FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20459
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 333-31931
NORTH ATLANTIC TRADING COMPANY, INC.
------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
Delaware 13-3961898
------------------------------- ----------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
257 Park Avenue South
New York, New York 10010-7304
--------------------- ----------
(Address of Principal (Zip Code)
Executive Offices)
(212) 253-8185
--------------
(Registrant's Telephone Number, Including Area Code)
Unchanged
---------
(Former name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
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 [ ].
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 528,241 shares of common stock,
$.01 par value, as of September 30, 1998.
NYFS10...:\80\64980\0003\2475\FRM0218M.36E
<PAGE>
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
NORTH ATLANTIC TRADING COMPANY, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(in thousands except par value)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
---- ----
(Unaudited)
<S> <C> <C>
Current Assets:
Cash $ 7,548 $ 4,087
Accounts Receivable 5,964 4,633
Inventory 55,786 56,110
Income Taxes Receivable - 5,326
Other Current Assets 2,615 1,718
----------- ----------
Total Current Assets 71,913 71,874
Property, Plant & Equipment (Net) 7,236 8,251
Deferred Income Taxes 33,193 34,091
Goodwill (Net) 141,342 145,517
Other Assets 11,868 13,506
----------- ----------
Total Assets $ 265,552 $ 273,239
=========== ==========
Current Liabilities:
Accounts Payable 450 659
Accrued Liabilities 10,008 5,873
Deferred Income Taxes 6,721 6,721
Current Portion of Long-Term Debt 11,901 9,375
----------- ----------
Total Current Liabilities 29,080 22,628
Long-Term Debt 205,848 220,625
Other Long-Term Liabilities 6,986 7,486
----------- ----------
Total Liabilities 241,914 250,739
----------- ----------
Preferred Stock, net of discount of $1,472 and $1,600,
respectively (Mandatory Redemption Value of $39,352) 38,076 34,581
Stockholders' Deficit:
Common Stock, voting, $.01 par value; authorized
shares, 750,000; issued and outstanding shares,
528,241 at September 30, 1998 5 5
Common Stock, nonvoting, $.01 par value; authorized
shares, 750,000; issued and outstanding shares,
-0- at September 30, 1998 - -
Warrants 2,410 2,410
Additional Paid-In Capital 6,310 5,906
Accumulated Deficit (23,163) (20,402)
----------- ----------
Total Stockholders' Deficit (14,438) (12,081)
Total Liabilities and Stockholders' Deficit $ 265,552 $ 273,239
=========== ==========
</TABLE>
The accompanying notes are an integral part of the unaudited condensed
consolidated financial statements.
2
<PAGE>
NORTH ATLANTIC TRADING COMPANY, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(in thousands except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
Three Months Three Months
Ended Ended
September 30, 1998 September 30, 1997
------------------ ------------------
<S> <C> <C>
Net Sales $ 31,361 $ 27,024
Cost of Sales 9,915 9,041
----------- ----------
Gross Profit 21,446 17,983
Selling, General & Administrative Expenses 7,285 7,135
Amortization of Goodwill 1,392 1,458
----------- ----------
Operating Income 12,769 9,390
Interest Expense & Financing Costs, Net 6,267 6,705
Other Income (7) (14)
----------- ----------
Income Before Income Tax Provision 6,509 2,699
Income Tax Provision 3,580 1,322
----------- ----------
Net Income 2,929 1,377
Preferred Stock Dividends 1,219 1,091
----------- ----------
Net Income Applicable to Common Shares $ 1,710 $ 286
=========== ==========
Net Income Per Common Share:
Basic $ 3.24 $ .54
=========== ==========
Diluted $ 2.75 $ .48
=========== ==========
Weighted Average Common Shares Outstanding
Basic 528.2 528.2
Diluted 621.5 600.2
</TABLE>
The accompanying notes are an integral part of the unaudited condensed
consolidated financial statements.
3
<PAGE>
NORTH ATLANTIC TRADING COMPANY, INC. AND SUBSIDIARIES
Condensed Consolidated Statement of Operations
(in thousands except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
Nine Months Nine Months
Ended Ended
September 30, 1998 September 30, 1997
------------------ ------------------
<S> <C> <C>
Net Sales $ 68,971 $ 52,962
Cost of Sales 23,716 18,341
----------- ----------
Gross Profit 45,255 34,621
Selling, General & Administrative Expenses 20,704 18,726
Amortization of Goodwill 4,175 1,924
----------- ----------
Operating Income 20,376 13,971
Interest Expense & Financing Costs, Net 18,786 11,900
Other (Income) (42) (58)
----------- ----------
Income Before Income Tax Provision
and Extraordinary Loss 1,632 2,129
Income Tax Provision 898 6,342
----------- ----------
Income (Loss) Before Extraordinary Loss 734 (4,213)
Extraordinary Loss, Net of Income Tax Benefit of $3,224 - (8,262)
----------- ----------
Net Income (Loss) 734 (12,475)
Preferred Stock Dividends 3,495 1,149
----------- ----------
Net Loss Applicable to Common Shares $ (2,761) $ (13,624)
=========== ==========
Net Income (Loss) Before Extraordinary Loss Per Common Share $ (5.23)
$ (10.15)
Extraordinary Loss, Net Per Common Share - (15.64)
----------- ----------
Net Loss Per Common Share:
Basic $ (5.23) $ (25.79)
=========== ==========
Diluted $ (5.23) $ (25.79)
=========== ==========
Weighted Average Common Shares Outstanding:
Basic 528.2 528.2
Diluted 528.2 528.2
Supplemental Unaudited Information(1):
Historical Income Before Income Tax and Extraordinary Loss $ 2,129
Pro Forma Income Tax Provision 852
----------
Pro Forma Net Income Before Extraordinary Loss 1,277
Extraordinary Loss, Net of Income Tax Benefit of $3,224 (8,262)
----------
Pro Forma Net Loss (6,985)
Preferred Stock Dividends 1,149
----------
Pro Forma Net Loss Applicable To Common Shares $ (8,134)
==========
Net Income Before Extraordinary Loss Per Common Share $ .24
Extraordinary Loss, Net of Income Tax Benefit of $3,224, Per
Common Share (15.64)
----------
Pro Forma Net Loss Per Common Share $ (15.40)
==========
Pro Forma Weighted Average Common Shares Outstanding 528.2
</TABLE>
The accompanying notes are an integral part of the unaudited condensed
consolidated financial statements.
