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 June 30, 1999
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to _________
Commission File Number 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 Executive Offices) (Zip Code)
(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 June 30, 1999.
<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>
June 30, December 31,
1999 1998
---- ----
(Unaudited)
<S> <C> <C>
Current Assets:
Cash $ 640 $ 2,817
Accounts Receivable 6,572 5,486
Inventory 58,273 58,487
Other Current Assets 1,123 1,274
------------- -------------
Total Current Assets 66,608 68,064
Property, Plant & Equipment (Net) 6,447 7,031
Deferred Income Taxes 34,212 32,937
Deferred Financing Costs 10,094 11,232
Goodwill (Net) 137,282 140,027
Other Assets 1,193 1,016
------------- -------------
Total Assets $ 255,836 $ 260,307
============= =============
Current Liabilities:
Revolving Credit Facility $ 4,000 $ -
Accounts Payable 526 458
Accrued Liabilities 4,191 3,696
Deferred Income Taxes 8,903 8,903
Current Portion of Long-Term Debt 13,721 12,983
------------- -------------
Total Current Liabilities 31,341 26,040
Long-Term Debt 194,052 202,603
Other Long-Term Liabilities 7,700 7,700
------------- -------------
Total Liabilities 233,093 236,343
------------- -------------
Preferred Stock, net of discount of $1,344 and $1,400,
respectively (Mandatory Redemption Value of $43,200) 41,900 39,332
-------------- --------------
Stockholders' Deficit:
Common Stock, voting, $.01 par value; authorized
shares, 750,000; issued and outstanding shares,
528,241 5 5
Common Stock, nonvoting, $.01 par value; authorized
shares, 750,000; issued and outstanding shares,
-0- - -
Additional Paid-In Capital 9,020 9,020
Loans to Stockholders for Stock Purchase (244) (247)
Accumulated Deficit (27,938) (24,146)
-------------- -------------
Total Stockholders' Deficit (19,157) (15,368)
------------- -------------
Total Liabilities and Stockholders' Deficit $ 255,836 $ 260,307
============= =============
</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
June 30, 1999 June 30, 1998
------------- -------------
<S> <C> <C>
Net Sales $ 18,030 $ 17,908
Cost of Sales 6,767 6,927
------------- -------------
Gross Profit 11,263 10,981
Selling, General & Administrative Expenses 6,398 6,397
Amortization of Goodwill 1,373 1,392
------------- -------------
Operating Income 3,492 3,192
Interest Expense & Financing Costs, Net 5,893 6,133
Other Income (4) (19)
------------- -------------
Loss Before Income Tax Benefit (2,397) (2,922)
Income Tax Benefit (1,218) (1,607)
-------------- --------------
Net Loss (1,179) (1,315)
Preferred Stock Dividends (1,301) (1,153)
-------------- --------------
Net Loss Applicable to Common Shares $ (2,480) $ (2,468)
============== ==============
Net Loss Per Common Share:
Basic and Diluted $ (4.70) $ (4,67)
============= =============
Weighted Average Common Shares Outstanding:
Basic and Diluted 528.2 528.2
===== =====
</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 STATEMENTS OF OPERATIONS
(in thousands except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
Six Months Six Months
Ended Ended
June 30, 1999 June 30, 1998
------------- -------------
<S> <C> <C>
Net Sales $ 38,777 $ 37,610
Cost of Sales 13,822 13,801
------------- -------------
Gross Profit 24,955 23,809
Selling, General & Administrative Expenses 12,818 13,418
Amortization of Goodwill 2,745 2,783
------------- -------------
Operating Income 9,392 7,608
Interest Expense & Financing Costs, Net 11,897 12,518
Other Income (5) (34)
------------- -------------
Loss Before Income Tax Benefit (2,500) (4,876)
Income Tax Benefit (1,275) (2,682)
-------------- --------------
Net Loss (1,225) (2,194)
Preferred Stock Dividends (2,567) (2,276)
-------------- --------------
Net Loss Applicable to Common Shares $ (3,792) $ (4,470)
============== ==============
Net Loss Per Common Share:
Basic and Diluted $ (7.18) $ (8.46)
============= =============
Weighted Average Common Shares Outstanding:
Basic and Diluted 528.2 528.2
===== =====
</TABLE>
The accompanying notes are an integral part of the unaudited
condensed consolidated financial statements.
