FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended September 30, 1998
[ ] 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 1-12521
SWISHER INTERNATIONAL GROUP INC.
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(Exact name of registrant as specified in its charter)
Delaware 13-3857632
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) identification No.)
20 Thorndal Circle, Darien, CT 06820
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(Address of principal executive offices)
203-656-8000
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(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
----- -----
The number of shares of Class A Common Stock (par value $.01) outstanding
at October 30, 1998 was 5,778,300.
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TABLE OF CONTENTS
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Page
Numbers
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Part I. Financial Information
Item 1. Financial Statements (unaudited)
Condensed Consolidated Balance Sheets
September 30, 1998 and December 31, 1997................................................ 3
Condensed Consolidated Statements of Income
Nine Months and Three Months Ended September 30, 1998 and 1997.......................... 4
Condensed Consolidated Statements of Cash Flows
Nine Months Ended September 30, 1998 and 1997........................................... 5
Notes to Condensed Consolidated Financial Statements...................................... 6-9
Item 2. Management's Discussion and Analysis of the Results
of Operations and Financial Condition................................................... 10-17
Part II. Other Information
Item 1. Legal Proceedings......................................................................... 18-19
Item 6. Exhibits and Reports on Form 8-K.......................................................... 19
Signatures......................................................................................... 20
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2
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PART I. FINANCIAL INFORMATION
SWISHER INTERNATIONAL GROUP INC.
Condensed Consolidated Balance Sheets
(Dollars in thousands)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------ ------------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 1,405 $ 1,057
Accounts receivable, less allowance for doubtful accounts of
$1,805 and $1,643, respectively 38,766 32,348
Inventories 78,147 60,714
Deferred income taxes 1,218 1,218
Other current assets 4,441 3,096
--------- ---------
Total current assets 123,977 98,433
--------- ---------
Property, plant and equipment:
Land 1,563 1,299
Buildings and improvements 21,687 10,812
Machinery and equipment 56,939 51,300
Construction in progress 2,012 11,998
--------- ---------
82,201 75,409
Less, accumulated depreciation 10,410 7,155
--------- ---------
71,791 68,254
--------- ---------
Goodwill, net of accumulated amortization of $4,459 and
$3,512, respectively 45,786 46,733
Investment in Affiliates 11,733 13,315
Prepaid pension cost 4,972 4,972
Other assets 5,142 6,050
--------- ---------
Total assets $ 263,401 $ 237,757
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 10,000 $ --
Short-term debt 10,000 --
Accounts payable 7,901 8,102
Accrued expenses 8,907 8,657
Due to Affiliates -- 5,900
Income taxes payable 5,739 2,863
--------- ---------
Total current liabilities 42,547 25,522
Long-term debt 83,579 101,092
Deferred income taxes 9,617 7,296
Accrued postretirement and postemployment benefits 15,366 14,241
Other liabilities 3,732 3,657
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Total liabilities 154,841 151,808
--------- ---------
Commitments and contingencies
Stockholders' equity:
Common stock 341 341
Paid-in capital 45,428 45,428
Retained earnings 65,592 40,069
Treasury stock, at cost, 221,700 shares (2,895) --
Cumulative translation adjustments 94 111
--------- ---------
Total stockholders' equity 108,560 85,949
--------- ---------
Total liabilities and stockholders' equity $ 263,401 $ 237,757
========= =========
</TABLE>
The accompanying notes are an integral part of the condensed
consolidated financial statements.
3
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SWISHER INTERNATIONAL GROUP INC.
Condensed Consolidated Statements of Income
(In thousands except per share amounts)
<TABLE>
<CAPTION>
Nine Months Ended Three Months Ended
September 30, September 30,
----------------- ------------------
1998 1997 1998 1997
---- ---- ---- ----
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Net Sales $204,244 $209,959 $ 73,738 $ 75,491
Cost of sales 103,392 106,024 38,279 37,780
-------- -------- -------- --------
Gross profit 100,852 103,935 35,459 37,711
Selling, general and administrative expenses 52,579 49,456 17,937 17,649
-------- -------- -------- --------
Operating profit 48,273 54,479 17,522 20,062
Interest expense, net 5,738 6,135 2,043 1,885
Other expense, net 748 97 872 109
-------- -------- -------- --------
Income before income taxes 41,787 48,247 14,607 18,068
Provision for income taxes 16,264 19,058 5,708 7,144
-------- -------- -------- --------
Net income $ 25,523 $ 29,189 $ 8,899 $ 10,924
======== ======== ======== ========
Earnings per share:
Basic $ .75 $ .86 $ .26 $ .32
======== ======== ======== ========
Diluted $ .75 $ .86 $ .26 $ .32
======== ======== ======== ========
Weighted average shares outstanding:
Basic 33,920 34,100 33,878 34,100
======== ======== ======== ========
Diluted 33,920 34,100 33,878 34,100
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of the condensed
consolidated financial statements.
4
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SWISHER INTERNATIONAL GROUP INC.
