be impacted by general economic conditions and other factors. See "Forward-Looking Statements." FORWARD-LOOKING STATEMENTS All statements, other than statements of historical fact, included in this quarterly report, are or may be forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Without limiting the foregoing, the words "believes," "anticipates," "plans," "intends," "expects," and similar expressions are intended to identify forward-looking statements. Various economic and competitive factors could cause actual results or events to differ materially from those discussed in such forward-looking statements, including without limitation, our degree of leverage (including the need to comply with covenants in our various financing agreements), our dependence on major customers and key personnel, the integration of the Rival acquisition (as described herein), competition, risks associated with foreign manufacturing, risks of the retail industry, potential product liability claims, the cost of labor and raw materials and the other factors which are discussed in our most recent Registration Statement on Form S-4 (File No. 333-77905), and from time to time in our reports filed with the Securities and Exchange Commission. Accordingly, such forward-looking statements do not purport to be predictions of future events or circumstances and may not be realized. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK At March 31, 2001, the carrying value of our debt totaled $353.5 million (including capital leases), which approximated its fair value. This debt includes amounts at both fixed and variable interest rates. For fixed rate debt, interest rate changes affect the fair market value but do not impact earnings or cash flows. Conversely, for variable rate debt, interest rate changes generally do not affect the fair market value but do impact earnings and cash flows, assuming other factors are held constant. At March 31, 2001, the Company had fixed rate debt of $135.2 million (including capital leases) and variable rate debt of $218.3 million. Holding other variables constant (such as foreign exchange rates and debt levels), a one percentage point decrease in interest rates would increase the unrealized fair market value of fixed rate debt by approximately $6.7 million. Based on the amounts of variable rate debt outstanding at March 31, 2001, the earnings and cash flows impact, net of taxes, for the next year resulting from a one percentage point increase in interest rates would be approximately $2.2 million, holding other variables constant. In order to help hedge our interest rate exposure, effective May 7, 1999, we entered into an interest rate collar transaction agreement with our agent bank. This arrangement is described in Note 7 of Notes to Consolidated Financial Statements. -------------------------------------------------------------------------------- Page 21 22 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS We are involved in various legal proceedings incident to our normal business operations, including product liability and patent and trademark litigation. Management believes that the outcome of such litigation will not have a material adverse effect on our business, financial condition or results of operations. We have product liability and general liability insurance policies in amounts management believes to be reasonable. There can be no assurance, however, that such insurance will be adequate to cover all potential product or other liability claims against us. We also face exposure to voluntary or mandatory product recalls in the event that our products are alleged to have manufacturing or safety defects. We do not maintain product recall insurance. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS Not applicable ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS We held a Special Meeting in lieu of an Annual Meeting of Stockholders on May 16, 2001. At the meeting, each of the following matters was approved by a vote of 17,759,583 shares of Common Stock, out of 20,336,567 shares outstanding and eligible to vote: (a) Re-election of our six incumbent directors; (b) Increasing our authorized Common Stock from 25,000,000 shares to 28,500,000 shares; and (c) Increasing the number of shares of Common Stock reserved for issuance under our 1997 Stock Option Plan from 4,260,978 shares to 4,460,978 shares. ITEM 5. OTHER INFORMATION Investor Conference Call We will hold a telephone conference call on June 12, 2001 at 2 p.m., Eastern time in order for investors and other interested stakeholders to hear management's views on our results of operations during the first quarter of 2001. If you are interested in accessing the call in listen-only mode, please fax the following information to Kay Ford, Executive Assistant, at 508-422-1676: - Name of Participant(s) - Company Affiliation - Nature of Business - Address - Phone, Fax and E-mail ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a. Exhibits: Not applicable b. Reports on Form 8-K: Not applicable -------------------------------------------------------------------------------- Page 22 23 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. THE HOLMES GROUP, INC. ------------------------------------ Registrant May 31, 2001 By: /s/ Jordan A. Kahn -------------------------------- Jordan A. Kahn, President, Chief Executive Officer (Principal Executive Officer) May 31, 2001 By: /s/ Ira B. Morgenstern -------------------------------- Ira B. Morgenstern, Chief Financial Officer (Principal Financial and Accounting Officer) -------------------------------------------------------------------------------- Page 23

HOLMES GROUP INC 10-Q