ITEM 1. BUSINESS
General
The Company believes it is one of the leading suppliers of specialty plumbing, floor and surface protection and other hardware products to the repair and remodeling market in the United States. The Company also distributes its products in non-U.S. countries through its operations based in Asia, primarily to wholesale distributors, industrial and original equipment manufacturer (“O.E.M.”) customers. The Company distributes its products to approximately 700 customers, including a wide variety of large national and regional retailers, independent retail customers and wholesalers. The Company’s consolidated net sales were $67.1 million in fiscal 2003.
The Company conducts its business primarily through its wholly-owned subsidiaries, Waxman Consumer Products Group Inc. (“Consumer Products”), WAMI Sales, Inc. (“WAMI Sales”) and TWI, International, Inc. Consumer Products, the Company’s largest operation, is a supplier of specialty plumbing, floor and surface protection and other hardware products to a wide variety of large retailers. WAMI Sales distributes galvanized, black, chrome and brass pipe nipples and fittings to industrial and wholesale distributors. TWI, International, Inc. includes TWI International Taiwan Inc. and its sales operation, TWI Industrial, Inc. (collectively, “TWI”), located primarily in Taiwan, and CWI International China, Ltd. (“CWI”), located in Mainland China. TWI and CWI manufacture, package, source and assemble products purchased by Consumer Products and non-affiliated businesses. Approximately 36% of Consumer Products’ purchases are from TWI or CWI. The Company’s non-intercompany sales are classified into two segments; (i) retail sales, which are made to the Company’s base of retail store customers and (ii) industrial sales, which are made to industrial supply distributors, O.E.M.’s and other wholesale trade businesses.
Until March 31, 2001, the Company also supplied plumbing and hardware products to hardware stores and smaller independent retailers through Medal of Pennsylvania, Inc. (“Medal,” formerly known as WOC Inc. (“WOC”)), when substantially all of the assets and certain liabilities of this business were sold (see Note 5). Until its sale on September 29, 2000, the Company owned 44.2% of Barnett, a direct marketer and distributor of an extensive line of plumbing, electrical, hardware and security hardware products. The Company recorded equity earnings from this investment of $1.4 million for the first fiscal quarter ended September 30, 2000. The Company did not report equity earnings thereafter, due to the sale of its ownership interest in Barnett. See the “Business – Comprehensive Financial Restructuring Plan” section, the “Management’s Discussion and Analysis – Significant Developments - Prior Strategic and Restructuring Developments” section and Notes 2 and 3 of the Notes to
Consolidated Financial Statements in this Form 10-K for information regarding the sale of the Company’s interest in Barnett.
Forward-Looking Statements
Statements that are not historical facts, including statements about our confidence in our prospects and strategies and our expectations about growth of existing markets and our ability to expand into new markets and to attract new sources of financing, are forward-looking statements that involve risk and uncertainties. In addition to statements which are forward-looking by reason of context, the words “anticipate,” “believe,” “continue,” “design,” “estimate,” “expect,” “intend,” “goal,” “may,” “objective,” “optimistic,” “should,” “will,” and other similar expressions identify forward-looking statements. In light of the risks and uncertainties inherent in all future projections, the inclusion of forward-looking statements should not be regarded as a representation by us or any other person that our objectives or plans will be achieved. Many factors could cause our actual results to differ materially and adversely from those in the forward-looking statements, including the following:
• the continuity of business relationships with major customers and a high concentration of business with several customers • the competitive nature of other suppliers in our business and pricing pressure from retailers and other customers • the limited ability to push pricing pressure from customers through to our vendors or absorb these pressures within our own operations • the ability of the Company to expand into new markets, attract new customers and develop new products, including access to sufficient working capital to fund such actions • any large or unusual cash outlay that would strain our relatively modest positive operating cash flow and available financing • the effect of competition by businesses developing sourcing or manufacturing operations in Asia and other low cost markets • our ability to continue to meet the terms of our debt and bank credit facilities which include certain financial covenants and other restrictions • a continuation of the economic slowdown in the domestic retail economy and / or financial failure, closure or sale of one of our larger customers • the effect on our international operations of unexpected changes in regulatory requirements, export restrictions, currency controls, tariffs and other trade barriers, difficulties in staffing and managing foreign operations, political and economic instability, fluctuations in currency exchange rates and potential adverse tax consequences • a significant amount of product is purchased from our own operations in Asia, which could cause temporary supply problems if the ability for those operations to provide product were impaired • the effect of any interruption in supply of material, including any work slowdowns such as the one caused by the Longshoreman’s strike earlier this fiscal year
You must consider these risks and others that are detailed in this Form 10-K in deciding whether to invest and in assessing any existing investment in the Company.