4
<PAGE>
NORTH ATLANTIC TRADING COMPANY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Six Months Six Months
Ended Ended
June 30, 1999 June 30, 1998
------------- -------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net Loss $ (1,225) $ (2,194)
Adjustments to Reconcile Net Loss
to Net Cash Provided by (Used In) Operating Activities:
Income Tax Benefit (1,275) (2,682)
Depreciation 900 900
Amortization of Intangible Assets 2,745 2,783
Amortization of Deferred Financing Costs 1,138 1,086
Stock Option Expense 58 490
Changes in Operating Assets and Liabilities:
Accounts Receivable (1,086) 221
Inventory 214 (3,757)
Income Tax Receivable - 5,326
Other Current Assets 151 (899)
Accounts Payable 68 (217)
Other Assets (176) -
Accrued Expenses and Other 436 (1,791)
------------- --------------
Net Cash Provided by (used in) Operating Activities 1,948 (734)
------------- --------------
Cash Flows from Investing Activities:
Capital Expenditures (316) (223)
------------- --------------
Net Cash Used in Investing Activities (316) (223)
------------- -------------
Cash Flows from Financing Activities:
Proceeds from Revolving Credit Facility 4,000 8,000
Payments on Term Loans (7,812) (10,087)
Repayment of Loans to Stockholders for Stock Purchases 3 -
------------- --------------
Net Cash Used In Financing Activities (3,809) (2,087)
------------- --------------
Net Decrease In Cash (2,177) (3,044)
Cash, Beginning of Period 2,817 4,087
------------- --------------
Cash, End of Period $ 640 $ 1,043
============= ==============
</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. INVENTORIES
The Company uses the last-in, first-out (LIFO) method for valuing its
inventories.
<TABLE>
<CAPTION>
6/30/99 12/31/98
------- --------
<S> <C> <C>
Raw Materials and Work In Process $ 1,747 $ 1,960
Leaf Tobacco 17,217 19,679
Finished Goods - Smokeless Tobacco 3,294 3,074
Finished Goods - Roll-Your-Own 8,627 6,470
Other 465 381
------------- -------------
31,350 31,564
LIFO Reserve 26,923 26,923
------------- -------------
$ 58,273 $ 58,487
============= =============
</TABLE>
3. PROVISION FOR INCOME TAXES
The provision for income taxes for the six months ended June 30, 1999 has been
computed based on the estimated annual effective income tax rate, which is
expected to be 51%. 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.
4. 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
National Tobacco Company, L.P. ("National Tobacco"), a subsidiary of the
Company, 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.
6
<PAGE>
Following is unaudited parent-only summarized financial information of the
Company:
<TABLE>
<CAPTION>
6/30/99 12/31/98
------- --------
<S> <C> <C>
Current Assets $ - $ -
Noncurrent Assets 241,735 247,140
Current Liabilities 24,677 19,964
Noncurrent Liabilities 194,052 202,603
Redeemable Preferred Stock 41,900 39,332
For the Six Months Ended June 30: 1999 1998
---- ----
Equity in Earnings of Subsidiaries $ 7,821 3,617
Net Loss Before Payment of Preferred
Stock Dividends (1,305) (2,166)
</TABLE>
5. NET LOSS PER COMMON SHARE RECONCILIATION
The following is a reconciliation of the basic and diluted per share
computations:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
------------------ ----------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net Loss $ (1,179) $(1,315) $ (1,225) $(2,194)
Less: Preferred Stock Dividends (1,301) (1,153) (2,567) (2,276)
---------- --------- ---------- ---------
Net Loss Available to Common Stockholders $ (2,480) $(2,468) $ (3,792) $(4,470)
========== ========= ========== =========
Weighted Average Shares of Common Stock Outstanding: Basic and
Diluted 528.2 528.2 528.2 528.2
========== ========= ========== =========
Net Loss per Common Share
Basic and Diluted $ (4.70) $ (4.67) $ (7.18) $ (8.46)
========== ========= ========== =========
</TABLE>
The calculations are based on the weighted average number of shares of common
stock outstanding during the period. Common equivalent shares from stock options
and warrants are excluded from these computations as their effect is
antidilutive.