- -----------------------------------
1. Supplemental unaudited information represents the Company's pro forma
results of operations assuming income taxes at the combined state and federal
rate of 40% for the period from January 1, 1997 through September 30, 1997.
4
<PAGE>
NORTH ATLANTIC TRADING COMPANY, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Nine Months Nine Months
Ended Ended
September 30, 1998 September 30, 1997
------------------ ------------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net Income (Loss) $ 734 $ (12,475)
Adjustments to Reconcile Net Income (Loss)
to Net Cash Used in Operating Activities:
Income Tax Provision 898 -
Depreciation 1,350 1,363
Amortization of Intangible Assets 4,175 1,926
Amortization of Deferred Financing Fees 1,638 1,552
Extraordinary Loss, Net of Income Tax Benefit of $3,224 - 8,262
Recognition of Deferred Income Taxes - 5,017
Compensation Expense 709 -
Changes in Operating Assets and Liabilities:
Accounts Receivable (1,331) (1,107)
Inventory 324 2,204
Income Tax Receivable 5,326 -
Other Current Assets (897) 2,725
Accounts Payable (209) 1,242
Borrowings Under Inventory Financing Agreement - 6,565
Payments on Borrowings Under Inventory
Financing Agreement - (23,526)
Accrued Expenses and Other 3,330 (9,821)
----------- ----------
Net Cash Provided by (used in) Operating Activities 16,047 (16,073)
----------- ----------
Cash Flows from Investing Activities:
Acquisition of Business, Net of Cash Acquired of $2,602 - (156,818)
Capital Expenditures (335) (520)
----------- ----------
Net Cash Used in Investing Activities (335) (157,338)
----------- ----------
Cash Flows from Financing Activities:
Proceeds from Revolving Loans 8,000 1,550
Payments on Revolving Loans (8,000) (1,550)
Payments on Term Loans (12,251) (43,250)
Proceeds from Senior Notes - 155,000
Proceeds from Term Loans - 85,000
Proceeds from Subordinated Notes Payable - 576
Payments on Subordinated Notes Payable - (21,082)
Payments on Capital Lease - (9)
Proceeds from Issuance of Preferred Stock and Warrants - 34,000
Redemption of Warrants - (27,000)
Increase in Preferred Interest - 198
Redemption of Preferred Interest - (2,935)
Capital Contributions - 712
----------- ----------
Net Cash Provided by (used in) Financing Activities (12,251) 181,210
----------- ----------
Net Increase In Cash 3,461 7,799
Cash, Beginning of Period 4,087 2,208
----------- ----------
Cash, End of Period $ 7,548 $ 10,007
=========== ==========
</TABLE>
The accompanying notes are an integral part of the unaudited condensed
consolidated financial statements.
5
<PAGE>
NORTH ATLANTIC TRADING COMPANY, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(in thousands except per share amounts)
1. Basis of Presentation
The accompanying condensed consolidated financial statements are presented
in accordance with the requirements of Form 10-Q and consequently do not include
all the disclosures normally required by generally accepted accounting
principles. The condensed consolidated financial statements have been prepared
in accordance with North Atlantic Trading Company, Inc.'s (the "Company's")
customary accounting practices and have not been audited. In the opinion of
Management, all adjustments necessary to fairly present the results of
operations for the reported interim periods have been made and were of a normal
recurring nature. The year-end balance sheet data was derived from audited
financial statements, but does not include all disclosures required by generally
accepted accounting principles.
2. Acquisition
On June 25, 1997, the Company acquired NATC Holdings, USA, Inc. ("NATC")
for a purchase price of $162.6 million. The excess of the net assets of $117.3
million was recorded as goodwill and is being amortized over 25 years. The
Acquisition was accounted for under the purchase method of accounting and,
accordingly, the results of operations of NATC have been included in the
accompanying financial statements since the date of acquisition.