Comprehensive Financial Restructuring Plan
In fiscal 2001, the Company completed its comprehensive financial restructuring plan (See Note 3 of the Notes to Consolidated Financial Statements in this Form 10-K), disposing of 7,186,530 shares of Barnett Common Stock and using the $94.5 million in proceeds as follows:
| - | paid or reserved for payment approximately $1.35 million for state and federal taxes associated with the sale of the Barnett shares. | ||
| - | reduced its borrowings under its working capital credit facility by approximately $10.0 million. | ||
| - | retired all of its approximately $35.9 million principal amount of 11 1/8% Senior Notes due 2001 (the “Senior Notes”) of Waxman USA Inc., a direct wholly-owned subsidiary of the Company, plus accrued interest. | ||
| - | paid approximately $6.0 million in semi-annual interest due on June 1, 2000 to the holders of the Company’s 12 3/4% Senior Secured Deferred Coupon Notes due 2004 (the “Deferred Coupon Notes”). | ||
| - | funded a dedicated account with the remaining gross proceeds of approximately $39.0 million, which was used for the full satisfaction of the Deferred Coupon Notes, including accrued interest, upon confirmation of the Joint Plan (as defined below). |
The sale of the Barnett Common Stock and payments outlined above were made subsequent to the Company and an ad hoc committee representing a controlling portion of the Deferred Coupon Notes and Senior Notes developing a jointly sponsored, prepackaged plan of reorganization in advance of its filing with the United States Bankruptcy Court (the “Joint Plan”). The Joint
Plan received the approval of the holders of approximately 97% of the Deferred Coupon Notes. Under the Joint Plan, the holders of the Deferred Coupon Notes were the only impaired class of creditors; none of the Company’s operating subsidiaries or operating divisions were included in the filing and they paid their trade creditors, employees and other liabilities under normal conditions. On October 2, 2000, the Company filed a petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code in the United States Court for the District of Delaware. On November 14, 2000, the Company’s Joint Plan was approved by the Court and on March 14, 2001, the Court closed the Chapter 11 case, and the Company emerged from bankruptcy.
Consumer Products
Consumer Products actively markets and distributes approximately 2,900 products to a wide variety of retailers, primarily mass merchandisers, do-it-yourself (“D-I-Y”) warehouse home centers and home improvement centers. Consumer Products’ customers include large national retailers such as Wal-Mart, Lowe’s, Kmart and Sears, as well as several regional D-I-Y retailers such as Meijers, Fred Meyers and Menards. Consumer Products works closely with its customers to develop comprehensive marketing and merchandising programs designed to improve their profitability, efficiently manage shelf space, reduce inventory levels and maximize floor stock turnover. Consumer Products also offers certain of its customers the option of private label programs and direct import programs. Consumer Products’ net sales for fiscal 2003 were $36.3 million, excluding direct import sales.
In recent years, the rapid growth of large mass merchandisers and D-I-Y retailers has contributed to a significant consolidation of the United States retail industry and the formation of large, dominant, product specific and multi-category retailers. These retailers demand suppliers who can offer a broad range of quality products and can provide strong marketing and merchandising support. Due to the consolidation in the retail industry, a substantial portion of Consumer Products’ net sales are generated by a small number of customers. Sales to Consumer Products’ larger customers for fiscal 2003, 2002 and 2001, respectively, were as follows; Wal-Mart accounted for 34.0%, 29.0% and 25.0%; Lowe’s accounted for 20.9%, 16.1% and 8.4%; and Kmart accounted for 3.7%, 13.6% and 11.3%. The retail industry consolidation has resulted in the cessation of business for a number of weaker organizations over the past several years, including some companies served by Consumer Products. In January 2002, Kmart filed for Chapter 11 bankruptcy protection. The Company had adequate reserves to account for any loss on its accounts receivable at the time of Kmart’s Chapter 11 filing. The Company continued to provide Kmart with approximately $1.2 million in floor and surface protection products in fiscal 2003. The Company is working to expand its sales to Kmart to include some products in plumbing repair, a program that ended in June 2002.
