<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
--------------------------------------------------
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 333-58233
---------
DIAMOND BRANDS INCORPORATED
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(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MINNESOTA 41-1565294
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(STATE OR OTHER JURISDICTION OF INCORPORATION OR (I.R.S. EMPLOYEE
ORGANIZATION) IDENTIFICATION NO.)
1800 CLOQUET AVE., CLOQUET, MINNESOTA 55720
- --------------------------------------------------------------------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
218/879-6700
- --------------------------------------------------------------------------------
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
- --------------------------------------------------------------------------------
(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 PERIODS THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH
REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE
PAST 90 DAYS.
YES NO X
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<PAGE>
DIAMOND BRANDS INCORPORATED
TABLE OF CONTENTS
PAGE
PART I - FINANCIAL INFORMATION
ITEM-1. Financial Statements (Unaudited)
Consolidated Balance Sheets 3
Consolidated Statements of Operations 4
Consolidated Statements of Cash Flow 5
Notes to Consolidated Financial Statements 6
ITEM-2. Management's Discussion and Analysis of Results
of Operations and Financial Condition 9
PART II - OTHER INFORMATION
Signature 16
<PAGE>
DIAMOND BRANDS INCORPORATED
Consolidated Balance Sheets (Unaudited)
(In Thousands, Except Share Amounts)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Accounts receivable, net of allowances of $773 and $1,195 $17,374 $15,526
Inventories 22,285 20,744
Deferred tax asset 2,641 -
Prepaid expenses 2,205 406
------------- ------------
Total current assets 44,505 36,676
------------- ------------
PROPERTY, PLANT AND EQUIPMENT, net of
accumulated depreciation of $17,854 and $16,715 17,152 17,544
GOODWILL 38,192 39,454
DEFERRED FINANCING COSTS 9,049 876
------------- ------------
$108,898 $94,550
------------- ------------
------------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Current maturities of long-tem debt $2,000 $7,892
Accounts payable 6,541 4,500
Accrued expenses 11,851 11,037
------------- ------------
Total current liabilities 20,392 23,429
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DEFERRED INCOME TAXES 735 -
POSTRETIREMENT BENEFIT OBLIGATIONS 1,586 1,586
LONG-TERM DEBT, net of current maturities 226,921 41,605
------------- ------------
Total liabilities 249,634 66,620
------------- ------------
COMMITMENTS AND CONTINGENCIES
Redeemable preferred stock, $0.01 par value; 1,000,000 shares authorized;
47,000 issued and outstanding, net of subscriptions receivable of $1,217 34,836 -
STOCKHOLDERS' EQUITY (DEFICIT):
Common stock, $.01 par value; 50,000,000 shares authorized;
1,491,000 and 16,112,500 shares issued and outstanding 15 161
Warrants 10,640 -
Additional paid in capital 1,488 774
Retained earnings (deficit) (187,715) 26,995
------------- ------------
Total stockholders' equity (deficit) (175,572) 27,930
------------- ------------
$108,898 $94,550
------------- ------------
------------- ------------
The accompanying notes are an integral part of these consolidated balance
sheets.
</TABLE>
3
<PAGE>
DIAMOND BRANDS INCORPORATED
Consolidated Statements of Operations (Unaudited)
(In Thousands)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
NET SALES $30,675 $31,498 $89,233 $86,165
COST OF SALES 21,024 20,758 62,372 58,380
-------------- -------------- -------------- --------------
Gross profit 9,651 10,740 26,861 27,785
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 3,291 2,940 15,925 8,274
GOODWILL AMORTIZATION 420 420 1,261 1,100
-------------- -------------- -------------- --------------
Operating income 5,940 7,380 9,675 18,411
INTEREST EXPENSE 5,951 1,185 13,588 3,391
-------------- -------------- -------------- --------------
Income (Loss) before provision (benefit) for income taxes (11) 6,195 (3,913) 15,020
PROVISION (BENEFIT) FOR INCOME TAXES 68 - (2,763) 1,376
-------------- -------------- -------------- --------------
Net income (loss) (79) 6,195 (1,150) 13,644
PREFERRED STOCK DIVIDENDS AND ACCRETION 1,255 - 2,301 -
-------------- -------------- -------------- --------------
Net income (loss) applicable to common stock ($1,334) $6,195 ($3,451) $13,644
-------------- -------------- -------------- --------------
-------------- -------------- -------------- --------------
PRO FORMA NET INCOME:
Income (loss) before provision for income taxes ($11) $6,195 ($3,913) $15,020
Pro forma income tax expense (benefit) (Note 2) - 2,500 (1,600) 6,000
-------------- -------------- -------------- --------------
Pro forma net income (loss) ($11) $3,695 ($2,313) $9,020
-------------- -------------- -------------- --------------
-------------- -------------- -------------- --------------
The accompanying notes are an integral part of these consolidated statements.
