FORM 10 - Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _________
Commission File Number 0-20829
DIAMOND HOME SERVICES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 36-3886872
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
222 Church Street, Woodstock, Illinois 60098
(Address of principal executive offices, including zip code)
(815) 334-1414
(Registrant's telephone number, including area code)
-------------------------------------------------
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 ( )
The number of shares of the registrant's common stock outstanding as of
July 31, 1998, the latest practicable date, was 8,507,375 shares.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
DIAMOND HOME SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1998 1997 1998 1997
(In thousands, except per share data)
<S> <C> <C> <C> <C>
Net sales $65,615 $43,787 $94,491 $73,962
Cost of sales 41,951 24,065 58,140 40,877
Gross profit 23,664 19,722 36,351 33,085
Operating expenses:
Selling, general, and
administrative expense 21,602 18,688 33,891 31,874
Operating interest expense 68 -- 123 --
Amortization expense 274 153 434 296
Operating income 1,720 881 1,903 915
Interest expense 752 -- 752 --
Interest income and other 130 186 256 406
Income before income taxes 1,098 1,067 1,407 1,321
Income tax provision 475 416 599 515
Net income $623 $651 $808 $806
Net income per share:
Basic $0.07 $0.07 $0.09 $0.09
Diluted $0.07 $0.07 $0.09 $0.09
Weighted average number of
common shares outstanding:
Basic 8,507 9,037 8,507 9,058
Diluted 8,507 9,037 8,507 9,119
See accompanying notes.
</TABLE>
<TABLE>
DIAMOND HOME SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
<CAPTION>
June 30, 1998 December 31,
1997
(Unaudited)
(In thousands)
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents $4,061 $9,966
Accounts receivable, net 22,726 6,630
Inventories, net 17,761 --
Refundable income taxes 1,087 986
Prepaids and other current assets 2,228 1,959
Deferred income taxes 611 872
Total current assets 48,474 20,413
Finance company accounts receivable, net 10,643 8,758
Net property, plant and equipment 17,645 5,546
Intangible assets, net 37,553 16,514
Deferred income taxes 2,648 1,892
Other 9,308 3,466
Total assets $126,271 $56,589
LIABILITIES AND COMMON STOCKHOLDERS' EQUITY
Current Liabilities
Current portion of long-term debt $5,946 $ --
Due to bank 3,770 2,050
Accounts payable and accrued liabilities 23,569 10,070
Deferred revenue 1,068 --
Due to stockholders 554 554
Total current liabilities 34,907 12,674
Long-term liabilities:
Long-term debt 43,389 --
Warranty and retention 9,727 9,161
Deferred income taxes 1,094 --
Due to stockholders 256 544
Other 1,823 --
Total long-term liabilities 56,289 9,705
Common stockholders' equity 35,075 34,210
Total liabilities and common
stockholders' equity $126,271 $56,589
See accompanying notes.
</TABLE>
<TABLE>
DIAMOND HOME SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<CAPTION>
Six Months Ended
June 30
(In thousands)
1998 1997
<S> <C> <C>
Net income $808 $806
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 852 463
Deferred income taxes (495) 35
Other 134 --
Changes in operating assets and liabilities:
Accounts receivable and other assets (2,626) (996)
Inventories (455) --
Accounts payable and accrued expenses (99) (2,066)
Deferred revenues (17) --
Warranty and retention 566 912
Net cash used in operating activities (1,332) (846)
Investing activities:
Acquisition of Reeves Southeastern Corporation, net of cash acquired (30,938) --
Consumer finance loans originated, net of collections (1,885) (2,225)
Advances to "captive" insurance company and other (2,230) (512)
Capital expenditures, net (1,509) (1,660)
Net cash used in investing activities (36,562) (4,397)
Financing activities:
Advances under revolving credit agreement 500 --
Proceeds on issuance of term debt 30,000 --
Borrowings on finance company bank line of credit, net 1,720 --
Payments on notes receivable from officers for treasury stock and other 57 (525)
Payments due to stockholders (288) (260)
Net cash provided by (used in) financing activities 31,989 (785)
Net decrease in cash and cash equivalents (5,905) (6,028)
Cash and cash equivalents at beginning of period 9,966 18,928
Cash and cash equivalents at end of period $4,061 $12,954
Supplemental cash flow disclosure:
Interest paid $127 --
Income taxes paid $1,006 $90
Investing and financing activities exclude the following non-cash transactions:
Acquisition of Reeves Southeastern Corporation through notes payable $11,413 --
See accompanying notes.
</TABLE>
DIAMOND HOME SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial
statements have been prepared in accordance with generally accepted
accounting principles for interim financial information and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for
complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary
for a fair presentation have been included. Operating results for the
three-month and six-month periods ended June 30, 1998 are not necessarily
indicative of the results that may be expected for the year ending
December 31, 1998. For further information, refer to the consolidated
financial statements included in the Company's 1997 Annual Report on Form
10-K and Form 8-K/A filed May 13, 1998.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements
and accompanying notes. Actual results could differ from those estimates.