6. SEGMENT INFORMATION
In 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information." The Company is organized primarily on the
basis of product lines which comprise its two reportable segments: the Smokeless
Tobacco segment, which manufactures smokeless tobacco products that are
distributed primarily through wholesale and food distributors in the United
States, and the Roll-Your-Own segment, which imports and distributes cigarette
papers and related products through wholesale distributors in the United States.
Segment data includes a charge allocating all corporate costs to each operating
segment. The Company evaluates the performance of its segments and allocates
resources to them based on earnings before interest, taxes, depreciation,
amortization, certain noncash charges and other income and expenses (Adjusted
EBITDA).
7
<PAGE>
The table below present's financial information about reported segments (in
thousands):
<TABLE>
<CAPTION>
SMOKELESS
TOBACCO ROLL-YOUR-OWN TOTAL
------- ------------- -----
<S> <C> <C> <C>
THREE MONTHS ENDED JUNE 30, 1999
- -----------------------------------------------------
Net Sales $ 12,902 $ 5,128 $ 18,030
Adjusted EBITDA 4,578 863 5,441
THREE MONTHS ENDED JUNE 30, 1998
- -----------------------------------------------------
Net Sales $ 14,315 $ 3,593 $ 17,908
Adjusted EBITDA 5,012 366 5,378
SIX MONTHS ENDED JUNE 30, 1999
- -----------------------------------------------------
Net Sales $ 23,405 $ 15,372 $ 38,777
Adjusted EBITDA 7,649 5,640 13,289
SIX MONTHS ENDED JUNE 30, 1998
- -----------------------------------------------------
Net Sales $ 25,111 $ 12,499 $ 37,610
Adjusted EBITDA 7,920 4,111 12,031
</TABLE>
A reconciliation of Adjusted EBITDA to Consolidated Operating Income is as
follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
------------------------------------------- --------------------------------------------
JUNE 30, 1999 JUNE 30, 1998 JUNE 30, 1999 JUNE 30, 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Adjusted EBITDA $ 5,441 $ 5,378 $ 13,289 $ 12,031
Depreciation Expense (450) (450) (900) (900)
Amortization Expense (1,373) (1,392) (2,745) (2,783)
Stock Option Expense (29) (219) (58) (490)
Postretirement Expense (97) (125) (194)
--------- --------- ---------- ----------
(250)
Operating Income $ 3,492 $ 3,192 $ 9,392 $ 7,608
========= ========= ========== ==========
</TABLE>
7. CONTINGENCIES
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, 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., Save-On Drug Stores Inc., The
Southland Corporation, Circle K Stores, Inc., Longs Drug Stores Corporation,
Walgreen Co., Safeway, Inc. and DOES 1-500. The plaintiff amended their claim on
June 10, 1998 and subsequently served the complaint on National Tobacco. The
complaint purports to be brought by the City and County of San Francisco on
behalf of the people of the State of California and by the Environmental Law
Foundation on behalf of the general public.
8
<PAGE>
Plaintiffs claim that the defendants violated the California Safe Drinking Water
and Toxic Enforcement Act of 1986, Health and Safety Code 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 Unfair Competition Act, Business & Professions
Code 17200, et seq., by marketing smokeless tobacco to children, and by
fraudulently concealing from the public the alleged adverse consequences and
addiction allegedly 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 exposure to substances known to the State
of California to cause cancer and reproductive harm. The plaintiffs also seek an
award of statutory penalties and damages for each violation of Proposition 65
and the Unfair Competition Act, disgorgement of profits from the sale of
smokeless tobacco products, and attorney's fees and costs. Discovery is
currently ongoing and a trial date has been set for January 14, 2000. National
Tobacco intends to defend the action vigorously.
Kentucky and Illinois Complaints. On July 15, 1998, North Atlantic Operating
Company, Inc. ("NAOC"), a subsidiary of the Company, 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. The
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 papers under the
JOB and TOP brand names. The Kentucky Complaint alleges, inter alia, that
Republic Tobacco's use of exclusivity agreements, rebates, incentive programs,
buy-backs and other activities related 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 point or purchase vendor displays
for RYO cigarette papers by covering up the Zig-Zag brand name and advertising
material with advertisements for Republic Tobacco's RYO cigarette brands. The
Kentucky Complaint alleges that these activities constitute unfair competition
under the 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 the amended complaint are
referred to herein as the "Illinois Complaint"). In the Illinois Complaint,
Republic Tobacco seeks declaratory relief that (a) Republic Tobacco's action 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 tortuous
interference with customer relationships, false advertising, violations of
9
<PAGE>
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.