During fiscal 2003, the Company replaced a majority of the net sales reduction due to the loss of the Kmart plumbing repair revenue base. It has also reduced its cost structure, where possible, for the loss of this program, but believes that it may not be appropriate to diminish its infrastructure beyond a level that best supports all of its retail customers and the additional business being developed. The Company expects that programs with other retailers will continue to offset the loss of the Kmart business. In the event Consumer Products were to further lose any of its larger retail accounts as a customer or one of its larger accounts were to significantly curtail its purchases from Consumer Products, there would be material short-term adverse effects until the Company could further modify Consumer Products’ cost structure to be more in line with its anticipated revenue base. Consumer Products would likely incur significant charges if a materially adverse change in its customer relationships were to occur.
Consumer Products utilizes a modern and efficient national distribution center in Groveport, Ohio, a suburb of Columbus, where it uses radio frequency technology to manage its inventory systems in a virtually paperless environment. The Company believes that this system is important in meeting its customers requirements and in maintaining a cost efficient environment that allows it to remain competitive.
Consumer Products’ marketing strategy includes offering mass merchandisers and D-I-Y retailers a comprehensive merchandising program, which includes design, layout and setup of selling areas. Sales and service personnel assist the retailer in determining the proper product mix in addition to designing category layouts to effectively display products and optimally utilize available floor and shelf space. Consumer Products supplies point-of-purchase displays for both bulk and packaged products, including color-coded product category signs and color-coordinated bin labels to help identify products and backup tags to identify products that require reordering. Consumer Products also offers certain of its customers the option of private label programs for their plumbing and floor care products. In-house design, assembly and packaging capabilities enable Consumer Products to react quickly and effectively to service its customers’ changing needs. Consumer Products’ products are packaged and designed for ease of use, with “how to” instructions to simplify installation, even for the uninitiated D-I-Y consumer. In addition, Consumer Products has sophisticated EDI capabilities, enabling customers to minimize inventory levels and increase return on investment.
In the past several years, certain retailers have begun to develop direct import programs to improve their profitability. Those retailers generally select certain product categories and import full containers of such products to their domestic
distribution centers. Consumer Products has responded to this trend by working with the Company’s foreign sourcing operations to provide the products, while Consumer Products provides certain value added services, such as account management, selling and marketing support and customer service. Due to the sharing of responsibilities in servicing the domestic retail accounts, profits are shared by Consumer Products and the foreign operation. The direct shipment arrangement generally results in lower gross profit margins for the Company, but also results in lower selling, general and administrative costs.
Products
The following is a discussion of Consumer Products’ principal product groups:
Plumbing Products. Consumer Products’ plumbing repair products include toilet repair, sink and faucet repair, water supply repair, drain repair, shower and bath repair, hose and pipe repair, and connection repair. Consumer Products also offers proprietary lines of faucets under the trade name AquaLife® and a line of shower and bath accessories under the proprietary trade names Spray Sensations®, Body Moods® and distinctives™. Consumer Products’ product line also includes a full line of valves and fittings, rubber products and tubular products such as traps and elbows. Many of Consumer Products’ plumbing products are sold under the proprietary trade name Plumbcraft®. In addition, Consumer Products offers certain of its customers the option of private label programs.
Floor and Surface Protective Hardware Products. Consumer Products’ floor and surface protective hardware products include casters, doorstops, and other floor, furniture, felt and rubber surface protective and wall protective items. Consumer Products markets a complete line of floor and surface protective hardware products under the proprietary trade names SoftTouch®, SuperSliders® and EZSliders™ and also under private labels.
New Product and Packaging Introductions. In recent years, as the consolidation in the United States retail industry has accelerated, decreasing the number of potential customers in the Company’s traditional market, the Company has placed an emphasis on new product development, product line extensions and the redesign of existing products and packaging concepts to allow it to diversify its product offerings to its existing customers and to enable it to penetrate new customer categories. Consumer Products has several new product and new packaging initiatives planned.
In the shower category, Consumer Products has repackaged and re-named its shower product line with eye catching graphics targeted to the female consumer. In addition, new shower products with the features and functions desired most by consumers have been added. Consumer Products has also developed a new line of luxury shower products targeted for placement in home stores and with mass merchandisers. This line has product features with designer packaging that will command premium yet affordable pricing.