Following are the unaudited pro forma results of operations as if the June
25, 1997, transaction had occurred on January 1, 1997:
Nine Months
Ended
September 30, 1997
------------------
Net Sales $ 70,468
=========
Income Before Extraordinary Loss 7,122
Extraordinary Loss (8,262)
---------
Net Loss (1,140)
Preferred Stock Dividends 3,559
---------
Net Loss Applicable to Common Shares $ (4,699)
=========
Basic and Diluted Loss per Common Share:
Income Before Extraordinary Loss, per Common Share $ 6.75
Extraordinary Loss, Net, per Common Share (15.65)
---------
Net Loss per Common Share $ (8.90)
=========
6
<PAGE>
Weighted Average Common Shares Outstanding:
Basic and Diluted 528.2
This unaudited pro forma financial information is not necessarily
indicative of the operating results that would have occurred had the transaction
been consummated as of January 1, 1997, nor is it necessarily indicative of
future operating results.
3. Inventories
The Company uses the last-in, first-out (LIFO) method for valuing its
inventories.
9/30/98 12/31/97
------- --------
Raw Materials and Work In Process $ 2,144 $ 1,492
Leaf Tobacco 35,547 36,675
Finished Goods - Tobacco 4,699 5,444
Finished Goods - Cigarette Papers 12,977 12,241
Other 419 258
--------- --------
$ 55,786 $ 56,110
========= ========
4. Provision for Income Taxes
Prior to June 25, 1997, the Company was a limited liability company and
prior to May 17, 1996, the predecessor was a partnership, neither of which were
subject to state or federal income taxes. Effective June 25, 1997, the Company
became a taxable corporation and recorded a one-time non-cash provision for
income taxes of approximately $5.0 million in order to record its previously
unrecorded deferred income tax assets of $3.1 million and liabilities of $8.1
million. During the fourth quarter of 1997, the Company recorded an adjustment
of $8.7 million to adjust the impact related to this reorganization to a $3.7
million benefit due to a final determination which occurred in the fourth
quarter.
The provision for income taxes for the nine months ended September 30,
1998 has been computed based on the estimated annual effective income tax rate,
which is expected to be 55%. The primary difference between the effective income
tax rate and the statutory income tax rate is certain goodwill amortization,
which is not deductible for income tax purposes.
7
<PAGE>
5. Notes Payable and Long-Term Debt
North Atlantic Trading Company, Inc. is a holding company with no
operations and no assets other than its investment in subsidiaries, deferred
income tax assets related to the differences between the book and tax basis of
its investment in the Partnership and deferred financing costs related to its
debt. All of the Company's subsidiaries are wholly-owned and guarantee the
Company's debt on a full, unconditional and joint and several basis. In
Management's opinion, separate financial statements of the subsidiaries are not
meaningful to investors and are not included in these financial statements.
Following is unaudited parent-only summarized financial information of the
Company:
As of September 30, 1998:
Current Assets $ -
Noncurrent Assets 251,106
Current Liabilities 21,160
Noncurrent Liabilities 205,848
Redeemable Preferred Stock 38,076
For the Nine Months Ended September 30, 1998:
Equity in Earnings of Subsidiaries $ 9,425
Net Loss Before Payment of Preferred
Stock Dividends (785)
6. Net Income (Loss) per Common Share Reconciliation
The following is a reconciliation of the basic and diluted per share
computations:
<TABLE>
<CAPTION>
Nine Months Ended Three Months Ended
September 30, September 30,
------------- -------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net Income (Loss) Before Extraordinary Loss $ 734 $ (4,213) $ 2,929 $ 1,377
Less: Preferred Stock Dividends (3,495) (1,149) (1,219) (1,091)
-------- -------- -------- --------
Income (Loss) Available to Common Stockholders $ (2,761) $ 5,362) $ 1,710 $ 286
Extraordinary Loss $ - $ (8,262) $ - $ -
-------- -------- -------- --------
Net Income (Loss) Available to Common Stockholders $ (2,761) $(13,624) $ 1,710 $ 286
======== ======== ======== ========
Weighted Average Shares of Common Stock Outstanding:
Basic 528.2 528.2 528.2 528.2
Plus: Dilutive Effect of Warrants - - 63.5 63.5
Plus: Dilutive Effect of Stock Options - - 29.8 8.5
-------- -------- ------- -------
Diluted 528.2 528.2 621.5 600.2
======== ======== ======= =======
Basic Net Income (Loss) per Common Share:
Income (Loss) Before Extraordinary Loss $ (5.23) $ (10.15) $ 3.24 $ .54
Extraordinary Loss - (15.64) - -
-------- -------- -------- -------
8
<PAGE>
Basic Net Income (Loss) per Common Share $ (5.23) $ (25.79) $ 3.24 $ .54
======== ======== ======= ========
Diluted Net Income (Loss) per Common Share:
Income (Loss) Before Extraordinary Loss $ (5.23) $ (10.15) $ 2.75 $ .48
Extraordinary Loss - (15.64) - -
-------- -------- -------- --------
Diluted Net Income (Loss) per Common Share $ (5.23) $ (25.79) $ 2.75 $ .48
======== ======== ======= ========
</TABLE>
The calculations are based on the weighted average number of shares of
common stock outstanding during the period. Common equivalent shares from
warrants of 63.5 and stock options of 29.8 and 8.5 were excluded from the
computation for the nine months ended September 30, 1998, and September 30,
1997, as their effect is antidilutive.