Condensed Consolidated Statements of Cash Flows
(Dollars in thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-----------------
1998 1997
---- ----
(unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net income $ 25,523 $ 29,189
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 5,140 4,808
Deferred income taxes 2,321 2,698
Provision for loss on closure of joint venture 806 --
Gain on disposal of property, plant and equipment -- (29)
Changes in assets and liabilities:
Accounts receivable (8,526) (16,815)
Inventories (13,490) 747
Other current assets (1,346) (1,792)
Other assets (30) (1,056)
Accounts payable and accrued expenses 47 1,124
Income taxes 2,876 2,999
Other liabilities 1,200 1,001
Other, net -- 25
--------- ---------
Net cash provided by operating activities 14,521 22,899
--------- ---------
Cash flows from investing activities:
Proceeds from disposal of property, plant and equipment -- 563
Additions to property, plant and equipment (6,503) (9,450)
Investments in Affiliates (7,259) --
--------- ---------
Net cash used in investing activities (13,762) (8,887)
--------- ---------
Cash flows from financing activities:
Long-term borrowings 446,100 56,000
Payments of long-term debt (453,613) (69,072)
Change in short-term debt 10,000 --
Repurchase of common stock (2,895) --
--------- ---------
Net cash used in financing activities (408) (13,072)
--------- ---------
Effect of foreign exchange rate on cash (3) --
--------- ---------
Net increase in cash and cash equivalents 348 940
Cash and cash equivalents, beginning of period 1,057 1,744
--------- ---------
Cash and cash equivalents, end of period $ 1,405 $ 2,684
========= =========
</TABLE>
The accompanying notes are an integral part of the condensed
consolidated financial statements.
5
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SWISHER INTERNATIONAL GROUP INC.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except share data)
1. ACCOUNTING POLICIES
The accompanying Condensed Consolidated Financial Statements should be
read in conjunction with the Consolidated Financial Statements and the Notes
thereto contained in Swisher International Group Inc.'s (the "Company's") 1997
Annual Report to Stockholders. The interim statements are unaudited but include
all adjustments, which consist of only normal recurring accruals, that
management considers necessary to fairly present the results for the interim
periods. Results for interim periods are not necessarily indicative of results
for a full year. The year end balance sheet data was derived from audited
financial statements, but, as presented here, does not include all disclosures
required by generally accepted accounting principles.
2. SUPPLEMENTAL STATEMENT OF CASH FLOWS INFORMATION
"Net cash provided by operating activities" includes the following cash
payments for interest and income taxes:
Nine months ended
September 30,
-------------------
1998 1997
---- ----
Interest, net of amount capitalized $ 4,904 $ 6,664
Income taxes 11,011 13,220
During the three months ended September 30, 1998, a decision was made to
close the COTABEX joint venture, a three-party arrangement between the Company
and two other cigar manufacturers. As a result, the Company received inventory
and machinery and equipment with a total value of $4,238, as settlement of a
receivable from one of its partners ($2,103), and return of its investment
($2,941), which resulted in a loss of $806.
3. EARNINGS PER SHARE
In 1997, the Financial Accounting Standards Board issued SFAS No. 128,
"Earnings per Share". SFAS No. 128 replaced the calculation of primary and fully
diluted earnings per share with basic and diluted earnings per share. Unlike
primary earnings per share, basic earnings per share excludes any dilutive
effects of options, warrants and convertible securities. Diluted earnings per
share is similar to the previously required fully diluted earnings per share.
All earnings per share amounts for all periods have been presented, and where
appropriate, restated to conform to the SFAS No. 128 requirements. Weighted
average shares used in computing diluted earnings per share may differ from the
weighted average shares used in computing basic earnings per share as a result
of employee stock options.
6
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SWISHER INTERNATIONAL GROUP INC.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except share data)
4. INVENTORIES
Inventories consist of the following:
September 30, December 31,
1998 1997
------------- ------------
Finished goods $23,124 $16,908
Work-in-process 2,679 2,871
Raw materials 42,906 33,485
Stores and supplies 9,438 7,450
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$78,147 $60,714
======= =======
5. CONTINGENCIES
The tobacco industry continues to experience significant health-related
litigation. Plaintiffs in such cases typically seek compensation and, in some
cases, punitive damages, for various injuries allegedly sustained from the use
of tobacco products or exposure to tobacco smoke, including health care costs.
The Company is not aware of any adverse decision or judgment having been
rendered against smokeless tobacco or cigar manufacturers.
The Company is a defendant, along with other defendants in an action
brought by an individual plaintiff in Louisiana seeking damages and other relief
in connection with injuries allegedly resulting from use of the Company's and
the other defendants' products. The Company and other defendants have been named
in a Texas action brought by another individual seeking damages and other relief
in connection with injuries allegedly caused to plaintiff by products
manufactured by the Company and the other defendants. The Company believes that
it has meritorious defenses and is vigorously defending these lawsuits.
In addition, 65 individuals have filed simultaneous actions in a West
Virginia court against 20 manufacturers of tobacco products (including the
Company) and fourteen other defendants, alleging that products made by one or
more of the defendants caused them injury (see "Legal Proceedings").