EZ Mount™, a unique self adhering, non marking, reusable product that sticks on any surface, was launched in the fall of 2002. This exciting new product line with dozens of decorating, mounting and communications uses, has specifically been targeted for office supply stores, mass merchandisers, home center stores and specialty toy stores.
EZ Caster™ is a unique self stick caster that requires no tools for installation and has a locking mechanism that is designed to fit a number of surfaces and will not scratch hardwood or vinyl floors. EZ Caster™ is targeted for placement in office supply stores, mass merchandisers, and other D-I-Y retailers. The Company expects to test the product in selected retailers over the next 12 to 18 months.
Other Domestic Operations
WAMI Sales
WAMI Sales distributes pipe nipples, fittings and other products to industrial supply and wholesale operations throughout the United States and, to a lesser extent, Canada. It distributes approximately 2,000 products to approximately 560 customers through its own sales force and through outside sales representative organizations. WAMI Sales utilizes foreign suppliers, principally from Asia, to supply the products it distributes. WAMI Sales’ net sales amounted to $3.2 million in fiscal 2003.
Medal
Prior to its sale effective March 31, 2001, Medal was a supplier of hardware and plumbing products to approximately 600 independent hardware stores and small independent retailers within a 250 mile radius of its facility in Sharon, Pennsylvania. Medal was formerly a division of WOC Inc., which also included U.S. Lock, a full line supplier of security hardware products,
until its sale on January 1, 1999. In fiscal 2001, WOC was renamed Medal of Pennsylvania, Inc. to reflect its only remaining operation. Medal’s net sales amounted to $3.4 million for the nine-month period it operated in fiscal 2001.
Foreign Operations
The Company conducts its foreign operations through TWI, International, Inc. including TWI in Taiwan and CWI in Mainland China. TWI and CWI manufacture, package, source and assemble product purchased by Consumer Products and non-affiliated businesses. These businesses were initially established to support Consumer Products and other operations of the Company, but have developed their own base of customers, which now represent approximately 41.1% of the Company’s consolidated net sales. TWI and Consumer Products have also responded to the increasing interest by certain retailers in direct import programs, with the added benefit of domestic account management. For the years ended June 30, 2003, 2002 and 2001, products purchased from the foreign operations accounted for approximately 17.4%, 15.9% and 15.1%, respectively, of the total product purchases made by the Company. For fiscal 2003, the combined foreign operations had net sales of $35.4 million, of which $7.8 million were intercompany transactions, which are eliminated in consolidation. In fiscal 2003, 2002 and 2001, approximately $10.6 million, $13.1 million and $16.6 million, respectively, of the Company’s industrial sales were to Barnett. However, the Company has made significant progress in recent years in its effort to develop the industrial customer base served by its foreign operations.
The Company believes that these foreign facilities provide a competitive advantage in terms of cost and flexibility in sourcing. Both labor and physical plant costs are significantly below those in the United States. Substantially all of the other products purchased by the Company are manufactured by unrelated third parties. The Company estimates that it purchases products and materials from approximately 340 suppliers and is not dependent on any single unaffiliated supplier for a material portion of its requirements.
Principal Product Groups
The following table sets forth the approximate percentage of net sales attributable to the Company’s principal product groups.
| 2003 | 2002 | 2001 | ||||||||||
Plumbing |
70 | % | 72 | % | 77 | % | ||||||
Hardware |
30 | % | 28 | % | 23 | % | ||||||
Total net sales |
100 | % | 100 | % | 100 | % | ||||||
Import Restrictions and Customs Issues
Under current United States government regulations, some products manufactured offshore are subject to import restrictions. The Company currently imports goods from China and Taiwan. When the Company chooses to directly import goods purchased outside of the United States, the Company may be subject to import quota restrictions, depending on the country of origin of assembly. If the Company cannot obtain the necessary quota, the Company will not be able to import the goods into the United States. These restrictions may limit the amount of goods from a particular country that may be imported into the United States or increase the cost of goods being imported into this country. In fiscal 2002, the United States imposed a 15% tariff on many imported products made of steel, including products imported by WAMI Sales. This tariff has increased the cost structure of this business. Export visas for the goods purchased offshore by the Company are readily available. As indicated above, many of the Company’s imported goods are of Chinese origin, which was granted most favored nation status in the spring of 2000. There is no guarantee this will continue to be the case in the future.