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 have been historically underdeveloped.
The Company intends to vigorously pursue its claims set forth in the Kentucky
Complaint. With respect to the claims set forth in the Illinois Complaint, the
Company has filed a Motion to Dismiss concerning a substantial portion of the
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.
On April 9, 1999, the Court in the Illinois case ruled on the motion to dismiss,
dismissing certain of Republic's claims against the Company, including
Republic's monopolization claim. The Court also dismissed the Company's
counterclaims with leave to replead those claims. The Company has done so.
Discovery is continuing.
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. Phillip Morris Incorporated, et al.
(Civil Action Nos. 98-C-2401). While the Company was served with a single
service and complaint, the caption lists 65 separate plaintiffs, each with an
individual case number.
In the Allen case, the plaintiffs have specified the defendant companies for
each of the 65 cases. The Company was named in only six of the cases, five of
which alleged consumption prior to the existence of the Company of products
bearing the trademarks currently owned by the Company. The remaining case
alleges lung cancer as the injury. The Company anticipates being dismissed from
the first five cases, and intends to vigorously defend the remaining action.
On November 13, 1998, the Company was served with a summons and complaint in an
action in the Circuit Court of Kanawha County, West Virginia, entitled Billie J.
Akers, et al. v. Phillip Morris Incorporated et al. (Civil Action Nos. 98-C-2696
to 98-C-2713). While the Company was served with a single summons and complaint,
the caption of the complaint lists 18 separate plaintiffs, each with an
individual case number. This action was filed by the same plaintiff's attorney
who filed the Allen action and the complaint is identical in most material
respects.
These two actions were commenced by two separate plaintiffs, "individually
and/or as the representatives of the various descendants 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 complaint contains no specific allegations
referring to any individual plaintiff. These two actions were brought against
major manufacturers of cigarettes, smokeless tobacco products, and certain other
organizations.
10
<PAGE>
The complaint alleges that "plaintiffs and plaintiffs' descendents suffer/had
suffered from a form of cancer or vascular disease and other injuries due wholly
or in part to defendants' products and/or activities." The complaint further
alleges that the actions "arise from decades of intentionally wrongful conduct
by the defendants who have manufactured, promoted, and sold cigarettes and both
smokeless and loose tobacco to the plaintiffs and plaintiffs descendants and
millions of Americans while knowing, but denying and concealing that their
products cause diseases, including but not limited to esophageal, laryngeal,
pharyngeal, mouth and throat cancers and Buerger's Disease." The complaints do
not identify which plaintiffs, if any, allege injury as a result of the use of
smokeless tobacco.
The Akers complaint asserts 24 unspecified counts and seeks 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.
Discovery and trials of all tobacco cases in West Virginia, including Akers and
Allen, have been stayed pending a decision of whether to refer the tobacco cases
to the West Virginia Mass Litigation Panel (the "MLP"). However, a motion to
refer the tobacco cases to the MLP, made by the judge presiding over the Akers
case, was rejected by the Chief Justice of the West Virginia Supreme Court as
inadequately presented. No motion to refer is currently pending.
Although the Company believes that it has good defenses to the above actions in
West Virginia and California, no assurance can be given that it will prevail. If
the plaintiffs were to prevail, the results could have a materially adverse
effect on the Company's financial position.
Other Regulatory Events. Regulations that had been issued by the previous
Massachusetts Attorney General affecting point of sale and certain advertising
issues with respect to tobacco products, which were to become effective August
1, 1999, have been delayed until December 31, 1999 to allow for further review.
In August 1995, the FDA published proposed rules for regulation of tobacco and
tobacco products, including smokeless tobacco. Following a year of comment and
revision, in August 1996 the FDA promulgated final rules, which were scheduled
to take effect on August 1997, except for a portion of the rules prohibiting the
sale of tobacco to persons under 18, which have become effective already. The
FDA's regulations restrict access to tobacco and tobacco products, regulate
tobacco labeling, and limit promotion and advertising of tobacco.