2. Consumer Financing
The following summarized condensed financial information for
Marquise Financial, the Company's finance subsidiary, is before elimination
of inter-company transactions in consolidation:
<TABLE>
June 30, December 31,
1998 1997
(Unaudited)
<S> <C> <C>
Assets:
Cash $74,000 $23,000
Financing receivables, net 10,643,000 8,758,000
Other assets 994,000 1,046,000
Total assets $11,711,000 $9,827,000
Liabilities and stockholder's equity:
Due to Bank $3,770,000 $2,050,000
Due to Diamond Exteriors, Inc. 7,550,000 7,388,000
Other 131,000 147,000
Total liabilities 11,451,000 9,585,000
Total stockholder's equity 260,000 242,000
Total liabilities and stockholder's equity $11,711,000 $9,827,000
</TABLE>
Results of operations for the three months and six months ended June 30,
1998 and 1997, respectively:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1998 1997 1998 1997
(Unaudited)
<S> <C> <C> <C> <C>
Financing income $412,000 $335,000 $787,000 $574,000
General and administrative expenses (1)
509,000 643,000 966,000 992,000
Loss before tax benefit 97,000 308,000 179,000 418,000
Income tax benefit 39,000 120,000 72,000 163,000
Net loss $58,000 $188,000 $107,000 $255,000
(1) Includes interest expense paid to Diamond Home Services, Inc. (the
"Company") and provision for credit losses.
</TABLE>
Cash flow for the six months ended June 30, 1998 and 1997, respectively:
<TABLE>
<CAPTION>
Six Months Ended June 30
1998 1997
(Unaudited)
<S> <C> <C>
Cash at beginning of period $23,000 $50,000
Net cash used in operating activities (16,000) (255,000)
Net cash used in investing activities (1,885,000) (1,944,000)
Net cash provided by financing activities 1,952,000 2,149,000
Cash at end of period $74,000 $0
At June 30, 1998, Marquise Financial had approximately $1.0 million
in approved but not funded loan commitments.
3. Acquisition
On April 20, 1998, the Company consummated the purchase of all the
outstanding and voting shares in the capital of Reeves Southeastern
Corporation ("Reeves") for an aggregate consideration of $42,900,000
consisting of: 1) $30,000,000 cash at closing; 2) $3,700,000 non-
interest bearing notes payable in installments through June 2000; 3)
$8,000,000 in 7% notes payable (to be paid into an escrow account for
future possible environmental expenses, as defined) in installments through
June 2005; and 4) $1,500,000 in transaction costs (the "Acquisition"). In
connection with the Acquisition, the Company replaced its $15 million
unsecured bank line of credit with a $45 million secured bank line of
credit.
Based on the terms of the transaction, the acquisition is accounted
for as a purchase, in accordance with Accounting Principles Board Opinion
No. 16 ("APB No. 16"). Accordingly, the accompanying condensed
consolidated statements of income include Reeves' results of operations
since the date of acquisition. The Company revalued the basis of Reeves'
acquired assets and assumed liabilities to fair value at the date of
purchase. The purchase price of Reeves is calculated as the cash plus fair
value of notes paid plus the Company's transaction costs. The difference
between the purchase price and the fair value of identifiable tangible and
intangible assets acquired and the liabilities assumed and incurred is
recorded as goodwill and will be amortized over a period of 40 years. The
Company has not completed its valuation of the Reeves acquisition and the
purchase price allocation is subject to change as additional information
concerning asset and liability valuation is completed. The preliminary
allocation of purchase price is as follows:
Purchase price $41,413,000
Transaction costs 1,500,000
Total purchase price $42,913,000
Purchase price has been preliminarily allocated as follows:
Fair value of assets acquired $48,832,000
Goodwill 21,366,000
Liabilities assumed (27,285,000)
Total $42,913,000
The following unaudited pro forma information reflects the results
of the Company's operation as if the acquisition had occurred at the
beginning of the period presented adjusted for 1) the effect of the
recurring charges related to the acquisition, primarily the amortization of
goodwill, interest expense on borrowings to finance the acquisition, and an
increase in depreciation expense due to the write-up to fair market value
of fixed assets; and 2) the elimination of compensation for prior
management and directors, certain benefit plans, and non-recurring charges.
</TABLE>
<TABLE>
<CAPTION>
Three months ended June 30, Six months ended June 30,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Revenues $74,040,000 $79,855,000 $125,020,000 $134,975,000
Net income 885,000 1,480,000 735,000 1,455,000
Net income per
share -- diluted $.10 $.16 $.09 $.16
</TABLE>
The pro forma results have been prepared for comparative purposes
only and do not purport to be indicative of the results which actually
would have been attained if the Acquisition had been consummated on the
dates indicated above, nor does it purport to indicate or suggest what the
results of the operations of the Company will be for any future period.