</TABLE>
4
<PAGE>
DIAMOND BRANDS INCORPORATED
Consolidated Statements of Cash Flows (Unaudited)
(In Thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
1998 1997
-------------- --------------
<S> <C> <C>
OPERATING ACTIVITIES
Net income (loss) ($1,150) $13,644
Adjustments to reconcile net income (loss) to net cash provided by operating activities
Depreciation and amortization 4,424 3,740
Deferred income taxes (1,906) 1,376
Accretion of debentures 2,566 -
Change in operating assets and liabilities, net of effects of acquisition
Accounts receivable (1,848) (4,781)
Inventories (1,541) (3,003)
Prepaid expenses (1,799) 367
Accounts payable 2,041 248
Accrued expenses 4,416 1,190
-------------- --------------
Net cash provided by operating activities 5,203 12,781
-------------- --------------
INVESTING ACTIVITIES
Acquisition of Empire, net of cash received - (24,696)
Purchases of property, plant and equipment (1,523) (2,455)
-------------- --------------
Net cash used for investing activities (1,523) (27,151)
-------------- --------------
FINANCING ACTIVITIES
Borrowings under bank revolving line of credit 27,200 32,900
Repayments of bank revolving line of credit (30,700) (26,800)
Net proceeds from preferred stock and warrants 44,529 -
Borrowings on long-term debt 225,105 21,000
Repurchase of common stock (211,421) -
Repayments of long-term debt (44,747) (5,509)
Exercise of warrants 4 -
Exercise of options 1,258 -
Distributions to stockholders (5,488) (6,851)
Debt issuance costs (9,420) (370)
-------------- --------------
Net cash provided by (used for) financing activities (3,680) 14,370
-------------- --------------
NET INCREASE IN CASH AND CASH EQUIVALENTS - -
CASH AND CASH EQUIVALENTS, beginning of period - -
-------------- --------------
CASH AND CASH EQUIVALENTS, end of period $ - $ -
-------------- --------------
-------------- --------------
The accompanying notes are an integral part of these consolidated statements.
</TABLE>
5
<PAGE>
DIAMOND BRANDS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of
Diamond Brands Incorporated ("Holdings") and its wholly owned subsidiary,
Diamond Brands Operating Corp. ("Operating Corp") and Operating Corp.'s
wholly-owned subsidiaries, Forster Inc. and Empire Candle, Inc. after
elimination of all material intercompany balances and transactions.
Holdings and Operating Corp. are collectively referred to as "the
Company".
The Company is a leading manufacturer and marketer of a broad range of
consumer products, including wooden matches and firestarters, plastic
cutlery and straws, scented, citronella and holiday candles, and
toothpicks, clothespins and wooden crafts. The Company's products are
marketed primarily in the United States and Canada under the nationally
recognized Diamond, Forster and Empire brand names.
The interim consolidated financial statements of the Company are unaudited;
however, in the opinion of management, all adjustments necessary for a fair
presentation of such consolidated financial statements have been reflected
in the interim periods presented. The significant accounting policies and
certain financial information which are normally included in financial
statements prepared in accordance with generally accepted accounting
principles, but which are not required for interim reporting purposes, have
been condensed or omitted. The accompanying consolidated financial
statements of the Company should be read in conjunction with the
consolidated financial statements and related notes included in the
Company's audited financial statements for the year ended December 31,
1997.