The Company is also a defendant along with multiple other defendants in
three actions brought under California Proposition 65 and the California Unfair
Competition Act (see "Legal Proceedings").
Further, the Company is subject to other litigation, claims and
contractual agreements arising in the ordinary course of business. In the
opinion of management, the cost, if any, of resolving all litigation and
contingencies should not have a significant impact on the Company's consolidated
financial position. There can be no assurance, however, that the Company may not
be named as a defendant in future suits, nor can there be any assurance that
existing or future litigation will not result in an adverse judgment against the
Company which could have a material effect on the Company's business, future
results of operations or cash flows. The Company does not carry insurance to
protect against health-related product liability because the cost of obtaining
such coverage is commercially prohibitive. Additionally, a judgment against the
Company with respect to a product or any related products could preclude the
further sale of such product, which could have a material adverse effect on the
Company's business.
7
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SWISHER INTERNATIONAL GROUP INC.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except share data)
5. CONTINGENCIES (continued)
In 1996, the federal Food and Drug Administration ("FDA") for the first
time asserted jurisdiction over nicotine in tobacco as a "drug" and issued
regulations purporting to regulate smokeless tobacco products as "medical
devices." These regulations prohibit the sale of smokeless tobacco products to
minors and severely restrict advertising, marketing and promotion of smokeless
tobacco products. The regulations also require the Company and other
manufacturers to comply with a wide range of labeling, reporting and other
requirements. In 1997, ruling in a case filed by the Company and other smokeless
tobacco manufacturers to challenge the FDA's authority, a federal court held
that the FDA as a matter of law is not precluded from regulating smokeless
tobacco products as "medical devices" or from implementing certain labeling and
access restrictions. At the same time, however, the court said that the FDA has
no authority to restrict the advertising and promotion of smokeless tobacco
products and stayed the effectiveness of any of the restrictions related to
labeling, access, advertising and promotion due to take effect in 1997 and 1998
pending further order of the court. The court's opinion was appealed to the U.S.
Court of Appeals for the Fourth Circuit in 1997. Due to the death of one of the
Appeals Court judges who originally heard the appeal, the appeal was reargued,
and on August 14, 1998 a reconstituted appellate panel reversed the District
Court ruling and held that the FDA had no jurisdiction to regulate tobacco. That
holding has been appealed. The Company is unable to predict the outcome of the
appeal or its impact on those portions of the regulations that have not been
given effect. Any further provisions of these regulations that become effective
could have a materially adverse effect on the Company's business.
Cigars and smokeless tobacco products have long been subject to federal,
state and local excise taxes. Such taxes are frequently subject to proposed
increases, in some cases significant increases, to fund various legislative
initiatives. The Balanced Budget Act adopted by Congress in 1997, provides for
increases in federal excise taxes on all tobacco products in two stages,
beginning in 2000. Management does not believe that these increases will have a
material adverse effect on the Company's operations; however, enactment of new
or significant further increases in existing federal, state or local excise
taxes could have a material adverse effect on the Company's business.
The Company is subject to laws and regulations relating to the protection
of the environment. While it is not possible to quantify with certainty the
potential impact of future actions regarding environmental matters, in the
opinion of management, compliance with the present environmental protection laws
will not have a material adverse impact upon the Company's consolidated
financial position, results of operations or cash flows.
In June 1997, the five largest tobacco companies announced an agreement
with trial lawyers and the Attorneys General of several states suing to recoup
Medicare and Medicaid expenses (the "Proposed Settlement"). Although the Company
was not a party to any of the actions being settled (the "State AG Actions"),
legislation introduced in Congress in the wake of the Proposed Settlement sought
to raise the price of cigarettes and other tobacco products significantly and to
regulate all tobacco products (including smokeless tobacco and, in some cases,
cigars) by imposing full FDA regulation and by adopting new and highly
restrictive marketing requirements. In September 1998, when insufficient votes
could be found to support a cloture motion, Congressional leadership tabled the
proposed legislation. However, press reports indicate that alternative
legislation is being developed in the Congress and that the tobacco companies
which were parties to the Proposed Settlement have entered into new negotiations
with certain state Attorneys General to settle the State AG Actions. The Company
cannot anticipate whether the new legislation, if introduced, will be adopted;
8
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SWISHER INTERNATIONAL GROUP INC.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except share data)
5. CONTINGENCIES (continued)
whether the State AG Actions will be settled; or the extent to which such
potential legislation or settlement may impact the Company's business.
On February 9, 1998, the Company was notified by the Federal Trade
Commission ("FTC") of the adoption by the FTC of an Order to File a Special
Report on the Company's advertising and marketing expenditures with regard to
its cigar business for 1997 and 1996. This information, which is similar to
information the Company has filed with the FTC for many years with respect to
its smokeless tobacco products, was filed on April 9, 1998.