4. Inventories
The components of inventories at June 30 are as follows:
1998
Raw materials $667,000
Work in progress 617,000
Finished goods 16,477,000
Total $17,761,000
5. Debt
In connection with the Reeves acquisition, in April 1998, the
Company replaced its $15,000,000 unsecured bank line of credit with a
$45,000,000 secured syndicated bank credit facility. The credit facility
is for a term of five years expiring April 2003. The credit facility
provides, among other things: 1) $30,000,000 in term notes (to be used
solely for the Reeves acquisition) with quarterly principal payments of
$1,047,000 commencing in December 1998; and 2) a $15,000,000 revolving line
of credit (to be used for Reeves' working capital requirements and general
corporate purposes). The term notes and revolving line of credit provide
for monthly interest payments at varying premiums over LIBOR or bank prime
rates, at borrower's option, based on EBITDA coverage ratios. Through the
first quarter 1999, the interest rates are fixed as follows: 1) Term
Notes: LIBOR plus 2.50% or prime plus .50%; and 2) Revolving line of
credit: LIBOR plus 2.50% or prime plus .50%. The terms of the credit
facility contain, among other provisions, restrictive requirements for
maintaining cash flow and debt coverage ratios, minimum net worth,
restrictions on incurring additional debt, dividends and stock repurchases.
Deferred loan fees and costs are amortized over the term of the credit
facility (5 years).
At June 30, 1998, debt consisted of:
Term notes $30,000,000
Revolver 7,678,000
7% Notes payable 8,000,000
0% Notes payable 3,700,000
Discount (287,000)
Capital leases 244,000
49,335,000
Less: current portion (5,946,000)
$43,389,000
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RECENT DEVELOPMENTS
On April 20, 1998, the Company acquired all of the outstanding
capital stock of Reeves. The acquisition of Reeves was accounted for as a
purchase in accordance with APB No. 16; accordingly, the results of
operations for Reeves are included in the Company's results of operations
from the date of acquisition, April 20, 1998.
Prior to the acquisition, the Company operated in one primary
business segment: installation of home improvement products, including
roofing systems, gutters, fencing and doors; and, through its finance
subsidiary, Marquise Financial, also offered financing to its customers.
Following the acquisition of Reeves, the Company has operated in an
additional business segment: manufacturing and distribution of fencing and
perimeter security products.
RESULTS OF OPERATIONS
Second Quarter 1998 Compared to Second Quarter 1997
Net Sales
Net sales increased $21.8 million, or 49.9%, from $43.8 million for
the second quarter 1997 to $65.6 million for the second quarter 1998.
Reeves contributed $24.5 million to net sales for the second quarter 1998.
Installed Home Improvements
Installed home improvement product sales decreased $2.7 million, or
6.1%, from $43.8 million for the second quarter 1997 to $41.1 million for
the second quarter 1998. Net sales attributable to roofing and gutter
products and services decreased $272 thousand, or 1.0%, to $26.0 million in
the second quarter 1998. Net sales attributable to fencing products and
services decreased $1.3 million, or 13.8%, to $8.5 million in the second
quarter of 1998. Net sales attributable to garage doors, entry doors, and
other products and services decreased $1.3 million, or 18.1%, to $5.7
million in the second quarter 1998. Credit participation fee income
increased $137 thousand to $557 thousand in the second quarter 1998.
Finance interest income increased $77 thousand to $412 thousand on
receivables financed by the Company's finance subsidiary, Marquise
Financial. Backlog, defined as jobs sold but not installed, increased $4.0
million from $12.0 million at the end of March 1998 to $16.0 million at the
end of the second quarter 1998. Backlog increased $7.1 million from $13.1
million at the end of March 1997 to $20.2 million at the end of the second
quarter 1997. The decrease in installed sales and the reduced amount of
backlog was attributable to a significant decrease in lead count or number
of in-home presentations and lower unit sales prices partially offset by
improved operating efficiencies measured in close ratio, reduced
cancellations and increased credit approvals.
Manufacturing and Wholesale Distribution
Manufacturing and wholesale distribution sales are comprised of the
following major product lines:
Chain link and accessories $17,077,000
Wood 4,488,000
Ornamental/specialty 1,929,000
Gate operators and access control 903,000
Security systems 1,647,000
26,044,000
Less: inter-segment sales 1,560,000
$24,484,000
Gross Profit
Gross profit increased $4.0 million, or 20%, from $19.7 million, or
45.0% of net sales, for the second quarter 1997 to $23.7 million, or 36.1%
of net sales, for the second quarter 1998. Reeves contributed $6.0 million
to gross profit in the second quarter 1998.