2. RECAPITALIZATION
On March 3, 1998, the stockholders of the Company entered into a
recapitalization agreement (the "Recapitalization Agreement") with Seaver
Kent - TPG Partners, L.P. and Seaver Kent I Parallel, L.P. (collectively
"the Sponsors"), which provided for the recapitalization of the Company.
Pursuant to the Recapitalization Agreement, in April 1998, the Company
purchased from the existing stockholders 15,129,232 shares of the Company's
common stock for $211.5 million by (i) issuing $100.0 million of senior
subordinated notes and $45.1 million senior discount debentures, (ii)
entering into a bank credit agreement which provided for $80.0 million in
term loan facilities and a $25.0 million revolving credit facility, and
(iii) selling redeemable preferred stock with warrants to the Sponsors and
other investors for $47.0 million. The Sponsors and other investors
exercised warrants for 417,382 shares of common stock at closing. The
recapitalization was accounted for as a recapitalization transaction for
accounting purposes.
6
<PAGE>
3. REDEEMABLE CUMULATIVE PREFERRED STOCK
Pursuant to the Recapitalization Agreement, the Company issued $47.0
million ($45.8 million in cash and $1.2 million in notes receivable) of
redeemable cumulative preferred stock (the Preferred Stock) and common
stock warrants (the Warrants). The Warrants are exercisable at $0.01 per
share of common stock and expire in April 2008. The Preferred Stock ranks
senior to all classes of common stock of the Company and is entitled to
receive cash dividends equal to 12% of the liquidation preference of $1,000
per share ($47.0 million) plus all unpaid dividends until the mandatory
redemption date of October 15, 2009. The Company has the option at any
time to redeem the Preferred Stock at a price equal to liquidation
preference plus all unpaid dividends.
The net proceeds from the issuance of the Preferred Stock and Warrants were
allocated based on the relative fair values of the securities issued. The
value assigned to the Warrants of $12.3 million has been reflected as a
discount to the Preferred Stock which is being accreted to its mandatory
redemption value using the effective interest method (15% effective yield).
4. LONG TERM DEBT
In April 1998, the Company completed offerings of $100.0 million of 10 1/8%
senior subordinated notes due to 2008 and $84 million of 12 7/8% senior
discount debentures due 2009 with an original issue discount of $38.9
million. The net proceeds to the Company for the offerings, after
discounts, commissions and other offering costs were $138.4 and were used
to repay existing indebtedness and purchase common stock of the Company.
The Company also entered into a bank credit agreement which provides for
$80.0 million in term loan facilities with interest rates from LIBOR
(5.56250% at September 30, 1998) plus 2.0% to LIBOR plus 2.25% due in
installments through March 2006 and a $25.0 million revolving credit
facility at LIBOR plus 2.0%. As of September 30, 1998, the Company was in
compliance with the provisions of its debt covenants.
5. INCOME TAXES
Effective January 1, 1997, the Company converted from a C corporation to an
S corporation due to a change in the tax laws allowing entities with
subsidiaries to elect this status. Deferred tax assets and liabilities as
of December 31, 1996 are reflected as a charge in the consolidated
statement of operations for the nine months ended September 30, 1997.
The taxable income or loss of the Company for the years ended after
December 31, 1996 and prior to the recapitalization is included in the
individual returns of the stockholders for federal tax purposes and, to the
extent allowed and elected, for state tax purposes. Accordingly, there is
no provision for current income taxes for the period from January 1, 1998
to April 20, 1998 and the nine months ended September
7
<PAGE>
30, 1997. Effective with the recapitalization in April 1998, the
Company elected C corporation status and recognized deferred income
taxes for temporary differences between the tax and financial reporting
bases.
The unaudited pro forma income tax expense is presented assuming the
Company had been a C corporation since January 1, 1997.