6. COMPREHENSIVE INCOME
In September 1997, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 130, "Reporting Comprehensive Income". SFAS No. 130, which the
Company adopted in the first quarter of 1998, establishes standards for
reporting and displaying comprehensive income and its components. The Company's
comprehensive income consists of net income and foreign currency translation
adjustments. Comprehensive Income for the nine months and three months ended
September 30, 1998 was $25,506 and $8,926, respectively.
7. RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the FASB issued SFAS No. 131, "Disclosure About Segments of
an Enterprise and Related Information," which changes the way public companies
report information about segments. SFAS No. 131, which is based on the
management approach to segment reporting, includes requirements to report
selected segment information quarterly and entity-wide disclosures about
products and services, major customers, and the material countries in which the
entity holds assets and reports revenues. This statement's disclosure
requirements become effective for the Company as of the end of the 1998 fiscal
year. The Company is in the process of evaluating the disclosure requirements
under this standard.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits," which amends SFAS No. 87, 88,
and 106, and is intended to standardize the disclosure requirements for employer
sponsored retirement plans and other retiree benefits. SFAS No. 132 will require
new information from plan sponsors, eliminate certain information that is no
longer considered useful, but will not modify recognition or measurement
requirements. The Company has not yet evaluated the effects of this standard on
its financial statement disclosures.
9
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SWISHER INTERNATIONAL GROUP INC.
Management's Discussion and Analysis of the Results
of Operations and Financial Condition
Three Months Ended September 30, 1998 Compared to Three Months Ended September
30, 1997
Net Sales. Net sales decreased $1.8 million or 2.3% to $73.7 million for
the three months ended September 30, 1998 from $75.5 million for the three
months ended September 30, 1997. The decrease in net sales was due to lower
sales of premium cigars and smokeless tobacco products and higher product
returns, offset partially by higher sales of mass market cigars. Mass market
cigar sales increased principally due to unit volume growth and price increases.
Premium cigar sales decreased as a result of volume decline and lower pricing.
Smokeless tobacco sales decreased as a result of volume decline, offset
partially by price increases in all smokeless tobacco categories. Higher product
returns were due to excess wholesale inventories of premium and mass market
large cigars and a moderation in the growth of retail sales.
Gross Profit. Gross profit decreased $2.3 million or 6.0% to $35.5 million
(48.1% of net sales) for the three months ended September 30, 1998 from $37.7
million (50.0% of net sales) for the three months ended September 30, 1997. As a
percentage of net sales, gross profit decreased due to a shift in sales mix.
Selling, General and Administrative ("SG&A") Expenses. SG&A expenses
increased $0.3 million or 1.6% to $17.9 million (24.3% of net sales ) for the
three months ended September 30, 1998 from $17.6 million (23.4% of net sales)
for the three months ended September 30, 1997. The increase of $0.3 million is
principally due to an increase in selling and marketing expenses.
Operating Profit. Operating profit decreased $2.5 million or 12.7% to $17.5
million (23.8% of net sales) for the three months ended September 30, 1998 from
$20.1 million (26.6% of net sales) for the three months ended September 30,
1997. The decrease, as a percentage of net sales, was primarily due to lower
gross profit margins, and an increase in SG&A expenses both absolutely and as a
percentage of net sales.
Interest Expense, Net. Interest expense, net increased $0.2 million or 8.4%
to $2.0 million for the three months ended September 30, 1998 from $1.9 million
for the three months ended September 30, 1997. For the three months ended
September 30, 1998, the average debt balance was $109.8 million, with an average
effective interest rate of 7.44%. For the three months ended September 30, 1997,
the average debt balance was $111.6 million, with an average effective interest
rate of 6.75%.
Other (Income) Expense, Net. For the three months ended September 30, 1998,
other (income) expense, net includes a charge of $0.8 million related to the
closure of the COTABEX joint venture, a three party arrangement between the
Company and two other cigar manufacturers, which is expected to be completed
within the next several months.
Income Taxes. The effective income tax rate was 39.1% and 39.5 % for the
three month periods ended September 30, 1998 and 1997, respectively. The lower
effective income tax rate for the three month period ended September 30, 1998
reflects a change in the geographical composition of earnings.
10
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SWISHER INTERNATIONAL GROUP INC.
Management's Discussion and Analysis of the Results
of Operations and Financial Condition
Three Months Ended September 30, 1998 Compared to Three Months Ended September
30, 1997 (continued)
Net Income. Net income decreased $2.0 million or 18.5% to $8.9 million
(12.1% of net sales), for the three months ended September 30, 1998 from $10.9
million (14.5% of net sales), for the three months ended September 30, 1997.
Nine Months Ended September 30, 1998 Compared to Nine Months Ended September 30,
1997
Net Sales. Net sales decreased $5.7 million or 2.7% to $204.2 million for
the nine months ended September 30, 1998 from $210.0 million for the nine months
ended September 30, 1997. The decrease in net sales was due to lower sales of
smokeless tobacco products and higher product returns, offset partially by
higher sales of cigars. Cigar sales increased principally due to price increases
in all categories except premium cigars, offset by unit volume decline, in all
categories except little cigars. Smokeless tobacco sales decreased as a result
of volume decline, offset partially by price increases in all smokeless tobacco
categories. Higher product returns were due to excess wholesale inventories of
premium and mass market large cigars and a moderation in the growth of retail
sales.