7. Contingency
Proposition 65. On March 30, 1998, an action was filed in California State
Court, in the City and County of San Francisco, against defendants United States
Tobacco Company, Inc., Conwood Company, L.P., Pinkerton Tobacco Company, Inc.,
National Tobacco Company, L.P., Swisher International Group, Inc., Brown &
Williamson Tobacco Corporation, Merrill Reese, Inc., Lucky Stores, Inc., Quick
Stop Markets, Inc., Raley's, Inc., Save Mart Supermarkets, Inc., Sav-On Drug
Stores, Inc., The Southland Corporation, Circle K Stores, Inc., Longs Drug
Stores Corporation, Walgreen Co., Safeway, Inc. and DOES 1-500. The plaintiffs
amended their complaint on June 10, 1998 and subsequently served the complaint
on National Tobacco Company, L.P. The complaint purports to be brought on behalf
of The City and County of San Francisco, the People of the State of California
and the Environmental Law Foundation.
Plaintiffs claim that the defendants violated the California Safe Drinking
Water and Toxic Enforcement Act of 1986, Health and Safety Code ss.ss.25249.6
("Proposition 65") by "knowingly and intentionally" exposing California
consumers to carcinogens and reproductive toxins in smokeless tobacco products
while failing to provide a "clear and reasonable" warning that smokeless tobacco
products contain substances that are "known to the state to cause cancer" and
"known to the state to cause reproductive toxicity." Plaintiffs further claim
that the defendants violated California's Unfair Competition Act, Business &
Professions Code ss.ss.17200, et seq., by marketing smokeless tobacco products
to children, and by fraudulently concealing from the public the adverse
consequences and addiction associated with smokeless tobacco products.
The complaint seeks a preliminary and permanent injunction preventing
defendants from selling smokeless tobacco products without a "clear and
reasonable" warning, as well as an injunction ordering defendants to undertake a
court-approved public information campaign to instruct children that the use of
smokeless tobacco products results in exposures to substances known to the State
of California to cause cancer and reproductive harm. The plaintiffs also seek an
award of statutory penalties and dam-
9
<PAGE>
ages for each violation of Proposition 65 and the Unfair Competition Act,
disgorgement of profits from the sale of smokeless tobacco products, and
attorneys' fees and costs. National Tobacco Company, L.P. intends to defend the
action vigorously.
Kentucky and Illinois Complaints. On July 15, 1998, NAOC and National
Tobacco filed a complaint against Republic Tobacco, Inc. and its affiliates
("Republic Tobacco") in Federal District Court for the Western District of
Kentucky. This complaint was subsequently amended on August 18, 1998
(collectively, the complaint and the amended complaint are referred to herein as
the "Kentucky Complaint"). Republic Tobacco imports and sells RYO cigarette
paper under the JOB(R) and TOP(R) brand names. The Kentucky Complaint alleges,
inter alia, that Republic Tobacco's use of exclusivity agreements, rebates,
incentive programs, buy-backs and other activities relating to the sale of RYO
cigarette papers in the southeastern United States violate federal and state
antitrust and unfair competition laws. The Kentucky Complaint also alleges that
Republic Tobacco has defaced and directed others to deface NAOC's and National
Tobacco's point of purchase vendor displays for RYO cigarette papers by covering
up the Zig-Zag(R) brand name and advertising material with advertisements for
Republic Tobacco's RYO cigarette brands. The Kentucky Complaint alleges that
these activities constitute acts of unfair competition under federal and state
law.
Republic Tobacco on June 30, 1998 filed a complaint against the
Company and NAOC in the United States District Court of the Northern District of
Illinois. Republic Tobacco did not serve this complaint or otherwise notify the
Company of its existence until after the filing and service of the Kentucky
Complaint. The Company believes that this complaint was filed in anticipation of
the filing of the Kentucky Complaint. This complaint was amended by Republic
Tobacco on September 16, 1998 (collectively, the complaint and amended complaint
are referred to herein as the "Illinois Complaint"). In the Illinois Complaint,
Republic Tobacco seeks declaratory relief that (a) Republic Tobacco's actions in
defacing the Company's point of purchase display vendors do not violate federal
or state laws and (b) that Republic Tobacco's trade practices do not violate
federal or state antitrust or unfair competition laws. In addition, the Illinois
Complaint alleges that certain actions taken by the Company to inform its
customers of its claims against Republic Tobacco constitute tortious
interference with customer relationships, false advertising, violations of
Uniform Deceptive Trade Practices and Consumer Fraud Acts, defamation and unfair
competition. In addition, although not included in its original complaint, in
its amended complaint Republic Tobacco alleges that the Company has unlawfully
monopolized and attempted to monopolize the market for RYO cigarette papers.
10
<PAGE>
The Company has alleged that Republic Tobacco's trade practices in
the southeastern United States have unlawfully restricted the Company's ability
to expand the distribution of Zig-Zag RYO cigarette papers in the Southeast,
where sales of Zig-Zag have been historically underdeveloped.
The Company intends to vigorously pursue its claims set forth in the
Kentucky Complaint. With respect to the claims contained in the Illinois
Complaint, the Company has filed a Motion to Dismiss concerning a substantial
portion of Republic Tobacco's claims against the Company, and believes that
Republic Tobacco's claims against the Company are without merit. The Company
intends to vigorously defend the Illinois Complaint.