Installed Home Improvements
Installed home improvement product gross profit decreased $2.1
million, or 10.5%, from $19.7 million, or 45.0% of installed home
improvement product sales, for the second quarter 1997 to $17.6 million, or
42.9% of installed home improvement product sales, for the second quarter
1998. The decrease in gross profit amount was attributable to lower sales
volume due to the decrease in lead count. The decrease in gross profit,
expressed as a percentage of installed home improvement product sales,
resulted from a decrease in average unit sales price as a result of
expanded and lower price points, partially offset by a $214 thousand
increase in credit participation fee income and in finance interest income.
The license fee incurred to Sears decreased $536 thousand, or 11.5%, from
$4.6 million, or 10.8% of net installed home improvement product sales, for
the second quarter 1997 to $4.1 million, or 10.2% of net installed home
improvement product sales, for the second quarter 1998. The decrease in
the license fee amount and index incurred to Sears for the second quarter
1998 was due to an overall decrease in net installed home improvement
product sales and to a shift in the balance of sales, primarily roofing
repairs and pricing test programs, to lower license fee products and
services. Sears and the Company entered into a three-year license
agreement effective January 1, 1996. Among other things, the license
agreement provides for a fixed license fee, at the March 1995 license fee
rate, to be charged during the term of the license agreement. Gross profit
before the Sears license fee, credit participation fee and finance interest
income decreased $2.8 million, or 11.9%, from $23.6 million, or 54.9% of
net installed home improvement product sales, for the second quarter 1997
to $20.8 million, or 51.8% of net installed home improvement product sales,
for the second quarter 1998. The decrease in gross profit amount and gross
profit index was attributable to lower sales volume and unit prices. The
unit costs of materials, installation labor and warranty expense remained
relatively constant during the quarterly period.
Manufacturing and Wholesale Distribution
Manufacturing and wholesale distribution gross profit was $6.0
million or 22.9% of gross (before inter-segment elimination) manufacturing
and wholesale distribution revenue. Gross profit, as a percentage of
segment sales, approximates last year's index.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased $2.9 million,
or 15.6%, from $18.7 million in the second quarter 1997 to $21.6 million in
the second quarter 1998 and, as a percentage of net sales, decreased from
42.7% to 32.9%. Reeves contributed $4.2 million in selling, general and
administrative expense in the second quarter 1998.
Installed Home Improvements
Selling, general and administrative expenses for this segment
decreased $1.3 million, or 6.7%, from $18.7 million in the second quarter
1997 to $17.4 million in the second quarter 1998 and, as a percentage of
installed home improvement sales, decreased from 42.7% to 42.4%. Direct
advertising expense decreased $694 thousand, or 20.0%, from $3.5 million
for the second quarter 1997 to $2.8 million for the second quarter 1998; as
a percentage of net installed sales, direct advertising expense decreased
from 8.1% for the second quarter 1997 to 6.9% for the second quarter 1998,
reflecting decreased radio and newspaper advertising placements and below
plan lead generating effectiveness of ad placements offset by improved
close ratios during the quarter. Selling commission expense, including
attendant payroll-related benefits, decreased $652 thousand, or 13.9%, from
$4.7 million in the second quarter 1997 to $4.0 million in the second
quarter 1998; as a percentage of net installed sales, selling commission
expense decreased from 10.8% to 10.0% in the second quarter 1998. Sales
representatives are compensated on a variable commission basis depending
upon the type and gross profit of product sold. Performance-based
compensation paid to officers and field, sales and production managers
decreased $183 thousand to $183 thousand in the second quarter, reflecting
the decrease in net installed home improvement sales and operating profit.
The balance of selling, general and administrative expenses, primarily
sales lead-generation activities, administrative, field operations and
Marquise Financial payrolls and related costs and general expenses,
increased $217 thousand, or 2.1%, from $10.2 million, or 23.2% of net
sales, in the second quarter 1997 to $10.4 million, or 25.2% of net segment
sales, in the second quarter 1998. Included in general and administrative
expenses were special charges related to the Reeves acquisition and lead
center activities aggregating $450 thousand and information technology
project expenses approximating $450 thousand. Information technology
expenses are expected to continue into the third and fourth quarters before
expected benefits may be realized.
Manufacturing and Wholesale Distribution
Selling, general, and administrative expenses for this segment
includes selling expenses of $3.4 million representing the operations,
primarily payroll and related costs, and facilities and equipment costs, of
31 distribution centers and $832 thousand of general and administrative
expenses.
Operating Interest Expense
Operating interest expense increased from $0 in the second quarter
1997 to $68 thousand in the second quarter 1998. The increase in operating
interest expense resulted from the Company's finance subsidiary's
borrowings during the quarter.