6. NEW ACCOUNTING PRONOUNCEMENTS
Statement of Accounting Standards (SFAS) No. 131, "Disclosures About
Segments of an Enterprise and Related Information," issued in June 1997 and
effective for fiscal years beginning after December 15, 1997, redefines how
operating segments are determined and requires expanded quantitative and
qualitative disclosure relating to the company's operating segments. The
Company believes that the effect of adopting SFAS No. 131 will not be
significant.
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities", issued in June 1998, establishes accounting and reporting
standards for derivative instruments and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities and measure those instruments at fair value. The Company
believes that the effect of adopting SFAS No. 133 will not be significant
to the results of operations.
8
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
Diamond Brands Incorporated, through its subsidiary Diamond Brands Operating
Corp. (collectively the Company), is a leading manufacturer and marketer of a
broad range of consumer products, including wooden matches and firestarters
(Wooden Lights), plastic cutlery and straws (Cutlery), scented, citronella
and holiday candles (Candles), and toothpicks, clothespins and wooden crafts
(Woodenware). The Company's products are marketed primarily under the
nationally recognized Diamond, Forster and Empire brand names, which have
been in existence since 1881, 1887 and 1950, respectively.
The Company derives its revenue primarily from the sale of its products to
substantially all major grocery stores, drug stores, mass merchandisers and
warehouse clubs in the United States. During the nine months ended September
30, 1998, sales to the Company's top 10 customers accounted for approximately
36% of the Company's gross sales, with one customer accounting for
approximately 15% of the Company's gross sales. The Company's ability to
maintain and increase its sales depends on a variety of factors including its
competitive position in such areas as price, quality, brand identity,
distribution and customer service. The Company's products are manufactured
at its four automated manufacturing facilities located in Cloquet, Minnesota,
East Wilton, Maine, Strong, Maine, and Kansas City, Kansas.
Net sales, as calculated by the Company, are determined by subtracting
discounts and allowances from gross sales. Discounts and allowances consist
of price promotions, cash discounts, corporate rebates, slotting fees,
consumer coupons, co-op advertising and unsaleables. The Company's cost of
sales and its resulting gross margin (defined as gross profit as a percentage
of net sales) are principally determined by the cost of raw materials, the
cost of the labor to manufacture its products, the overhead expenses of its
manufacturing facilities, warehouse costs and freight expenses to its
customers. In recent years, the Company has focused on improving its gross
margin by seeking to: (i) consolidate manufacturing operations; (ii) reduce
headcount and expenses in manufacturing; and (iii) increase operating
efficiencies through capital projects with rapid returns on investment.
Polystyrene resin, a commodity whose market price fluctuates with supply and
demand, is a significant component of cost of sales in the Company's Cutlery
products. In order to mitigate the impact of changing polystyrene resin
prices, the Company in January 1997 entered into a three-year supply contract
with a major supplier of polystyrene resin, under which the Company believes
it receives the lowest price available to any customer purchasing similar
volume, and receives short-term price protection during periods of rising
prices. During periods of rising prices, the Company generally has been able
to pass through the majority of the polystyrene resin price increases to its
customers on a delayed basis. During periods of declining polystyrene resin
prices, the Company generally has reduced prices to its customers.
Selling, general and administrative expenses consist primarily of selling
expenses, broker commissions and administrative costs. Broker commissions
and certain selling expenses generally vary with sales volume while
administrative costs are relatively fixed in nature.
9
<PAGE>
RECAPITALIZATION. Diamond Brands Incorporated (Holdings), the Stockholders
and Seaver Kent & Company, LLC (the Sponsors) entered into the
Recapitalization Agreement, the Sponsors and other investors purchased from
Holdings, for an aggregate purchase price of $47.0 million, Holdings
Preferred Stock together with the Warrants to purchase from Holdings Holdings
Common Stock. The Warrants provide the holders with the right to subscribe
and purchase from Holdings Holdings Common Stock at the purchase price at
$0.01 per share at any time prior to their expiration date in April 2008.