West Virginia Complaints. On October 6, 1998, the Company was served
with a summons and complaint in an action in the Circuit Court of Kanawha
County, West Virginia, entitled Kelly Allen, et al. v. Philip Morris
Incorporated, et al. (Civil Action Nos. 98-C-2401). While the Company was served
with a single summons and complaint, the caption of the complaint lists 65
separate plaintiffs, each with an individual case number.
The Company, among others, has been named in action filed on October
28, 1998, in the Circuit Court of Kanawha County, West Virginia, entitled Billie
J. Akers, et al. v. Philip Morris Inc., et al. (Civil Action No. 98-C-2696 to
98-C-2713). While a single complaint was filed, the caption of the complaint
lists 18 separate plaintiffs, each with an individual case number. This action
was filed by the same plaintiffs' attorney who filed the Allen action and the
complaint is identical in most material respects. The Company has not been
served in this action.
These two action were commenced by separate plaintiffs,
"individually and/or as the personal representatives of the various decedents
named herein [who] are residents of the State of West Virginia and/or smoked
cigarettes or used other tobacco products, manufactured, promoted, advertised,
marked, sold and/or distributed by all defendants." The complaints contain no
specific allegations relating to any individual plaintiff. These two actions
were brought against major manufacturers of cigarettes, smokeless tobacco
products (including the Company) and other tobacco products, and certain other
organizations.
The complaints allege that "plaintiffs and plaintiffs' decedents
suffer/had suffered from a form of cancer of vascular disease and other injuries
due wholly or in part to defendants' products and/or activities." The complaints
further allege that the actions "arise from decades of intentionally wrongful
conduct by the defendants who have manufactured, promoted, and sold
11
<PAGE>
cigarettes and both smokeless and loose tobacco to the plaintiffs and
plaintiffs' decedents and millions of Americans while knowing, but denying and
concealing that their products caused diseases, including but not limited to
esophageal, laryngeal, pharyngeal, mouth cancer, throat cancers and Buerger's
Disease." The complaints do not identify which plaintiffs, if any, allege injury
as a results of the use of smokeless tobacco.
The complaints assert 24 unspecified counts and seek referral to the
West Virginia Mass Litigation Panel, because the actions allegedly "involve
multiple plaintiffs pursuing related claims or actions involving one or more
common questions of act or law and the plaintiffs seek damages caused by some
"product." The complaints seek unspecified compensatory damages. The Company
intends to vigorously defend against each such complaint.
12
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Overview
On June 25, 1997, the Company acquired all of the issued and outstanding
capital stock of NATC Holdings USA, Inc. ("NATC") (the "Acquisition"), at which
time NATC and its subsidiaries were merged into North Atlantic Operating
Company, Inc. ("NAOC"), a wholly-owned subsidiary of the Registrant. The
Acquisition was accounted for under the purchase method of accounting and the
operating results of NATC have been included from the date of acquisition. The
aggregate acquisition purchase price of $162.6 million was allocated to the
acquired net assets based on the fair market value of such net assets.
Results of Operations
Comparison of Three Months Ended September 30, 1998,
To Three Months Ended September 30, 1997
Net Sales. The Company's net sales for the three months ended September 30,
1998, were $31.3 million, an increase of $4.3 million, or 16.1%, from the prior
year's period.
National Tobacco Company L.P.'s ("National Tobacco") net sales of smokeless
tobacco products for the three months ended September 30, 1998, increased 3.0%
as a result of the price increases of January and June 1998 and various
promotional programs offered by National Tobacco during the quarter. Net sales
for the Company's value brand, Durango, represented 11.1% of National Tobacco's
net sales for the quarter. National Tobacco does not anticipate maintaining the
same level of promotional activity during the fourth quarter of 1998.
NAOC's net sales of roll-your-own ("RYO") cigarette paper when compared to the
prior period's results increased 31.1%. This increase was primarily due to
increased demand following the decline in net sales experienced during the first
half of 1998 as a result of Management's decision to reposition its promotional
activity by decreasing the inventory level maintained at the distributor level.
On July 13, 1998, NAOC announced a price increase, averaging approximately 5.0%,
effective August 10, 1998.
Gross Profit. Gross profit for the three months ended September 30, 1998, was
$21.4 million, an increase of $3.5 million, or 19.3%, from the prior year's
period due to the increase in net sales described above and a reduction in cost
of goods sold as a percentage of net sales.
13
<PAGE>
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the three months ended September 30, 1998, were $7.3
million, an increase of 2.1% from last year's $7.1 million. This was due
primarily to normal increases in operating expenses.
Interest Expense and Financing Costs. Interest expense and financing costs
decreased to $6.3 million for the three months ended September 30, 1998, from
$6.7 million for the prior year's period. This decrease was the result of a
lower average term loan balance as well as a lower interest rate environment.
Income Taxes. The income tax provision reflects the application of the estimated
annual effective tax rate of 55% based on projected earnings for 1998. The
Company's estimated effective tax rate was 40% prior to accounting for the
amortization of non-deductible goodwill. The Company has a net operating loss
carryforward of approximately $9.5 million, as of December 31, 1997, and does
not expect to pay material federal income taxes during 1998.
Net Income. Due to the factors described above, the net income for the three
months ended September 30, 1998, was $2.9 million compared to $1.4 million for
the prior year's period.