On April 25, 1997, a federal court in Greensboro, North Carolina ruled that the
FDA has statutory authority to regulate tobacco products. The court upheld the
FDA's rules restricting access to tobacco products and regulating tobacco
labeling. However, the court ruled that the FDA does not have authority to
regulate promotion and advertising of tobacco products. The judge certified the
case for interlocutory appeal to the United States Fourth Circuit Court of
Appeals, which subsequently ruled that the FDA statue does not provide this
authority. The FDA has petitioned the Supreme Court of the United States for a
11
<PAGE>
writ of certiorari. On April 26, 1999, the Supreme Court granted the writ.
Briefing is expected to be completed by October. No hearing date has been set.
The FDA regulations prohibit self-service displays of tobacco, including
smokeless tobacco, and require that a retailer sell cigarettes and smokeless
tobacco only in a direct, face to face exchange between the retailer and the
consumer. Historically, smokeless tobacco has been sold primarily by allowing
customers direct access to the product. Accordingly, there can be no assurance
that prohibiting such direct access would not have an adverse effect on sales.
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
COMPARISON OF THREE MONTHS ENDED JUNE 30, 1999 TO THREE MONTHS ENDED JUNE 30,
1998
Net Sales. Net sales for the three months ended June 30, 1999 were $18.0
million, an increase of 0.6% or $0.1 million, from the prior year's period.
Net sales of the Smokeless Tobacco segment for the three months ended June 30,
1999, decreased 9.9% due to greater discounting in the industry and to a volume
decrease in net pounds of 12.1% given the change to a cents-off strategy, both
of which were partially offset by price increases in January and July 1998 and
May 1999.
Net sales of the Roll-Your-Own segment when compared to the prior period's
results increased 42.7% due primarily to a more successful Spring 1999 promotion
as compared to that of 1998 and to increased sales of the expanded Make-Your-Own
product line, which consists of smoking tobaccos and accessory products.
Gross Profit. Gross profit for the three months ended June 30, 1999, increased
$0.3 million, or 2.6%, from the prior year's period due to the increase in net
sales of the Roll-Your-Own segment described above. Gross profit of the
Smokeless Tobacco segment decreased $0.6 million or 7.5% while gross profit of
the Roll-Your-Own segment increased $0.9 million or 42.8%.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the three months ended June 30, 1999, remained
unchanged at $6.4 million as compared to the prior year's period.
Amortization of Goodwill. Amortization of goodwill for the three months ended
June 30, 1999 also remained unchanged at $1.4 million as compared to the prior
year's period.
Interest Expense and Financing Costs. Interest expense and financing costs
decreased to $5.9 million for the three months ended June 30, 1999, from $6.1
million for the prior year's period. This decrease was the result of a lower
average term loan balance as well as a lower average interest rate.
Income Taxes. The income tax provision reflects the application of the estimated
annual effective tax rate of 51% based on projected earnings for 1999. The
Company's estimated effective tax rate was 40% prior to accounting for the
amortization of non-deductible goodwill.
12
<PAGE>
Net Loss. Due to the factors described above, the net loss for the three months
ended June 30, 1999, was $1.2 million compared to $1.3 million for the prior
year's period.
COMPARISON OF SIX MONTHS ENDED JUNE 30, 1999 TO SIX MONTHS ENDED JUNE 30, 1998
Net Sales. Net Sales for the six months ended June 30, 1999 were $38.8 million,
an increase of 3.1% or $1.2 million, from the prior year's period.
Net Sales of the Smokeless Tobacco segment for the six months ended June 30,
1999 decreased 6.8% due to increased discounting practices in the industry and
to a volume decrease in net pounds of 8.9%, both of which were partially offset
by price increases in January and July 1998 and May 1999.
Net Sales of the Roll-Your-Own segment when compared to the prior period's
results increased 23.0% due primarily to a more successful spring 1999 promotion
as compared to that of 1998 and to increased sales of the expanded Make-Your-Own
product line, which consists of smoking tobaccos and accessory products.