Gross Profit. Gross profit decreased $3.1 million or 3.0% to $100.9 million
(49.4% of net sales) for the nine months ended September 30, 1998 from $103.9
million (49.5% of net sales) for the nine months ended September 30, 1997. The
decrease in gross profit for 1998 was due to the decrease in net sales and a
shift in sales mix .
SG&A Expenses. SG&A expenses increased $3.1 million or 6.3% to $52.6
million (25.7% of net sales) for the nine months ended September 30, 1998 from
$49.5 million (23.6% of net sales) for the nine months ended September 30, 1997.
The increase of $3.1 million is principally due to an increase in selling and
marketing expenses.
Operating Profit. Operating profit decreased $6.2 million or 11.4% to $48.3
million (23.6% of net sales) for the nine months ended September 30, 1998 from
$54.5 million (25.9% of net sales) for the nine months ended September 30, 1997.
The decrease, as a percentage of net sales, was primarily due to an increase in
SG&A expenses both absolutely and as a percentage of net sales, and lower gross
profit margins.
Interest Expense, Net. Interest expense, net decreased $0.4 million or 6.5%
to $5.7 million for the nine months ended September 30, 1998 from $6.1 million
for the nine months ended September 30, 1997. For the nine months ended
September 30, 1998, the average debt balance was $102.3 million, with an average
effective interest rate of 7.48%. For the nine months ended September 30, 1997,
the average debt balance was $111.2 million, with an average effective interest
rate of 7.36%.
11
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SWISHER INTERNATIONAL GROUP INC.
Management's Discussion and Analysis of the Results
of Operations and Financial Condition
Nine Months Ended September 30, 1998 Compared to Nine Months Ended September 30,
1997 (continued)
Other (Income) Expense, Net. For the nine months ended September 30, 1998,
other (income) expense, net includes a charge of $0.8 million related to the
closure of the COTABEX joint venture, a three party arrangement between the
Company and two other cigar manufacturers, which is expected to be completed
within the next several months.
Income Taxes. The effective income tax rate was 38.9% and 39.5% for the
nine month periods ended September 30, 1998 and 1997, respectively. The lower
effective income tax rate for the nine month period ended September 30, 1998
reflects a change in the geographical composition of earnings.
Net Income. Net income decreased $3.7 million or 12.6% to $25.5 million
(12.5% of net sales), for the nine months ended September 30, 1998 from $29.2
million (13.9% of net sales), for the nine months ended September 30, 1997.
Liquidity and Capital Resources
Net cash flows provided by operating activities were $14.5 million and
$22.9 million for the nine month periods ended September 30, 1998 and 1997,
respectively. The decrease of $8.4 million was primarily due to higher working
capital requirements resulting from increased inventory levels and lower net
income.
The Company's raw material inventory requirements for cigar production are
relatively modest due to its long standing relationships with major tobacco
suppliers who commit to supply tobacco inventory as needed by the Company. The
Company's largest working capital requirements are driven by its smokeless
tobacco operations. The tobacco for dry and moist snuff and loose-leaf chewing
tobacco requires aging of two to three years before being processed into
finished products. The Company maintains sufficient smokeless tobacco raw
material inventories to ensure proper aging and an adequate supply. Although the
Company's business is not seasonal, purchases of smokeless tobacco raw material
inventory typically occur from the middle of the fourth quarter through the end
of the first quarter of each year. Therefore, smokeless tobacco inventories at
year end and at the end of the first quarter are typically higher than during
the rest of the year. The Company will fund its seasonal working capital
requirements through operating cash flows, and, if needed, bank borrowings.
Cash flows used in investing activities were $13.8 million and $8.9 million
for the nine month periods ended September 30, 1998 and 1997, respectively. Cash
flows used in 1998 were primarily related to investments in joint ventures for
the production of premium cigars, and purchases of property, plant and
equipment. Cash flows used in 1997 were for the purchases of property, plant and
equipment. For all of 1998, the Company currently expects that capital
expenditures will be between $7 million and $10 million and will be used to
expand its smokeless tobacco production capacity in moist snuff, expand its
domestic production capacity in mass market cigars and continue its capital
improvement program. Capital expenditures are estimated to be between $5 million
and $8 million for each of 1999 and 2000 and are expected to be used to maintain
existing equipment and
12
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SWISHER INTERNATIONAL GROUP INC.
Management's Discussion and Analysis of the Results
of Operations and Financial Condition
Liquidity and Capital Resources (continued)
facilities as well as increase production capacity. The capital expenditures
referred to above are expected to be funded by cash flows from operations and,
if needed, bank borrowings.
Cash flows used in financing activities were $0.4 million and $13.1 million
for the nine month periods ended September 30, 1998 and 1997, respectively. The
1998 amount is due principally to changes in long-term and short-term borrowings
and the repurchase of common stock. The 1997 amount is due principally to
changes in long-term borrowings.