Comparison of None Months Ended September 30, 1998,
To Nine Months Ended September 30, 1997
Net Sales. The Company's net sales for the nine months ended September 30, 1998,
were $69.0 million, an increase of $16.0 million, or 30.2%, from the prior
year's period due primarily to the Acquisition and price increases.
National Tobacco's net sales of smokeless tobacco products for the nine months
ended September 30, 1998, decreased 0.7%, reflecting a volume decline in net
pounds of 3.1%. This volume decline was due, in part, to the Company's change in
its smokeless tobacco promotional strategy, from a free goods to a cents-off
marketing plan, to achieve a more profitable product mix. For the nine months
ended September 30, 1998, National Tobacco's free goods activity in net pounds
declined 5.2% compared to the prior year's period; whereas, its cents-off
activity in net pounds increased 15.6%. Additionally, the decline in net sales
was partially offset by price increases. Net sales of Durango, a value brand,
for the nine months ended September 30, 1998, represented 8.8% of National
Tobacco's net sales.
NAOC's net sales of RYO cigarette paper when compared to the
prior period's pro forma results declined 4.0%. This decline was
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<PAGE>
due primarily to Management's decision to reposition its promotional activity
and to reduce inventory at the distributor level during the March 1998
promotion.
Gross Profit. Gross profit for the nine months ended September 30, 1998,
increased $10.6 million, or 30.7%, from the prior year's period due primarily to
the Acquisition.
Selling, General, and Administrative Expenses. Selling, general, and
administrative expenses for the nine months ended September 30, 1998, increased
10.6% to $20.7 million from last year's $18.7 million. This increase was due
primarily to the Acquisition and, secondarily, to expenses associated with the
addition of new members of senior management, an increase in legal and
professional fees and the reorganization and expansion of the Company's sales
organization.
Amortization of Goodwill. Amortization of goodwill for the nine months ended
September 30, 1998, was $4.2 million compared to $1.9 millon for the prior
year's period. This increase was due to an increase in goodwill as a result of
the Acquisition.
Interest Expense and Financing Costs. Interest expense and financing costs
increased to $18.8 million for the nine months ended September 30, 1998, from
$11.9 million for the period year's period. This increase was the result of
additional indebtedness incurred in connection with the Acquisition and related
recapitalization.
Income Taxes. The income tax provision reflects the application of the estimated
annual effective tax rate of 55% based on projected earnings for 1998. The
Company's estimated effective tax rate was 40% prior to accounting for the
amortization of non-deductible goodwill. The Company has a net operating loss
carryforward of approximately $9.5 million, as of December 31, 1997, and does
not expect to pay material federal income taxes during 1998.
Extraordinary Loss. The Company recorded an extraordinary loss of $8.3 million
(net of income tax benefit of $3.2 million) for the nine months ended September
30, 1997, related to the write-off of deferred financing costs and the debt
discount due to the recapitalization of the Company on June 25, 1997.
Net Income (Loss). Due to the factors described above, the net income for the
nine months ended September 30, 1998, was $0.7 million compared to a net loss of
$12.5 million for the prior year's period.
15
<PAGE>
Liquidity and Capital Requirements
At September 30, 1998, working capital was $42.8 million compared to $49.2
million at December 31, 1997. This decrease was primarily the result of the
receipt of the federal tax carry-back refund of $5.3 million in April 1998,
which was used to prepay $5.3 million of the Term Loan. The tax treatment of
certain expenses arising out of the Acquisition are under examination by the
Internal Revenue Service and no proposed adjustment has been received to date.
The Company expects to continue to fund its seasonal working capital
requirements through its operating cash flows, and, if needed, bank borrowings.
The Company currently has an undrawn availability of $24 million under its
committed $25 million revolving credit facility.
The tobacco for loose leaf chewing tobacco requires aging of approximately two
years before being processed into finished products. The Company believes that
its National Tobacco subsidiary maintains sufficient tobacco inventories to
ensure proper aging as well as an adequate supply based on its historical and
anticipated sales activity. The Company also believes that its NAOC subsidiary
maintains adequate inventories based on its past and estimated future sales
activity and that its supply of such inventory will remain stable for the
forseeable future.
The Company believes that any effect of inflation at current anticipated levels
will be minimal. Historically, the Company has been able to increase prices at a
rate greater than that of inflation and believes that this trend will continue.
In addition, the Company has been able to maintain a relatively stable variable
cost structure for its smokeless tobacco products in significant part due to its
procurement and reformulation activities.
Given its current operation, the Company believes that its capital expenditure
requirements for 1998 will remain within the $500,000 to $650,000 range. The
Company believes that its operating cash flows, together with its revolving
credit facility, should be adequate to satisfy its reasonable foreseeable
capital requirements. The financing of any significant future products, business
or property acquisitions may require additional debt or equity refinancing.
Year 2000
During fiscal 1997, the Company assessed the steps necessary to address matters
related to "Year 2000" issues. The assessment included a review of all the
Company's hardware and software requirements. The Company has developed and
begun implementing a
16
<PAGE>
strategy for attaining "Year 2000" compliance that includes modifying existing
software, purchasing new software and acquiring new hardware.