The values assigned to the Warrants and Holdings Preferred Stock were $12.3
million and $34.7 million, respectively, based upon the sale prices of
comparable preferred stock instruments in the marketplace. Dividends in
respect of Holdings Preferred Stock accumulate at 12% per annum (representing
a 15% per annum effective yield) to its mandatory redemption value of $47.0
million on the mandatory redemption date of October 15, 2009. Holdings has
the option, at any time, to redeem Holdings Preferred Stock at a price equal
to the Liquidation Preference plus all accumulated and unpaid dividends. The
shares of Holdings Common Stock issuable upon the full exercise of the
Warrants would represent 77.5% of the outstanding shares of Holdings Common
Stock after giving effect to such issuance. In addition, Holdings purchased
for $211.4 million, subject to certain working capital adjustments, from the
Stockholders all outstanding shares of Holdings' capital stock, other than
the Retained Shares. The Retained Shares would represent 22.5% of the
outstanding shares of Holdings Common Stock after giving effect to the full
exercise of the Warrants, having the Implied Value of $15.0 million. The
Equity Repurchase price of $13.98 per share was determined based upon a
competitive process with potential investors managed by Donaldson, Lufkin &
Jenrette Securities Corporation on behalf of the Company. Holdings, the
Sponsors and the holders of the Retained Shares also entered into a
Stockholers Agreement pursuant to which, among other things, the Sponsors
have the ability to direct the voting of outstanding shares of Holdings
Common Stock in proportion to their ownership of such shares as if the
Warrants were exercised in full. Accordingly, the Sponsors have voting
control of Holdings.
In connection with the Recapitalization, Holdings organized Diamond Brands
Operating Corp. and, immediately prior to the consummation of the
Recapitalization, Holdings transferred substantially all of its assets and
liabilities to Operating Corp. Holdings' current operation are, and future
operations are expected to be, limited to owning the stock of Operating Corp.
Operating Corp. repaid substantially all of the Company's funded debt
obligations existing immediately before the consummation of the
Recapitalization in the amount of $51.8 million.
Funding requirements for the Recapitalization (which consummated on April 21,
1998) were $296.5 million (including the Implied Value of the Retained
Shares) and were satisfied through the Retained Shares and the following:
(i) the purchase by the Sponsors and other investors of Holdings Preferred
Stock and the Warrants for $47.0 million ($45.8 million in cash and $1.2
million in officer notes receivables); (ii) $45.14 million of gross proceeds
from the Offering, (iii) $80.0 million of borrowings under the Term Loan
Facilities; (iv) $10.6 million of borrowings under the Revolving Credit
Facility; and (v) $100.0 million of gross proceeds from the sale by Operating
Corp. of the Senior Subordinated Notes in a separate offering.
The Equity Repurchase, the Offering, the Debt Retirement, the issuance and
the sale by Holdings of Holdings Preferred Stock and the Warrants, the
issuance and sale by Operating Corp. of Senior Subordinated Notes and the
borrowing by Operating Corp. of funds under the Bank Facilities (which
proceeds were distributed by Operating Corp. to Holdings) were effected in
connection with the Recapitalization. The Recapitalization was accounted for
as recapitalization transaction for accounting purposes.
10
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, gross sales and
gross sales as a percentage of the Company's aggregate net sales for the
Company's major product groups, as well as the Company's aggregate net sales,
EBITDA, EBITDA margin, adjusted EBITDA and adjusted EBITDA margin.