As of September 30, 1998, borrowings under the Credit Agreement were $93.5
million, and the Company had $35.325 million of unused availability thereunder,
after taking into account approximately $1.175 million utilized to support
letters of credit. Short-term debt consists of a $10.0 million Term Promissory
Note which was repaid on October 15, 1998.
To convert floating rate debt into fixed rate debt, the Company previously
entered into two interest rate swap agreements. As of September 30, 1998, the
total notional amount covered by existing swap agreements was $50.0 million. The
notional amount decreases to $15.0 million on November 16, 1998, and the
remaining agreement terminates on July 2, 1999. Under the terms of these
agreements, the Company receives a variable interest rate equal to three-month
LIBOR and pays a fixed rate of approximately 5.9%, as of September 30, 1998. If
the Company terminated these agreements on September 30, 1998 or 1997, the
effect, as of the end of each period, would be insignificant.
The Company believes that net cash flow generated from future operations
and the availability of borrowings will be sufficient to fund its working
capital requirements, capital expenditures and debt service requirements for the
foreseeable future.
Inflation
The Company has historically been able to pass inflationary increases for
raw materials and other costs onto its customers through price increases,
however, there is no assurance it will be able to do so in the future.
Seasonality
Although the Company's business is generally non-seasonal, consumption of
smokeless tobacco products increases slightly during the summer months.
Additionally, purchases of smokeless tobacco raw materials typically occur from
the middle of the fourth quarter to the end of the first quarter.
Regulation
In 1996, the federal Food and Drug Administration ("FDA") for the first
time asserted jurisdiction over nicotine in tobacco as a "drug" and issued
regulations purporting to regulate smokeless tobacco products as "medical
devices." These regulations prohibit the sale of smokeless tobacco products to
minors and severely restrict advertising, marketing and promotion of smokeless
tobacco products. The regulations also require the Company and other
manufacturers to comply with a wide range of labeling, reporting and other
requirements. In 1997, ruling in a case filed by the Company and other smokeless
tobacco manufacturers to challenge the FDA'a authority, a federal court held
that the FDA as a matter of law is not precluded from regulating smokeless
tobacco products as "medical devices"
13
<PAGE>
SWISHER INTERNATIONAL GROUP INC.
Management's Discussion and Analysis of the Results
of Operations and Financial Condition
Regulation (continued)
or from implementing certain labeling and access restrictions. At the same time,
however, the court said that the FDA has no authority to restrict the
advertising and promotion of smokeless tobacco products and stayed the
effectiveness of any of the restrictions related to labeling, access,
advertising and promotion due to take effect in 1997 and 1998 pending further
order of the court. The court's opinion was appealed to the U.S. Court of
Appeals for the Fourth Circuit in 1997. Due to the death of one of the Appeals
Court judges who originally heard the appeal, the appeal was reargued, and on
August 14, 1998, a reconstituted appellate panel reversed the District Court
ruling and held that the FDA had no jurisdiction to regulate tobacco. That
holding has been appealed. The Company is unable to predict the outcome of the
appeal or its impact on those portions of the regulations that have not been
given effect. Any further provisions of these regulations that become effective
could have a materially adverse effect on the Company's business.
In June 1997, the five largest tobacco companies announced an agreement
with trial lawyers and the Attorneys General of several states suing to recoup
Medicare and Medicaid expenses (the "Proposed Settlement"). Although the Company
was not a party to any of the actions being settled (the "State AG Actions"),
legislation introduced in Congress in the wake of the Proposed Settlement sought
to raise the price of cigarettes and other tobacco products significantly and to
regulate all tobacco products (including smokeless tobacco and, in some cases,
cigars) by imposing full FDA regulation and by adopting new and highly
restrictive marketing requirements. In September 1998, when insufficient votes
could be found for a cloture motion, Congressional leadership tabled the
proposed legislation. However, press reports indicate that alternative
legislation is being developed in the Congress and that the tobacco companies
which were parties to the Proposed Settlement have entered into new negotiations
with certain state Attorneys General to settle the State AG Actions. The Company
cannot anticipate whether the new legislation, if introduced, will be adopted;
whether the State AG Actions will be settled; or the extent to which such
potential legislation or settlement may impact the Company's business.
On February 9, 1998, the Company was notified by the Federal Trade
Commission ("FTC") of the adoption by the FTC of an Order to File a Special
Report on the Company's advertising and marketing expenditures with regard to
its cigar business for 1997 and 1996. This information, which is similar to
information the Company has filed with the FTC for many years with respect to
its smokeless tobacco products, was filed on April 9, 1998.
The Company is subject to laws and regulations relating to the protection
of the environment. While it is not possible to quantify with certainty the
potential impact of future actions regarding environmental matters, in the
opinion of management, compliance with the present environmental protection laws
will not have a material adverse impact upon the Company's consolidated
financial position, results of operations or cash flows.