Amortization of Intangibles
Amortization of intangibles increased $121 thousand from $153
thousand in the second quarter 1997 to $274 thousand in the second quarter
1998. The amortization expense relates primarily to goodwill incurred in
connection with the September 1994 stock repurchase from management and the
Reeves acquisition in April 1998.
Interest Expense
Interest expense increased from $0 in the second quarter 1997 to
$752 thousand in the second quarter 1998. This increase relates to
interest expense incurred related to working capital requirements and
the debt associated with the acquisition of Reeves.
Interest Income and Other
Interest income decreased $56 thousand from $186 thousand in the
second quarter 1997 to $130 thousand in the second quarter 1998, primarily
due to decreased interest income from lower invested cash balances.
Income Tax Provision
The Company's income tax provision increased from $416 thousand, or
an effective rate of 39.0%, for the second quarter 1997 to $475 thousand,
or an effective rate of 43.3%, for the second quarter 1998. The difference
in the effective income tax rate and the federal statutory rate (34%) is
due primarily to amortization of intangibles which are not deductible for
income tax purposes and the effect of state income taxes.
First Six Months 1998 Compared to First Six Months 1997
Net Sales
Net sales increased $20.5 million, or 27.8%, from $74.0 million for
the first six months 1997 to $94.5 million for the first six months 1998.
Reeves contributed $24.5 million to net sales in the first six months 1998.
Installed Home Improvements
Installed home improvement product sales decreased $4.0 million, or
5.3%, from $74.0 million for the first six months 1997 to $70.0 million for
the first six months 1998. Net sales attributable to roofing and gutter
products and services decreased $1.9 million or 4.0% to $44.6 million for
the first six months 1998. Net sales attributable to fencing products and
services decreased $1.0 million or 7.7% to $12.3 million for the first six
months 1998. Net sales attributable to garage doors, entry doors, and
other products and services decreased $1.4 million or 11.1% to $11.4
million for the first six months 1998. Credit participation fee income
increased $143 thousand to $913 thousand in the first six months 1998.
Interest income on receivables financed by the Company's consumer finance
subsidiary, Marquise Financial, increased $213 thousand to $787 thousand
for the first six months 1998. Backlog, defined as jobs sold but not
installed, increased $5.1 million from $10.9 million at the end of
December, 1997 to $16.0 million at the end of the first six months 1998.
Backlog increased $5.4 million from $14.8 million at the end of December
1996 to $20.2 million at the end of the second quarter 1997. The decrease
in installed sales and the reduced amount of backlog was attributable to a
significant decrease, primarily in the second quarter 1998, in lead
production or number of in-home presentations and lower unit sales prices
partially offset by improved operating efficiencies measured in close
ratio, reduced cancellations and increased credit approvals.
Manufacturing and Wholesale Distribution
Manufacturing and wholesale distribution sales are comprised of the
following major product lines:
Chain link and accessories $17,077,000
Wood 4,488,000
Ornamental/specialty 1,929,000
Gate operators and access control 903,000
Security systems 1,647,000
26,044,000
Less: inter-segment sales 1,560,000
$24,484,000
Gross Profit
Gross profit increased $3.3 million, or 9.9%, from $33.1 million, or
44.7% of net sales, for the first six months 1997 to $36.4 million, or
38.5% of net sales, for the first six months 1998. Reeves contributed $6.0
million to gross profit in the first six months 1998.
Installed Home Improvements
Installed home improvement product gross profit decreased $2.8
million, or 8.3%, from $33.1 million, or 44.7% of installed home
improvement product sales, for the first six months 1997 to $30.3 million,
or 43.3% of installed home improvement product sales, for the first six
months 1998. The decrease in gross profit amount was attributable to lower
sales volume due primarily to the decrease, in the second quarter, in lead
count. The decrease in gross profit, expressed as a percentage of
installed home improvement product sales, resulted from a decrease in
average unit sales price as a result of expanded and lower price points,
partially offset by a $356 thousand increase in credit participation fee
income and in finance interest income. The license fee incurred to Sears
decreased $824 thousand, or 10.5%, from $7.9 million, or 10.8% of net
installed home improvement product sales, for the first six months 1997 to
$7.0 million, or 10.3% of net installed home improvement product sales, for
the first six months 1998. The decrease in the license fee incurred to
Sears for the first six months 1998 was due to an overall decrease in net
installed home improvement product sales and to a shift in the balance of
sales, primarily roofing repairs and pricing test programs, to lower
license fee products and services. Sears and the Company entered into a
three-year license agreement effective January 1, 1996. Among other
things, the license agreement provides for a fixed license fee, at the
March 1995 license fee rate, to be charged during the term of the license
agreement. Gross profit before the Sears license fee, credit participation
fee and finance interest income decreased $3.9 million, or 9.9%, from $39.6
million, or 54.5% of net installed home improvement product sales, for the
first six months 1997 to $35.7 million, or 52.2% of net installed home
improvement product sales, for the first six months 1998. The decrease in
gross profit amount and gross profit index was attributable to lower sales
volume and unit prices. The unit costs of materials, installation labor
and warranty expense remained relatively constant during the six month
period.