In the fiscal 2003 fourth quarter, the United States Commerce Department issued a preliminary report on anti-dumping duties that they recommend be imposed on malleable fittings from specific suppliers in Asia. A final report is expected to be issued in October or November 2003. The Company purchases some of its malleable fittings from one of the suppliers listed in the report, which could raise cost of these products by the recommended increase from a 6% duty to a 13.5% duty. The range of anti-dumping duty increases sought by the Commerce Department is different for each supplier, but ranges from a low of 13.5% to 144%. It is not possible to evaluate the impact of this potential action until the ruling and amounts are final and the Company evaluates the opportunity to minimize the impact of this price increase by passing along all or a portion of the potential price increase to customers.
Equity Investment - Barnett Affiliate
Until September 29, 2000, the Company held an equity interest in Barnett, a direct marketer and distributor of an extensive line of plumbing, electrical, hardware and security hardware products to professional contractors, independent hardware stores,
maintenance managers, liquid propane gas dealers and locksmiths throughout the United States. The Company owned 100% of Barnett prior to an initial public offering in April 1996. A secondary offering in April 1997 reduced the Company’s ownership interest to approximately 44.4% of the Barnett Common Stock. In July 2000, the Company announced that it had reached an agreement to monetize its Barnett Common Stock for $13.15 per share as part of the purchase of all of Barnett’s outstanding shares by Wilmar Industries, Inc. (the “Barnett Merger”). In September 2000, the remaining 7,186,530 shares of Barnett Common Stock were used to raise $94.5 million in proceeds as part of the Company’s comprehensive financial restructuring plan. The Company’s equity investment in Barnett amounted to $44.3 million immediately prior to the sale, including equity earnings recognized by the Company in the quarter ended September 30, 2000 of $1.4 million. The Company reported a net gain on the sale of Barnett of $47.5 million, after the write-off of $2.7 million in transaction related costs and other costs associated with the comprehensive financial restructuring of the Company. In addition, the Company recognized $7.8 million in deferred gain on the sale of U.S. Lock in fiscal 2001, which was being recognized as Barnett amortized the goodwill associated with its purchase of U.S. Lock.
Competition
The Company faces significant competition within each of its product lines, although it has no competitor offering the range of products in all of the product lines that the Company offers. The Company believes that its buying power, extensive inventory, use of technology, emphasis on customer service and merchandising programs have contributed to its ability to compete successfully in its various markets. The Company faces significant competition from smaller companies which specialize in particular types of products and larger companies which manufacture their own products and have greater financial resources than the Company. The Company believes that competition in sales to retailers is primarily based on price, product quality and selection, as well as customer service, which includes speed of responses for packaging, delivery and merchandising for retailers.
Employees
As of June 30, 2003, the Company employed 437 persons, 131 of whom were clerical and administrative personnel, 83 of whom were sales and service representatives and 223 of whom were either production or warehouse personnel. None of the Company’s employees are represented by collective bargaining units. The Company considers its relations with its employees to be satisfactory.
Trademarks
Several of the trademarks and trade names used by the Company are considered to have significant value in its business. See “Business – Consumer Products – Products.”
Environmental Regulations
The Company is subject to certain federal, state and local environmental laws and regulations. The Company believes that it is in material compliance with such laws and regulations applicable to it. To the extent any subsidiaries of the Company are not in compliance with such laws and regulations, the Company, as well as such subsidiaries, may be liable for such non-compliance.
The Company and two of its indirect subsidiaries were threatened with litigation by two separate California public interest groups alleging unlawful discharge of chemicals under California’s Safe Drinking Water & Toxic Enforcement Act of 1986 (“Proposition 65”). Both public interest groups ultimately sued the Company and two of its indirect subsidiaries in different lawsuits. The Company successfully settled one action for an immaterial amount in late June 2003. The Company continues to evaluate the merits of the allegations in the second action and is contesting and vigorously defending itself in that matter. Any potential liability related to this litigation cannot be assessed at this time, as the Company is in the early stages of the proceedings.
Seasonality
The Company’s sales are generally consistent throughout its fiscal year, although the third fiscal quarter is generally weaker in sales than the other quarters.