14
<PAGE>
SWISHER INTERNATIONAL GROUP INC.
Management's Discussion and Analysis of the Results
of Operations and Financial Condition
Excise Taxes
Cigars and smokeless tobacco products have long been subject to federal,
state and local excise taxes. Such taxes are frequently subject to proposed
increases, in some cases significant increases, to fund various legislative
initiatives. The Balanced Budget Act adopted by Congress in 1997, provides for
increases in federal excise taxes on all tobacco products in two stages,
beginning in 2000. Management does not believe that these increases will have a
material adverse effect on the Company's operations. However, enactment of new
or significant further increases in existing federal, state or local excise
taxes could have a material adverse effect on the Company's business.
Litigation
The tobacco industry continues to experience significant health-related
litigation. Plaintiffs in such cases typically seek compensation and, in some
cases, punitive damages, for various injuries allegedly sustained from the use
of tobacco products or exposure to tobacco smoke, including health care costs.
The Company is not aware of any adverse decision or judgment having been
rendered against smokeless or cigar manufacturers.
The Company is a defendant, along with other defendants in an action
brought by an individual plaintiff in Louisiana seeking damages and other relief
in connection with injuries allegedly resulting from use of the Company's and
the other defendants' products. The Company and other defendants have been named
in a Texas action brought by another individual seeking damages and other relief
in connection with injuries allegedly caused to plaintiff by products
manufactured by the Company and the other defendants. The Company believes that
it has meritorious defenses and is vigorously defending these lawsuits.
In addition, 65 individuals have filed simultaneous actions in a West
Virginia court against 20 manufacturers of tobacco products (including the
Company) and fourteen other defendants, alleging that products made by one or
more of the defendants caused them injury (see "Legal Proceedings").
The Company is also a defendant along with multiple other defendants in
three actions brought under California Proposition 65 and the California Unfair
Competition Act (see "Legal Proceedings").
Further, the Company is subject to other litigation, claims and contractual
agreements arising in the ordinary course of business. In the opinion of
management, the cost, if any, of resolving all litigation and contingencies
should not have a significant impact on the Company's consolidated financial
position. There can be no assurance, however, that the Company may not be named
as a defendant in future suits, nor can there be any assurance that existing or
future litigation will not result in an adverse judgment against the Company
which could have a material adverse effect on the Company's business, future
results of operations or cash flows. The Company does not carry insurance to
protect against health-related product liability because the cost of obtaining
such coverage is commercially prohibitive. Additionally, a judgment against the
Company with respect to a product or any related products could preclude the
further sale of such product, which could have a material adverse effect on the
Company's business.
15
<PAGE>
SWISHER INTERNATIONAL GROUP INC.
Management's Discussion and Analysis of the Results
of Operations and Financial Condition
Year 2000
The "Year 2000 Issue" is the result of computer programs that were written
using two digits rather than four to define the applicable year. If the
Company's computer programs with date-sensitive functions are not Year 2000
compliant, they may recognize a date using "00" as the Year 1900 rather than the
Year 2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary inability
to process transactions, send invoices or engage in similar normal business
activities.
The Company has modified all its existing computer applications and
believes they are Year 2000 compliant. All databases currently contain
four-digit years in their date fields, instead of the former two-digit years,
and all software has been tested to ensure that these dates are read and
interpreted correctly. All non-compliant hardware has been replaced with
machinery represented as compliant, and all non-IT systems have been reviewed
with their manufacturers and are now believed to be compliant.
The Company's use of third-party software applications is limited to
UNIX-and Microsoft Windows-based operating systems and standard personal
computer office software such as word processing and spreadsheet applications.
The manufacturers have reported all such software as Year 2000 compliant. As the
Company uses Electronic Data Interchange extensively to communicate with certain
customers, specifically for order taking and invoicing, this area is being
monitored carefully to ensure that these customers are able to send and receive
compliant data no later than June 30, 1999.
Most Year 2000 compliance efforts were completed by the Company's IT staff
with minimal time and without affecting progress of other IT projects. As a
result, the Company's Year 2000 expenditures have approximated only $50,000, and
future costs are expected to be insignificant.
While the Company believes its current state of readiness mitigates most
risks associated with the Year 2000 Issue, it will continue to monitor the
progress of its customers, suppliers and other business partners in addressing
the Year 2000.
Other
Due to industry-wide excess retail inventory levels of premium cigars, the
Company has reduced production at its offshore facilities, including closure of
the COTABEX joint venture.
16
<PAGE>
SWISHER INTERNATIONAL GROUP INC.
Management's Discussion and Analysis of the Results
of Operations and Financial Condition
Other (continued)
This Management's Discussion and Analysis of Financial Condition and
Results of Operations and other sections of this Form 10-Q contain
forward-looking statements that are based on current expectations, estimates and
projections about the industry in which the Company operates, management's
beliefs and assumptions made by management. Words such as "expects", "believes",
"estimates", variations of such words and similar expressions are intended to
identify such forward-looking statements. These statements are not guarantees
of future performance and involve certain risks, uncertainties and assumptions
which are difficult to predict. Therefore, actual outcomes and results may
differ materially from what is expressed or forecasted in such forward-looking
statements. The Company undertakes no obligation to update publicly any
forward-looking statements, whether as a result of new information, future
events or otherwise.