Manufacturing and Wholesale Distribution
Manufacturing and wholesale distribution gross profit was $6.0
million or 22.9% of gross (before inter-segment elimination) manufacturing
and wholesale distribution revenue.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased $2.0 million,
or 6.3%, from $31.9 million in the first six months 1997 to $33.9 million
in the first six months 1998 and, as a percentage of net sales, decreased
from 43.1% to 35.9%. Reeves contributed $4.2 million in selling, general
and administrative expense in the first six months 1998.
Installed Home Improvements
Selling, general and administrative expenses for this segment
decreased $2.1 million, or 6.6%, from $31.9 million in the first six months
1997 to $29.8 million in the first six months 1998 and, as a percentage of
installed home improvement sales, decreased from 43.1% to 42.5%. Direct
advertising expense decreased $1.2 million, or 22.9%, from $5.3 million for
the first six months 1997 to $4.1 million for the first six months 1998; as
a percentage of net segment sales, direct advertising expense decreased
from 7.2% for the first six months 1997 to 5.9% for the first six months
1998, reflecting decreased radio and newspaper advertising placements and
below plan lead generating effectiveness of ad placements offset by
improved close ratios during the first six months. Selling commission
expense, including attendant payroll-related benefits, decreased $882
thousand, or 11.4%, from $7.7 million in the first six months 1997 to $6.8
million in the first six months 1998; as a percentage of net installed
sales, selling commission expense decreased from 10.6% to 10.0% in the
first six months 1998. Sales representatives are compensated on a variable
commission basis depending upon the type and gross profit of product sold.
Performance-based compensation paid to officers and field, sales and
production managers decreased $248 thousand to $246 thousand in the first
six months, reflecting the decrease in net installed home improvement sales
and operating profit. The balance of selling, general and administrative
expenses, primarily sales lead-generation activities, administrative, field
operations and Marquise Financial payrolls and related costs and general
expenses, increased $239 thousand, or 1.3%, from $18.4 million, or 24.9% of
net segment sales, in the first six months 1997 to $18.6 million, or 26.6%
of net segment sales, in the first six months 1998. Included in general
and administrative expenses were special charges related to the Reeves
acquisition and lead center activities aggregating $450 thousand and
information technology project expenses approximating $450 thousand.
Information technology expenses are expected to continue into the third and
fourth quarters before expected benefits may be realized.
Manufacturing and Wholesale Distribution
Selling, general, and administrative expenses for this segment
includes selling expenses of $3.4 million representing the operations,
primarily payroll and related costs, and facilities and equipment costs, of
31 distribution centers and $832 thousand of general and administrative
expenses.
Operating Interest Expense
Operating interest expense increased from $0 in the first six months
1997 to $123 thousand in the first six months 1998. The increase in
operating interest expense resulted from the Company's finance subsidiary's
borrowings during the first six months.
Amortization of Intangibles
Amortization of intangibles increased $138 thousand from $296
thousand in the first six months 1997 to $434 thousand in the first six
months 1998. The amortization expense relates primarily to goodwill
incurred in connection with the September 1994 stock repurchase from
management and the Reeves acquisition in April 1998.
Interest Expense
Interest expense increased from $0 in the first six months 1997 to
$752 thousand in the first six months 1998. This increase relates to
interest expense incurred related to working capital requirements and
the debt associated with the acquisition of Reeves.
Interest Income and Other
Interest income decreased $150 thousand from $406 thousand in the
first six months 1997 to $256 thousand in the first six months 1998,
primarily due to decreased interest income from lower invested cash
balances.
Income Tax Provision
The Company's income tax provision increased from $515 thousand, or
an effective rate of 39.0%, for the first six months 1997 to $599 thousand,
or an effective rate of 42.6%, for the first six months 1998. The
difference in the effective income tax rate and the federal statutory rate
(34%) is due primarily to amortization of intangibles which are not
deductible for income tax purposes and the effect of state income taxes.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary capital needs have been to fund the growth of
the Company, to fund the September 1994 stock repurchase from management,
to fund the operations of the Company's finance subsidiary, Marquise
Financial, and, more recently, to fund new information technology systems
and the acquisition of Reeves. The Company's primary sources of liquidity
have been cash flow from operations, borrowings under its bank credit
facility, and, in June 1996, the net proceeds of its initial public
offering. The Company's home improvement installation business is not
capital intensive. Capital expenditures for first six months 1998 and
years 1997 and 1996 were approximately $1.5 million, $4.3 million, and $461
thousand, respectively. Capital expenditures for 1998 are expected to
approximate $3.3 million, primarily related to ongoing new equipment
purchases and software development for the Company's information technology
systems and major plant repairs. Future requirements for new information
technology and other capital expenditures are expected to be funded by cash
flow from operations and operating leases. On April 30, 1997, the Company
announced a stock repurchase program to repurchase up to 500,000 shares of
its common stock and on August 12, 1997, the Company increased the number
of shares it is authorized to repurchase by 500,000 to 1,000,000 shares.