Gross Profit. Gross profit for the six months ended June 30, 1999 increased $1.1
million, or 4.8%, from the prior year's period due to the increase in net sales
of the Roll-Your-Own segment described above. Gross profit of the Smokeless
Tobacco segment decreased $0.9 million or 5.8% while gross profit of the
Roll-Your-Own segment increased $2.0 million or 25.0%.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the six months ended June 30, 1999 decreased 4.5% to
$12.8 million from the prior year period's $13.4 million. This decrease was due
primarily to a reduction in expenses as result of the changes in the Company's
management structure and, secondarily, to the reduction in the free goods volume
of the Smokeless Tobacco segment.
Amortization of Goodwill. Amortization of goodwill for the six months ended June
30, 1999 was $2.7 million compared to $2.8 million for the prior year's period.
Interest Expense and Financing Costs. Interest expense and financing costs
decreased to $11.9 million for the six months ended June 30, 1999 from $12.5
million for the prior year's period. This decrease was the result of a lower
average term loan balance as well as a lower average interest rate.
Income Taxes. The income tax provision reflects the application of the estimated
annual effective tax rate of 51% based on projected earnings for 1999. The
Company's estimated effective tax rate of 40% prior to accounting for the
amortization of non-deductible goodwill.
Net Loss. Due to the factors described above, the net loss for the six months
ended June 30, 1999 was $1.2 million compared to $2.2 million for the prior
year's period.
13
<PAGE>
LIQUIDITY AND CAPITAL REQUIREMENTS
At June 30, 1999, working capital was $35.3 million compared to $42.0 million at
December 31, 1998. This decrease was primarily the result of a revolving credit
facility borrowing of $4.0 million in June, 1999 to fund short-term operating
requirements. The Company had an undrawn availability of $20 million under its
committed $25 million revolving credit facility as of June 30, 1999. The $4.0
million borrowing was paid in full on July 30, 1999. The Company will continue
to fund its seasonal working capital requirements through its operating cash
flows, and, if needed, bank borrowings.
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 of roll-your-own products based on its past and
estimated future sales activity and that its supply of such inventory will
remain stable for the foreseeable 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, in general, 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 1999 will approximate $750,000.
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 financing.
YEAR 2000
During fiscal 1997, the Company assessed the steps necessary to address matters
related to "Year 2000 " issues. This assessment included a review of all the
company's hardware and software requirements. The Company developed and
implemented a strategy for attaining Year 2000 compliance for its internal
systems, which included modifying existing software, purchasing new software and
acquiring new hardware. By March 1999, the Company had completed its internal
compliance adjustments. By June 30, 1999, the Company completed its last
dual-testing segment. The aggregate cost of the Company's Year 2000 compliance
is estimated to be approximately $400,000.
The Company has identified significant service providers, vendors, suppliers and
customers that are critical to its business operation and is assessing potential
vulnerabilities arising from these third parties. Steps have been and are being
undertaken in an attempt to ascertain their stage of readiness through
interviews and other means. To the extent these third parties are not compliant,
the Company will request a description of their plans to become "Year 2000"
compliant. To the extent that these third parties have failed to certify by June
30, 1999 that they are Year 2000 compliant, the Company is assessing the impact
14
<PAGE>
of that failure on the Company's business and intends to take appropriate
remedial action to the extent feasible. Currently, the Company feels that there
is minimal exposure in this area due to the limited dependence on electronic
components in the manufacturing process, the small numbers of major suppliers,
and the preponderance of customers that are relatively unimpacted in terms of
electronic data exchange. Further, the Company believes that it has taken all
reasonable steps to minimize third party activity.
Due to the general uncertainty inherent in Year 2000 problems, resulting in part
from the uncertainty of the Year 2000 readiness of third party suppliers and
customers, the Company will be unable to fully determine whether the consequence
of Year 2000 failures will have a material impact on the Company's results of
operation, liquidity or financial condition. The Company believes with the
implementation of the new business systems and the completion of its various
projects, the possibility of significant interruptions of normal operations has
been mitigated to a reasonable business standard. If the present efforts to
address the Company's Year 2000 compliance arrangements prove not to be
successful or if the Company's service providers, vendors, and customers have,
in fact, not successfully addressed their issues, the Company's results of
operation, liquidity, and financial condition could be materially or adversely
affected.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1998 the FASB issued SFAS No.133, "Accounting for Derivative Instruments
and Hedging Activities." This statement establishes accounting and reporting
standards for derivative instruments and hedging activities. In July 1999 the
FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of SFAS No. 133", which delays the
adoption until first quarter 2001. Management is currently evaluating the impact
of these statements on the Company's future financial reporting.