As of September 30, 1998, Phases I and II of the four-phase program were
completed. Phase I included Purchasing, Accounts Payable and Inventory. These
functions have been tested and are fully operational. Phase II included the
remaining Accounting and Finance functions. This Phase, including all related
conversions, is completely installed and testing is ongoing. Phase III involves
the linking of the Operating Companies in Louisville with the Corporate Office
located in New York. This effort is currently under evaluation and is expected
to be in place by early 1999. Phase IV, the last major Phase to be implemented,
involving the Customer Ordering and Invoicing systems, is approximately 25%
completed and is expected to be finished by March 31, 1999.
In addition, the Company has identified significant service providers, vendors,
suppliers and customers that are critical to its business operations. Steps are
being undertaken in an attempt to reasonably ascertain their stage of readiness
through interviews and other means. The Company believes that there is minimal
exposure in these areas due to the limited reliance on electronic components
involved in the manufacturing process, the small number of major suppliers and
the preponderance of customers that are relatively unimpacted in terms of
electronic data interchange.
It is currently estimated that the aggregate cost of the Company's Year 2000
compliance efforts will be approximately $330,000, of which approximately
$175,000 has been spent. This includes both replacement of hardware and the
updating and replacement of software systems and is being funded through
operating cash flows.
Due to the general uncertainty inherent in the Year 2000 problem, resulting in
part from the uncertainty of the Year 2000 readiness of third-party suppliers
and customers, the Company is unable to fully determine, at this time, whether
the consequences of Year 2000 failures will have a material impact on the
Company's results of operations, liquidity or financial condition. The Company
believes that, with the implementation of the new business systems and the
completion of the project as scheduled, the possibility of significant
interruptions of normal operations will be mitigated.
17
<PAGE>
Recently Issued Accounting Pronouncements
During June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosure about Segments of an
Enterprise and Related Information" ("SFAS No. 131"). The Company will adopt
SFAS No. 131 in 1998 as required. Because this standard requires only disclosure
of certain additional information, the effect of adoption will not have a
significant impact on the Company's financial position.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting For Derivative Instruments
and Hedging Activities" ("SFAS No. 133"). The statement establishes accounting
and reporting standards for derivative instruments and hedging activities. The
Company will adopt SFAS No. 133 in the Company's quarterly reporting for the
year ending December 31, 2000, as required. The Company is in the process of
assessing the impact of this standard on its financial statements.
Forward-looking Statements
We caution you that certain statements in the Management's Discussion and
Analysis of Financial Condition and Results of Operations section and elsewhere
in this Form 10-Q are "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. Forward-looking statements are
not guarantees of future performance. They involve risks, uncertainties and
other important factors, including the risks discussed below. The Company's
actual future results, performance or achievement of results may differ
materially from any such results, performance, achievement implied by these
statements. Among the factors that could affect the Company's actual results and
could cause results to differ from those anticipated in the forward-looking
statements contained herein is the Company's ability to implement its business
strategy successfully, which will be dependent on business, financial, and other
factors beyond the Company's control, including, among others, competitive
pressures, prevailing changes in consumer preferences, consumer acceptance of
new product introductions and other marketing initiatives, access to sufficient
quantities of raw material or inventory, wholesale ordering patterns, product
liability litigation and changes in tobacco products regulation.
We caution you not to put undue reliance on any forward-looking statements. In
addition, we do not have any intention or obligation to update the
forward-looking statements in this document. The Company claims the protection
of the safe harbor for forward-looking statements contained in Section 21E of
the Securities Exchange Act of 1934.
18
<PAGE>
Item 3. Not Applicable.
19
<PAGE>
PART II
OTHER INFORMATION
Item 1. Legal Proceedings.
Proposition 65. On July 15, 1998, NAOC and National Tobacco filed a
complaint against Republic Tobacco, Inc. and its affiliates ("Republic Tobacco")
in Federal District Court for the Western District of Kentucky. This complaint
was subsequently amended on August 18, 1998 (collectively, the complaint and the
amended complaint are referred to herein as the "Kentucky Complaint"). Republic
Tobacco imports and sells RYO cigarette paper under the JOB(R) and TOP(R) brand
names. The Kentucky Complaint alleges, inter alia, that Republic Tobacco's use
of exclusivity agreements, rebates, incentive programs, buy-backs and other
activities relating to the sale of RYO cigarette papers in the southeastern
United States violate federal and state antitrust and unfair competition laws.
The Kentucky Complaint also alleges that Republic Tobacco has defaced and
directed others to deface NAOC's and National Tobacco's point or purchase vendor
displays for RYO cigarette papers by covering up the Zig-Zag(R) brand name and
advertising material with advertisements for Republic Tobacco's RYO cigarette
brands. The Kentucky Complaint alleges that these activities constitute acts of
unfair competition under federal and state law.
Republic Tobacco on June 30, 1998 filed a complaint against the
Company and NAOC in the United States District Court of the Northern District of
Illinois. Republic Tobacco did not serve this complaint or otherwise notify the
Company of its existence until after the filing and service of the Kentucky
Complaint. The Company believes that this complaint was filed in anticipation of
the filing of the Kentucky Complaint. This complaint was amended by Republic
Tobacco on September 16, 1998 (collectively, the complaint and amended complaint
are referred to herein as the "Illinois Complaint"). In the Illinois Complaint,
Republic Tobacco seeks declaratory relief that (a) Republic Tobacco's actions in
defacing the Company's point of purchase display vendors do not violate federal
or state laws and (b) that Republic Tobacco's trade practices do not violate
federal or state antitrust or unfair competition laws. In addition, the Illinois
Complaint alleges that certain actions taken by the Company to inform its
customers of its claims against Republic Tobacco constitute tortious
interference with customer relationships, false advertising, violations of
Uniform Deceptive Trade Practices and Consumer Fraud Acts, defamation and unfair
competition. In addition, although not included in its original complaint, in
its amended complaint Republic Tobacco alleges that the Company has unlawfully
monopolized and attempted to monopolize the market for RYO cigarette papers.