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
1998 1997 1998 1997
---------------- ---------------- ----------------- -----------------
(DOLLARS IN MILLIONS) (DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Wooden Lights $5.9 19.2% $5.2 16.5% $15.7 17.6% $14.8 17.2%
Cutlery 9.1 29.6 7.6 24.2 29.4 33.0 26.3 30.5
Candles 7.6 24.8 10.4 33.0 18.7 21.0 17.1 19.8
Woodenware 7.3 23.8 6.9 21.9 23.1 25.9 22.5 26.1
Institutional/Other 4.4 14.3 4.0 12.7 12.7 14.2 13.0 15.1
---- ----- ---- ----- ----- ----- ----- -----
Total gross sales 34.3 111.7 34.1 108.3 99.6 111.7 93.7 108.7
Discounts and allowances (3.6) (11.7) (2.6) (8.3) (10.4) (11.7) (7.5) 8.7
---- ----- ---- ----- ----- ----- ----- -----
Net sales $30.7 100.0% $31.5 100.0% $89.2 100% $86.2 100.0%
---- ----- ---- ----- ----- ----- ----- -----
---- ----- ---- ----- ----- ----- ----- -----
EBITDA (1) $7.0 22.8% $8.6 27.3% $12.9 14.5% $22.0 25.5%
Recapitalization - - - - 6.1 - - -
Expenses (2)
Adjusted EBITDA (3) $7.0 22.8% $8.6 27.3% $19.0 21.3% $22.0 25.5%
---- ----- ---- ----- ----- ----- ----- -----
---- ----- ---- ----- ----- ----- ----- -----
</TABLE>
(1) EBITDA represents operating income plus depreciation and amortization
(excluding amortization of deferred financing costs). The Company
believes that EBITDA provides useful information regarding the Company's
ability to service its debt; however, EBITDA does not represent cash
flow from operations as defined by generally accepted accounting
principles and should not be considered a substitute for net income
as an indicator of the Company's operating performance or cash flow as a
measure of liquidity.
(2) Represents one time costs incurred in connection with the
Recapitalization including brokerage fee ($2.7 million), change in
control management bonuses and option payments ($2.2 million), and legal
and professional fees ($1.2 million).
(3) Represents EBITDA excluding Recapitalization Expenses.
11
<PAGE>
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1997
The following table sets forth, for the periods indicated, certain historical
statement of operations data and such data as a percentage of net sales for the
Company.
<TABLE>
<CAPTION>
Three Months Ended September 30,
1998 1997
------------------ ------------------
(dollars in millions)
Actual Actual
<S> <C> <C> <C> <C>
Net sales $30.7 100.0% $31.5 100.0%
Cost of sales 21.0 68.4 20.8 66.0
----- ----- ----- -----
Gross profit 9.7 31.6 10.7 34.0
Selling, general and administrative expenses 3.3 10.7 2.9 9.2
Goodwill amortization .4 1.3 .4 1.3
----- ----- ----- -----
Operating income 6.0 19.6 7.4 23.5
Interest expense 6.0 19.6 1.2 3.8
----- ----- ----- -----
Income before provision for
income taxes $ - - % $6.2 19.7%
----- ----- ----- -----
----- ----- ----- -----
</TABLE>
NET SALES. Net sales for the three months ended September 30, 1998 were $30.7
million, down $.8 million from the comparable three months in 1997. Total
gross sales, however, increased .6% over third quarter 1997, gross sales to
$34.3 million. Gross sales for Cutlery increased $1.5 million or 19.7% due
to continued strong performance in both branded and private label. Gross
sales of Wooden Lights, Woodenware and Institutional/Other products all
experienced solid increases (13.5%, 5.8% and 10.0% respectively), while
Candle sales declined $2.8 million or 26.9% from the comparable quarter in
1997. The drop in Candle sales can be attributed to a lost customer in 1998
and production lagging demand. The modest growth in gross sales was offset
by an increase in promotions and slotting allowances of $1.0 million,
primarily for Cutlery and Candles.
GROSS PROFIT. Gross profit for the three months ended September 30, 1998,
decreased $1.1 million or 10.1% to $9.6 million, representing a corresponding
drop in gross margin to 31.5% from 34.1% in 1997. The decline in gross
profit results from production problems relating to the candle line ($.4
million); additional obsolescence provision associated with candles ($.3
million) and high freight and distribution costs ($.4 million).
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased $.4 million to $3.3 million for the three
months ended September 30, 1998. General spending was up slightly due to
travel and year 2000 remediation matters and the Company had one time
non-recurring cost relating to the severance of the Vice President of Sales
and Marketing ($.2 million).