FORWARD-LOOKING STATEMENTS
The Company cautions the reader 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 effect 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.
15
<PAGE>
The Company cautions the reader not to put undue reliance on any forward-looking
statements. In addition, the Company does 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.
Item 3. Not Applicable
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
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, 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., Save-On Drug Stores Inc., The
Southland Corporation, Circle K Stores, Inc., Longs Drug Stores Corporation,
Walgreen Co., Safeway, Inc. and DOES 1-500. The plaintiff amended their claim on
June 10, 1998 and subsequently served the complaint on National Tobacco. The
complaint purports to be brought by the City and County of San Francisco on
behalf of the people of the State of California and by the Environmental Law
Foundation on behalf of the general public.
Plaintiffs claim that the defendants violated the California Safe Drinking Water
and Toxic Enforcement Act of 1986, Health and Safety Code 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 Unfair Competition Act, Business & Professions
Code 17200, et seq., by marketing smokeless tobacco to children, and by
fraudulently concealing from the public the alleged adverse consequences and
addiction allegedly 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 exposure to substances known to the State
of California to cause cancer and reproductive harm. The plaintiffs also seek an
award of statutory penalties and damages for each violation of Proposition 65
and the Unfair Competition Act, disgorgement of profits from the sale of
smokeless tobacco products, and attorney's fees and costs. Discovery is
currently ongoing and a trial date has been set for January 14, 2000. National
Tobacco 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. The
complaint was subsequently amended on August 18, 1998 (collectively, the
complaint and the amended complaint are referred to herein as the Kentucky
16
<PAGE>
Complaint"). Republic Tobacco imports and sells RYO cigarette papers under the
JOB and TOP brand names. The Kentucky Complaint alleges, inter alia, that
Republic Tobacco's use of exclusivity agreements, rebates, incentive programs,
buy-backs and other activities related 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 point or purchase vendor displays
for RYO cigarette papers by covering up the Zig-Zag brand name and advertising
material with advertisements for Republic Tobacco's RYO cigarette brands. The
Kentucky Complaint alleges that these activities constitute unfair competition
under the 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 the amended complaint are
referred to herein as the "Illinois Complaint"). In the Illinois Complaint,
Republic Tobacco seeks declaratory relief that (a) Republic Tobacco's action 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 tortuous
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.
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 have been historically underdeveloped.
The Company intends to vigorously pursue its claims set forth in the Kentucky
Complaint. With respect to the claims set forth in the Illinois Complaint, the
Company has filed a Motion to Dismiss concerning a substantial portion of the
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.
On April 9, 1999, the Court in the Illinois case ruled on the motion to dismiss,
dismissing certain of Republic's claims against the Company, including
Republic's monopolization claim. The Court also dismissed the Company's
counterclaims with leave to replead those claims. The Company has done so.
Discovery is continuing.
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. Phillip Morris Incorporated, et al.
(Civil Action Nos. 98-C-2401). While the Company was served with a single
service and complaint, the caption lists 65 separate plaintiffs, each with an
individual case number.
17
<PAGE>
In the Allen case, the plaintiffs have specified the defendant companies for
each of the 65 cases. The Company was named in only six of the cases, five of
which alleged consumption prior to the existence of the Company of products
bearing the trademarks currently owned by the Company. The remaining case
alleges lung cancer as the injury. The Company anticipates being dismissed from
the first five cases, and intends to vigorously defend the remaining action.
On November 13, 1998, the Company was served with a summons and complaint in an
action in the Circuit Court of Kanawha County, West Virginia, entitled Billie J.
Akers, et al. v. Phillip Morris Incorporated et al. (Civil Action Nos. 98-C-2696
to 98-C-2713). While the Company was served with a single summons and complaint,
the caption of the complaint lists 18 separate plaintiffs, each with an
individual case number. This action was filed by the same plaintiff's attorney
who filed the Allen action and the complaint is identical in most material
respects.
These two actions were commenced by two separate plaintiffs, "individually
and/or as the representatives of the various descendants 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 complaint contains no specific allegations
referring to any individual plaintiff. These two actions were brought against
major manufacturers of cigarettes, smokeless tobacco products, and certain other
organizations.