17
<PAGE>
SWISHER INTERNATIONAL GROUP INC.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On March 31, 1998, The City and County of San Francisco et. al. v. United
States Tobacco Company, Inc. et. al. was filed in Superior Court of the State of
California for the County of San Francisco against the Company, five other
smokeless tobacco manufacturers and eleven retailers. The plaintiffs in the
action, Environmental Law Foundation and the City and County of San Francisco,
allege that the defendants violated California Proposition 65 and the California
Unfair Competition Act by (a) selling products that expose California residents
(without providing a "clear and reasonable warning" thereof) to substances known
to the State of California to cause cancer, birth defects and reproductive harm,
and (b) engaging in fraudulent and unfair business practices by marketing
smokeless tobacco products to "young consumers". Plaintiffs claim uncalculated
penalties under Proposition 65 and seek disgorgement of an unspecified amount of
revenues obtained through allegedly wrongful sales. The Company believes that it
has meritorious defenses and is vigorously defending the action.
On July 14, 1998, The People of the State of California et. al. v. Philip
Morris Incorporated et. al. was filed in Superior Court of the State of
California for the County of Los Angeles against the Company, six other cigar
manufacturers, six cigarette manufacturers, fifteen retailers and one pipe
tobacco manufacturer. The plaintiffs in the action, the Los Angeles City
Attorney on behalf of the People of California and American Environmental Safety
Institute, allege that the defendants violated California Proposition 65 and the
California Unfair Competition Act by (a) selling products that expose California
non-smokers to environmental tobacco smoke (resulting in exposure without
warning "to chemicals known to the State of California to cause cancer and/or
reproductive toxicity"), and (b) thereby engaging in fraudulent and unfair
business practices. Plaintiffs claim uncalculated penalties under Proposition 65
and seek disgorgement of an unspecified amount of revenues obtained through
allegedly wrongful sales. The Company believes that it has meritorious defenses
and is vigorously defending the action.
On July 28, 1998, The People of the State of California et. al. v.
General Cigar Co., Inc. et. al. was filed in Superior Court of the State of
California for the County of San Francisco against the Company and nine other
manufacturers of cigars and pipe tobacco. The plaintiffs in the action, the San
Jose City Attorney on behalf of the People of California and Lexington Law
Group, allege that the defendants violated California Proposition 65 and the
California Unfair Competition Act by (a) selling products that expose California
non-smokers to environmental tobacco smoke (resulting in exposure without
warning "to chemicals known to the State of California to cause cancer and/or
reproductive toxicity"), and (b) thereby engaging in fraudulent and unfair
business practices. Plaintiffs claim uncalculated penalties under Proposition 65
and seek disgorgement of an unspecified amount of revenues obtained through
allegedly wrongful sales. The Company believes that it has meritorious defenses
and is vigorously defending the action.
18
<PAGE>
SWISHER INTERNATIONAL GROUP INC.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings (continued)
On October 1, 1998, a group of 65 cases were filed jointly in the Circuit
Court of Kanawha County, West Virginia against the Company under the collective
title, Kelly Allen, et al. v. Phillip Morris Incorporated, et al. Among the 34
defendants named are twenty manufacturers of cigarettes, roll-your-own tobacco
and/or smokeless tobacco products including the Company, nine distributors and
retailers and four trade associations. The 65 distinct plaintiffs in these
actions (who seek to have their cases grouped to take advantage of a mass
litigation panel recently established by the West Virginia courts) allege in
their common complaint that each of them is a West Virginia resident (or the
representative of a deceased West Virginia resident) who uses or has used
tobacco products manufactured by one or more of the defendants and has developed
"some form of cancer or vascular disease". The complaint does not attempt to
establish that any specific plaintiff used any specific product or the name of
the manufacturer thereof or the damage that was allegedly caused thereby;
nevertheless, damages in an unspecified amount are sought against all the
defendants. The Company intends to defend the action vigorously.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Description
------ -----------
27.1 --Financial Data Schedule.
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the nine months ended
September 30, 1998.
19
<PAGE>
SWISHER INTERNATIONAL GROUP INC.
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.
Swisher International Group Inc.
Date: November 4, 1998 By: /s/ William Ziegler, III
------------------- -----------------------------
William Ziegler, III
Chairman of the Board
and Chief Executive Officer
(principal executive officer)
Date: November 4, 1998 By: /s/ Robert A. Britton
------------------- -----------------------------
Robert A. Britton
Executive Vice President
and Chief Financial Officer
(principal financial and
accounting officer)
20
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This Schedule contains summary financial information extracted from the balance
sheet as of September 30, 1998 and statements of income for the nine and three
months ended September 30, 1998, and is qualified in its entirety by reference
to such financial statements.
</LEGEND>
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