GOODWILL AMORTIZATION. Goodwill amortization for the three months ended
September 30, 1998 was $.4 million, equal to such amount for the comparable
three months in 1997.
INTEREST EXPENSE. Interest expense for the three months ended September 30,
1998 totaled $6.0 million compared to $1.2 million in 1997. This increase
resulted from the increased debt load and deferred financing costs associated
with the Recapitalization.
12
<PAGE>
EARNINGS BEFORE INTEREST, TAXES, DEPRECIATION AND AMORTIZATION (EBITDA). EBITDA
for the three months ended September 30, 1998 was $7.0 million compared to
$8.6 million, or 22.8% of net sales for 1998 compared to 27.3% for 1997.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1997
The following table sets forth, for the periods indicated, certain historical
statement of operations data and such data as a percentage of net sales for the
Company.
<TABLE>
<CAPTION>
Nine Months Ended September 30,
1998 1997
----------------- ------------------
(dollars in millions)
Actual Actual
<S> <C> <C> <C> <C>
Net sales $89.2 100.0% $86.2 100.0%
Cost of sales 62.3 69.8 58.4 67.8
----- ----- ----- -----
Gross profit 26.9 30.2 27.8 32.2
Selling, general and administrative expenses 9.8 11.0 8.3 9.6
Recapitalization Costs 6.1 6.8 - -
Goodwill amortization 1.3 1.5 1.1 1.3
----- ----- ----- -----
Operating income 9.7 10.9 18.4 21.3
Interest expense 13.6 15.2 3.4 3.9
----- ----- ----- -----
Income (loss) before provision for income taxes $(3.9) (4.3%) $15.0 17.4%
----- ----- ----- -----
----- ----- ----- -----
</TABLE>
NET SALES. Net sales for the nine months ended September 30, 1998, increased
3.5% to $89.2 million from $86.2 million for the comparable period in 1997,
primarily due to the February, 1997 acquisition of Empire which added net
sales of $3.0 million. The Company continued to experience solid growth in
Cutlery as the gross sales increased $3.1 million or 11.8% due to strong
performance in both branded and private label. Gross sales of Wooden Lights
and Woodenware increased 6.1% or 2.7% respectively while gross sales of
Institutional/Other decreased slightly. Actual gross sales on Candles
decreased $1.4 or 8.2%, when adjusted for the February 1997 acquisition. The
growth in gross sales was offset by increased promotions and slotting
allowances of $2.9 million, primarily for Candles and Cutlery, including $.3
million of unusual Candle allowances.
GROSS PROFIT. Gross profit decreased $.9 million for the nine months ended
September 30, 1998, while corresponding gross margin declined from 32.2% to
30.2%. The impact of the February, 1997 acquisition of Empire ($.8 million)
was offset by inventory and production problems ($1.5 million) associated
with the Candle product line. The Company has made a claim against the
former majority shareholders under the Recapitalization Agreement to recover
certain of these costs. Management believes the inventory problems were one
time and non-recurring in nature. Excluding the effects of these factors,
gross margin would have been 31.8%.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by $1.5 million to $9.8 million in the
nine months ended September 30, 1998. The Company had non-recurring costs
relating to the severance of the Chief Operating Officer of the Candle
division and Vice President of Sales and Marketing ($.3 million), the
write-off of receivables as a result of the Venture Stores bankruptcy ($.1
million) and expensing of recruiting and relocation costs ($.2 million) to
strengthen the management team. In addition, the Company incurred higher
expenses to support the introduction of Reflections candles into the grocery
trade.
13
<PAGE>
RECAPITALIZATION EXPENSES. One-time charges of $6.1 million associated with
the recapitalization on April 21, 1998 were expensed, including brokerage
fees of $2.7 million, change of control management bonuses and option
payments of $2.2 million and legal, professional and accounting fees of $1.2
million.