The complaint alleges that "plaintiffs and plaintiffs' descendents 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 complaint further
alleges that the actions "arise from decades of intentionally wrongful conduct
by the defendants who have manufactured, promoted, and sold cigarettes and both
smokeless and loose tobacco to the plaintiffs and plaintiffs descendants and
millions of Americans while knowing, but denying and concealing that their
products cause diseases, including but not limited to esophageal, laryngeal,
pharyngeal, mouth and throat cancers and Buerger's Disease." The complaints do
not identify which plaintiffs, if any, allege injury as a result of the use of
smokeless tobacco.
The Akers complaint asserts 24 unspecified counts and seeks 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.
Discovery and trials of all tobacco cases in West Virginia, including Akers and
Allen, have been stayed pending a decision of whether to refer the tobacco cases
to the West Virginia Mass Litigation Panel (the "MLP"). However, a motion to
refer the tobacco cases to the MLP, made by the judge presiding over the Akers
case, was rejected by the Chief Justice of the West Virginia Supreme Court as
inadequately presented. No motion to refer is currently pending.
18
<PAGE>
Although the Company believes that it has good defenses to the above actions in
West Virginia and California, no assurance can be given that it will prevail. If
the plaintiffs were to prevail, the results could have a materially adverse
effect on the Company's financial position.
Other Regulatory Events. Regulations that had been issued by the previous
Massachusetts Attorney General affecting point of sale and certain advertising
issues with respect to tobacco products, which were to become effective August
1, 1999 have been delayed until December 31, 1999 to allow for further review.
In August 1995, the FDA published proposed rules for regulation of tobacco and
tobacco products, including smokeless tobacco. Following a year of comment and
revision, in August 1996 the FDA promulgated final rules, which were scheduled
to take effect on August 1997, except for a portion of the rules prohibiting the
sale of tobacco to persons under 18, which have become effective already. The
FDA's regulations restrict access to tobacco and tobacco products, regulate
tobacco labeling, and limit promotion and advertising of tobacco.
On April 25, 1997, a federal court in Greensboro, North Carolina ruled that the
FDA has statutory authority to regulate tobacco products. The court upheld the
FDA's rules restricting access to tobacco products and regulating tobacco
labeling. However, the court ruled that the FDA does not have authority to
regulate promotion and advertising of tobacco products. The judge certified the
case for interlocutory appeal to the United States Fourth Circuit Court of
Appeals, which subsequently ruled that the FDA statue does not provide this
authority. The FDA has petitioned the Supreme Court of the United States for a
writ of certiorari. On April 26, 1999, the Supreme Court granted the writ.
Briefing is expected to be completed by October. No hearing date has been set.
The FDA regulations prohibit self-service displays of tobacco, including
smokeless tobacco, and require that a retailer sell cigarettes and smokeless
tobacco only in a direct, face to face exchange between the retailer and the
consumer. Historically, smokeless tobacco has been sold primarily by allowing
customers direct access to the product. Accordingly, there can be no assurance
that prohibiting such direct access would not have an adverse effect on sales.
In Bollore, S.A. v. Import Warehouses, Inc., Civ. No. 3-99-CV-1196-R (N.D.
Texas), Bollore, the Company's Licensor of ZIG-ZAG brand cigarette papers,
obtained a sealed order allowing them to conduct a seizure of infringing and
counterfeit ZIG-ZAG products in the United States. On June 7, 1999, seizures of
products occurred in Michigan and Detroit. Subsequently, all named defendants
have been enjoined from buying and selling such infringing or counterfeit goods.
A full trial, to obtain permanent injunctive relief and damages, is currently
scheduled for November 1999. Management believes that successful prosecution of
this litigation will have a favorable impact on the paper business in the
future.
19
<PAGE>
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 Second Quarter of 1998.
20
<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.
/s/ Thomas F. Helms, Jr.
-------------------------------------------
Date: August 3, 1999 Thomas F. Helms, Jr.
President & Chief Executive Officer
/s/ David I. Brunson
-------------------------------------------
Date: August 3, 1999 David I. Brunson
Chief Financial Officer
21
<PAGE>
Exhibit Index
-------------
Exhibit
Number Description
- ------ -----------
27.1 Financial Data Schedule
22
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