During the second and third quarters 1997 the Company purchased 572,300
shares of its common stock for $4.7 million.
On April 20, 1998, the Company acquired all of the issued and
outstanding stock of Reeves for approximately $43 million, including
transaction expenses.
The Company believes that it has sufficient operating cash flow,
working capital base, and available bank lines of credit to meet all of its
obligations for the foreseeable future, including ongoing funding for
Marquise Financial, for the stock repurchase program announced in 1997, for
investments in information technology, and for the acquisition,
development, and expansion of complementary new products and services and
markets.
In November 1995, the Company commenced the operations of Marquise
Financial. Marquise's primary objective is to support, along with other
designated third-party finance companies, the Company's requirement for
providing financing to its core installation business customers. In the
fourth quarter 1996, as a follow-on objective to expanding Marquise
Financial's consumer financing markets and products, Marquise introduced a
new finance product -- fixed rate loans secured by developed residential
real estate -- to a segment of its creditworthy customers that cannot
obtain unsecured consumer loans. During the second quarter 1997, Marquise
Financial expanded its scope of operations, in part to leverage its
consumer finance infrastructure to i) purchase from third parties
portfolios of secured receivables, and ii) originate secured receivables
from customers of, and/or purchase individual secured receivables
originated by, entities other than the Company and its affiliates. These
entities do not necessarily engage in business in any of the Company's
product lines. As a general proposition, these entities are all expected
to operate businesses related to installed home improvement products and
services, although from time to time Marquise Financial may also originate
or purchase receivables secured by commercial real estate or otherwise
acquire or originate loans that do not constitute obligations arising from
installed home improvements. The outstanding principal amount of
individual receivables purchased by Marquise Financial from entities other
than the Company may significantly exceed the average amount of all
receivables owned by Marquise Financial. The Company is continually
mindful of the risks associated with consumer financing and plans to
increase its consumer finance receivable portfolio at a measured pace
commensurate with its available resources and acceptable levels for losses
on finance receivables. Marquise Financial has been capitalized and funded
with the Company's excess operating cash flow and borrowings under the
Company's former $15 million bank line of credit, which were subsequently
paid down with a portion of the proceeds from the Company's June 1996
initial public offering. In December 1997, Marquise Financial obtained a
$10 million secured line of credit and, at June 30, 1998, had borrowed $3.8
million. At June 30, 1998, Marquise Financial has approximately $10.6
million in net finance receivables. During 1998, Marquise Financial
originated or purchased approximately $3.8 million of fixed rate, secured
loans. At June 30, 1998, Marquise had approximately $1.0 million in
outstanding commitments of the fixed rate, secured loans. The Company
anticipates that its existing cash balances, the bank lines of credit, the
sale of Marquise Financial's consumer loan finance receivables as market
conditions may warrant from time to time and excess cash flow from its core
installation operations will be sufficient to satisfy the Company's
financing cash requirements in the foreseeable future.
In December 1996, with an initial investment of approximately $450
thousand, the Company completed agreements with insurance companies with
the effect of establishing a captive insurance company. At June 30, 1998,
the investment in the captive insurance company approximated $1.1 million.
The primary objective of this captive insurance business is to provide the
means for offering workers' compensation and general liability insurance
coverage, primarily for Company installations, to qualified installers as
the Company seeks to maintain and expand its core complement of independent
installers. Premiums are immediately collected through deductions from
payments to installers; and the excess cash balances, after administrative
expenses, are invested, pursuant to agreement, with the insurance
companies. Losses are comprised of actual claims paid, reserves for open
claims and allowances for incurred but not reported claims. The Company
maintains individual and aggregate stop-loss reinsurance coverage at levels
deemed to be adequate by management of the Company. Premiums collected in
the first six months 1998 and year 1997 were approximately $275 thousand
and $571 thousand, respectively.
From its inception in June 1993, the Company has generated cash flow
from operations of approximately $22.0 million. Cash flows from operations
have been used to fund and leverage the Company's investing activities,
including Reeves acquisition, Marquise Financial consumer lending
activities, and capital expenditures; and its financing activities,
including the repurchase of 40.2% of common stock in September 1994 from
management, and repurchase of 6.3% of common stock in 1997. At June 30,
1998, the Company had approximately $26.8 million in cash and cash
equivalents and trade receivables and net working capital of $13.6 million.