GOODWILL AMORTIZATION. Goodwill amortization in 1998 was $1.3 million, up
from $1.1 million in 1997 as the result of the Empire Acquisition.
INTEREST EXPENSE. Interest expense for the nine months ended September 30,
1998 totaled $13.6 million compared to $3.4 million for the compared nine
months in 1997. This increase is the result of the increased debt load and
deferred financing costs associated with the recapitalization.
Included are the one time expensing of bridge commitment fees ($1.0 million)
relating to the recapitalization and write-off of deferred finance costs ($.7
million) related to pre-recapitalization debt.
EARNINGS BEFORE INTEREST, TAXES, DEPRECIATION AND AMORTIZATION (EBITDA).
EBITDA for the nine months ended September 30, 1998 was $12.9 million or
14.5% compared to $22.0 million or 25.5% for 1997. Excluding
recapitalization costs, the adjusted EBITDA is $19.0 million or 21.3%.
LIQUIDITY AND CAPITAL RESOURCES. Cash provided by operating activity was
$5.2 million for nine months ending September 30, 1998 and $12.8 million for
1997. The Company's primary cash requirements are for working capital and
capital expenditures which generally are funded internally or available under
the current revolving credit facility.
Capital expenditures for the nine months ended September 30, 1998 were $1.5
million compared to $2.5 million for 1997.
RECENTLY ISSUED ACCOUNTING STANDARDS. Financial Accounting Standards Board
Statement (SFAS) NO. 131, "Disclosures About Segments of an Enterprise and
Related Information," issued in June 1997 and effective for fiscal years
beginning after December 15, 1997, redefines how operating segments are
determined and requires expanded quantitative and qualitative disclosures
relating to the company's operating segments. The Company believes that the
effect on it of adopting SFAS No. 131 will not be significant.
INFLATION AND ECONOMIC TRENDS. Although its operations are affected by
general economic trends, the Company does not believe that inflation has had
a material impact on its results of operations.
14
<PAGE>
YEAR 2000
Many computer systems and software applications, including most of
those used by the Company, identify dates using only the last two digits of
the year. These systems are unable to distinguish between dates in the year
2000 and dates in the year 1900. That inability (referred to as the "Year
2000" issue), if not addressed, could cause certain systems or applications
to fail or provide incorrect information after December 31, 1999 or when
using dates after December 31, 1999. This in turn, could have an adverse
effect on Diamond Brands, due to Diamond Brands' direct dependence on its own
system and applications and indirect dependence on those of other entities
with whom Diamond Brands must interact.
The Company has implemented a process to either replace or modify all of the
Company's current computer systems and software applications which will be
Year 2000 compliant. The Company expects to complete the entire project by
June 1999. In connection with this process, the Company has retained two
information technology consulting groups.
The Company currently estimates that its costs incurred in 1997 and through
the year 2000 to enhance its information systems will cost approximately $1.2
million. These costs include estimates for employee compensation on the
project team, consultants, hardware and software. The Company does not
anticipate incurring any additional expenses in connection with the Year 2000
issue.
As a result of the implementation of the new information system, Diamond
Brands is not likely to initiate other major systems projects in connection
with the Year 2000 issue. There can be no assurance that Diamond Brands will
not experience cost overruns or delays in connection with its plan for
replacing or modifying systems.
FORWARD-LOOKING STATEMENTS. Forward-looking statements herein are made
pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. There are certain important factors that could cause
results to differ materially from those anticipated by some of the statements
made herein. Investors are cautioned that all forward-looking statements
involve risks and uncertainty. In addition to the factors discussed above,
among the factors that could cause actual results to differ materially are
the following: The timing and strength of new product offerings, pricing
strategies of competitors and the Company's ability to obtain sufficient
financing to meet its liquidity needs.
15
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DIAMOND BRANDS INCORPORATED (Registrant)
By: /s/ Thomas W. Knuesel
---------------------
Thomas W. Knuesel Vice President of Finance
and Chief Financial Officer (authorized
officer, principal financial and
accounting officer)
Date: November 13, 1998
-----------------
16
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