20
<PAGE>
The Company has alleged that Republic Tobacco's trade practices in the
southeastern United States have unlawfully restricted the Company's ability to
expand the distribution of Zig-Zag RYO cigarette papers in the Southeast, where
sales of Zig-Zag have been historically underdeveloped.
The Company intends to vigorously pursue its claims set forth in the
Kentucky Complaint. With respect to the claims contained in the Illinois
Complaint, the Company has filed a Motion to Dismiss concerning a substantial
portion of Republic Tobacco's claims against the Company, and believes that
Republic Tobacco's claims against the Company are without merit. The Company
intends to vigorously defend the Illinois Complaint.
West Virginia Complaints. On October 6, 1998, the Company was served
with a summons and complaint in an action in the Circuit Court of Kanawha
County, West Virginia, entitled Kelly Allen, et al. v. Philip Morris
Incorporated, et al. (Civil Action Nos. 98-C-2401). While the Company was served
with a single summons and complaint, the caption of the complaint lists 65
separate plaintiffs, each with an individual case number.
The Company, among others, has been named in action filed on October
28, 1998, in the Circuit Court of Kanawha County, West Virginia, entitled Billie
J. Akers, et al. v. Philip Morris Inc., et al. (Civil Action No. 98-C-2696 to
98-C-2713). While a single complaint was filed, the caption of the complaint
lists 18 separate plaintiffs, each with an individual case number. This action
was filed by the same plaintiffs' attorney who filed the Allen action and the
complaint is identical in most material respects. The Company has not been
served in this action.
These two action were commenced by separate plaintiffs, "individually
and/or as the personal representatives of the various decedents named herein
[who] are residents of the State of West Virginia and/or smoked cigarettes or
used other tobacco products, manufactured, promoted, advertised, marked, sold
and/or distributed by all defendants." The complaints contain no specific
allegations relating to any individual plaintiff. These two actions were brought
against major manufacturers of cigarettes, smokeless tobacco products (including
the Company) and other tobacco products, and certain other organizations.
The complaints allege that "plaintiffs and plaintiffs' decedents
suffer/had suffered from a form of cancer of vascular disease and other injuries
due wholly or in part to defendants' products and/or activities." The complaints
further allege that the actions "arise from decades of intentionally wrongful
conduct by the defendants who have manufactured, promoted, and sold
21
<PAGE>
cigarettes and both smokeless and loose tobacco to the plaintiffs and
plaintiffs' decedents and millions of Americans while knowing, but denying and
concealing that their products caused diseases, including but not limited to
esophageal, laryngeal, pharyngeal, mouth cancer, throat cancers and Buerger's
Disease." The complaints do not identify which plaintiffs, if any, allege injury
as a results of the use of smokeless tobacco.
The complaints assert 24 unspecified counts and seek referral to the
West Virginia Mass Litigation Panel, because the actions allegedly "involve
multiple plaintiffs pursuing related claims or actions involving one or more
common questions of act or law and the plaintiffs seek damages caused by some
"product." The complaints seek unspecified compensatory damages. The Company
intends to vigorously defend against each such complaint.
The information which is set forth under the caption "Contingencies"
in the Notes to Condensed Consolidated Financial Statements in Item 1 of Part I
of this Report, relating to the March 30, 1998 civil action against National
Tobacco Company,
L.P., is incorporated herein by reference.
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 in the First Quarter of 1998.
22
<PAGE>
SIGNATURES
The Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NORTH ATLANTIC TRADING COMPANY, INC.
Date: November 12, 1998 /s/ Thomas F. Helms, Jr.
------------------------------------------
Thomas F. Helms, Jr.
President & Chief Executive Officer
Date: November 12, 1998 /s/ David I. Brunson
------------------------------------------
David I. Brunson
Chief Financial Officer
23
<PAGE>
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
27.1 Financial Data Schedule
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<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-30-1998
<PERIOD-END> SEP-30-1998
<CASH> 7,548
<SECURITIES> 0
<RECEIVABLES> 5,964
<ALLOWANCES> 0
<INVENTORY> 55,786
<CURRENT-ASSETS> 71,913
<PP&E> 11,239
<DEPRECIATION> 4,003
<TOTAL-ASSETS> 265,552
<CURRENT-LIABILITIES> 29,080
<BONDS> 0
38,076
0
<COMMON> 5
<OTHER-SE> (14,443)
<TOTAL-LIABILITY-AND-EQUITY> 265,552
<SALES> 31,361
<TOTAL-REVENUES> 31,361
<CGS> 9,915
<TOTAL-COSTS> 9,915
<OTHER-EXPENSES> (7)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 6,267
<INCOME-PRETAX> 6,509
<INCOME-TAX> 3,580
<INCOME-CONTINUING> 2,929
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,710
<EPS-PRIMARY> 3.24
<EPS-DILUTED> 2.75
</TABLE>