At June 30, 1998, the Company had $13.5 million in unused bank lines of
credit and $53.9 million total debt including $41.5 million under its bank
lines of credit.
The Company has not completed its assessment of compliance issues
for the Year 2000 date change. The Company has also not determined the
cost of these compliance issues or the time it will take to complete
compliance. As a preliminary assessment, the Company believes its new
investments in information technology systems, including software, are Year
2000 compliant and as such should not pose significant operational problems
for its computer systems. The Company expects to complete its full
assessment of the Year 2000 issue, including its manufacturing and
distribution systems and operations, not later than December 31, 1998,
which is prior to any anticipated impact on its operating systems and
manufacturing and distribution systems and processes. As part of the Year
2000 assessment, the Company has initiated formal communications with all
of its significant suppliers, third-party finance sources, and Sears to
determine the extent to which the Company's interface systems are
vulnerable to those parties' failure to remedy their Year 2000 issues.
There is no guarantee that the systems of other companies on which the
Company relies will corrected in a timely manner or that the failure to
correct will not have a material adverse effect on the Company's systems.
Year 2000 modifications and assessments are based on management's best
estimates, which were derived utilizing numerous assumptions of future
events, including availability of certain resources and other factors.
However, there can be no guarantee the estimates and assessments will be
achieved or come to pass, and actual results could differ materially from
those anticipated.
Certain statements contained herein, including without limitation,
statements addressing the beliefs, plans, objectives estimates or
expectations of the Company or future results or events constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements involve
known or unknown risks, including, but not limited to, general economic and
business conditions, matters related to the licensing agreement between
Diamond Exteriors, Inc. and Sears, Roebuck and Co., the impact of the
Company's response to Year 2000 issues, warranty exposure, the Company's
reliance on sales associates and on the availability of qualified
independent installers, and conditions in the installed home improvement
industry, including, without limitation, the fencing and perimeter security
products business. There can be no assurance that the actual future
results, performance, or achievements expressed or implied by such forward-
looking statements will occur. Users of forward-looking statements are
encouraged to review Item 7 of the Company's 1997 annual report on Form 10-
K, its filings on Form 10-Q, management's discussion and analysis in the
Company's 1997 annual report to stockholders, the Company's filings on Form
8-K, and other federal securities law filings for a description of other
important factors that may affect the Company's business, results of
operations and financial condition.
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 14, 1998, the Company held its Annual Meeting of
Shareholders. The only matter voted on by the shareholders was the
election of directors to the Board of Directors. By a majority of shares
represented at the Annual Meeting, the shareholders elected directors to
serve one-year terms as follows: Messrs. C. Stephen Clegg, James F. Bere,
Jr., James M. Gillespie, Jacob Pollock, William R. Griffin and George A.
Stinson.
Shares were voted as follows:
Number of Shares of Common Stock
Election of Directors For Withheld
James F. Bere, Jr. 7,690,190 204,825
Stephen Clegg 7,688,890 206,125
James M. Gillespie 7,690,640 204,375
Jacob Pollock 7,689,180 205,835
William R. Griffin 7,690,640 204,375
George A. Stinson 7,602,190 292,825
ITEM 5. OTHER INFORMATION
The Company has amended its By-Laws in respect to the period of
notification to include new business to be taken up at any meeting of
stockholders. Accordingly, stockholders wishing to bring a proposal before
the 1999 Annual Meeting of Stockholders (but not include it in the
Company's Proxy Statement) must cause written notice of the proposal to be
received by the Secretary of the Company at the Executive and
Administrative offices of the Company not less than 90 days and not more
than 120 days before the date of the Annual Meeting of Stockholders.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(27) Financial Data Schedule.
(b)(i) A report on Form 8-K was filed on April 30, 1998 announcing the
the closing of the acquisition of Reeves Southeastern Corporation
and the Credit Agreement between the Company and Harris Trust and
Savings Bank and providing copies of the Stock Purchase Agreement
for the Acquisition of Reeves Southeastern Corporation and the
Credit Agreement with Harris Trust and Savings Bank.
(ii) A report on Form 8-K/A was filed on May 13, 1998 providing
financial statements, pro forma financial information and
exhibits pertaining to the acquisition by the Company's wholly-
owned subsidiary Diamond Acquisition Corp. on April 20, 1998
of all the issued and outstanding voting stock of Reeves
Southeastern Corporation.
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.
DIAMOND HOME SERVICES, INC.
/s/ Richard G. Reece
---------------------------------
By: Richard G. Reece
Date: August 14, 1998 Vice President and
Chief Financial Officer
(For the Registrant and as
Principal Financial Officer)
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<CASH> 4,061,000 12,954,000
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